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Devyani International set to join mega IPO fest: Investors should consider these risks first

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Major QSR (quick-service restaurant) player, Devyani International which operates popular brands like KFC, Pizza Hut and Costa Coffee in India has filed for a Rs 1,400 cr IPO with SEBI.

Devyani International set to join mega IPO fest: Investors should consider these risks first
Major QSR (quick-service restaurant) player, Devyani International which operates popular brands like KFC, Pizza Hut and Costa Coffee in India has filed for a Rs 1,400 cr IPO with SEBI. The IPO will be a combination of Fresh Issue worth Rs 400 cr and an Offer For Sale (OFS) of 125,333,330 equity shares.
Devyani International’s IPO will provide a partial exit to RJ Corp & DunearnIPO Investments which is a wholly-owned subsidiary of Tamasek. Devyani International’s IPO will be the third QSR IPO in the last six months after Burger King and Barbeque Nation.
Here are the risks which investors should know about before joining this QSR IPO wave:
CHALLENGES AROUND FINANCIALS
Divyani International reported losses of Rs 94 cr, 121.4 cr and Rs 63 cr in FY19, 20 and 21 respectively. This financial trend is one of the biggest risks as the sustained losses have resulted in erosion of a portion of company’s net worth. As per the company, the net losses have historically resulted primarily from high operating costs incurred towards expansion of store network and the inability to successfully recover these costs through operations at such stores. These losses have also come from high corporate level overhead costs and towards funding certain loss-making businesses such as our operations at airports.
Going forward, the company plans to continue to grow the business by opening new stores every year, and expects to report losses till such time these new stores mature.
Another concern flagged by the company is increase in operating costs and other expenses which according to the company may make the investments towards business unsuccessful. The company adds that increase in costs, expenses and investments may also reduce margins and materially affect business, financial condition and results of operations.
Further on financials, Divyani International has had negative cash flows in the past, and as per the company it may see negative cash flows in the future as well. Negative cash flows could adversely affect the company’s cash flow requirements and hence the ability to operate business and implement its growth plans, thereby affecting its financial performance.
IMPACT OF COVID-19 AND RESTRICTIONS
The company’s DRHP filed with SEBI clearly shows that challenges arising out of COVID-19 are the biggest ones to deal with for the sector as well as the company.  Devyani International has permanently closed 61 stores under its core brands in FY21 due to a significant decline in footfalls because of COVID-19 restrictions. Declining footfalls have also taken a toll on the company’s revenue where the in-store dining revenue fell to 29.8% from 48.85% in FY21. It wasn’t just in-store dining but overall revenue from operations for Devyani International’s flagship brands fell by over 25% to Rs 1,134 cr from Rs 1,516 cr in FY21.
The company expects the impact of COVID-19 to continue as footfalls and sales remain affected due to the second wave of COVID-19. A direct result of COVID restrictions, as the company mentions in its DRHP is the impact on company’s ability to manage inventory of products, resulting in significant write-offs of the inventory, the majority of which comprise perishable ingredients for immediate consumption.
CHALLENGES AROUND EXPANSION PLANS
The company also mentions that in the current environment expansion has become increasingly challenging.  While the company has been able to mutually agree on revised timelines for development commitments for KFC and Pizza Hut stores with Yum, there can be no assurance that it will be able to meet these commitments in the event of subsequent waves of the pandemic in India that leads to additional restrictive measures or hamper overall economic recovery.
The company further adds that in the event the second wave worsens or is not controlled in a timely manner, it may not be able to meet the revised development commitments, or further revise these arrangements, or operate our stores profitably, or at all. This may result in various consequences, including termination of various agreements entered into with Yum and such termination of or inability to renew these arrangements will have a material adverse effect on our business, results of operations and financial condition.
CONCENTRATION IN BUSINESS
There is a great amount of concentration is business for Devyani International as well. Revenue from operations from our KFC and Pizza Hut stores together represented 76.08 percent, 77.49 percent and 92.28 percent of the total revenue from operations in FY19, 20 and 21 respectively. The company, therefore, is significantly dependent on the arrangements with Yum for its business and operations. Lack of diversification in business also poses a significant risk to the company’s business model. Devyani International commenced its relationship with Yum in 1997 with its first Pizza Hut store in Jaipur and currently operates 297 Pizza Hut stores and 264 KFC stores.
CHALLENGES AROUND COSTA COFFEE’S INDIA BUSINESS
Devyani International relies on its International Development Agreement (IDA) with Costa for the Costa Coffee stores in India. Pursuant to the IDA with Costa, the company was been granted exclusive development rights in India that were contingent upon the ability to meet certain development commitments set out therein. Owing to Devyani International’s inability to meet such development commitments, the exclusive development rights were subsequently terminated. As a result, while Devyani International has the right to operate the existing Costa Coffee stores, they are refrained from opening any new stores in India without prior consent from Costa. This limits the ability to grow our Costa business in India. Divyani International operates 44 Costa Coffee stores as on March 2021.
ISSUES AROUND DASMPL (Subsidiary)
As per Devyani International, there have been certain issues around operations and management of DASMPL and there is no assurance if the company will be able to resolve these issues in a timely manner or at all. Devyani International holds 51% in DASMPL, while the remaining 49% is held by High Street Food Services (HSFPL).
There have been issues with HSFPL in relation to the operation and management of DASMPL on account of non-cooperation by HSFPL’s nominee directors and lack of support from HSFPL as a shareholder of DASMPL. For instance, nominee directors of HSFPL appointed on the board of DASMPL have not attended certain board meetings of DASMPL in certain fiscals. As a result, the annual accounts of DASMPL for some fiscals were not approved by HSFPL’s nominee directors. Further, HSFPL, on certain occasions, has also not attended DASMPL’s general meetings in its capacity as a shareholder of DASMPL. DASMPL, as a result, may not have been in compliance, and may not be able to comply in future, with its contractual requirements under the shareholders’ agreement. Consequently, these issues may result in delays and noncompliance (including those relating to certain regulatory filings) on part of DASMPL from time to time.

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