India real estate research

1

LANCASTER UNIVERSITY

Growth Strategy, IPO

&

Performance

Of

INDIAN REAL ESTATE COMPANIES

RESEARCH PAPER

For

MA in Practicing Management

By

Sharad Jhingan

2

Contents Page No:

1. Introduction and Purpose 3

2. Chapter 1: Background 6

3. Chapter 2: Methodology and Performance Analysis of

Sample Companies 20

4. Chapter 3: Strategic Comparison and Case study of DLF Limited 42

5. Chapter 4: Trend Analysis, Conclusion & Need for Regulator 48

6. Bibliography 70

7. Annexure – 1 Share Price Movement Chart 71

8. Annexure – 2 DLF IPO : The Untold Story 77

3

Introduction and Purpose

Real Estate Industry in India witnessed a historic boom during 2002 to 2007. Record number of

projects were launched and sold during this period. Real Estate Developers in India grew

multifold very fast. Land and property prices skyrocketed. Many developers went for public

issue of shares at very high valuations. Attracted by liberalization of foreign investment

regulations, International investors invested billions of dollars in Indian real estate sector. The

global economic boom, easy availability of money, crazy jumps in asset valuation and mad rush

to go for the IPOs and desire to claim very high company valuation typically characterized real

estate industry at that time.

A number of real estate companies went for IPOs between 2006 and 2008. Some companies

approached International Markets, like Alternative Investment Market of London Stock

Exchange or Singapore Stock Exchange, using innovative structures for raising funds. Innovative

multi-tiered structures, using off shore tax shelters like Mauritius and BVI/Panama, were created

to ensure tax efficiency and help getting subsidiaries listed in overseas market without having to

go through regulatory rigor with SEBI in India.

All these IPOs and fund raising exercises had one thing in common, they all valued real estate

companies on the basis of NAV (Net Asset Value) models. Expected future free cash flows from

different projects were discounted, and liabilities netted off against such discounted NPVs (Net

Present Value), to arrive at company NAVs, which formed the basis of issue pricing. Interest in

Real Estate, availability of cheap money and dearth of quality stocks made it possible for

companies to get away with such highly probabilistic valuation models for IPOs. In their zeal to

achieve highest possible price for their shares; companies also included NPVs of projects for

which the land acquisition had not even started. Such questionable practices were overlooked by

investors, riding the global asset price boom, assuming that the growth and profitability of these

companies would continue to skyrocket due to insatiable demand for housing and commercial

properties.

This paper examines the growth of real estate industry in India and attempts to test share

valuations made by real estate companies. Taking a sample size of six publicly listed real estate

4

development companies and their published accounts over a five year period, I have analyzed the

historical and recent performance data of these companies, claims and promises held out in their

prospectus, as filed with the market regulator (SEBI), at the time of going for the IPO. Actual

performance of the companies and movement of their stock prices from the time of listing is also

compared.

While comparing the strategies of the sample group of companies, we find that there is very little

to differentiate between the companies. Except for size and geographical focus, none of the

developers distinguish themselves from the other in any significant manner. We also find that

they resorted to similar tactics in respect of fund raising and financing of projects. They are all

highly leveraged companies with very high interest cost incidence. All these real estate

companies issued a very small part of their shareholding, at a very high price, to the public by

IPO. On analyzing performance of these companies, by comparing the 5 year performance data,

we find that none of these companies were able to maintain the profitability or income levels. As

soon as market became aware of the fact that growth rates or profitability of these companies are

not sustainable in the long run, it withdrew support. Consequently, the share prices of these

companies fell to record lows and have not been able to touch their IPO price level, even a

couple of years later.

This paper argues that opportunism and creative valuation methods do not, in the long run,

support share prices or company valuations; instead, consistent authentic performance over time,

creates value for all stakeholders and differentiates good companies from other market players. It

further analyses the performance and identifies factors which contribute to value creation in real

estate business. This paper also looks at growth strategies adopted by six Indian Real Estate

Companies in an effort to identify effective strategies for real estate developers. Indian real estate

industry operates in a dynamic and high risk environment. It is susceptible to changes in

macroeconomic environment. Real Estate Developers will have to mitigate the risk by

disciplined and close monitoring of cash flows. Their ability to create and maintain self

sustaining cash flows from projects will determine strength of corporate cash budgets. Moreover,

each project should be viewed as an independent cost/profit centre also responsible for

generating its own cash, once seed capital in the form of land, licensing, mobilization capital etc

is put in place.

5

I further felt the need for a strong regulatory framework to provide a level and fair playing field.

In an ambiguous and opaque environment, property buyers and investors suffer alike; hence

there is strong evidence in favor of some kind of regulatory framework. Consumer action groups

and industry insiders also demand policy action by the Government towards establishing a

proper regulatory regime to govern the sector. Laws relating to property registration and transfer,

zoning and approval of construction plans and subsequent marketing and disclosure of utilization

of advances collected from customers should be made mandatory to remove some of the haze

surrounding the whole development process.

In the next chapter we will review the literature and take a close look at the background leading

to the boom and crash thereafter. Economic factors behind the boom and development of real

estate industry in India, its relative importance and business practices adopted by Real Estate

developers, are discussed to enable proper appreciation of the backdrop. In chapter 2 we take a

close look at the six companies, their performance and share price movement over a 5 year

period. In chapter 3 we compare and contrast the strategies of the 6 companies in our sample

group and look at a case study of DLF Ltd‟s IPO. We further analyze the performance trends on

important parameters and draw our conclusions in Chapter 4 and examine the need for a

regulatory framework to regulate real estate development industry in India.

6

Chapter – 1: Background

1.1 Review of Literature

In his well known doctrine of Competitive Advantage and Five Forces Model, Micheal Porter

(1980), argues that businesses should strive to create and sustain competitive advantage, either in

terms of lower cost of production or in terms of product differentiation, which can provide

justification for the existence of the firm. In his lecture on application of competitive strategy and

five forces model for development of strategy for real estate development companies (1989), he

pointed out that this industry in America was characterized by low barriers of entry, identical

cost structures and high degree of competition. In his opinion the companies engaged in this

industry should try to deliver customer value by differentiation. He also pointed out that the

different segments which comprise real estate industry e.g. housing, retail, and commercial,

hospitals and hotels are in fact different industries, with their own separate and distinct business

models. Customers and investors in each of the above respectively, have different value

perceptions and needs. Therefore, real estate industry is virtually a sector of economy and

different segments e.g., retail, housing and commercial offices should be independently

evaluated, and business models for each of them should be created keeping in mind specific

client and investor requirements. The umbrella strategy of doing everything and being all things

to all people, adopted generally by real estate developers, does not contribute any real value. He

further underscored the absence of long term strategic vision and prevalence of “Deal Mindset”

in minds of American Developers.

This research draws inspiration from Porter‟s thoughts. I have tried to look at Indian Real Estate

Industry through Porter‟s prism of competitive advantage and long term value creation. To this

end, I have evaluated the performance of six listed real estate companies, to understand their

growth and performance historically; their strategies to become large pan India companies and

promises held out by them in the IPO document. I have also analyzed their performance after the

IPO; to look at actual delivery made on their promises, and whether the valuations claimed at the

time of IPO were justified. Lastly I have attempted to identify factors helpful in formulating long

term strategy for real estate developers in India.

7

In his book “Housing Sector and the Economy: Global Experiences”, T R Venkatesh echoes

similar thoughts. R. Venkatesh (2008), in his article, Recent Trends in Real Estate Marketing in

India, writes about the contribution of IT Sector to fast growth of real estate sector in India. He

highlighted that the expansion of Indian IT industry impacted profoundly the real estate industry.

Highly paid young IT professionals led the boom by buying into high priced apartments in major

IT centers across the country. The consequential rise in prices and boom leaves him wondering

about the sustainability of the whole growth rate.

Mintzberg‟s (1987) Emergent Strategies model also underscores the need to balance the past,

present and future. Predominance of Grass-root Strategies in the portfolio increases the risk and

long term value creation becomes contingent upon the growth of the larger economy. In case of

company valuation for the IPO, the entire value was driven by Grass-root Strategies. Large land

banks and land purchase agreements, future development potential and calculation of NAVs on

the basis of future cash flows; operations being funded almost entirely by debt and very small

proportion of company valuations coming from Emergent or Deliberate Strategies or „projects

under different stages of implementation is indicative of this.

This paper finds that in India all the developers are doing almost everything, across the board

prevalence of deal mindset; lack of specialization or efforts towards creating a niche market, and

a rush for unrestricted geographical expansion without factoring in economic benefit or even

long term sustainability.

