• Delifrance has a strong brand and good niche position in the retail food industry. The "Delifrance" brand encompasses a lifestyle concept which rides on economic affluence.
• Historic earnings CAGR of 42%, a debt free position, strong cash flows and cash holdings. Negative operating cash cycle from its retail operations should would help enable it to tide over this economic downturn.
• Low consumer confidence in the region will result in slower growth and lower profitability.
• Regional exposure will place earnings from foreign subsidiaries and franchises at risk.
• Delifrance is facing increased competition from the entry of alternative "café-deli" chains in the region.
• Planned synergies after the acquisition by Sembawang Corporation (SembCorp) have failed to materialise.
• Delifrance’s incumbent chairman, Mr Alexandre Vilgrain, was asked to resign at the request of SembCorp and some key executives have left or are expected to leave.
• The "Delifrance" trademark is due for renewal in 1July 2006 and either party has the right of non-renewal.
• In the long term, Delifrance’s strong brand visibility, debt free position and strong cash flows should enable it to fund future expansion with little difficulty.
• Based on our EBO model, we assign a private market value of $101.3 million to Delifrance.

Delifrance was incorporated in Singapore on 4 April 1983 as a private limited company named Vie de France Singapore Pte Ltd. The Company was converted into a public limited company on 2 October 1996 and adopted its present name Delifrance Asia Limited. It has had an enviable growth record with CAGR in turnover and earnings of 26% and 42% respectively between 1992 and 1997. Its initial public offering of 45.2 million shares at 78 cents per share was five and a half times oversubscribed. Its share closed at 97 cents on the first day of trading or a premium of 24% over the offer price. This was regarded as quite remarkable given the lacklustre market conditions then.

Delifrance is a management and investment company that provides freshly baked bread, sandwiches, soups and a wide range of café beverages with time-sensitive services. Its business activities can be classified into retail, wholesale and franchising activities. Retail operations, supported by manufacturing facilities, comprise café bakeries, bakery corners and restaurants. Wholesale operations comprise sales to hotels, supermarkets, clubs and airlines. Franchising income gained prominence towards the end of 1997 with the signing of an Indonesian master franchise agreement. A value chain of its activities can be found in Exhibit 1.

On 2 October 1997, Sembawang Corporation Ltd (SembCorp) announced that it would take over 51% of Delifrance from the Company’s founding shareholders for $165.8 million in cash or $1.80 per Delifrance share. In accordance with Singapore takeover regulations, SembCorp also made a general offer for the remaining Delifrance shares at the same price in cash. The takeover offer by SembCorp closed on 26 January 1998 and current major shareholders can be seen in Exhibit 2. The takeover by SembCorp has resulted in the free float of Delifrance shares being reduced from around 25% to 2.6%. This would result in an inaccurate pricing of Delifrance's shares because of a liquidity premium attached to it.

Delifrance has the right to use the "Delifrance" trademark in 20 countries. These are Australia, Myanmar, Brunei, PRC, Fiji, Guam, HK, Indonesia, India, South Korea, Malaysia, New Guinea, New Zealand, Philippines, Singapore, Solomon Islands, Sri Lanka, Taiwan, Thailand and Vietnam. Grand Moulins de Paris (previously controlled by the Vilgrain family) is the registered owner of the "Delifrance" trademark. The use of this trademark was renewed for a period of nine years commencing from 1 July 1997. Renewal will be due on 1 July 2006. Exhibit 3 provides an overview of Delifrance’s current operations in the region.

Key Success Factors

Delifrance’s record of success has been based on strong management and conservative business practices. Key to their success are the following factors:

• Economies of scale achieved through centralising manufacturing activities and spreading overheads among outlets.
• Increasing affluence in the region allowing Delifrance to ride the growth line (see Exhibit 7).
• Strong brand recognition, clear market segmentation and high perceived quality appeals to a certain lifestyle which attracts middle income and expatriate consumers.
• Good location of outlets with emphasis on revenue per square feet.

With the acquisition of Delifrance by SembCorp, it is important that these success factors are translated effectively in their strategy for a regional drive. Failure to do so may result in the dilution of the "Delifrance" brand and an increase in the cost of doing business.
 

OPERATING REVIEW

In reviewing the operations of Delifrance, we will first look at the financial performance of the Group as a whole before analysing the current situation in key markets. After which, we will discuss the performance of Delifrance in relation to its competitors before exploring the impact of the its recent takeover by SembCorp and the effects of the current regional economic crisis.

