Talwalkars Better Value

Fitness
Spreading FitnessWhat about Value???
3/31/2014

This report deals with fundamental business analysis of Talwalkars Better Value Fitness, determining expected
return based on a fair estimate of future value of the company (substantiated with detailed rationale) and finally
our view on the suitability of Talwalkars as an investment in terms of return as well as risk

What does Talwalkar do? How does it make money? Most probably you
know that!!!
Talwalkars Better Value Fitness (TBVF) aka Talwalkars, is a very popular
brand in the fitness space and is primarily in the business of operating
gymnasiums (referred to as health clubs by the company)
Its primary revenue source is the gym membership fees it charges to its
customers.
As of Dec-13, the company operates 149 health clubs across 78 cities/towns
in India. Also, it is the only listed player in India in this space.

Since the last few years, the company has diversified from a core gym player
to one offering holistic fitness and wellness offerings like spa, massage, Yoga,
weight loss, nutrition, Zumba (dance based fitness regime), etc.
Brief history of the Brand Talwalkars:
Talwalkars Family entered the gym business in 1932 with the first gym set
up in Bandra. Till 2003, the Talwalkars family operated 11 gyms of which 7
gyms were owned Talwalkars family directly through their proprietary
undertakings and partnership firms. The other 4 gyms were held by Life
Fitness India Pvt Ltd, which was owned 50% by Talwalkars family.
In 2003, the Talwalkar Group (expertise in running gyms) joined hands with
the Gawande Group (expertise in the field of finance, taxation and legal
matters) to incorporate Talwalkars Better Value Fitness with the aim of
promoting Talwalkars Brand as a leader in health clubs.
In Apr-10, the company launched its IPO raising INR 77.44 Cr by issuing
6.05 million shares at INR 128 per share valuing the company at INR 308
cr post money implying a P/BV multiple of 2.7x post money and 6.2x premoney.
~21 Cr of the IPO proceeds were used to retire high cost debt (14.75%
interest) taken from the promoter entities and ~50Cr was used to set up 27
additional gyms.
IPO valuation snapshot
Stake sale in IPO (post issue)
25.09%
Amt raised (INR Cr)
77.44
Post money valuation (INR Cr)
308.6
Pre money valuation (INR Cr)
231.2

Post money BV(INR Cr)

Pre money BV (INR Cr)
Post money P/BV
Pre money P/BV

116.7
39.2
2.65x
5.89x

Understanding the story narrated by the numbers.

How has the company grown historically?
INR Cr
Sales
Op. profit
PAT

FY06

FY07

FY08

FY09

FY10

FY11

9.3
1.6
0.4

19.9
3.0
1.1

34.2
7.3
4.5

53.4
10.2
6.7

60.2
13.4
7.7

93.2
21.7
16.0

FY12
119.6
30.0
22.1

FY13

9MFY14

151.2
39.2
30.1

128.3
29.2
21.0

CAGR
(06-10)
59%
71%
107%

CAGR
(10-13)
36%
43%
57%

The company has demonstrated a phenomenal growth partly because of a

very small base of 9cr revenue in FY06. Although, the company has
maintained its growth even after crossing the 100cr revenue landmark which
is an encouraging sign. One interesting thing to note is that the operating
profit and profit after tax have outpaced the revenue and this is something we
will investigate and understand the driver later in the investment note
On the face of it, TBVFL looks like a classic growth company with revenue
and profit growth of more than 30%, in an industry which is very
underpenetrated (0.4% penetration rate compared to 2.3% for China and
16% for US) and has very favorable demographics.
Industry size by segment (FY13)
Market size (INR crore)

Slimming
Services
1,000

Slimming
Products
500
Fitness
Services
2,500

Fitness services refers to the core gym

membership services from which Talwalkars
derives most of its revenues ~80% as of
FY13.
TBFVLs market share in core gym services
comes to ~4.8% which is expected as gym is
a pretty fragmented industry.
Slimming Services and Slimming Products
refer to weight loss, nutrition and related
services in which Talwalkars has been
focusing on increasingly and currently
derives 20% revenues from them implying a
market share of around ~2%

Demographic Tailwinds:
Target population (Million) for
Core Gym (15-34 Yr)
450

410

427

33%

38%

43%

2011

2012

2031

2041

0%
2005

2010

Wow!!! Such a high

growth company
available at only 13x
trailing PE, I have
found a real
BARGAIN
Wait! Are you missing
something which the
market knows and you
are ignoring?
Continue reading to
find out.

29%

20%

350

60%
40%

384

400

Target population as % total for

Value Added Services (40+ Years)

2015

To be frank, this is an industry where common

sense tells there is a lot of growth and we dont
need facts to substantiate that point.
Considering that Talwalkars is such a high growth
company, Let us pause for a moment and look at

trading multiples of TalwalkarsWow!!! Such a high growth company available at only

13x trailing PE, I have found a real BARGAIN
Wait! Are you missing something which the market
knows and you are ignoring?