1.2 Evolution and Metamorphosis

Right from independence (15th

August 1947), land has been an intensely emotional issue in

India. In order to correct the imbalances in society, symbolized by large hereditary land holdings

being concentrated in the hands of few feudal families, successive Indian Governments followed

a socialist path. „Right to Property‟ was classified as “Legal Right” as opposed to “Fundamental

Right”. Poor landless peasants and sharecroppers constituted majority of people across the

country. It was considered critical for the development of the country to mitigate the problems of

landless and poor peasantry. Land reforms were implemented to redistribute land for mitigating

poverty following adoption of socialism as the guiding principle for development of the country.

8

Zamindari System (a system of right to collect land revenue over large tracts of land) was

abolished and Land Ceiling Acts were enacted by various State Governments, prescribing the

limits of land holdings of individuals. Separate limits were prescribed for agricultural and urban

land holdings. All extra land holdings were compulsorily vested in the Government. Various

Urban Development Authorities and State Housing Boards were formed and entrusted with the

work of acquiring the extra land and developing the cities and towns across the country.

Government, through its urban development arms and housing boards and municipal

corporations, thus became the largest and most organized player in Real Estate Sector. It still is

the largest player in terms of land holding, size and spread of projects and impact. Private sector

was always a much smaller, fragmented and extremely local presence for decades. It was only in

1980s that we saw emergence of larger companies focused on providing housing and

development of commercial space. DLF, Ansal‟s and Unitech in North India; Hiranandani,

Raheja and Tata Housing in West and Purvankara, Sobha etc in South India emerged as larger

development companies with project development and execution capabilities. This also

coincided with growth of housing finance providers like HDFC, ICICI, and LIC Housing

Finance etc.

With growth in economy, gradual opening up of society and spread of media networks,

consumer sophistication, demand and expectations also changed. Favorable demographic

composition, phenomenal growth of IT industry and general economic growth placed huge

purchasing power in the hands of youth. This provided the boost to real estate sector and laid the

groundwork for the real estate boom of 2001 to 2007.

1.3 Industry Characteristics Observed in Last Decade:

Indian real estate industry witnessed a historical boom during the period 2002 – 2007. Revenues,

volume, profitability and prices of properties skyrocketed. Developers announced a chain of

projects and expanded operations exponentially across the country. Foreign investment was

virtually locked out of this sector, Government of India liberalized direct foreign investment

policy for real estate sector, and billions of dollars were invested in projects across the country.

9

Interest in Real Estate and dearth of quality stocks resulted in companies adopting highly

probabilistic valuation models. NAVs were computed by factoring present value of potential

profits expected from projected sales of built up areas on land being held under purchase

agreement and which was yet to be paid for.

Valuations were extremely stretched, and it was evident that a major correction was in the offing.

Yet driven by collective greed and supported by massive injection of cheap global liquidity,

people throw caution to wind and invested in real estate for short term capital gains, so much so

that residential and commercial units were booked and position liquidated, within a couple of

months, for profit. Prices were rising almost on a weekly, if not on a daily basis.

Some developers went and listed themselves on London Stock Exchange. The timing of boom

coincided with the global liquidity surge. Cheap money sloshed around the system driving asset

prices to unprecedented levels. With this backdrop, after financial crisis, real estate stocks are

barely a pale shadow of themselves.

All these excesses came to nest when the global financial crisis started unfolding in late 2007.

The resulting crash in stock market and its reverberations are still being felt. Real estate

companies have not been able to creep back to their issue prices even almost three years after

their IPOs. In a span of three years, events have reversed the course for real estate developers,

thus erasing the gains made by the industry. In the next section we will try to analyze the

economic factors leading to the boom and fall thereafter.

1.4 The Indian Economy

The annual GDP Growth Rate, Personal Disposable Income Growth Rate and Growth in

Financing, Insurance and Real Estate Sector in percentage terms from the fiscal year 2000-01 to

2008-09 are given in the table below:

10

Table-1 Indian GDP, Personal Incomes and Sector Growth Rates

Year GDP at

Constant

Prices

(Million Rs)

GDP Growth

%age terms

Year on Year

Growth in

personal

disposable

incomes (%)

Growth in

Financing,

Insurance and

Real Estate

Sector

2000-01 18643010 4.35% 9.6% 4.06%

2001-02 19726060 5.81% 10.21% 7.28%

2002-03 20482860 3.83% 5.60% 7.98%

2003-04 22227580 8.51% 10.52% 5.57%

2004-05 23887680 7.47% 9.32% 8.69%

2005-06 26161010 9.52% 12.48% 11.39%

2006-07 28711200 9.75% 13.41% 13.78%

2007-08 31297170 9.00% 12.87% 11.74%

2008-09 33393750 6.69% 7.81%

(Source – Handbook of statistics – Reserve Bank of India)

As seen from above table, a consistent 8-9% growth rate was returned by the economy during the

period 2003-04 to 2007 -08. Personal Disposable Incomes grew at correspondingly higher rate

over this period. As a result growth in Financing, Insurance and Real Estate Sector was also very

high. In fact as evidenced in the chart, this sector mirrored the growth in personal disposable

Income. We can see that there is a marked decline in Growth Rates after 2006-07. GDP Growth

rate fell from a high of 9.75% in 2006-07 to 9.00% in 2007-08 and further to 6.69% in 2008 –

09. Smaller but visible decline was also observed in Personal Disposable Incomes. However, the

rate of growth of Finance, Insurance and real Estate Sector declined quite sharply from a high of

11

13.78% in 2006-07 to 11.74% in 2007-08, and further to 7.81% in 2008-09, pointing to a cooling

down of the sector.

In terms of relative weight of Real Estate Sector to the GDP, we do not have official data.

However some studies have tried to estimate the contribution made by this sector to the GDP.

The report of „Expert Group on Informal Sector Statistics‟ (2006) constituted by National

Commission on Enterprises in the Unorganized/Informal Sector, India had estimated the

contribution of this sector to the economy to be anywhere between 5% to 7% of the GDP, in

study carried out by G Raveendran in 2006. CREDAI (Confederation of Real Estate Developers

Associations of India) puts the contribution of housing sector to be almost 5% to 6%% of the

GDP. We have tried to look at total Market Cap of BSE and compare it with total market cap of

BSE Realty. The market cap of BSE Realty, as recently as on 4th

March 2010 was almost 2% of

the total market cap of all stocks listed on BSE on that date (Table - 2).

Therefore if we assume these that the Real Estate Sector comprises about 5% of the economy

and is capable of growing by say 25% to 30% as claimed by Industry Associations, this sector

could add at least 1% extra growth to the Indian GDP and is extremely important from the

poverty alleviation perspective.

This spurt of growth, from fiscal 2003-04 until 2006-07, was supported by a number of

favorable economic and demographic factors including huge inflow of foreign funds, growing

reserves in the foreign exchange sector, both an IT and real estate boom, and a flourishing capital

market. Growth in IT and ITES industry created unprecedented number of skilled jobs, and large

number of young Indians started earning high salaries. In almost all the IT / ITES locations, this

employment generation caused upsurge in demand for housing and commercial space.

The growth rate of the IT/ITES led service sector was 11.18% in the financial year 2006,

whereas the industrial sector experienced a growth rate of 10.63% in the same period. The

growth rate of the manufacturing sector rose steadily from 8.98% in 2005, to 12% in 2006. The

storage and communication sector also registered a significant growth rate of 16.64% in the same

year.

12

This period also witnessed high investment and high savings rates. Gross capital formation in

GDP rose from 22.8% in the fiscal year 2001, to 35.9% in the fiscal year 2006. Further, the gross

rate of savings as a proportion to GDP registered growth from 23.5% to 34.8% for the same

period.

Chart – 1: Indian Real GDP Growth Rate

(Chart Source: The Economist)

1.5 Reforms in Real Estate Sector

Realizing the acute shortage of housing and commercial space in Indian cities, and potential of

real estate sector in creation of jobs and alleviation of poverty, Government of India decided to

open real estate sector to foreign investment. To encourage transparency and competition

following major reforms were carried out:

1. Government of India supported repealing of Urban Land Ceiling Act (ULCA); by 2007

nine States had already repealed ULCA.

2. Modification in Rent Control Acts to give more protection to home owners to encourage

rental housing investments.

3. Property tax rationalization.

13

4. Large scale computerization of land records.

5. Liberalization of foreign direct investment (FDI) guidelines, enabling large scale fund

flow to the realty sector.

1.6 Real Estate Project Development Process

Indian Real Estate Industry operates in a complex environment. Land is controlled by State

Governments and land laws are enacted by every State Government differently. Major

differences exist in land laws of different States.

A residential project takes anywhere between 2-4 years for development from the date of

receiving the license from the zoning authorities. If we include the time required for aggregating

land and/or obtaining the CLU (change in land usage), this period can easily stretch by a couple

of years.

Fragmented land ownership makes the process of land acquisition cumbersome and problematic.

Absence of digitized land ownership records, and multiple owners belonging to the same family,

further compounds the process.