Summary of Financial Performance

Source: Delifrance Annual Reports (see Appendix 1 for a breakdown)

Delifrance’s sales increased by 21.2% in 1996 over 1995 mainly through its retail operations in Australia, Hong Kong and Malaysia. Sales in 1997 grew by a further 24.3% due to increased retail and wholesale volumes in Hong Kong (28.9% increase) and the opening of four new outlets in Singapore (26% increase). Operating performance in 1998 reflect the difficult conditions facing Delifrance since the latter half of FY 1998. Sales growth has slowed to 13.7% while operating margins have declined by 2.6%. ROS, ROE and ROA have also declined relative to prior years. Revenue and profit growth by country can be seen in Exhibits 4 and 5.

Delifrance has a very healthy balance sheet. Since its IPO in 1996, Delifrance’s cash position has improved tremendously and its debt to equity ratio has fallen from 1.40 to 0.53. Delifrance is a primarily a cash business, with over 80% of sales to retail customers who pay in cash terms. In terms of share price performance, EPS has risen from 3.79 cents in 1995 to 5.40 cents in 1998, or a CAGR of 9.25%. Although its PE ratio has fallen since 1995 the fall in the PE ratio should be taken against a backdrop of falling stock prices. A look at Delifrance’s stock performance can be seen in Exhibit 6.

Singapore

Singapore remains the highest contributor to profits and revenues of the Delifrance Group (see Exhibits 4 and 5). Delifrance’s longest operating presence in Asia is through its Singapore operations. As of press date, Delifrance has opened its eightieth outlet in Singapore and the bulk of its assets are concentrated here. Singapore also serves as a test-bed for new products and concepts.

Looking at Exhibit 7, we see that the revenue per capita is approximately $19. The entry of new competitors like Au Bon Pain and other alternative lifestyle café concepts like Starbucks and Spinelli’s pose a threat to Delifrance. The increasingly saturated market and new competition will place pressures on profitability.

Hong Kong

Hong Kong is the second largest contributor in terms of profits and revenues to the Delifrance Group (see Exhibits 4 and 5). Looking at Exhibit 7, we see that there is high potential for Delifrance to achieve similar levels of revenue per capita in Hong Kong as it has in Singapore by moving up the growth line. Sales and PBT per outlet in Hong Kong is the highest among all countries in the Delifrance Group (see Exhibit 8). Sales and profit growth in local currency terms over the past three years were 16.1% and 14.0% respectively (see Exhibit 10-A).

Australia

Almost half the outlets in Australia and franchise outlets. The Delifrance franchise was started in Australia by the former UK franchise-holder. A new distribution centre was started in Melbourne and a new fresh bake centre was started in Sydney in 1997. Sales to franchisees are expected to increase as more new franchise outlets are opened. Again, the potential for higher revenue per capita can be achieved by moving up the growth line. Sales and profit growth in local currency terms over the past three years were 12.1% and 16.7% respectively (see Exhibit 10-B).

Malaysia

Malaysia has the second most number of outlets after Singapore (see Exhibit 9), but is only the fourth largest contributor to revenues and profits (see Exhibits 4 and 5). Looking at profitability in local currency, Malaysia has the highest profit growth among all the countries over the past three years (see Exhibit 10-C). Delifrance operates a bakery and central kitchen in Kuala Lumpur and has both wholesale and retail activities in Malaysia. Although recent announcements by the Malaysian government to introduce currency controls have put a damper on the market, we expect such measures to have little effect on Delifrance’s Malaysian operations. This is because all capital equipment had been purchased earlier and the only currency exposure is from the import of raw materials for making the dough. We expect such costs to be only a small proportion of total expense.

Other Countries

Delifrance’s operations in Indonesia has been put on hold after its Master Franchisee defaulted on the payment of its second license fee. There is great uncertainty surrounding the socio-political situation in Indonesia and we believe that short-term opportunities for Delifrance in Indonesia are limited.

The People’s Republic of China (PRC) is another potentially large market for Delifrance. A recent survey by US&FCA reported that 5.7% of Beijing residents dined at Delifrance 3 months prior to 18 June 1997, making Delifrance the fifth most popular fast-food outlet after McDonald’s, KFC, Pizza Hut and California Beef Noodle King respectively. Delifrance has teamed up with a strong local partner (CITIC) and currently operates six café-bakeries and eight bake-off/take-away corners in Beijing (see Exhibit 9).