The key question to ask in such a situation is; How profitably the company
is growing because growth in revenue and earnings in isolation have no value,
unless the growth is achieved by earning a return on capital invested which is
more than the required return.

De-coding the Profitability of Growth!

We believe that the profitability of a company is best understood by
separating the operating activities from all the other activities of the
company. And therefore our focus will be not only be on the overall
profitability (Return on Average Equity ROE ) but also the operating
profitability of the company
Return on Average Equity
60%

52%

50%

42%

40%
30%
20%

25%

22%
12%

13%

FY05

FY06

20%

18%

18%

FY11

FY12

FY13

10%
0%

FY07

FY08

FY09

FY10

- From FY05 to FY08 the company consistently kept on improving its

return on equity, reaching a peak of 52% in FY08. But since then the ROE
has been on the downside and currently stands at ~18%
So, although the company is growing very fast but its ROE has fallen
consistently since FY08. This may be one of the arguments behind why
market is giving TBVFL a PE multiple of ~12x only as it is skeptical
regarding its profitability. But, taking ROE at face value can be very
dangerous for an investor without understanding what is driving it. The three
main drivers of ROE are
1. Profitability of the companys core operations (return on net operating
assets - RNOA)
2. Amount of leverage (for every rupee of capital invested by owners, how
much has been borrowed)

3. Difference between the profitability of a companys core operations

(RNOA) and its net cost of borrowing (NBC)

The interesting thing about leverage is that it is more like a magnifier which
instead of size magnifies the quality or profitability of a company. It makes a
good company look great and a bad company look worse. So its important to
look behind leverage to understand the true quality / profitability of a
companys operations

ROE = RNOA + [(RNOA-NBC)*Leverage] = RNOA + Leverage Effect

Lets uncover the story behind TBFVLs rising and then falling ROE
Separating the drivers of ROE
60%
50%
40%
40%

30%
20%
10%
0%

5%
8%

5%
8%

FY05

FY06

28%

13%

13%

8%

6%

6%

8%

12%

14%

11%

12%

12%

12%

FY07

FY08

FY09

FY10

FY11

FY12

FY13

RNOA

Leverage Effect

Financial Leverage (FLEV)

6.6x

7.0x

5.9x

5.8x

5.3x

6.0x

4.5x

5.0x
4.0x

2.7x

3.0x
2.0x

1.1x

0.8x

0.8x

FY11

FY12

FY13

1.0x
0.0x

FY05

FY06

FY07

FY08

FY09

FY10

The above two figures are very important to understand the true story behind
the performance and profitability of TBFVL

To conclude, between
FY08 and FY13,
ROE has fallen at the
expense of leverage
(and with it risk
associated with the
business) and not due
to deterioration in
operating profitability

In 2008, the company had posted a record ROE

of 52%. But out of the 52%, only 12% came
from operating profitability and the remaining
40% was due to leverage of ~6x.
That is, for every 1 rupee put in by shareholders
in the business, 6 rupees was borrowed and
therefore the return on shareholders equity
(money put in by shareholders) was magnified.

ROE of 52% in FY08 was not of high quality

and sustainable as it was magnified by leverage. It

was extremely risky because due to the high debt,
any slowdown in business would have affected TBVFLs ability to pay
interest and maturing debt.
In contrast, in FY13, although the company had much lesser ROE of 18%,
but its operating profitability of 12% was as good as in FY08. The fall in
the ROE was attributable solely to fall in leverage.
To conclude, between FY08 and FY13, ROE has fallen due to decreasing
leverage (and with it risk associated with the business) and not due to
deterioration in operating profitability

In spite of that, fact remains that TBFVL is earning only a ~12% return on
its operations, just above the risk-free return which you can get on a Fixed
Deposit. So, unless we believe that the current return on operations do not
reflect the full potential of the business and therefore, TBFVL has the ability
to earn ~18-20% RNOA in the future, there is no point in looking at
TBFVL as an investment opportunity.
So, lets decode the profitability of operations to understand the drivers and
the future potential of the business
De- coding the Profitability of Operations:
Operating Profit Margin:
30%
20%

15%

17%

FY05

FY06

22%

23%

22%

23%

26%

26%

FY08

FY09

FY10

FY11

FY12

FY13

15%

10%
0%

FY07

The trend of Operating Profit Margin is impressive (We will look into the
driver a bit later) and has been on an upward trajectory i.e. for every rupee of
revenue earned, more is going to the bottom line indicating operating
efficiency. Although, it is positive, we have seen earlier that the Return on
Net Operating Assets (RNOA) for TBFVL has been in the ~12% inspite of
such high margins. There is more to the business which we need to
understand.
Asset Turnover (Revenue Generated per Rupee of Net Operating Asset):
0.80x
0.60x

