*this post is a collaboration between me and my friend Naman Chandak. He has put in a lot of efforts( probably more than me) and this analysis would not have been possible without him!
I recently worked on the co-working space and out of all these businesses, I found EFC the most interesting. Hence, we decided to delve deeper into and explain whats working and whats not for the business. So lets begin!
Disc: Invested and biased
Industry background
India is witnessing a trend of value migration. Instead of leasing and building an office of your own, companies, startups, freelancers, etc., are looking for an intermediary who bears the costs of setting up the office space, admin costs, maintenance costs, negotiations with the landlord and everything else at a fixed rate. These businesses are called co-working spaces, precisely what we are here to study.
A co-working space is a fully furnished office space leased by a co-working company. The company splits the area into parts and lends it to freelancers, startups, small businesses, big businesses, etc.
Business model
They have multiple business models, such as a co-working model where multiple small businesses and freelancers rent out a few seats on a daily, weekly, or monthly basis. The one we need to focus on is Managed offices. When a big corporation takes up the entire space from the operator, the operator puts up the upfront capex and designs the interior to the needs of the corporation. Managed offices have a few key advantages. This ensures 100% occupancy and that the place is filled from the first day. the most important thing is that the leases are a minimum of 3-5 years long, which helps prevent asset-liability mismatch.
Growth
Out of 810 mn sqft of commercial estate, co-working spaces only acquire 61 mn sq ft of it! There is a huge leeway of growth and a report by Avendus had said that The co-working space is expected to grow at a CAGR of 21% for the next five years and could be valued at 9 billion dollars.
Since this report is focused on EFC limited, we have given a brief of the industry. For a detailed report of the whole industry and key variables( which is highly recommended) check this out: https://www.investingstoics.com/post/co-working-spaces-a-multibagger-trend
About the business
EFC(I) or Entrepreneurial Facilitation Centre is a business that provides co-working spaces and managed spaces in multiple cities of India. It also operates in a few additional business verticals; they have a subsidiary called White Hills that focuses on interior design and fit-outs and another vertical that produces and trades furniture.
EFC(I) (formerly Amani Trading and Exports Ltd) is the holding company of EFC limited. EFC Limited was established in 2012 by Mr Umesh Sahay and Mr Abhishek Narbaria and is also the first listed business in this space. Now that we know a bit about the company let's learn about each business vertical!
Co-working model
Operational numbers
EFC has a seating capacity of 43,000 with an average rental of 6250 rupees. It manages a total of 1.9 million square feet of area and has also contracted to add more than 4,00,000 square feet of leased space across Pune, Noida and Hyderabad. They currently have 50 sites under management, and the business aims to increase its seating capacity from 43,000 to 96,000 by FY26 and 65,000 seats by FY25. They currently operate in seven cities of India: Pune, Mumbai, Ahmedabad, Hyderabad, Noida, Kolkata and Chennai.
Fun fact: Till FY23, the company has managed to double its seating capacity consistently for the past decade!
Managed offices
The co-working division clocked in 263 crores in revenue(62% of the total revenue) and out of that, About 80% of co-working model revenue comes from big corporate clients such as Tech mahindra, Bajaj Finance, Eureka etc. This is a big advantage as it provides longer tenures and increases capacity utilisation. However, there are potential issues, such as the bargaining power of the corporation. Due to a high concentration in managed offices, EFC is able to maintain a capacity utilisation of 92.5% and an average lease tenure of 2 years.
The average tenure with the landlord is around 7-9 years outside of Maharastra, while it's 5 years in Maharashtra. So, we do notice a mismatch to some extent. However, it can be tackled if the company can find a replacement for their existing clients at the end of their tenure. Until now, the capacity utilisation of 92% mitigates this worry as their capacity is filled to the brim. Still, a potential downturn in the industry can cause worries, which will be discussed below!
Efficiency
EFC has managed to be one of the most cost-effective businesses amongst its peers. The capex per seat is about 50,000 rupees, and the per sqft capex is 1250. For example, Kontor spends 3000-4000 per sq ft and 80,000 to 90,000 per seat, while AWFIS spends about 1700-1800 rupees per sq ft. Their number is one of the lowest in the entire industry. The sqft per seat is also about 40-50, which allows for higher capacity in a fixed area under management. Due to the nature of the industry, which will be discussed below, it has become essential to be cost-effective.