Looking at the remaining countries where Delifrance has been granted the right to use the "Delifrance" trademark, we feel that opportunities for growth can be ranked according to GDP per capita and population (see Exhibit 11). GDP is used as a proxy for disposable income; the larger the GDP per capita, the more disposable income consumers have to spend. A large population will enable Delifrance to spread its fixed overheads by opening more outlets. The fixed cost of setting up a factory in each country means that outlets would be needed for Delifrance to cover its manufacturing overheads.

Integrated Analysis

Using the basic Dupont three step model, we see that the overall efficiency has improved. This is indicated by an increase in sales turnover. The company's profitability suffered a slight decline due to economic factors and increased competition. The successful IPO in 1996 has enabled Delifrance to reduce its debt position. This has enabled the company to generate profits without using additional leverage.

Looking at the Extended Dupont Model to analyse the effect of interest and tax payments, we see that the overall interest burden was relatively low in 1997 and was further reduced in 1998. The profit margins have also shown a slight decline.

Comparative Analysis

Delifrance’s operating performance in terms of profit margins and returns on sales, equity and assets was superior to that of its comparative firms in FY 1997. Except for Super which achieved a higher sales growth and better operating margins and return on sales, Delifrance’s double digit performance in key operating areas far exceeded those of its comparative firms.

Source: Moody’s Global Company Data Report

Impact of the Asian Economic Crisis

The recent economic crisis that has engulfed Asia since July last year will have an impact on the short term operating performance of Delifrance. Since Delifrance sells a relatively elastic product which is dependent on disposable income, low consumer confidence coupled with decreasing levels of disposable income due to weakening of local currencies, GDP contraction and general belt tightening by consumers should adversely affect sales. Three of Delifrance’s top four markets, namely Singapore, Hong Kong and Malaysia, are facing recession and the lowest consumer confidence levels seen in years. In another consumer report, around half the respondents in Hong Kong, Philippines and Singapore stated that they would be spending less this year, and over 60% in Malaysia said the same.

As economic conditions worsen, even Delifrance’s traditional target market of middle income earners and Western expatriates will be affected. However, we feel that Delifrance’s strong financial position and government linked parent company place it in a better position to ride out this crisis.

Impact of the Takeover by SembCorp

On 2 October 1997, SembCorp entered into an option agreement with Alexendre Vilgrain to purchase 51% of Delifrance at a record 33.8 times earnings. In its takeover of Delifrance, SembCorp identified the following areas as key to Delifrance’s future growth:

• Repeating Delifrance’s Singapore success in other existing markets.
• Expansion in new and underdeveloped markets.
• Franchise operations to accelerate market development.
• Building on its established distribution network and facilities.
• Opportunities in current economic conditions.
• Management expertise and strategic partners.

Based on their stated intentions, we believe that there are several issues that will affect the operating performance of Delifrance:

• Synergies from the redeployment of fixed assets and termination of staff through the merging of operations are unlikely.
• Aggressive expansion into new and underdeveloped markets at a time of weak consumer sentiment might result in loss making ventures.
• Use of franchise operations to accelerate market development might result in loss of strategic control over franchise holders and being locked out of strategic markets.
• Mismatch in network of operations in the region between both companies would mean that Delifrance would still have to develop its own network to capitalise on opportunities in new markets.
• Use of Delifrance’s free cash holdings to pay for the cost of acquiring Delifrance would leave the Company with little cash to fund future growth.
• Differences in management styles and culture might result in problems over day to day operational issues and

Furthermore, the high price paid by SembCorp for Delifrance might limit the ability of Delifrance to internally fund future expansion. This assertion can be supported using the following scenario:

1. SembCorp issued no new equity for the purchase of Delifrance.
2. Delifrance’s free cash flow in 1997 was $10.2m.
3. Assume interest cost of 8% (SIBOR +1.5%)
4. Two thirds of purchase price finance or $163.5m financed.
5. Delifrance has free cash holdings of $22m.
6. Therefore, loan required: $163.5m - $22.5m = $141.5m

VALUATION

In this section, we will look at the valuation of Delifrance using two models:

