Even as the secondary market falters, the primary market is gearing up for one of the larger initial public offerings (IPOs) seen in recent months. Adlabs Entertainment Ltd plans to raise up to 467 crore from the primary market through this public offer. The company owns and operates Imagica and Aquaimagica, which are both theme parks, and is also in the mid of constructing a luxury hotel to be operated under the Novotel brand name. It is raising funds primarily to prepay some of the debt on books and for operational expenditure.

The company is offering 20,326,227 shares in a price range of 221-230 per share. Of this, 10% of the issue is reserved for retail investors, those who can bid up to a maximum of 2 lakh per application, and 15% is reserved for non-institutional investors. The remaining 75% will be allocated to qualified institutional buyers (QIBs). The IPO is open 10-12 March.

Business case

Theme parks aren’t yet a big entertainment attraction in India, but the industry is well poised to grow and take advantage of consumerism trends here. Adlabs will be one of the few firms from this industry that will be available in the listed space, and could offer investors an opportunity to participate in the earnings of the sector.

In India, this is still a nascent sector, with only about 150 parks across the country. Imagica is considered to be among the top theme parks in India, and it has been built based on international quality standards. According to an IPO note from Emkay Global Financial Services Ltd, Imagica and Aquaimagica have been conceptualized to give an international theme park experience with an Indian flavour. The note goes on to say that the parks are positioned in an enviable location—almost midway between Mumbai and Pune. This gives it a unique advantage of being able to tap into urban consumers with high disposable incomes from these cities.

Kapil Bagla, chief executive officer, Adlabs Entertainment, said, “Footfalls to the park have been growing; till December 2014, we had 1.56 million footfalls. Around 65% (visitors) come in the second half of the year."

The hotel is expected to be completed this year, added Bagla. Year 2016 is expected to be a good year financially as all three units will be functional.

There are many rides in the theme park that have been conceptualized and created in-house; these are likely to help keep competition at bay. Setting up theme parks requires large monetary investment and that means the entry barriers for this business are high, which gives Imagica a unique position.

Be mindful of risks

Theme parks sound like a lot of fun and that’s where the good news ends for now. Both the Adlabs parks are very new and the company is yet to recover the investment made in them. As a result, the company posted heavy losses in 2014 and the year before that was also loss-making. The hotel project is likely to have a long gestation period as well, and will not be accretive to earnings for sometime. The operating profit bears the burden of heavy costs, as the theme park is yet to operate at full capacity. Hence, last year, the company posted an operating margin of 6.5%. The high fixed costs may keep operating margins subdued for a while. Add to this the heavy interest burden, and you get a big net loss. The company’s long-term debt to net worth ratio is at 4.65 (September 2014). Any further expansion will also require heavy capital investment and the gestation will be long. So, positive cash flows and net profit might be a while away. Bagla said, “Any further expansion will be undertaken only once the present theme parks show stable earnings."

Then there are qualitative risks. Theme parks are dependent on positive publicity and feedback, and anything that is not favourable can erode market value too. Imagica has already had one roller coaster accident in the past in which two people were injured. According to the Emkay IPO note, for theme parks, the risk of accidents is a key cause for concern and can have a detrimental impact on the brand value. The media coverage of the above mentioned accident in Imagica, the note said, hurt its image.

Moreover, the promoters have been previously involved in investigation by the Securities and Exchange Board of India for sale of shares of Adlabs Films Ltd (matter settled) and have some civil cases pending against them and the company.

Mint Money take

The advantage for retail investors is that they can subscribe to the issue at a discount of 12 to the issue price, but they will have to remain invested for a very long time for this investment to yield positive returns. If the issue is oversubscribed, then you aren’t likely to get many shares since only 10% is reserved for retail investors. Valuations, too, aren’t favourable with the enterprise value to earnings before interest, taxes, depreciation and amortization being around 370 times. Since it’s early days for the business; return on capital employed is also negative.

It’s best to avoid the stock at the IPO stage, and wait for the company to turn in a profit or for the theme park to operate at full capacity. Then take a re-look.