Large capital is required to carry out following activities before a project can be sold in the

market and developer can collect advance payment from customers:

1. Acquire land or enter into a “Development Agreement” with the landowner, which

entitles the developer to develop the land.

2. Get the land use changed if it is not within a „zoned‟ area i.e., beyond urban limits.

3. Prepare a development plan and get it approved.

4. Once the plan is approved the developer can start marketing the project.

5. Appoint contractors and start construction activity.

14

6. Once the construction is complete, hand over possession and executes registration

documents in favor of the buyer.

Since this process takes anywhere between 2 – 5 years, entire initial costs and any funding gap

(not mitigated out of sale receipts) thereafter, are required to be invested by the developer.

Proper management of cash flow cycle for each project is extremely important. Any delay in

construction results in additional costs on account of interest, overheads etc. etc.

Reserve Bank had imposed restriction on financing of real estate projects by banks. Provisioning

norms for extending bank finance for real estate activity were high. This sector therefore

primarily relied on private financing and advances received from customers. During the high

growth phase ingenious methods were adopted by developers to sustain growth.

1.7 Accounting Practices

Prior to 2005-06, revenue from real estate projects was recognized once the property was

registered in the name of the buyer or the possession of the property was handed over. Therefore,

developers could book sales and profit in their books only at the time of handing over the

possession. This is known as the completed contract method of accounting. Under this system,

all moneys received from customers against sale price, were treated as Advances from customers

and appeared in the liability side of the balance sheet. The total cost incurred was charged to

work-in-progress account and shown on the asset side of the balance sheet till the date of

possession, when it was charged to revenue.

Subsequently, new Accounting Standard - AS-9 was issued by Institute of Chartered

Accountants of India (2006). AS-9 allowed the developers to recognize revenue and profits from

real estate projects, on percentage completion basis, like long term construction contracts. It was

argued that the transaction of sale effectively takes place at the time of entering into an

agreement to purchase the property and the risk and rewards of ownership passes on to the buyer

as soon as he signs that agreement; Developer virtually becomes a contractor, to carry out

construction, on behalf of the buyer.

Introduction of this Accounting Standard allowed developers to recognize revenue of a project

over a number of accounting periods; thus reducing the fluctuation in revenue and profits from

15

year to year in their books. By implication, it also meant that any slowdown in Real Estate sales

would not be immediately reflected in the quarterly results of Real Estate Companies. Typically

assuming a three year project period, it takes three years or 12 quarters, for revenue from a

project to be fully recognized. By implication this meant that if a slow down begins, it may be a

couple of years before the quarterly results actually reflect the effect of such market slowdown.

We can test this fact by looking at the revenue/profit trend lines of our sample companies.

Slowdown actually started in 2007 however; the numbers fully reflect this trend only in 2008-09.

1.8 Residential Real Estate Development

Residential real estate market grew very fast during this period due to rising disposable incomes,

rapidly growing middle class households, low interest rates, fiscal incentives (tax deductions) on

payment of interest and repayment of principals on home loans, increased urbanization and

disintegration of large families. Large scale migration of highly educated young Indian workers,

to work in Information Technology (IT) / Business Process Outsourcing (BPO) outfits in major

cities, provided a boost to housing demand. Cities like Bangalore, Gurgaon, Mumbai, Noida,

Chennai, Hyderabad developed into major IT centers‟, causing a sharp rise in demand for

housing and commercial space.

RBI further relaxed provisioning norms for loans against property. Home loan availability and

development finance for commercial properties were easily available. Banks were providing 20

year mortgages at interest rate ranging from 6% -7%, whereas a few years earlier home

mortgages were not available for less than 12%, moreover the procedure for sanctioning such

loans was also simplified. All these measures reduced cost of borrowing, increased ease of

processing and availability of home loans.

FDI (Foreign Direct Investment) guidelines for investment in real estate projects and repatriation

of profits were liberalized by Press Note-2. For the first time international investors could invest

in small real estate projects in India, earn profits from his investments and repatriate the profits

in accordance with specified rules.

16

Driven by fast growing Indian Economy, demand for housing and commercial real estate grew

multi-fold over 2002 - 2006. Real Estate Consultant Jones Lang La Salle highlighted the

increase in India‟s housing shortage from 19.4 million units in 2004 to 22.4 million units in 2005

-06 stating that is expected to rise further. They further mentioned that the retail market for

mortgages grew by 30% in second quarter of 2004 and is further expected to grow at a CAGR of

17% from USD 16 billion in 2006 to USD 30 billion in 2009. Indian Council of Applied

Economic Research has estimated that the number of households with annual incomes between

Rs 2 million per year to Rs 10 million or more per year is expected to increase by 23 % to 28%,

between fiscal 2002 and fiscal 2010.

1.9 Commercial Real Estate Development and Special Economic Zones (SEZ)

The growth in commercial real estate segment followed the growth pattern of services sector led

by IT/ITES and BPO growth. In the twelve year period between 1994 and 2006, Services sector

grew fastest. As per estimates of Centre for Monitoring Indian Economy, during this period

Agriculture grew by 35%, Industry by 123% and Services by 157% (Monthly review of Indian

Economy – April 2006).

The commercial segment comprises of Office Spaces, Retail Malls, Multiplexes and

Entertainment Facilities. With growing urbanization there is a spurt in growth of all of these

segments. Organized retail requires modern retailing premises. New housing colonies drive

development of Malls and neighborhood shopping centers. New format of retailing e.g.

departmental shops, supermarkets and hypermarkets have come to India. Restaurant chains, hotel

chains, brand marketers, large format stores and mixed use integrated development are major

drivers of commercial real estate.

This segment also saw the introduction of Special Economic Zone concept by the Government of

India. Modeled on the Chinese experience, idea behind the SEZs was to provide a fillip to

exports, by creating islands within the domestic tariff area and providing incentives to units

located within the SEZ. In order to enable large scale private sector participation, and ensure

rapid development, lots of incentives were announced for SEZ developers. Almost all the real

estate developers made a beeline and obtained a number of licenses. Some even sought

17

Government help to acquire land from landowners unwilling to sell, and the whole experiment

was ultimately politicized and became subject to lot of land acquisition related controversy.

1.10 Industry Characteristics:

The Indian real estate industry at present has following characteristics:

I. Most of the development typically takes place around existing urban agglomerations,

akin to clusters or pockets of projects. These projects may be promoted by different

developers but are typically located in close proximity to each other with very little to

differentiate. As a result in normal times the developers chase customers and only in

good times we find the reverse happening except for some exceptionally good projects.

II. Entry barriers are low and anyone having access to land can develop a project. Only real

difference being the specific location of a project and the class of development.

III. Brokers have a very strong say in the market and can influence the market greatly, hence

marketing the project typically requires close co-ordination with the broker community.

IV. Construction activities are funded in major part by the client who is required to make

cash advances on various points of time during the course of development and

construction of a project.

V. Generally commercial projects were yielding higher margins than residential projects.

However ROCE was higher in residential projects due to the fact in case of a well located

project it was possible to finance almost entire construction from client advances.

VI. Commercial properties can either be sold or rented/leased. Lease rentals are then

securitized to monetize income. Whereas, in case of residential properties leasing option

is not available.

VII. Developer carries huge contingent liabilities on account various performance guarantees

and construction contracts.

VIII. Large number of approvals required to start construction process. This is an extremely

cumbersome process.

18

IX. Peculiar nature of risks associated with the industry, economy risk, price risk, customer

preference and some degree of credit risk is also associated with this industry.

1.11 Financing Strategies:

Real Estate Developers adopted various strategies to finance this extremely high growth phase.

In our discussions about individual companies later in this paper, we will see that all of them had

grown very fast in the run up to 2006-07. In fact not only the projects under execution, at the

time of going to IPO, were many times larger than what they had historically completed; the

number and size of the projects which they had planned, was exponentially larger still, and the

land banks which they proposed to acquire for their future projects could probably out last an

entire generation.

In this process all these companies leveraged to the maximum extent possible and their balance

sheets were almost entirely funded by debt. Additionally, they entered into a number of

structured deals with foreign investors to finance projects. Return expectations were extremely

high due to galloping property prices. Large capital gains on land holdings made the transactions

look very simple and extremely lucrative at that time.

Banks unwittingly supported large scale speculation in land banking by providing liberal finance

to developers for construction of projects and easy home loans at zero margins to home buyers.

Another strategy adopted by developers and supported by banks was to disburse upfront to

homebuyer, by making payment directly to the developer, 100% of home loan sanctioned to

purchase a property. In such a case the EMIs would start only from the date possession and the

home buyer would not have to pay any interest during construction period, interest being paid

out by the Developer to the lender by way of subvention payments.