0.49x

0.45x

FY05

FY06

0.58x

0.57x

0.60x

FY07

FY08

FY09

0.53x

0.53x

FY10

FY11

0.47x

0.46x

FY12

FY13

0.40x
0.20x
0.00x

Now, the asset turnover tells us that although, the company has high margins
on its sales, the sales themselves are not high enough with respect to the
capital invested by the company in operating assets.
For every 100 rupee invested in net operating assets, the company has
generated ~45-50 rupee. This tells us that that running gym/health clubs is
a highly capital intensive business. This is common sense because the
maximum amount of revenue that can be generated from a single gym is fixed
(assuming fixed membership fee) and depends on maximum number of
members that can be enrolled given the area of the gym.

Therefore, the only way to grow revenue and thus operations is to open more
gyms for which we need to invest heavily.
The typical costs involved in opening a gym (Apr-10) has been shown below:
Particulars

Amount in
INR Lakh
77.5
53.5
35.0
10.0
10.0
186.0

Interior Costs (for an average area of 5000 square feet)

Cost of Gymnasium Equipment
Other infrastructure related Costs
Deposit
Pre-operative Costs 1.00
Total estimated cost
Source: Company IPO Prospectus

According to Prospectus of TBFVL (Apr-10), company needs to spend

around INR ~2cr to set up a full-fledged gym covering an area of 5000 sqft
which is the maximum area of a TBFVL gym. The equivalent cost now
assuming an average inflation of ~8% comes out to be INR 2.7cr
Let us compare the increase in revenues with the investment made by the
company in the operations:
INR Cr

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

Sales
Avg. Operating Assets
Avg. NOA

9.3

19.9

34.2

53.4

60.2

93.2

119.6

151.2

22.6
20.8

37.1
34.6

66.4
59.8

101.0
88.6

132.2
114.2

199.1
174.6

277.6
252.6

357.7
329.4

CAGR
(06-10)
59%

CAGR
(10-13)
36%

55%

39%

53%

42%

No of gyms
160
140
120
100
80
60
40
20
0

7
FY05

23

30

42

54

FY06

FY07

FY08

FY09

63
FY10

144

149

FY13

9MFY14

115

94

FY11

FY12

As we can see, the increase in revenues have been in line or somewhat lower
than the increase in the operating assets, which clearly shows the capital
intensity of this business.
The next question to ask is, since the only way for the company to grow is to
open new gyms for which it needs a lot of capital, does the company generate
enough cash from operations to finance these investments or does it have to
borrow from capital markets?
INR Cr
CFO
Capex
FCF
Net Debt
raised
Equity

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

Total

2.7
-8.6
-5.9

3.1
-12.1
-9.0

12.5
-27.2
-14.8

22.4
-35.5
-13.1

21.3
-32.7
-11.4

16.3
-80.2
-63.9

40.4
-63.5
-23.0

62.9
-103.6
-40.7

181.5
-363.4
-181.9

4.0

12.0

20.0

20.1

13.7

21.3

40.1

26.8

158.0

3.6

1.9

77.2

0.0

42.9

125.5

From, FY06 to FY13, company has invested ~360 cr in operations but

generated only ~180 cr of cash resulting in cash short fall (negative free cash
flow) of ~180 cr which was financed through a combination of equity as
well as debt to expand operations
TBFVL has raised total equity of 125 cr during this period, INR 77cr in
FY11 during its IPO and INR ~43 cr in FY13 through a QIP issuing 42.4
cr shares @ INR 205 for setting up a sports/leisure club in collaboration
with David Lloyd Leisure. The progress on setting up of the sports/leisure
club has not been divulged by the company, but we believe the project has

not started yet and all the funds are currently sitting as cash/investments on
the balance sheet. It has also raised a net debt (net of repayment) of 158 cr
Thus, we can see that, one of the key risks in Talwalkars is the asset heavy
business, due to which company has to raise funds from outside frequently
resulting in Equity Dilution as has happened on two occasions.
But the still worse news is that the extra investment in operations is
producing a mediocre return of 12% as of now primarily because of a very
low asset turnover of 0.45x which is partially aided by a pretty high margin
of ~26%. If the operating margin of the business falls and the asset turnover
remains the same, the business is going to earn a still lower return on its
operations.
But the good news is that the Talwalkars management realizes the fact that
unless it can squeeze out the maximum revenues possible from its existing
gyms, it cannot hope to produce extraordinary returns for its shareholders.
In its AR2013, CFO says that At Talwalkars, the key to our core profit lies
in being able to sweat larger revenues from existing fitness centre
infrastructure on a year on year basis
But how do you do that?