1. Discounted cash flow (DCF).
2. Abnormal earnings or Edwards-Bell-Ohlson (EBO).

• We expect operations in Singapore, Hong Kong and Malaysia to experience a decline in consumer demand because of the economic crisis. Given this scenario, profit before tax (PBT) contributions from these countries are expected to decline by 10% during financial years 1999 and 2000. Assuming economic recovery begins by year 2001, we believe that a 5% growth in PBT from 2001 to 2003 is achievable.
• Operations from Australia, China and the Philippines will continue to grow but at a slower rate. Australian operations should be able to sustain a PBT growth of 5%. However, operations in the Philippines will continue to experience a loss but a turnaround is expected in year 2000 when they open their tenth outlet (see Appendix 3). China experienced a decline in PBT for FY 1998 due mainly to operating adjustments. We expect growth to resume at 10% annually from next year.
• We do not take into account any potential contributions from operations in Brunei as we are of the opinion that contribution from royalties will not significantly impact the profitability of the company.
• Retail operations will continue to expand with the addition of more outlets during but at a slower pace. In the past, the company opened an average of 35 outlets a year. The recent slowdown will no doubt have an impact on the growth of outlet openings. We believe that opening 25 new outlets a year for the next five years is attainable (see Appendix 3). However, we do not expect Delifrance to enter new markets, namely India, Indonesia, South Korea and Taiwan, due to current economic conditions
• The capital expenditures required to open 25 new outlets each year is pegged at $12.5 million. The company uses a straight-line depreciation method and takes three to ten years to depreciate furniture, fitting and office equipment. Using a five-year time frame to depreciate such capital expenditure will increase depreciation expense by $2.5 million a year.
• The Company’s working capital grew at an average rate of 15% over the past two years. We expect this growth to remain constant as the company would need capital to fund the expansion of new outlets.
• Based on the regression of Delifrance stock price and the Straits Times Industrial Index, the value of beta for Delifrance is -0.164 (refer to Appendix 4). The average market return to date is -42% (STII stood at 1529.84 at the beginning of 1998 but by 10 September1998, the index was at 885.46). The risk free rate used is the POSB savings interest rate of 3.65%. Using the CAPM model, the discount rate K_s, is 11.14%.

Using the DCF model:

Value of Delifrance = [7,185,933/(1.1114)] + [9,892,690/(1.1114)²]

+ [13,749,557/(1.1114)³] + [17,590,617/(1.1114)⁴]

+ [21,517,849/(1.1114)⁵]+ [215,178,490/(1.1114)⁵]

= $175,604,660

Using the EBO model:

S (ROE_i – r)(B_i-1) (P_T – B_T)

P₀ = B₀ + ----------------------------- + --------------

(1 + r)^I (1 + r)^T

Key assumptions:

• Constant dividend payment of 2 cents per share or $3,612,000;
• Ignore any change to translation reserve; and,
• Constant ROE from year 2004 onwards (reversion to mean).

Therefore,

P₀ (ROE₁ – r) (ROE₂ – r)(1+g₁) (ROE₃ – r)(1 + g₁)(1 + g₂)

----- = 1 + --------------- + ----------------------- + -----------------------------------

B₀ (1 + r) (1 + r)² (1 + r)³

(ROE₄ – r) (1 + g₁)(1 + g₂)(1 +g₃) (ROE₅ –r)(1 + g₁)(1 + g₂)(1 +g₃)(1 + g₄)

+ ---------------------------------------------- + -----------------------------------------------------

(1 + r)⁴ (1 +r)⁵

(ROE₆ –r) (1 + g₁)(1 + g₂)(1 +g₃)(1 + g₄)(1 + g₅)

+ ------------------------------------------------------------------ = 1.97

r(1 + r)⁵

The value of Delifrance using the EBO model is 1.97 * 51,420,000 or $101,297,400. The value of the company derived by both models can be compared in the following manner:

The terminal value calculation is a significant issue. From the above table, the terminal value from the DCF model constitutes 72% of the entire value of the company compared to 35% in the EBO model. This huge concentration of value in one category can be risky as the margin of error is large. Any small change in assumption will affect the terminal value greatly. This could result in a greater margin of error.

The EBO model, on the other hand, focuses on the difference between the firm value and the book value, i.e., abnormal earnings. Book value itself contains quantified future benefits as the accrual system of accounting essentially quantifies net assets in terms of future benefits. The DCF model undoes the accrual process, forecasts future cash flow and the terminal value using market multiple and then rebundles them into the present value calculation.