The entire revenue was thus received upfront by the developer who could then utilize this cash to

acquire more land and announce more projects. The flip side of this was huge interest cost being

loaded on to the development process and balance sheets of companies. The liability of the

developer, to pay interest on such loans, was unlimited in case of construction delays. Another

cause of concern was very low stake of buyer in this whole process. An investor could

practically speculate by paying small margin money (0% to 15%) of the cost of house property to

19

the developer, balance 85 % disbursed by the bank upfront, the developer servicing the interest

for the period of construction. Therefore, in case of declining prices, the investor would opt for

backing out of his commitment to take delivery by forfeiting the margin money. This practice,

instead of helping the genuine buyers, increased the risk inherent in such deals.

The catch being that although it was the developer who was liable for payment of interest during

construction period, the loan never appeared in his books, because the investor was the borrower.

In such cases, investors acted as the agent of developer to enable very high over all leverage in

individual projects.

International real estate investors and funds, hedge funds and private equity funds raised lot of

money from investors for investing in Indian Real Estate Market. Due to rapid price rise in land

and property prices, there was a rush to participate in the market. Investors were pressurizing

fund managers to quickly close deals in Indian real estate. As a result a number of unwise,

inadequately evaluated, and improperly valued investments were made by these global investors.

Global private equity funds and investment banks invested billions of dollars in Indian Real

Estate Projects. This created a situation of excess liquidity chasing few good deals in the market.

Many Indian companies went and listed themselves on Alternative Investment Market (AIM) of

London Stock Exchange and raised billions of dollars. Prominent names which went to AIM

market are: Hiranandani Constructions (HIRCO), Raheja Developers (ISHAAN), Unitech, and

Indiabulls. The valuations were again driven by NAVs and hence suffered erosion of values to a

great extent. This virtually shut the AIM market for Indian paper. AIM market was established

by London Stock Exchange for alternative investments i.e., for such companies which would

need relatively smaller amounts of capital and which would find it costly and cumbersome to

approach the main market. AIM market was primarily meant for institutional investors and

provided some liquidity to the investors. Indian real estate developers raised billions of dollars

from that market when the interest in India was at its peak. As soon as markets corrected after

the crisis the valuations evaporated. As a result investors virtually turned away from Indian paper

being offered on AIM market.

20

Chapter – 2 Methodology and Performance Analysis of Sample Companies

2.1 Research Question

In this paper we will attempt to analyze the growth strategy and performance of real estate

industry through a prism of six listed real estate development companies. We will put to test;

their claims about huge company valuations, and justification of high share prices on the basis of

NAV (net asset value), calculated by monetizing the development potential of their land banks.

We will also analyze the extent to which, if at all, these companies actually delivered on their

IPO promise. We would also test the growth strategy adopted by these companies and look at

actual performance to draw lessons in strategy formulation.

2.2 Methodology

The real estate industry in India is large, extremely diversified and fragmented. On one hand we

have large pan India multi-billion dollar corporations like DLF, whereas on the other hand we

have tiny local developers trying to develop very small land parcels in a locality. The problem

was of availability of information, reliability of data and creating comparable performance

metrics for a representative sample. Therefore I decided to focus on listed companies. I looked at

the market capitalization of the BSE and compared it with the market capitalization of BSE

Realty Index and market caps of different realty stocks. A representative sample of six real estate

development companies was chosen, each of these companies were strong in at least one or two

the regional markets of India. This enabled me to create a representative sample which captured

nearly 3/4th of the total realty market cap and which covered the entire country. I have analyzed

following six companies for this paper.

1. DLF Limited

2. Parsvnath Developers Limited

3. Sobha Developers Limited

4. Purvankara Projects Limited

21

5. Housing Developments and Infrastructure Limited (HDIL)

6. Unitech Limited

Even on the basis of current market prices the market cap of the sample companies covers more

than 71% of the realty market cap (Ref: Table -2).

Table – 2: Coverage of Sample

Market Capitalization of BSE on 04.03.2010 (Rs Millions)

56725658

Market Capitalization of Realty on 04.03.2010 (Rs. Millions)

1109149

Market Capitalization of Six Companies 04.03.2010 (Rs.

Millions)

793637

Percentage of Realty to BSE as on 04.03.2010

1.96

Percentage of Six Companies to Realty as on 04.03.2010

71.55

We can see from the above table (Table-2) that Realty comprises almost 2% of the market cap of

all listed stocks. The sample companies comprise almost 72% of the BSE realty index. This

means that we are able to cover nearly 3/4th

of the realty sector by analyzing performance of

these companies.

I decided to study last 5 years performance data of these six companies. Long period of time

enabled me to look at the long term performance, and helped in identifying common trends. In

addition to analysis of numbers, the Draft Red Herring Prospectus (DRHP) of each of these

companies (barring Unitech, since it was listed some time back) were also studied and important

points related to their strategy compared. Line charts were plotted to highlight and compare

trends displayed by these companies. This in turn was compared with stock market prices and

sample average trend line to draw inferences and conclusions.

22

2.3 DLF Limited:

2.3.1 History

The largest real estate development company in India in terms of total area of completed

developments, DLF Limited was a listed company until 2005, when it got itself delisted. DLF

traces its route back to 1946. Initially its real estate business was focused in the Delhi/NCR

region. DLF has developed almost 3000 acres of integrated township in Gurgaon. It was

responsible for bringing GE to India and subsequent development of Gurgaon as an IT hub. As

stated in their prospectus; DLF has developed a cumulative aggregate Saleable area of 224

million sq. ft., comprising of 195 million sq. ft. of Land as plotted developments, 19 million sq.

ft. of Residential, 7 million sq. ft. of commercial properties and 3 million sq. ft. of Retail

properties.

The turnover of the group increased from Rs 2858 million for the year ended 31st March 2003 to

Rs 38390 for the year ended 31st March 2009. PAT increased from Rs 262 million (year ended

31-03-03) to Rs 15478 million (year ended 31-03-2009).

A real estate developer, the DLF franchise over time came to include Cinema, Retail Malls,

Hotels, Clubs, commercial office buildings, power, insurance etc.; the footprint of the company

is spread across India. They launched/planned or were planning projects in almost all large cities

in India.

2.3.2 Performance Indicators

Major performance parameters of DLF over five year period are given in the following Table-3.

The same data is charted (Chart-2), to obtain the trend lines for DLF, to see whether there is any

correlation between the parameters.

23

Table -3 DLF Performance Data

DLF LTD (Rs / Millions)

2005 2006 2007 2008 2009

Total Debt 6332 30139 67693 83864 96150

Income 4798 11450 14295 60584 38390

PAT 677 2275 4057 25746 15478

Book Value (Rupees per share) 1425.43 170.21

4.27 67.82 72.66

Interest cost 331 1461 3563 4476 8099

EBIT 1300 4940 9766 35655 26207

Share Price (Rs.) 0 0 0 687 162

Chart – 2: DLF Performance Chart

We can see from the DLF Performance Chart (Chart – 2) that the Income and PAT went up

sharply between 2005 and 2008 (IPO Year), declining sharply thereafter. In 2005 the Income

was Rs 4798 Million which went up to Rs 60584 million in 2008 and declined sharply to 38390

million in 2009. Total debt and interest however continued to rise the total debt in 2005 was Rs

24

6332 million which went up to Rs 96150 million and the total interest cost went up to Rs 8099

million in 2009 from Rs 339 million in 2005. The sharp decline in Income and PAT highlights

the degree of uncertainty regarding achievability of future projections related to very high

growth and unreasonable profit margins.

2.3.3 DLF’s IPO and Share Price Performance

Table 4: DLF’s IPO & Share Price

DLF LTD.

DATE OF IPO LISTING

11-Jun-07

ISSUE PRICE :

525

TOTAL NO OF SHARES ISSUED :

175000000

TOTAL EQUITY HELD BY

PROMOTERS

BEFORE IPO 97.42% 1490478440

AFTER IPO (WITHOUT GSO) 87.43% 1490478440

TOTAL MARKET CAPITAL OF THE COMPANY

ON BASIS OF ISSUE PRICE (In Millions)

(Economic Times) (As on 11.2.2010)

52110.18

ALL TIME HIGH PRICE 15-Jan-08 1225.00

ALL TIME LOW PRICE 4-Feb-09 124.15

CURRENT MARKET PRICE 11-Feb-10 301.75

In June 2007, DLF Limited issued 175 million shares of Rs 2 each at a price of Rs 525 per share

comprising of 10.26% of its fully diluted share capital after the issue. The issue was

oversubscribed 3.23 times. Rs. Total amount raised was Rs 9187.5 million. It was the largest

public issue of shares by any company in India till then. The share opened at a strong note

delivering 25% gains to investors, and in January /February 2008 touched a high of Rs 1225 per

share. Thereafter it has been a story of consistent underperformance. The current market price is

in the range of Rs 300 to Rs 350 per share. The share price trend line can be seen in „Chart no.

