This post is in a way a follow-up of our promise made in the recent post on Cera, where we mentioned we would discuss interesting fanatic traits as we observe them in concalls that we participate.
There is great beauty in Charlie Munger’s mental model of autocatalysis. Autocatalysis is a chemical reaction where the output of the reaction is itself a catalyst for the reaction. Put differently, it is nothing but a virtuous cycle or feedback loop where the output fuels the process continuously.
As we described in the case study on Rain Industries ,
"It is interesting to think how a majority of the things that we see today and that dominate are the result of positive feedback loops or virtuous cycles over a long period of time. The domination of our species, the rise of agriculture, the prevalence of capitalism, the rise and domination of science – all are a result of positive feedback loops. A positive feedback loop or mechanism is where the output enhances the original stimulus, which further enhances output, which further enhances stimulus and so on.
The power of positive feedback loops explains the strength of the business model of some dominant businesses today, including Amazon. Here is a famous pictorial representation of Amazon’s flywheel."
In our opinion the most effective autocatalysis reaction in business is that of win-win relationships. It is intuitively logical when one thinks of it - if a business takes care of all the stakeholders in its value chain there is an inherent incentive for the entire value chain to ensure the business succeeds. And this can play out in powerful and really interesting ways. If the cycle is not broken, it can result in immense scale.
I was reminded of the above post during Wonderla’s recent quarterly conference call.
Before we dive into the conference call dissection, let us first discuss the broad similarities between Wonderla and market driving firms. We first wrote about market driving firms here . Even though it was written in 2000, the paper contains a number of important insights which might help students of business. As we mentioned in the article,
In their research on 25 pioneering firms across industries including healthcare, airlines, media, etc, the authors came across a shared set of unique features and business practices which can only be described as market driving as opposed to market driven. Excellent, established companies like Unilever, P&G and Nestle implement the market driven approach – which starts with careful market research, investigating the customers’ needs, and developing differentiated products or services for a well-defined segment. But pioneering companies like Amazon, Ikea, Aravind Eye, etc create new markets by revolutionizing existing industries through radical business innovation, although it must be said that the base rates for success for this strategy is not high.
The authors observed that market driving firms succeeded due to radical innovation on two dimensions –i) A discontinuous leap in value proposition for the customer; ii) Implementation of a unique business system
Let us understand the above with the example of Wonderla-
A discontinuous leap in value proposition for the customer: There is considerable dearth of entertainment options for most of the Indian population - the culture of museums, parks, drama theatres, art galleries etcetera are not that well developed in India. The average purchasing power is also not that high. Thus most of the middle-class population in the cities have to rely on television, movie theatres or malls for entertainment. It is in this context that one has to understand the offering of Wonderla’s amusement parks. As we mentioned in our recently released book, each of Wonderla’s parks offer happiness and excitement combined with affordability, variety, safety, and hygiene, creating a very strong customer pull. They provide a great way to have a day of wholesome family fun. Each park has more than 40-50 rides (both land and water) and provides wholesome food. The average consumer gets all this at Wonderla for around $20.
Implementation of a unique business system: Every student of business knows, it is relatively easy to provide incredible value for the customer. It is doing that profitably using a system that cannot be replicated easily that makes a business sustainable over the long-term. Let us understand the seemingly irreconcilable constraints that Wonderla, well, reconciled.
An amusement park has to be near a city or a settlement with large addressable population.
An amusement park requires large land parcels. But India is the 2nd most populous country in the world with the 7th largest land mass. So given the population density land parcels near cities are pricey, not least because of the rapid urbanization happening.
An amusement park requires large capital for land and for the rides.
The price point of the service has to be low to get enough volumes to make the whole thing viable.
The first three points alone have the potential to make the ticket and ancillary products’ prices high enough so that the parks would not succeed. How did Wonderla manage? It managed due to Kochouseph Chittilappilly and his team’s brilliance. As mentioned in our book -
Chittilappilly did not outsource the new park’s design to an expert. Instead, he chose a local architect with no background in amusement park design. He wanted the design to be fresh, and so, for the first park, it was Chittilappilly himself, working with the architect, who came up with the design. Since then, Wonderla has designed all of its own parks, learning from the mistakes of each park and improving its in-house knowledge.