Core Gym

Value
Added
Services
(VAS)

Talwalkars
2.0

The next leg of Talwalkars story depend on two big things both of which
will lead it towards an asset light and a high margin route:
1. Focusing on franchise/subsidiary rather than wholly owned gyms:

HiFi Gyms:
Talwalkars introduced the brand HiFi in Jul-11 to enter into smaller cities
of India.
HiFi gyms are smaller format and low cost gyms than the usual Talwalkars
gym as it is not feasible to open a full fledged gym in the smaller cities to
achieve a respectable ROIC.
All the HiFi gyms are run on a franchise basis and are not owned by
Talwalkars, that is the entire capex is borne by the franchise, and Talwakars
receives a royalty of a certain % of revenue every year, the details of which are
given below.

Subsidiary Model for Talwalkars brand of gyms:

Trend of Gyms by ownership:

Owned

11
8
9

73

Jun-11

Subsidiary

10
15
13

90

May-12

Franchisee

Legacy

6
22

6
24

15

16

101

103

May-13

Dec-13

Note: Legacy gyms are gyms operating before the formation of TBFVL, the company and owned by
Talwalkars family. TBFVL has bought back some of the gyms overtime. The legacy gyms dont pay
any royalty to TBFVL for using trademark but share the marketing and advertising expenses

Value Added Services (The potential game changers)

In FY12, Talwalkars launched a slew of value added services in order to
widen its offerings to a wider set of customers with different fitness needs.

Why Game Changers? Have a look at their economics!!!

INR Mn

NuForm
10
8
40%
25%
0.8x
31%

Capex
Revenue
EBITDA
Return on Capital Employed
Asset Turnover
Operating Profit Margin

Zumba
2
1
55%
25%
0.5x
50%

Reduce
0.8
2
40%
75%
2.5x
30%

Fee structure:
Traditional offerings

Typical enrollment period

Core Gym Memberhip

Aerobics
Nutrition

Yearly
Monthly
Quarterly

Annual Fee (INR)

14,000 - 20,000
8,500 - 9,000
24,000 - 30,000

New Offerings

Typical enrollment period

Annual Fee (INR)

NuForm
Zumba Program
Reduce Program

Yearly
Monthly
Quarterly

36,000 - 42,000
24,000 - 30,000
60,000 - 80,000

Source: Management

Progress on roll out of VAS:

NuForm
Zumba
Program
Reduce
Program

8 centres as of Jun-13; Also available as a door step service

46 centres as of Dec-13; Projected to reach 100 by FY14
44 centres as of Jun-13; Plan to expand to 75 by FY14; Also available as a
door step service

So far so good, although VAS look very good on paper, there is no point in
feeling exuberant about them unless there is any result in terms of
profitability because thats what matters.
Now let us go back to two charts which we saw earlier:
Operating Profit Margin:
30%
20%

15%

17%

FY05

FY06

22%

23%

22%

23%

26%

26%

FY07

FY08

FY09

FY10

FY11

FY12

FY13

0.58x

0.57x

0.60x

0.53x

0.53x

0.47x

0.46x

FY07

FY08

FY09

FY10

FY11

FY12

FY13

15%

10%
0%

Asset turnover:
0.80x
0.60x

0.49x

0.45x

FY05

FY06

0.40x
0.20x
0.00x

As expected, since the launch of the VAS in FY11, the operating profit
margins have jumped by 3% but quite paradoxically, the asset turnover has
declined from 0.53x to 0.46x.
We would have expected the asset turnover to also increase as the new
offerings except Zumba have a turnover of more than 0.50x and also with the
ramp up of HiFi gyms, which involves no capex for TBFVL.

By now, we have understood that asset turnover remains the biggest driver of
TBFVL value generation in future.
And to add to that puzzle, since Talwakars has been expanding rapidly and
has opened 20-30 gyms every year since its incorporation, therefore the
optimum turnover at which TBFVL can operate is not know as it takes time
for a gym to ramp up fully and attain steady state.
But we can look at its subsidiaries which operate only a few gyms to get a
better sense of the possible steady state asset turnover for TBFVL.
Denovo Enterprises (INR Mn)

FY10

FY11

FY12

FY13

41.8
72.0
38.2
14.6
0.9

65.1
141.7
102.9
27.2
12.7

66.2
144.7
127.1
76.7
49.5

170.5
270.2
115.2
117.9
41.2

6.4%
2.4%
0.91x
0.53x

46.5%
12.3%
1.58x
0.73x

64.5%
39.0%
1.92x
0.88x

34.9%
35.7%
0.68x
0.43x

Aspire Fitness (INR Mn)

