Water Purifier Manufacturer

C : Okay. I'd like to reiterate the problem statement – our client is a leading water purifier manufacturer in India and is experiencing a decline in enterprise value. How would you approach identifying the reasons behind this?

I : Yes.

C : Sure. To start with, is it a company specific problem or can it be noticed across the industry too?

I : It is a company specific problem only.

C : I’d like to start by breaking down the formula for enterprise value, which is calculated as:

Enterprise Value = Market Capitalization + Debt − Cash

Market capitalization is a function of the company’s share price multiplied by the number of outstanding shares. If the enterprise value is declining, it suggests that either the market capitalization has fallen, the company has taken on more debt, or its cash reserves have changed.

I : That’s a good start. The decline seems to be driven by a drop in share price. Can you expand on that?

C : Certainly. A decline in share price can happen for several reasons:

1. Negative market sentiment: This can arise from poor financial performance or pessimism about future growth prospects

2. Increased competition: If competitors are introducing superior or cheaper products, the company’s market position may weaken

3. Investor concerns about debt: If the company takes on substantial debt without a clear strategy to manage it, investors may perceive the company as riskier, leading to a drop in share price

4. Macroeconomic factors: Broader market conditions like rising interest rates or economic downturns can depress share prices across industries Given that the enterprise value is declining, I would investigate if the decline in the company’s market cap (caused by the falling share price) is greater than any recent increase in debt.

I : Interesting. In this case, the company has indeed taken on more debt. The company is investing this debt in developing new water purification technology. How does that factor into the decline? What do you make of that?

C : Thanks a lot for that information. That’s a key factor. Investing in new technology can be a high-risk, high-reward situation. While it might offer long-term benefits, there’s uncertainty in the short term.

Investors could be wary because:

1. The technology is unproven: If the product doesn’t perform as expected, it could lead to losses

2. Delayed returns: New product development often takes time to yield results, which could strain the company’s ability to service its debt

3. Increased risk profile: More debt increases financial leverage, which amplifies both the potential gains and the potential losses

This could explain why the share price has fallen, as investors might be pricing in the risk of the new venture.

I : Understood. How would you suggest to mitigate the risks associated with this increase in debt?

C : The various ways to mitigate the risks inherent to this increase in debt is as

follows:

1. Cash Flow Risk: The company should maintain strong cash reserves or secure bridge financing to cover any short-term liquidity issues while waiting for the new product to generate revenue

2. Interest Rate Risk: Refinancing into fixed-rate debt or hedging against interest rate fluctuations could help reduce exposure to rising rates

3. Execution Risk: The company could run a pilot project or soft launch to test market reception before fully scaling the new technology. This would allow them to pivot or improve the product based on initial feedback

4. Market Risk: Clear communication with stakeholders is crucial. The company should update investors regularly on the progress of the technology, demonstrating transparency and maintaining confidence.

I : Thank you. That'll be all.