Another major part of the cost-reduction strategy is the in-house manufacturing and maintenance of rides. The family developed the ability to manufacture its own rides at its facility in Kochi. Domestically purchased rides are 30% to 40% more costly, and imported rides are 100%-200% more costly, than producing rides in-house. By manufacturing the common rides in-house, they were able to lower capital costs while also developing manufacturing expertise. This expertise was eventually leveraged further as Wonderla opportunistically purchased secondhand rides and refurbished them for use in various parks, which further improved the capital cost advantage. The organizational manufacturing knowledge allowed the company to save on maintenance costs as well, as it maintained all the rides in-house; this, in turn, improved ride safety.
And thus, they came out with an offering which had a considerable value proposition to the customer but at the same time created a hard-to-replicate business system. There is considerable institutional knowledge or culture (low cost amusement park that entertains audience) that is hard to develop.
Why is all this important? Well, coming back to our initial thought process of win-win relationships being the ultimate autocatalysis reaction, with its strategy -
Wonderla is able to keep customers happy.
Wonderla pays full corporate taxes and given its service intensive business, it generates a lot of direct employment (this does not include the ancillary employment it generates). It also provides discounts for people who come by public transport, has extensive rainwater harvesting and uses solar power. This keeps the government and the society happy.
The returns on capital on the mature parks are well above 25%-30%. Over a long time, that should keep the shareholders happy.
So how does all this help in autocatalysis reaction? For that, we (finally) turn to the recent conference call.
In the 2Q2019 concall, the management of Wonderla announced the following:
"As a further testimony to our operational efficiency, we have recently received an exclusive offer from the Government of Odisha to setup a new amusement park in that State. The Government of Odisha will provide the land on a long-term lease basis thus enabling us to develop an asset-light model and balance sheet friendly amusement park. The board of the company has given an in-principle approval to evaluate the proposal and we will keep you updated about the progress.
Odisha was not in our radar initially. There are no amusement park worth mention in Odisha. There are couple of small water parks. They are badly maintained. In our analysis we find that, being an asset-light model and the ticket prices lesser than what we have in our other parks, it will definitely be financially viable and we will have the same payback period like other parks.
The concerned authorities including the Minister of Tourism and the Secretary to Tourism visited to our Bengaluru park, then they came down to Kochi to meet us. We identified 4-5 locations, then zeroed in on a location in Bhubaneswar, which is around 19 to 20 km from Bhubaneswar and about 2.5 km from the National Highway. We are happy to mention to you that this is a very proactive State, they want to develop their tourism and they have offered many incentives. First is a long lease of 90 years at a rate per acre of only to Rs. 6 lakhs. Secondly, they are giving 20% investment subsidy capped at Rs.15 Crores. Thirdly, they have agreed to give us access from National Highway to our park. As of now there is a 30 feet road, they will convert it into a 60 feet road with a double line and the government will bear the cost. Number four, they will give potable water connection from Mahanadi River directly to our site at their cost and the water charge agreed is one-tenth of what we are paying at Hyderabad.
We do not need to incur heavy capex to obtain land-asset. If we look at our Chennai park, the investment in land is around Rs.75 Crores and in addition we have incurred around 10 Crores for filling, levelling and compound wall. In total it cost us around Rs.85 Crores whereas the cost of land in Bhubaneshwar is only Rs.3 Crores for a 90 year lease (for 50 acres).
We told the Government of Odisha that initially we will only go for a water park plus a few land rides and later we will go for some additional land rides depending upon the acceptance or the reception of the park by the people of Odisha. So we would like to restrict the initial investment to the extent of about Rs.75 Crores to Rs.100 Crores. In Odisha, as I mentioned, they are not used to parks. They have some water parks in and around Bhubaneswar, which have not been maintained well. So with a water park of our standard, and a couple of land rides, we will be able to attract sufficient crowd in the first year of operations. We promised to the government that in the second year we will come up with a land park and then in the third phase we will create a convention center and in the fourth phase we are planning a resort in Odisha."
There are a few things that jump out in the excerpt above:
Power of win-win relationships: When the government visited the existing Wonderla parks, they saw the long history of win-win that the parks had created. And this fit in well with what they were looking for. The proactive government was looking to build the tourism industry which has multiplier effect on the economy - creates jobs, generates income and taxes - the government does not have to spend much for it. It find the value proposition of Wonderla so good that it made a compelling proposition to Wonderla.