Using the EBO model which we believe to be the more stringent model, we assign a private market value of $101.3 million or 56.1 cents per share.
 
 
 
 
 
 

APPENDIX 2

ABR Holdings Ltd

The principal activities of the group are:

1. Manufacture of ice cream and the operation of Swensen's Ice Cream Parlours cum restaurants and operation of a chain of fast food restaurants;
2. Manufacturing and retailing of biscuits, cakes, confectionery and other food products;
3. Sales of food related equipment;
4. Rental and leasing of properties;
5. Managing , obtaining and exploiting industrial and intellectual property rights with respect to the ice cream and restaurant business; and
6. Investment holding.

1. Operation of bakery cafe's specialising in the sale of high quality food for breakfast and lunch, including fresh baked goods, made-to-order sandwiches on freshly baked breads, soups, salads, custom roasted coffee and other coffee beverages; and,
2. The company also generates income from its franchise operation from upfront franchise fees and annual royalties.

1. Investment holding;
2. Food manufacturing such sunshine bread, frozen pizza, pies and garlic bread;
3. Wholesale distribution of food products such as distributor for Kraft General Foods; and,
4. Allied fast-moving food consumer goods.

1. The manufacture of instant cereal flakes;
2. Packers and distribution of instant beverages and convenience food products;
3. Property management;
4. Manufacture and distribute its own brand of bakery products;
5. Supply and distribution of the beverage products; and,
6. Investment holding.

APPENDIX 3

 
 

	Stores	PBT	Tax	Net Profit
1999	205	13183935	3691502	9492433
2000	230	14057035	3935970	10121065
2001	255	16615400	4652312	11963088
2002	280	19252886	5390808	13862078
2003	305	22126290	6195361	15930929

Australia					China
Year	Outlet	PBT	PBT/Outlet		Year	Outlet	PBT	PBT/Outlet
1997	16	1528000	95500		1997	14	328006	23429
1988	21	2022048	96288		1988	17	217005	12765
1999	26	2628662	101102		1999	22	308913	14042
2000	31	3290883	106158		2000	27	417033	15446
2001	36	4012754	111465		2001	32	543687	16990
2002	41	4798585	117039		2002	37	691502	18689
2003	46	5652968	122891		2003	42	863443	20558

Malaysia					Philippines
Year	Outlet	PBT	PBT/Outlet		Year	Outlet	PBT	PBT/Outlet
1997	31	1855009	59839		1997	4	-462000	-115500
1988	34	1765994	51941		1988	4	-323400	-80850
1999	34	1589395	46747		1999	6	-242550	-40425
2000	37	1556672	42072		2000	8	-64680	-8085
2001	40	1767033	44176		2001	10	102000	10200
2002	43	1994538	46385		2002	12	134400	11200
2003	46	2240377	48704		2003	14	172788	12342

 
 

Hong Kong					Singapore
Year	Outlet	PBT	PBT/Outlet		Year	Outlet	PBT	PBT/Outlet
1997	22	3179000	144500		1997	67	4278017	63851
1988	27	3926988	145444		1988	77	4914987	63831
1999	32	4188787	130900		1999	82	4710728	57448
2000	37	4358957	117810		2000	87	4498171	51703
2001	42	5195405	123700		2001	92	4994520	54288
2002	47	6104601	129885		2002	97	5529260	57003
2003	52	7091728	136379		2003	102	6104987	59853

 
 

APPENDIX 4

Variables Entered/Removed
 

Model	Variables Entered	Variables Removed	Method
1	VAR00002	.	Enter

a. All requested variables entered.

b. Dependent Variable: VAR00001

Model Summary
 

Model	R	R Square	Adjusted R Square	Std. Error of the Estimate
1	.164	.027	-.034	.1804

a. Predictors: (Constant), VAR00002

ANOVA
 

Model		Sum of Squares	df	Mean Square	F	Sig.
1	Regression	1.438E-02	1	1.438E-02	.442	.516
	Residual	.521	16	3.255E-02
	Total	.535	17

a. Predictors: (Constant), VAR00002

b. Dependent Variable: VAR00001

Coefficients
 

		Unstandardized Coefficients		Standardized Coefficients	t	Sig.
Model		B	Std. Error	Beta
1	(Constant)	1.758	.252		6.984	.000
	VAR00002	-9.113E-05	.000	-0.164	-.665	.516

a. Dependent Variable: VAR00001