18‟ in Annexure -1.

In the preceding table-4, the key data related to IPO, market price of shares and market

capitalization can be seen. The current market price almost 3 years after the IPO (Rs 302 per

share) is almost 60% of the issue price (Rs 525 per share).

http://www.nseindia.com/marketinfo/equities/quotesearch.jsp?companyname=KPRMILL

http://www.nseindia.com/marketinfo/equities/quotesearch.jsp?companyname=PURVA

http://www.nseindia.com/marketinfo/equities/quotesearch.jsp?companyname=CENTRALBK


http://www.nseindia.com/marketinfo/equities/quotesearch.jsp?companyname=IVRPRIME

http://www.nseindia.com/marketinfo/equities/quotesearch.jsp?companyname=OMAXE

http://www.nseindia.com/marketinfo/equities/quotesearch.jsp?companyname=ALPA

25

2.4 Parsvnath Developers Limited

History

Parsvnath Developers was incorporated in 1990; their initial focus was marketing of Real Estate

projects. Subsequently they started construction of residential projects.

Till the date of DRHP, a total of 17 projects were completed by Parsvnath, these comprise of 9

housing and 8 commercial projects. Parsvnath has built approximately 3.01 million sq. ft. of

residential Projects comprising of 2249 Units and 0.38 million sq. ft. of commercial projects

comprising of 544 units. Most of these projects are located in Noida, Greater Noida and Gurgaon

in NCR Delhi.

Total Income grew from INR 272.95 million in fiscal 2002 to INR 6537.67 million in fiscal 2006

(CAGR of 121.23%) ; during the same period PAT increased from INR 32.97 million to INR

1069.89 million (CAGR of 138.67%).

The company went into an aggressive expansion mode, and planned projects in Gujarat, Madhya

Pradesh, Uttaranchal, Maharashtra, Karnataka, Andhra Pradesh, Kerala.; a total of 13 states and

37 Cities. This was a huge expansion of footprint in a drive to carve out pan-India identity.

Although, at the time of going to IPO, they were present largely in Delhi NCR, Punjab, Haryana,

U.P. and Rajasthan, they further broadened their focus to include non-metro cities in India; like

Lucknow, Moradabad, Greater Noida, Pune, Agra, Dharuhera, Gurgaon, Bhiwadi, Dehradun,

Faridabad, Amritsar, Ahmedabad, Hyderabad etc. etc .

As part of their portfolio diversification they planned to develop 19 Integrated townships, 26

commercial complexes including Malls, Multiplexes, office space, metro station; 24 residential

projects, 13 hotels, 3 IT Parks, 9 SEZ projects.

Parsvnath had decided to focus only on development of projects and consequently outsourced all

non core activities like Architecture, design and construction activities. They only retained

marketing, project management and quality control.

Parsvnath is engaged in development of residential projects, malls, multiplexes, commercial

properties, integrated townships, construction contracts.

They further improved their profitability by taking advantage of tax breaks announced under

section 80IB of Indian Income Tax Act for development of small dwelling units located 25 Km.

outside metropolitan limits of metro cities.

As per DRHP filed with SEBI, Parsvnath had identified 11 projects under development to be

financed out of issue proceeds. These projects were located at Lucknow, Greater Noida, Agra

and Moradabad in Uttar Pradesh; Gurgaon & Rewari in Haryana; Pune and Shirdi in

26

Maharashtra. Total Land Area of these projects was approximately 486,686 Sq. Mts or 120

Acres.

Including the above mentioned 11 projects, the DRHP mentions a total of 24 Residential projects

with a total saleable area of 18.93 million sq. mts., and capital outlay of INR 25963.54million. In

addition to the residential projects a total of 15 Commercial projects with a total saleable area of

2.17 million sq. ft involving a capital outlay of INR 5536.53 million; 11 DMRC projects in Delhi

involving construction of Malls having a saleable area of 1.77 million sq. mts. and capital

outlay of INR 5796.71 million; 19 Integrated townships with a total saleable area of 74.10

Million sq. mts involving capital outlay of INR 74461 million; 13 Hotel projects having a

saleable area of 2.06 million sq. mts and capital outlay of INR 6329 million; 3 IT Parks

involving a saleable area of 3.08 million sq. mts. and capital outlay of INR 4077 million.

In addition to foregoing, two residential projects in Delhi and Faridabad, involving Saleable area

of 1.7 million sq. mts (50% interest in JV), and 9 proposed SEZs comprising of a total area of

20 million sq. mts., was also proposed to be developed by them.


Table 5: Parsvnath Performance

2005 2006 2007 2008 2009

Total Debt

(Millions) 1207 2358 10118 17023 18367

Income (Millions) 3068 6538 12610 17922 7626

PAT (Millions) 656 1062 2718 4087 1130

Book Value

(Rupees per share) 127 20.31 79.06 97.65 103.76

Interest cost (Millions) 11 27 194 391 734

EBIT (Millions) 740 1484 3673 6254 2119

SHARE PRICES (Rs.) 0.00 0.00 260.50 217.50 34.50

27

Chart 3: Parsvnath Performance Chart

We can see from the Table-5 and Chart-3 that over the five year period the total debt increased

15 times from 1207 million to 18367 million, whereas the Income did not grow commensurately.

In fact, while the total debt continued to increase between 2008 and 2009, income went down by

almost 60% in the same period. The Company witnessed a sharp decline in income, PAT, EBIT

and share price. Debt and interest cost however rose sharply

The numbers clearly demonstrate that growth rates and profit margins can fluctuate greatly from

year to year depending upon market forces. In good years the company can return extremely

good performance however, high interest cost and rising corporate debt, implies low margin of

safety.

28

2.4.2 Parsvnath’s IPO and Share Price Performance

Table 6: Parsvnath IPO and Share Price

PARASVNATH DEVELOPERS LTD.

DATE OF IPO LISTING 6-Nov-06

ISSUE PRICE : 300

TOTAL NO OF SHARES ISSUED : 36325800


PROMOTERS

BEFORE IPO 100% 148370400


TOTAL MARKET CAPITAL OF THE

COMPANY ON BASIS OF ISSUE PRICE

(In Millions) (Economic Times) (As on

11.2.2010) 23786.59

ALL TIME HIGH PRICE 7-Jan-08 598.00

ALL TIME LOW PRICE 24-Mar-08 70.20


In November 2006, Parsvnath Developers issued 33.238 million shares of face value Rs 10 each

and share premium of Rs 290 per share, at a price of Rs 300 per share, aggregating Rs 9971.4

million, comprising of 18.30% of its fully diluted share capital after the issue. The issue was

oversubscribed 56.2661 times. The issue also included a Green shoe option of 3.087 million

shares issued at Rs 300 aggregating Rs 926.4 million. The total issue size was Rs 10897.74

million. After a strong opening the share touched all time high price of Rs 598 in January 2008.

Thereafter it has been a story of consistent underperformance. The current market price is in the

range of Rs 100 to Rs 150 per share. The share price trend line can be easily seen from the Chart

-19 in Annexure 1, the movements mirroring those of DLF Ltd.








29

2.5 Sobha Developers Limited

History

Sobha Developers was incorporated in August 1995; they launched their first residential project

in 1997. This project was completed in 2 years. Thereafter, in 1999 they began their first

contractual construction of the corporate block of Infosys Technologies. Till Sept-2006 they

have completed and delivered 21 Residential Projects in Bangalore comprising of 1552

apartments and 2.98 million sq. ft. of super built up area.

They completed their first construction project in Sept-2000. Till Sept 2006 Sobha had

completed 75 Contractual Projects covering 8.42 million sq. ft. and 2 commercial projects in

Bangalore aggregating 0.11 million sq. ft.

Sobha Developers‟ revenue (including other income) grew from INR 1177.10 million in Fiscal

2003 to INR 6284.36 million in fiscal 2006 (CAGR of 74.78%). PAT increased from INR 12.26

million in fiscal 2003 to INR 892.30 million in fiscal 2006 (CAGR of 317.52%)

Sobha is predominantly present in Bangalore as Residential Property Developer. However, they

had executed contractual Projects in 8 states in South and North India till the date of DRHP.

As part of their declared corporate strategy they decided to expand into 12 major cities of India.

They also decided to diversify and do residential projects, townships, malls, SEZs and retail

commercial projects. They further proposed diversification of portfolio by developing Hotels,

Integrated townships, multiplexes and shopping complexes. It was mentioned that they wanted to

enter into development JVs with other private sector entities to undertake large developmental

projects. Expand corporate relationship and execute contractual projects for more corporate

clients.

As on June‟ 2006 declared Land Reserves of Sobha were 2593 acres of land, with potentially

developable area of 118 million sq. ft. in 78 locations in 7 cities across India. Additionally, they

had also made land arrangements aggregating to 3456 acres of land representing a development

potential of 117 million sq. ft., over 13 locations in 3 cities across India.