Exclusivity / Monopoly(?): There is no one else the government considered other than Wonderla for setting up the work. In fact, probably there is no one else in India or for that matter the world, to set up a viable amusement park in their state.
Optionality: Odisha was initially not even in the radar of Wonderla to set up a park. By setting up a strong formula for amusement parks, Wonderla has created great optionality for itself in the industry. It would not be surprising for other states looking to increase tourism to invite Wonderla to set up a park. And remember, India is an entertainment starved destination.
Capital prudence: Despite running a heavily capital intensive business the Wonderla balance sheet is pristine with zero debt. This is a result of their prudence which is evident in how they plan to scale up the Odisha park if it does go ahead. Depending on the demand, they can take a call to scale up or down their investments. And also, the strong balance sheet allows them to quickly take up opportunities if and when they arise. For example, if their balance sheet had debt, they would not have been able to avail the phenomenal offer from the Odisha government.
Accounting, Capacity to Suffer and RoCE:
Here is another excerpt.
"The ROCE including land revaluation for Hyderabad park is about 4% and excluding revaluation is about 5% for the H1FY20 and for Kochi park the ROCE including revaluation is about 5% and excluding revaluation is about 29% and for Bangalore park ROCE is about is about 28% including revaluation and excluding revaluation it is about 156%. Chennai park will also have a similar ROCE in the initial years like Hyderabad park because the capital base is going to be bigger number, in 4% to 7% range and rise up to 10% to 12% range.
In case of Bengaluru and Kochi parks the payback period was about 7 to 9 years because the investment levels were also under control and in case of Hyderabad park, we have invested about Rs.272 Crores, so the payback period is going to be about 12 years. ROCE excluding the reevaluation of land is about 6% to 7% now. If you only take Kochi or a Bengaluru park, our ROCE is much higher. In case of Chennai park, where the investment is going to be about Rs.350 Crores plus and the major part is on the land, the payback period could be beyond 12 years. We are expecting ROCE on the parks to start with about 4% to 7% and go up to 10% to 12%. But at the same time, in the Odisha model where the investment in land is minimal, we will pass on the benefit to the people by reducing the ticket prices. But we expect higher footfall on account of the affordable ticker prices. "
Capacity to suffer: Tom Russo came up with this term “Capacity to suffer”. He noticed that businesses that tended to be still owned by founding families were willing to sacrifice the short-term gains for longer-term and more sustainable gains.
Wonderla’s parks have a payback period of 10-12 years. That is a really long and large capacity to suffer that the management has to develop. It is probably beyond the ability or willingness of most businessmen or investors to stomach.
Accounting and signalling: Before we dig deeper into the statement, it would be pertinent to note these tweets by Prof Bakshi.
As per our calculations, the mature parks generate returns on invested capital of above 25% comfortably. But Wonderla revalued its land basis the recently introduced accounting standard. It bought the Kochi and Bangalore land at historic prices and a couple of years back it took the choice to revalue it to the more current prices. This had the effect of increasing capital employed and thus lowering the calculated returns on capital employed. But the question is what is the actual return on capital employed - is it calculated on the actual capital investment made by the company or the returns made on the revalued land, which is just notional?
What would happen when a potential competitor looks at Wonderla’s return metrics today? The returns on capital (with revaluation of land) implies the returns potential of the park if one were to invest the capital to buy land today and were to run it like Wonderla does (which is in itself hard). Also, amusement park business is a dominating a niche kind of business. That is if there are two amusement parks of similar size and quality in India in the same location, both would suffer even more.
In effect probably Wonderla is signalling to the competition that
“See, my returns are not that attractive, and I run my business quite well. There is no incentive for you to come into my business in a geography where I am present or for that matter anywhere in India. On revalued land, the returns are not great.”
But here is the question. Wonderla is a direct-to-consumer branded business that provides happiness and memories to its customers. Is there pricing power for the business?
If no, it is a bad business.
If yes, how would the business look years from now when the fixed asset investment is not that high and the working capital investment is negligible? The existing parks are cash flow machines. What could it do with the cash in a country like India with the skills it would continue to develop into future?
Hope you enjoyed this interpretation of the concall. We would love to hear your thoughts on any business that you learned a lot from or admire immensely.
Wonderla Concalls, Intelligent Fanatics Website