LT Fixed Assets
Total Assets
Operating Revenue
Shareholders Equity
Net Profit

FY11
56.3
70.9
39.4
13.2
3.2

FY12
54.9
60.5
61.7
20.8
7.7

FY13
78.8
89.0
69.5
27.4
6.6

ROE
PAT Margin
LT Fixed Assets Turnover
Total Assets Turnover

24.2%
8.1%
0.70x
0.56x

36.7%
12.4%
1.12x
1.02x

24.0%
9.4%
0.88x
0.78x

LT Fixed Assets
Total Assets
Operating Revenue
Shareholders Equity
Net Profit

ROE
PAT Margin
LT Fixed Assets Turnover
Total Assets Turnover

Equinox Wellness (INR Mn)

LT Fixed Assets
Total Assets
Operating Revenue
Shareholders Equity
Net Profit

ROE
PAT Margin
LT Fixed Assets Turnover
Total Assets Turnover

FY10
13.2
17.1
10.4
7.2
-2.4

FY11
17.3
23.0
10.4
5.3
0.3

FY12
16.6
22.0
14.0
5.4
0.6

FY13
15.8
20.8
14.3
6.1
0.4

-33.7%
-23.3%
0.79x
0.61x

6.1%
3.1%
0.60x
0.45x

11.9%
4.6%
0.84x
0.64x

6.6%
2.8%
0.91x
0.69x

Global comparables:
Company
Town Sports International Holdings
Fit After Fifty, Inc.
The Sports Club Company, Inc.
Koshidaka Holdings Co., Ltd.
Average
Median

Asset turns
FY-3

Asset turns
FY-2

Asset turns
FY-1

Asset turns
Latest FY

1.0x
NA
0.7x
2.0x
1.2x
1.0x

1.0x
NA
0.8x
1.9x
1.2x
1.0x

1.1x
NA
0.8x
1.8x
1.2x
1.1x

1.1x
2.5x
0.8x
1.7x
1.5x
1.4x

The above comparables indicated that at a steady state, Talwalkars can

operate at an asset turnover of ~0.8x and this number will be a big driver of
TBFVL valuation because if they can improve their turnover from 0.46x to a
~0.8x, it will result in a RNOA of ~21% which means they can earn a ROE
of 21% with no leverage
At this point of time there isnt disclosure by the company with respect to
revenue split by offering to understand what has caused the decline in
turnover but our guess is growth in revenues in VAS has come majorly from
Zumba which has a lowest turnover but highest margins.
Again, lack of enough disclosure by TBFVL makes it tough to confidently
point at the source of margin expansion but falling turnover.

Checklist for Competitive positioning / Moat:

1. Degree of competition from existing players:
Health and fitness industry is a highly fragmented industry in India,
dominated by standalone gyms. There are only a handful of organized,
branded gym chains which include Golds Gym, Powerhouse Gym etc. Golds
Gym remains the biggest competitor to TBFVL with presence in 17 states
through a total of 87 gyms compared to 149 centers of TBFVL in 20 states
across 78 cities/towns in India.
Indirect sources indicated that Golds Gym is considered to be more
premium to TBFVL, primarily because of its international roots (US).
Overall, we think there is enough room for existing branded players to take
away share from unorganized segment and grow their business and therefore
the current competition does not bother us
2. Threat from new entrants:
Since business of operating gyms is a very low entry barrier business, the
threat from new entrants always remains high. But it will take time for a new
entrant to establish a brand and widen his reach to cause a real threat to the
incumbent players.
3. Threat from substitute products:
Gym and fitness services are bread and butter services which have been
around for years. Unless there is some magic formula or pill which meets all
the aspirations like weight loss / muscle building, we dont see any threat to
the services offered by TBFVL. But, we do feel that that there may be a
negative consequence of in house gyms in societies, residential complexes on
the business of TBFVL.
4. Bargaining power of customers:
One of the biggest advantages of being a organized / branded player is the
ability to charge higher membership fee than your unorganized neighbor
because people are willing to pay more to associate themselves with a brand.

To understand this point, let us look at the trend of average revenue per
member of TBFVL
Average Annual Revenue per Member (INR)
15,000
10,000
5,000
0

6,871
4,142

4,428

FY05

FY06

FY07

8,998

9,708

10,200

FY08

FY09

FY10

11,229

FY11

9,970

FY12

11,368

FY13

We can see that TBFVL has been able to demand higher fees from its
members which tells us something about its bargaining power. Except for
FY12 (reasons not clear) which saw a dip, the trajectory has been upwards.
5. Bargaining power of suppliers:
The major cost for TBFVL is the equipment cost and the lease rentals.
TBFVLs scale, enables to negotiate better prices with its suppliers specially
equipment manufacturers and also enables it to get better rates for
advertising/marketing on a pan India basis. But lease rentals remain a key risk
as it has no say over it.
Overall, we feel that TBFVL has a very narrow moat which arises out of its
Brand enabling it to demand higher prices to its customers and its wider
geographical reach and scale enabling to negotiate favorable prices with
suppliers but low switching costs for the customer and inability to control
lease rentals hampers the competitive positioning of TBFVL.
Checklist for Management Quality:
1. Operating / Execution skills:
One of the biggest strengths of TBFVL remains the execution capabilities of
its management enabling it to expand rapidly across India. From 5 gyms in
FY05 to 149 gyms now, TBFVL has come a long way.