30

As per Cushman & Wakefield, as on July 2006 the NPV of the Land Reserves was between INR

70356 million to INR 77762 million and after deducting the Developer‟s margin, the land value

of the Land Reserves was between INR 39717 million and INR 43898 million; and the NPV of

the Land Arrangements was between INR 43478 million and INR 48054 million, and after

deducting developer‟s margin, the land value of the Land Arrangements was between INR 23060

million and INR 25487 million.


We can see from the following 5 year performance Table-7 that like its peers, Sobha displays

sharp increase in the amount of Debt and interest cost. Income and PAT increased between 2005

and 2008, falling sharply thereafter.

Table 7: Sobha Developers Performance

2005 2006 2007 2008 2009

Total Debt

(Millions) 2233 4231 5837 17631 19122

Income

(Millions) 5912 6912 12911 14363 9917

PAT

(Millions) 347 886 1615 2283 1097

Book Value

(Rupees per share) 21.87 45.63 111.71 135.38 149.25

Interest cost

(Millions) 109 208 481 615 1052

EBIT

(Millions) 594 1276 2347 3324 2507

SHARE PRICES

(Rs.) 0.00 0.00 722.00 710.50 81.50

31

Chart 4: Sobha Developers Performance Chart

In 2009 the numbers virtually went into a tail spin. The fall in Income and PAT numbers and rise

in total debt and interest cost increased the vulnerability of the Company. It further placed a big

question mark on future growth prospects of the Company. Markets realized that it would be

extremely unlikely to increase the growth rates to levels which would sustain momentum in

share prices. This fact is also reflected in the share price numbers.

32

2.5.2 Sobha Developers’ IPO and Share Price Performance

Table 8: Sobha Developers Performance

SOBHA DEVELOPERS LTD

DATE OF IPO LISTING

20-Dec-06

ISSUE PRICE :

640


8893332


PROMOTERS

BEFORE IPO 99.09% 63421380


TOTAL MARKET CAP OF THE



11.2.2010)

25937.89

ALL TIME HIGH PRICE 8-Jan-07 1128

ALL TIME LOW PRICE 14-Jan-09 67.45


Sobha Developers went public in December 2006, issued 8.89 million shares of Rs 10 each at a

price of Rs 640 per share including a premium of Rs 630 per share, comprising of 12.20% of its

fully diluted share capital after the issue. The issue was oversubscribed 113.93 times. Total

amount raised was Rs 5691.73 million. The share opened strongly and in January /February 2008

reached a high of Rs 1128 per share. Thereafter it has been a story of consistent decline and

underperformance. The current market price is in the range of Rs 200 to Rs 250 per share. The

share price trend line can be easily seen from the Chart no 20 in Annexure -1; the broad trend

displayed by DLF and Parsvnath is also reflected by this stock.








33

2.6 Purvankara Projects Limited

Incorporated in 1986 in Mumbai the operational base of Purvankara was subsequently shifted to

Bengaluru. Till the time of filing the DRHP it had completed 14 Residential Projects with a total

saleable area of 3.59 million sq. ft. and 1 Commercial project comprising of approx 0.18 million

sq, ft of saleable area.

Revenues increased from INR 1510 million in 2005 to INR 4581 million in 2007 (CAGR of

78%) and PAT has, increased from 380 million (year 2003) to 1166 million (year 2007) (CAGR

of 111.69%) (Ref : Table – 9)

The company has presence in South Indian states of Karnataka, Kerala, Andhra Pradesh and Tamilnadu.

Specifically the cities of Bengaluru, Chennai and Kochi,

Purvankara Projects focused on development of residential and commercial/retail properties. They

announced different steps that they would take, in pursuance of their growth strategy, in their DRHP these

included inter-alia; Increase land bank in strategic locations across India(as of July 2007 MOUs/Joint

Development Agreements entered for 43.56 million sq. ft of land near Chennai, not included in the land

bank); Promote and expand the Brand by focusing on quality and innovation; Increase the scale of

operations by proposing to develop more than 30 million sq. ft land in JV with Keppel; diversification by

developing Hotels, commercial projects and going into other locations across India; enter into JV and

Partnerships, expand overseas operations, and in the process they had taken up project in Colombo, Sri

Lanka.

The company held approximately 874 Acres or 38.07 million sq. ft of land at 8 cities in India and in

Colombo, Sri Lanka. The total saleable area on this land would have amounted to 106.80 million sq. ft. Out

of the above the company was, at the time of filing the DRHP, developing 12.20 million sq. ft. saleable

area in Bangalore, Chennai and Kochi. Balance 94.60 million sq. ft saleable area being located across

Bangalore, Chennai, Kochi, Hyderabad, Mysore, Coimbatore, Kolkata and Colombo.


We can see that the trends of rising incomes and profits till 2008, and a sharp fall in income and

profitability thereafter, is consistently returned by all the companies. Total debt and interest cost

display a rising trend over the 5 year period. (Ref: Chart – 5)

34

Table – 9: Purvankara Performance

2005 2006 2007 2008 2009

Total Debt

(Millions) 1007 1622 6761 5823 7195

Income

(Millions) 1510 2804 4581 6570 5451

PAT

(Millions) 380 724 1166 2109 1329

Book Value

(Rupees per share) 135 282 10.9 54.98 61.59

Interest cost

(Millions) 61 72 424 814 994

EBIT

(Millions) 465 898 1749 2990 2349

SHARE PRICES

(Rs.) 0 0 0 242 41

Chart – 5: Purvankara Performance

After displaying a rising trend from 2005 to 2008, the Income EBIT and PAT numbers dipped

sharply in 2009. Total Debt however kept rising; it reached Rs 7195 million in 2009 from 1007

35

million in 2005. If we look at Debt in relation to turnover; in 2005 Income was 1.5 times more

than the total Debt whereas, in 2009 the total Debt reached almost 1.4 times of Income. This

implies huge fixed cost burden on the bottom-line and high leveraging on its Balance Sheet.

2.6.2 Purvankara’s IPO and Share Price Performance

Table – 10: Purvankara’s IPO and Share Price

PURAVANKARA PROJECTS LTD.

DATE OF IPO LISTING

30-Aug-07

ISSUE PRICE :

400


21467610


PROMOTERS

BEFORE IPO 99.99% 191997840





11.2.2010)

20403.37

ALL TIME HIGH PRICE 13-Dec-07 535

ALL TIME LOW PRICE 2-Dec-08 28.00


Purvankara projects issued 21.467 million shares of Rs 5 each at a price of Rs 400 per share

including share premium of Rs 395 per share comprising of 10.03% of its fully diluted share

capital after the issue. The IPO was oversubscribed 1.9233 times. Due to poor response the

original price band of Rs 500 to Rs 525 was reduced to Rs 400 to Rs 425 per share. The shares

were allotted in August 2007 and total amount raised was Rs 8562.75 million.








36

The share reached its peak of Rs 535 in December 2007. Thereafter it has been a story of decline.

The current market price is in the range of Rs 100 per share. The share price trend line can be

easily seen from the Chart No 21 in Annexure -1. Purvankara‟s share price trend also mirrors the

previous three companies.

2.7 Housing Development and Infrastructure Limited (HDIL)

Incorporated in 1996, HDIL had developed 24 projects comprising of 11.287 million sq. ft. of

saleable area till the time of filing its DRHP, this includes Residential Area of 2.07 million sq. ft.

Commercial Area of 0.667 million sq. ft., Retail area of 0.533 million sq. ft. Land development

of 5.7 million sq. ft. Slum Rehabilitation of 2.2 million sq. ft of under slum rehabilitation scheme

of Slum Rehabilitation Authority (SRA).

Total Income has increased from INR 337.07 million for the year ended 31st March 2003 to INR

20964.22 million for the year ended 31st March 2007 and PAT has grown from INR (-28.64)

million for the year ended 31st March 2003 to INR 5481.72 million for the year ended 31

st

March 2007 (Ref Table-11). The company is focused almost exclusively in Mumbai

Metropolitan region. They are doing residential, commercial, retail and slum rehabilitation

projects.

HDIL, as part of its broad strategic initiative disclosed in DRHP the following initiatives:

Continued expansion of land reserves and development rights, expanding geographically into

Kochi, Palghar and Hyderabad, expanding the project portfolio to include Hotels, SEZs, and

Mega Structures for mixed use development and enhancement of slum rehabilitation business.

Total Land reserves of the company comprise of 2574.2 Acres (112.1 million sq. ft.) of land with

a potential developable area of 112.1 million sq. ft. The total saleable area of ongoing is 112.1

million sq. ft. comprising of Residential (86.55 million sq. ft.), Commercial (0.013 million sq.

ft.), Retail (18.994 million sq. ft.), and Slum Rehabilitation (6.426 million sq. ft.). Out of the

above 82.8% area is concentrated in Mumbai Metropolitan Region, 2.2% in Palghar, 6.2% in

Kochi and 8.8% in Hyderabad.


