Personal Finance

Lessons from the Coffee Day meltdown

Hemanth Gorur | Updated on September 05, 2019 Published on September 01, 2019

A few takeaways for small investors on when to invest in a company’s stock

After the tragic demise of coffee king VG Siddhartha (VGS), a line in his last letter came to light wherein he admitted to “failing as an entrepreneur.” The irony was not lost on India Inc. His success as an entrepreneur is what made Café Coffee Day (CCD) a brand that competed strongly even with global majors such as Starbucks and Costa Coffee.

However, the stock markets did not take too kindly to the tragic news of his demise. The CCD scrip witnessed a free fall and went cold instantly. Thefree fall was just the latest in a long list of events that punctuated CCD’s fairytale growth — events that should have served as alarm bells for retail investors of CCD shares.

Here are some takeaways for small investors in terms of what to watch out for when investing in any company’s stock.

First-mover advantage: CCD had its humble beginnings in 1996 with a single café in Bengaluru’s Brigade Road, but went on to carve a success story with 1,752 cafés across 243 cities.

Inspired by a German coffee chain, VGS opened CCD, offering clients air-conditioned ambience, high-speed internet and steaming coffee, all in one go. The brand became synonymous with designer coffee across India owing to its first-mover advantage.

Takeaway for investors: Look at companies driven by innovation and serving never-served-before offerings as they have a higher chance of success.

Going overboard: The x-factor that made CCD a vibrant success story also had the seeds of its impending downfall.

It’s quite natural for successful enterprises to have ambitious expansion plans, but going overboard with high-risk expansions and unrelated diversifications are all red flags.

Rapid expansion in a low-margin business meant CCD’s losses jumped from ₹7.72 crore in FY09 to over ₹150 crore in FY16.

VGS also forayed into adjacent domains such as real estate and logistics, and completely unrelated businesses such as technology consulting. The high capital expenditure and long gestation periods eventually spelt doom.

Takeaway: Keep an eye on the balance sheet and prioritise controlled expansion plans rather than merely the round of funding, brand equity or the posh lifestyle of founders.

Debt cycle: Debt, be it of the company or the founder, can quickly precipitate a crisis situation if not managed prudently.

For all its branding success, CCD had a debt of about ₹3,300 crore in 2018. VGS himself reportedly had a huge personal debt of about ₹1,000 crore. In recent times, he was also reportedly under pressure from his PE partners to buy back shares. While VGS was a majority shareholder at 32.75 per cent, of this, 71.4 per cent had already been pledged.

Takeaway: Check the company’s leverage ratios, and if possible, the promoter’s personal debt situation, before investing. Go for companies of founders who keep personal and business debt separate.

Political mingling: VGS’ father-in-law was a former Karnataka Chief Minister. This, no doubt, meant political heft, but it also backfired in an unexpected way. VGS’ name reportedly cropped up in unrelated income tax raids on a political leader known to be close to his father-in-law.

The I-T Department eventually attached shareholdings of VGS and Coffee Day Enterprises to other companies, which the CCD founder referred to as “harassment”.

Takeaway: Having political clout can help entrepreneurs, but can also be a double-edged sword. Companies having founders who ensure comprehensive tax compliance and are relatively unencumbered politically are better investment choices.

The writer is Managing Partner, Hubwords Media, and co-founder, HerMoneyTalks.com

Published on September 01, 2019
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