One of the unique strengths of the management is to collaborate with

international brands and bringing their offerings to its vast customer base.
For eg. It tied up with the Zumba LLC to bring Zumba to India. Then, it
collaborated with Miha Bodytec, a German company to offer revolutionary
EMS (Electronic Muscular Stimulation) technology in the form of Nu Form.
And now is in the process of launching sports/leisure club management and
consulting in partnership with David Lloyd
The company also launched an innovative weight loss program under the
brand Reduce.
Complementing the novel offerings is the catchy marketing strategy which
has been instrumental in the success of TBFVL and remains one of its core
strengths.
2. Capital allocation skills: The management has till now allocated capital in
the right direction (towards the core strategy of the company) albeit the
return on that capital has not been satisfactory. But we believe, the real
profitability of the company will get uncovered only when it reaches a steady
state in terms of gym roll out.
The company has also raised equity at appropriate time at prices that we
believe was more than the intrinsic value of the company, thus creating value
for the existing shareholders underscoring the shrewdness of the management.
3. Corporate Governance: THE BIGGEST RISK
1. Franchisee Fee remitted to the Promoter, Madhukar Talwalkar instead of
TBFVL
a. TBFVL owns 33% indirectly in a franchise called Equinox Wellness
which operates a gym in Kolkata, but 80% of the franchise fee is remitted to
the Talwalkar Family due to an agreement between them and TBFVL
b. Similarly, 100% of the franchise fee of Vashi gym, located in Navi
Mumbai and 80% of the franchise fee of two gyms operating in Nagpur is
remitted to the Talwalkar family.

These facts point towards the intention or rather the reality of promoters
milking Talwalkars for their own direct benefit
2. Inter-party Transactions:
a. One of the health club premises in Sangli measuring 6,600sqft, is leased
from Mr. Prashant Talwalkar, the promoter Managing Director, for a
monthly license fee of Rs. 1.4 lakh (as applicable on Apr-10). The license
period was till April 30, 2013. Current status in not known
b. The other premise in Ulsoor Road, Bangalore measuring 5,753 sqft was
leased from the Gawande Family and Harsha Bhatkal for a monthly license
fee of Rs 4.3 lakh (as applicable on Apr-10) and the license period is till
March 31, 2013. Current status is not known.
What amazes us is the huge disparity in the lease terms where the Bangalore
facility being 13% smaller has a license fee which is 3x that of Sangli. This
discrepancy may be purely due to the difference in the market rates as
Bangalore is a metro city compared to Sangli, which is more of a town in
Maharashtra. Nonetheless, it again makes us a bit alert and suspicious with
respect to the intention of the promoters to milk money from TBFVL to
their benefit.
3. According to the IPO prospectus, the registered office was owned by the
Gawande Family, who are the co-promoter along with Talwalkars Family.
The office was on lease and there is no assurity of favorable terms
4. Promoters involved in unrelated businesses like realty, infrastructure, and
hospitality through their proprietary companies.
5. Inappropriate accounting and insufficient disclosures: TBFVL recognizes
revenue the moment it is received irrespective of the period to which it
corresponds which is clearly violating the matching principle

6. Promoter Borrowing Power of up to INR 350 cr

A borrowing power of 350 Cr to promoters on behalf of a company which

has a PAT of ~30 Cr doesnt make us very comfortable.
Overall, we feel there are lot of corporate governance issues which need to be
kept in mind along with valuation and expected returns.
Valuation:
Historical Financial Summary (Reformulated)
Key Balance Sheet Items:
9M ended
INR Mn
Average OA
Average Fixed Assets
Average NOA
Average NFA
Average CSE

Mar-05 Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 Mar-13

179
169
161
-139
21

371
326
346
-296
51

226
213
208
-175
33

664
580
598
-512
86

1,010
895
886
-724
161

1,322
1,158
1,142
-833
309

1,991
1,675
1,746
-900
846

2,776
2,318
2,526
-1,139
1,387

3,577
3,077
3,294
-1,464
1,830

Dec-13
NA
NA
NA
NA
NA

Key Income Statement Items:

9M ended
INR Mn
Sales
Core operating income
Unusual items
Operating income
Comprehensive income (Before Minority Interest)
Minority Interest
Comprehensive income available to common
Net financial income (expense)