37

Like all the other real estate companies HDIL also shows rising incomes and profit till 2008,

sharp correction in both these indicators in 2009. Debt and interest cost continue to rise all the

while.

Table – 11: HDIL Performance

2005 2006 2007 2008 2009

Total Debt (Millions) 914 1965 3757 31127 41433

Income (Millions) 749 4402 12165 24323 18146

PAT (Millions) 147 1139 5414 14103 7212

Book Value (Rupees) 71.10 37.00 39.37 169.89 162.46


EBIT (Millions) 340 1397 6627 16064 8733

SHARE PRICES (Rs.) 0.00 0.00 0.00 666.00 76.00

Chart – 6: HDIL Performance Chart

38

It is interesting to observe from the above Table-11 and Chart-6 that in 2008 Total Debt

(Rs31127 million) surpassed Income (Rs 24323 million). While the Income dipped sharply to

Rs18146 million in 2009, the Total Debt reached Rs 41433 million, with proportionate increase

in Interest Cost. In 2009 the Interest cost was Rs 5782 million i.e. 31.3 % of Income. The impact

upon share prices was catastrophic.

2.7.2 HDIL’s IPO and Share Price Performance

Table -12: HDIL IPO and Share Price

HOUSING DEVELOPMENT & INFRASTRUCTURE

LTD.

DATE OF IPO LISTING

28-Jun-07

ISSUE PRICE

500


34155000


PROMOTERS

BEFORE IPO 73.08% 131772000





11.2.2010)

108075.84

ALL TIME HIGH PRICE 10-Jan-08 1432

ALL TIME LOW PRICE 9-Mar-09 62.50









39

HDIL issued 29.7 million shares of Rs 10 each at a price of Rs 500 per share including premium

of Rs 490 per share, comprising of 13.86 % of its fully diluted share capital after the issue. The

issue was oversubscribed 5.58 times. Total amount raised was Rs 17078.0 million.

The share opened modestly and in January 2008 touched a high of Rs 1432 per share. Thereafter

it has been a story of consistent decline. The current market price is in the range of Rs 350 to Rs

400 per share. The share price trend line can be easily seen from the chart. This chart also

reflects the same trend as in the case of previous four companies.

2.8 Unitech Limited

Unitech is the second largest real estate developer in India after DLF. It started as a construction

company and then diversified into real estate development. It has a large presence in Delhi NCR

region. It is also developing projects in Kolkata and Mumbai.

Unitech was listed for quite some time; therefore we do not have as much information about

them, unlike for their peers who filed DRHP with SEBI containing history and operational

background.

Unitech has executed residential projects, integrated townships, commercial buildings, retail

malls, entertainment parks, SEZs. It further listed its subsidiary on Alternative Investment

Market of London Stock Exchange and raised USD 750 million dollars.


Unitech was able to repay some of its debt in 2009 by selling majority stake in its telecom

subsidiary. Except for this fact, all the other trends like income and PAT rising till 2008 and

falling thereafter are displayed by Unitech as well.

40

Table – 13: Unitech Performance Indicators

2005 2006 2007 2008 2009

Total Debt (Millions)

0 6382 31578 72162 67757

Income (Millions) 0 6747 25996 29697 24548

PAT (Millions) 0 696 9835 10307 7396

Book Value (Rupees per share) 0 2.76 14.3 13.21 17.62


EBIT (Millions) 0 1406 15036 17239 16420

SHARE PRICES (Rs.) 0.00 0.00 0.00 301.50 31.00

Chart -7: Unitech Performance

41

We can see from the Table-13 that Income increased from Rs 6747 million in 2006 to Rs 29697

million in 2008 and then went down to Rs 24548 million. PAT also went up from Rs 696 million

in 2006 to Rs 10307 million in 2008, declining thereafter to Rs 7396 million in 2009. Debt

however went up to Rs 72162 million in 2008 declining to Rs 67757 million in 2009. We can

clearly see that although Unitech was able to marginally improve its leverage in 2009, the

indebtedness remains critical in relation of its level of activity.

2.8.2 Share Price Movement

Table-14: Unitech Share Price

Unitech shares touched all time high price of Rs 623.60 in May 2007 again making a peak

sometimes in January 2008 as can be observed in the following chart, falling thereafter to an all

time low of Rs 21 in November 2008. Currently the share trades in the range of Rs 65 to Rs 75

per share.

Chapter Summary:

We can see from the foregoing chapter about the six companies and their performance over a 5

year period that all these companies display similar trends. Their market prices peaked at

virtually the same time and have corrected greatly to fall substantially below their issue price

levels. In the next chapter we would look at the trend displayed by these companies on major

parameters and compare and contrast their strategies to help draw conclusions and learning from

the entire exercise.

ALL TIME HIGH PRICE 29-May-07 623.60

ALL TIME LOW PRICE 28-Nov-08 21.80




42

Chapter – 3: Strategic Comparison and Case Study of DLF Limited

3.1 Strategic Comparison:

On reading through the Draft Red Herring Prospectuses of all these companies, we can easily

observe a few common characteristics displayed by all these companies. Moreover, all the

DRHP‟s were identical with very little to distinguish between different offerings.

3.1.1 Market Segment: Residential, Commercial and Retail development activities are carried

out by all these companies. In addition Sobha does lot of contractual work and HDIL is

engaged in Slum Rehabilitation Business. Slum Rehab is peculiar to Mumbai. DLF, and

to some extent Parsvnath, is also present in the business of entertainment. DLF has

further listed „clubs‟ and „power‟ as additional lines of business. These Real Estate

Developers therefore are what can be called „Umbrella Developers‟. They are engaged in

all kind of development activities. In fact except for Sobha, all of them are doing almost

everything. Sobha also signified its intention to diversify into other types of development.

In advanced countries generally there is a clear segregation between residential and

commercial developers. This allows specialization and institutional/public ownership

through REITs. In India however the market is yet to attain maturity and hence it is

possible for a developer to engage in all kind of activities.

3.1.2 Key Locations: We can see that the focus of DLF and Parsvnath is predominantly in

North India. More specifically in NCR and major towns near to NCR Region, e.g.,

Chandigarh, Amritsar, Jaipur etc. Sobha Developers is concentrated in Bangaluru;

Purvankara in southern states of Karnataka, Andhra Pradesh, Tamil Nadu and Kerala,

HDIL focuses exclusively on Mumbai Metropolitan Region. In addition to this DLF had

announced ambitious Pan India plans as part of its DRHP document. It acquired large

land parcels in almost all major cities across India including Mumbai, Chennai,

Bangalore, Pune, Kolkata etc. This trend of expanding to other towns and cities across

India to acquire what was termed as “Pan India Presence” is clearly demonstrated by all

the developers in our sample. Similar ambitious expansion plans to other locations were

announced by other realty players as well.

43

3.1.3 Milestones and Project Execution: Some interesting commonalities emerge on careful

scrutiny of this parameter. When we look at the total quantity and numbers of projects

completed by the developers to the projects which were under execution at the time of

going public, we find that almost all the developers had expanded substantially and were

executing at least three times of what they had completed in last five years. All the real

estate developers were executing large number of projects at the time of going to public.

The cumulative size and number of the projects under execution was many times more

than what they had completed historically. The CAGR displayed in income as well as

profits was abnormally high. Actually we can see a virtual „hockey stick‟ pattern being

displayed by all these companies. As on April 2007 DLF had 7 million sq. ft. of

residential properties, 27 million sq. ft. of commercial properties and 10 million sq. ft. of

Retail properties (cumulative total 44 million sq. ft.) under development. Whereas, till

then i.e. over more than a 15 year period they had delivered a total of 30 million sq. ft.

comprising of 19 million sq. ft. of Residential, 7 million sq. ft. of commercial properties

and 3 million sq. ft. of Retail properties. The consolidated income of DLF increased from

INR 5266 million for the year ended 31st March 2004 to INR 40341 million for the year

ended 31st March 2007. PAT increased from INR 538 million for the year ended 31

st

March 2004 to INR 19413 for the year ended 31st March 2007 (Ref: Table -16). It is

evident from the comparison chart (Chart-8) that similar rapid exponential growth was

observed in all the sample companies.

3.1.4 Competitive Strengths: Almost all the companies listed the following attributes as their

major competitive strengths-

Brand Name and goodwill

Extensive Land Reserve

Better located projects

Experienced Management

44

In addition to the above some also listed their existing partnerships and contractual

relationships as their strengths. Sobha Developers talked about Backward Integration as

their additional advantage. One can see that in absence of any specialization a few

generic qualities were claimed by all these developers.