Costs
Furniture is a significant component of EFC's costs. About 60% of the capex cost, or 30,000 rupees per seat, goes to Furniture. Moreover, it is very important to understand what percentage of rental income goes towards lease payments. Out of 100, about 40 rupees is paid as lease payment to the landlord.
Another thing to know is that landlords require deposits to be paid, and so do the tenants of the co-working space. Hence, the deposits given by the tenants are used to give deposits to the landlord, allowing steady cash flows.
White hills/ Interior designs and fit-outs
This part of the business provides services that help with interior design. For FY24, their revenue stood at 113 crores or 27% of the total revenue. The global interior fit-out market is estimated at US$ 58.91 Billion in 2023 and is expected to reach US$ 100.31 Billion by 2030, growing at a compound annual growth rate (CAGR) of 7.9% from 2023 to 2030. As of FY24, they have contracts worth 132 crores which are given by big corporations such as Bosch, TCS, Coforge etc. A substantial advantage of having this business vertical is that they command good PAT margins of 15-16%, huge TAM( with an emphasis on organised markets increasing shares), higher ROCE due to the nature of the business and good cash flows.
Furniture division
The furniture business is a relatively new segment that recorded a revenue of 46 crores, about 11% of the total revenue. As we discussed earlier, furniture has been a significant cost for EFC; hence, backwards integration into this segment provides them with strong cost efficiencies and control of their Operations. Moreover, they plan on selling their products to others as well. A new plant will be going live in Q2, which will have the capacity to generate 300-400 crores of revenue. Moreover, the business expects a capacity utilisation of 60-80% in the first year. The working capital cycle is around 120 days, which is not ideal but is a standard norm for newer players in such industries. As of Q4 FY24, EFC has not started taking orders from external clients but expects 15,000 seats to be fulfilled by their segment.
Now that we understand the business, let us understand the key thesis and anti thesis pointers of the business.
Thesis
Industry growth: The industry is growing at a rapid pace of around 20%. Moreover, the players who control over 5000 seats are growing at a faster rate, EFC being one of them. EFC is also an efficient player in the industry, targeting to grow at around 75% in seating capacity by increasing its seat count from 40,000 to 65,000. The high growth rate is also a factor of low base.
Furniture fit-out:Integrating with the furniture fit-outs is a win-win situation where the cost of setting up a working space would be reduced significantly for EFC & at the same time, provide an additional flow of revenues for the consolidated entity. Having your in-house design & furniture team decreases the turnaround time for interiors. EFC takes 2 to 3 months to do the interior of a bare shell and 4 to 6 months for 90% + occupancy.
High share of Managed offices:Despite being in an industry where asset liability issues are common, one way to reduce this risk is to increase the mix with managed offices. In the latest quarter, 80% of their revenues came from managed spaces; managed office spaces also provided higher occupancy for the overall mix. Their average tenure is two years, which is decent( not exceptional), but their leases with big corporations are 3 to 5 years. This allows room to find new tenants if the earlier ones escape and help survive. Downcycle if /when it were to come.
Cost efficient: In an industry where most features and services are commodities, it essentially comes down to the cost structure and out all the listed businesses, EFC is the most efficient. Moreover, with its spread increasing around the whole of the value chain, the cost efficiency is only going to improve.
Increasing Margins: The furniture business is set to have a good chunk of the overall revenue and this segment comes with high margins! As the share of this division increases, we can expect margin improvements.
Antithesis
Asset Liability mismatch: In simple words, the operator generally takes leases of the commercial properties for around 5-9 years. Still, they offer the customer multiple flexible options for renting, i.e. they are willing to rent for even a single day. So naturally, there is a high chance of asset-liability mismatch. During black swan events such as COVID-19, the revenue visibility vanishes, while the obligation to rent stays can cause serious trouble, as it did for WeWork. A sustainable way to tackle this is to grow with strong unit economics instead of blindly chasing growth.
Commodity industry: To a large extent, the industry is a commodity product. The only way to differentiate itself is by the services provided. However, that, too, can be replicated with ease. Due to this, one must be careful of competition and focus on being the cheapest producer( which EFC is :)). Nonetheless, the nature of the industry can lead to deteriorating ROCE and margins, which investors should be careful of in the long run.