Mar-05 Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 Mar-13

79
12
0
12
3
0
3
-9

93
16
0
16
4
0
4
-12

199
30
0
29
11
0
11
-18

342
73
1
74
45
0
45
-29

534
102
19
121
67
0
67
-54

602
134
-3
131
77
0
77
-54

932
217
-1
216
168
8
160
-48

1,196
300
6
305
249
29
221
-56

1,512
392
0
393
326
26
301
-67

Dec-13
1,283
292
0
291
235
26
210
-56

Key Profitability Indicators:

9M ended
INR Mn
ROCE
RNOA
NBC (After Tax)
PM
Core sales PM
OA Turnover
Fixed Assets Turnover
NOA Turnover
Financial Leverage (FLEV)
SPREAD

Mar-05 Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 Mar-13

12.2%
7.5%
6.8%
15%
15%
0.44x
0.47x
0.49x
6.59x
0.7%

12.7%
7.5%
6.6%
17%
17%
0.41x
0.44x
0.45x
5.28x
1.0%

21.6%
8.5%
6.2%
15%
15%
0.54x
0.61x
0.58x
5.85x
2.2%

52.4%
12.3%
5.6%
22%
21%
0.52x
0.59x
0.57x
5.94x
6.7%

41.8%
13.7%
7.4%
23%
19%
0.53x
0.60x
0.60x
4.50x
6.2%

24.9%
11.4%
6.5%
22%
22%
0.46x
0.52x
0.53x
2.70x
5.0%

19.9%
12.4%
5.3%
23%
23%
0.47x
0.56x
0.53x
1.06x
7.1%

18.0%
12.1%
4.9%
26%
25%
0.43x
0.52x
0.47x
0.82x
7.2%

Dec-13

17.8%
11.9%
4.6%
26%
26%
0.42x
0.49x
0.46x
0.80x
7.4%

NA
NA
NA
23%
23%
NA
NA
NA
NA
NA

Challenging the market price:

Since TBFVL, is in a growth phase, it is investing heavily in operations to
open new gyms. But since it takes time (typically 2-3 years for a gym to fully
ramp up and run at full capacity i.e turnover), the optimum profitability of
the operating business is hidden until it achieves steady state.
The Paradox of Growth and Profitability:
So here is the paradox: While valuing a company the two most important
things are, first its future growth and second its profitability. But for TBFVL
true profitability will not emerge until it doesnt stop investing in new gyms
and achieves steady state. Growth and profitability are mutually exclusive. If
we have one the other suffers.
As we have seen earlier, RNOA for TBFVL has been ~12% as its NOA
turnover has been around ~0.5x compared to the steady state turnover of
0.8-1.0x possible.
So how do you value Talwalkars?
Let us assume that TBFVL doesnt invest any additional capital in operating
assets in the next four years.
How will the business look like at the end of four years?
Key assumptions:

1. TBFV will not invest any additional capital in operations, and therefore
the Net Operating Assets remain constant.
Note: We have assumed NOA to be constant for simplicity although it will decrease by the amount of
depreciation, but we assume that the company will compensate for it through maintenance capex

2. Since, the company will not invest in additional capacity, it will achieve its
optimum turnover of ~0.8x in FY18 that is 4 years from now. We have
stayed on the conservative side for the optimum turnover number and the
time required to achieve it.
3. Net Operating Profit Margin (NOPAT) remains constant at 26%,
although we feel that it will go up as the share of value added services will go
up from current 20% to ~30% in next 3-4 years as guided by management.
4. Net Profit Margin remains constant at 20%, although, we feel it will
expand in line with increase in NOPAT margin, but we will rather be on the
conservative side.
Summary Results
Current NOA turnover (FY13)
Current NOPAT margin (FY13)
Current PAT margin (FY13)
Current RNOA (FY13)
Current NOA (FY13) INR Cr
Current Shareholders Equity (FY13) INR Cr
Current Net Financial Obligations (FY13) INR Cr

FY14E FY15E FY16E FY17E FY18E

375.3 375.3 375.3 375.3 375.3
0.46x 0.54x 0.63x 0.71x 0.80x

Assumptions:
NOA
NOA turnover
NOPAT margin
PAT Margin
Pro-forma Financials (INR Cr)
Revenue
NOPAT
RNOA
PAT

0.46x
26%
20%
12%
375
217
159

26%
20%

26%
20%

26%
20%

26%
20%

26%
20%

FY13A FY14E FY15E FY16E FY17E FY18E CAGR

151.2 172.3 204.3 236.3 268.3 300.3 15%
39.3
44.7
53.0
61.3
69.6
78.0 15%

12%

12%

14%

16%

19%

21%

30.1

34.2

40.6

47.0

53.3

59.7

15%

Implied Return assuming no new investment in operations

Current Price Per Share (INR)
Shares Outstanding (million)
Current Market Value (INR Cr)
Exit PAT (INR Cr)
Exit PAT multiple
Exit value (Mar-18) (INR Cr)
Exit Price Per Share (INR)
Holding Period (Years)
Implied Return

167
26.2
436
59.7
12.0x
716
274
4.0
13.2%

Our estimates suggest that if the company does not invest in new gyms, we
can expect a return of ~13% assuming that the market gives a multiple of
12x to the earnings in FY18. The current multiple for TBFVL is 13x.
13% is not good enough for equities and therefore we need to understand
the circumstances under which we can earn our target return of ~18-20%
When do you get a 20% return?
Valuation for a 20% expected return
Required Return
Current Market Value (INR Cr)
Implied Exit value (Mar-18) (INR Cr)
Shares Outstanding (million)
Implied Exit Price Per Share (INR)
Implied PAT (Mar-18) assuming 12x exit multiple (INR Cr)
FY18 PAT estimate from existing operations (Cr)
Implied FY18 PAT from new investments in operations (Cr)

20%
436
904
26.2
345
75.3
59.7
15.6

Our calculations show that in order to give a return of 20% in 4 years,

TBFVL needs to have a PAT of INR76Cr of which INR16.4 Cr needs to
come from new investments in operations assuming the company does not

dilute the equity in the process of additional investment in operations.

How much does TBFVL need to invest to generate an additional PAT of
16.4Cr ?
Implied FY18 Revenue from additional investments assuming 20% PAT margin
Turnover Assumption for new investments
Additional Investment required

INR Cr
82.3
0.5x
164.5

What if TBFVL
resorts to raising
equity as it has done in
the past to expand
operations? Then our
return calculations will
go haywire as the
equity will be diluted
and per share value
will decline

TBFVL needs to invest ~INR165 crore to

generate additional revenue/profit so that we can
make a return of 20%. But the key question to ask
here is, how will the company finance its
investment? Can it generate enough cash from
existing operations after debt interest and
principal repayment, to finance investment in new
operations or will it have to resort to the capital
markets for funding? And what if TBFVL resorts
to raising equity as it has done in the past to
expand operations? Then our return calculations
will go haywire as the equity and per share value
will be diluted.

Item
Estimated Cumulative Operating Income from existng operations during FY14-18
Interest and Debt Repayment during FY14-18
Cash flow availabe for Investment (OI - Interest & Debt Repayment)
Additional Investment required in operations
Cash (shortfall) /surplus

INR Cr
307
232
74
157
(82.9)

TBFVL will generate cumulative cash from operations of INR 307cr

assuming operating profit as a proxy for CFO1. Of 307, only 74cr will be
available for investing in operations, leading to a shortfall of ~83cr.
We feel, that TBFVL will be comfortably able to raise INR 83cr debt2 in
order to finance the shortfall, thereby preventing dilution of equity, but given
the management has raised equity twice in the short span of 4 years, we
cannot be assured.
Historically, CFO has been greater than operating profit
2
Some investors may point that if TBFVL raises ~INR83cr debt to finance expansion, then it will
have to incur interest expense and therefore PAT will be less than 75.3cr in FY18. We believe that
since the company is paying down its current debt, increase in interest expense will be nullified by
decrease in interest expense from current debt. Obviously it is a simplistic assumption but one which is
reliable.
1

Summary Data for 20% return (FY18E)

Proforma Revenue
Proforma NOA
Asset turnover
Net Profit
Exit Value
Implied Revenue Multiple
Implied PAT Multiple

379.0
532.7
0.71x
75.3
904
2.39x
12.0x
Sanity check

Current Revenue Multiple (FY14E)

Current PAT Multiple (FY14E)

2.53x
12.7x

Sensitivity analysis if management uses equity to finance the capex

% Equity
15%
25%
40%
60%
80%
100%

Equity raised
NOSH
Exit value per
(INR cr)
Mar-18 (Mn) share (INR)
23.6
27.33
330.7
39.3
28.10
321.7
63.0
29.25
309.0
94.4
30.79
293.6
125.9
32.32
279.6
157.4
33.86
267.0

% Return
19%
18%
17%
15%
14%
13%

Verdict:
At current market price of INR167, we expect TBFVL to give a return of
18-20% for a time frame of 4 years, implying a Target Price of INR 345 per
share as of Mar-18
But, the biggest risk associated with TBFVL is Corporate Governance for
multitude of reasons highlighted in the investment note. Thus we advise our
clients to be cognizant of the presence of this risk while buying TBFVL and
take a decision accordingly. Also, since TBFVL has jumped post news of
stake sale to David Lloyd, we would advise our clients to stagger their

purchases as they may get a better price once the excitement around the news
settles.

Disclosure: The author of this investment note holds shares of TBFVL at an

average price of INR128 implying a 21% return assuming TBFVL does not
make any new investments in operations and 28% return in the case where
company invests in new operations.