Industry oversupply: Yes, the industry in India is growing around 20% per year. Still, seeing the demand, many players are targeting aggressive expansion, such as doubling the number of seats quickly, which can result in oversupply. This can lead to operating deleverage and pressure on margins.
Reliability on a single sector/client: Most of the demand for co-working spaces comes from the IT sector, and as we have mentioned above, most of their managed office clients, too, belong to the same sector. If the current headwinds were to continue, there would be job cuts and, hence, a reduced demand for seats. Thus, co-working businesses will be affected by the cycle of their end users, and the only way to mitigate this is to reduce the dependence on a single client or a sector. EFC needs to work on this as their clients are concentrated(the top 10 contribute 50% of revenue) and that is also true in the same sectors.
Negative Cash flows: Understandably, a growing business needs to keep investing cash. Hence, in my personal opinion, I think it is fair that a fast grower like EFC has a negative CFO. However, it can become a cause of concern if they fail to convert this position when growth rates moderate and the company transitions to a stalwart.
There has been frequent equity dilution in the near past: Again, equity dilution is common for businesses that need funds to grow. However, if there are headwinds or slowdowns, this can potentially evaporate the gains of the early investors. To tackle this, EFC has been working on a few ideas, which we will discuss below.
Optionalities
Integrating towards an anti fragile model?
Taking the properties on the lease may be a risk, as the commercial property owners might see the traction in co-working spaces and demand higher leasing prices or even opt for building co-working-based models themselves rather than leasing or renting to the operators, which do seem like a potential risk. Moreover, during adverse man-made crises such as COVID-19, companies opt out of co-working spaces, which would burden operators with leases without any revenue visibility, as happened with we-work in 2020.
To mitigate these risks, EFC is implementing a strategic solution. They are establishing an investment management entity that will create and manage Small and Medium Real Estate Investment Trusts ( SM REITs). This entity will play a crucial role in managing and mitigating the risks associated with leasing properties for co-working spaces.
EFC's strategy involves the establishment of a Real Estate Investment Trust (REIT) specifically dedicated to the flex space. The operator will raise funds from investors for this REIT, which will then use these funds to purchase office space for leasing. The returns generated from these leases will be distributed to the investors, while the REIT operator will receive their fees.
They will also secure funds through an AIF to acquire and manage properties. This approach eliminates equity dilution and removes the landlord from the equation by directly owning the property, thus minimising asset-liability mismatch.
Financial model
Valuations
Before we delve into the analysis, it's crucial to note that this is a personal opinion. It's essential for each of us to conduct independent research, as our individual investing styles and risk appetites may differ.
On an absolute basis, One might believe that a PE of 45-48 might be very expensive and to some extent, my biases would compel me to agree. However, we must compare the PE with the quality of the business, especially the growth rates. For a business that is expected to grow at 90-100%, I find the business valuations to be fair/moderately attractive. However, I can not agree that it's a steal deal despite a 0.5x PEG ratio (which is considered really good) because it's a relatively new industry. Hence, there can be unseen risks in the future, which is why a reasonable margin of safety is needed.
Technicals
This is the daily chart of EFC(I) ltd. The business seems to be in stage two and has recently broken out from a six month long consolidation with very strong volumes. It is currently consolidating at a higher range and is seeking support from the 21 EMA.
So guys, this is the end of the business analysis. Shoot me a message if you all have any doubts!
P.S: Subscribe if you enjoy my content!
Citations
Marathe, Neeraj. “Factors Driving ‘co-Working’ Spaces.” YouTube, 28 Mar. 2024, www.youtube.com/watch?v=-xJlmIdUYEg. Accessed 27 June 2024.
Bajaj, Dhruv. “Co-Working Office Spaces- the next Big Mega-Trend | Smart Sync Services #investing #stockmarket.” YouTube, 4 May 2024, www.youtube.com/watch?v=HKORPnHVTAY&t=100s. Accessed 27 June 2024.
Manhar, et al. “EFC - Entrepreneurial Facilitation Centre.” ValuePickr Forum, 11 June 2024, forum.valuepickr.com/t/efc-entrepreneurial-facilitation-centre/146688. Accessed 27 June 2024.
DRHP, Concalls and Annual reports of EFC(I), Awfis space solutions and Kontor space limited.
Great writeups Anshul! Read the entire set of blogs in one go. Thank you.
Should hv given full form of EFC!!