3.1.5 Business Strategy: In terms of business strategy, we do not see anything special, the

common strategic theme underlying all the DRHPs is of exponential expansion:

expansion of land reserves, geographical expansion across the country, expansion into

new lines of business like retail, multiplexes, hotels, SEZs and township development.

The lines were eerily similar.

3.1.6 Land holdings and Development Potential: All the sample companies have claimed to

have acquired thousands of acres of land banks across country; with hundreds of million

sq. ft. of potential developable area. If we carefully compare the development potential of

these land banks with historical performance growth data, we can easily see that all these

companies grew at phenomenal speed over a three – four year period prior to IPO. They

claimed control over huge tracts of land, in a large number of locations, spread over all

across the country. The potential developable area being many times more than what any

company can reasonably hope to exploit over a 10-12 year period. When we compare it

with their historical performance numbers. Therefore irrespective of all claims about

capability of development, none of these companies could be assumed to continue

expanding, at a rate which would enable development and hence monetization of the land

banks over a reasonable period of time. In addition to this the land holdings, in large part,

were comprised of development rights flowing through “Agreements to Purchase”.

Another substantial chunk was that of partly paid property.

45

3.1.7 Promoter’s Shareholding

Table-15 Promoter’s Shareholding

Company Holding %age before IPO Holding %age after IPO

DLF 97.42 87.43

Parsvnath 100 81.70

Sobha 99.09 87

Purvankara 99.99 89.95

HDIL 73.08 61.45

We can see from the preceding Table-15, that all these companies were closely held by

promoters and/or their close family members. These were virtually one man or one family

company, irrespective of their size or scale of operations, and they diluted only marginally in

the IPO process. Even the most broad based of these, HDIL, had issued shares to close

business associates. Thus we have DLF in which promoters K. P. Singh and family held

97.42% shares before the IPO and HDIL in which Promoters held 73.08% of shares at the

time of going for the IPO. All the other three companies were almost entirely held by

promoters at the time of going to the IPO. Due to small divestment, after the IPO, promoters

continued to own more than 75% of shareholding, outside shareholders relegated almost to

being a fringe minority. The concept of shareholder democracy and corporate governance

was, therefore, almost entirely dependent on the intentions of promoter group.

46

3.2 Note on DLF’s IPO

We have analyzed DLF as a special case, being representative of the larger problem afflicting the

entire Real Estate Sector. Each issue gets greatly magnified due to sheer scale of operations and

size. DLF is perhaps the only developer which was able to create a pan Indian foot print; it

further diversified into all the related verticals. Due to a few peculiar issues connected with it, its

importance, and sheer scale and size, it deserves to be looked as an independent case study. DLF

Limited is the market leader and largest player in Indian real estate industry. In May 2006, it

filed a Draft Red Herring Prospectus with SEBI (the market regulator). Amongst other details

about the company, the prospectus also carried a certificate from a multinational real estate

consultant certifying the NAV of DLF to be about USD 28 - 30 billion. This valuation was based

on estimated discounted cash flow values of potential land banks owned by the company. A

couple of other real estate developers also filed similar offer documents, proposing to raise huge

amount of money, claiming high valuation of their land banks.

The stock markets crashed in 2006, realizing that it would not be possible to come out with the

IPO, DLF withdrew and filed its prospectus again in 2007. The valuation of the company has

suffered at least 30% erosion over 18 month period. Even today almost three years after the

listing, the market price is at least 40% below the issue price. After the IPO, the Chairman and

the Vice Chairman had to issue statements reaffirming their commitment to corporate

governance and to ensure protection of the interest of minority shareholders. This, to me, is a

major illustration of how, ethically questionable business practices, affect future valuation of a

business in a real life situation, even in case of a market leader like DLF. (Please refer to

Annexure -2 for a news paper report on this IPO which corroborates the major points)

3.2.1 Shareholding and Ownership Issues

Originally DLF was a listed company. Promoters held almost 85 % of shares; they decided to

buy the outstanding stock, from the market, without making the mandatory open offer to the

public. This buy out violated the then existing share buyback guidelines. As a consequence, DLF

Ltd. was penalized by market regulator. Even after delisting, a few minority shareholders chose

47

not sell their holding and continued as shareholders. Subsequently, after some time, the

management decided to issue convertible bonds to existing shareholders however, the minority

shareholders did not get the application forms in time and majority group could buy all the bonds

so offered by the company.

This issue was raised in courts by minority shareholders aggrieved at being denied the right to

buy convertible bonds, in what was clearly a very valuable company. DLF pleaded that the share

application forms were posted to shareholders well within due dates. However this was

challenged by postal department, who contested claim by the company and declared the

supporting receipt a forgery. In this case (denial of opportunity to minority shareholders to buy

bonds) the company was directed to come to some kind of settlement with minority shareholders.

It, subsequently, issued equivalent shares to minority shareholders in settlement of the case.

3.2.2 Land Bank and Valuation

Questions were also raised about the correct status of land bank of the company. It was argued

that most of the land was under agreements to purchase, and titles were not in the name of the

company. The projected profits were based on estimates without considering absorption capacity

etc. SEBI (regulator) objected to such practice, and asked clarifications on the valuation.

Subsequently, company filed an updated draft offer document from which the land valuation was

dropped. It was further declared that the company owned only to the extent of 10% of claimed

land bank, and the balance land was under acquisition or purchase agreements. It further used a

sale transaction, which creatively generated very high profits, by selling properties to its sister

concern in order to justify P/E ratios. All these aspects were thoroughly discussed in the media,

analyzed and deliberated upon. The result was that the largest ever IPO (this was the largest IPO

till then) in the Indian markets, at a time when stock markets were booming, could not get full

subscription for the retail portion of the issue (the retail portion was subscribed only to the extent

of 97%).

48

Chapter 4: Trend Analysis , Conclusion and Need for Regulatory Framework

4.1 Trend Analysis: I have carried out trend analysis on various important parameters as

displayed by all the six companies and charted the same. Major findings are discussed hereafter:

4.1.1 Income

Table-16: Income

INCOME 2005 2006 2007 2008 2009

DLF LMITED 4798 11450 14295 60584 38390

UNITECH 0 6747 25996 29697 24548

PARASVNATH 3068 6538 12610 17922 7626

SOBHA

DEVELOPERS 5912 6912 12911 14363 9917

PURVANKARA 1510 2804 4581 6570 5451

HDIL 749 4402 12165 24323 18146

SAMPLE AVG. 3207 7771 16512 30692 20816

Chart – 8: Income

49

We can see from Table -16 and Chart - 8, that for all the six companies Income trend is secular

and common. The incomes rising fast till 2008, sharply falling thereafter. This mirrors the

economic trend displayed by the economic growth numbers of RBI. It also points to a

significant fact that it is impossible for a company to maintain the „hockey stick‟ pattern of

growth for a very long period of time, and sooner or later, the averaging out will take place in the

form of a correction. The IPO pricing and company valuation therefore has to factor in the

economic risk inherent in every business.

New Accounting standards introduced in 2006 allowed the companies to recognize revenue on

the basis of percentage completion of projects. This essentially implied that sales from a project

were reported as income from the accounting year in which at least 30% of the project was

completed. Therefore, the spike in income that we notice in 2008 is due to spurt in sales during

2006 and 2007. Most of the projects which these companies marketed in 2006 and 2007, were

under construction and advance bookings made during these two boom years were reported

partly in 2007 and in 2008(after 30% construction was completed), hence the spike in Income

numbers in 2008 and fall thereafter. This is further reinforced by falling receivables in 2009. We

will look at receivables later in this chapter.

4.1.2 Profit after tax

Table – 17: Profit After Tax

PROFIT AFTER TAX CHART (RUPEES IN MILLIONS)

2005 2006 2007 2008 2009

DLF LMITED 677 2275 4057 25746 15478

UNITECH 0 696 9835 10307 7396

PARASVNATH 656 1062 2718 4087 1130

SOBHA DEVELOPERS 347 886 1615 2283 1097

PURVANKARA 380 724 1166 2109 1329

HDIL 147 1139 5414 14103 7212

SAMPLE AVG. 441.40 1356.40 4961.00 11727.00 6728.40

50

Chart – 9: Profit After Tax

PAT also mirrors the Income trend. We can notice the sharp spike in numbers between 2006 and

2007 (Refer Table – 17, Chart – 9). In fact 2006 - 2007 was probably the best year for property

sales and marked high point in property market. The profit numbers are also important because

the cost structures remained either same or increased due to higher interest cost. The cumulative

impact on bottomlines of these companies was greater. In fact, new accounting policies pursuant

to new guidelines pertaining to revenue recognition (Percentage Completion Method) created a

revenue overhang, which compounded the problem by making the correction appear steeper than

what it would have been.

4.1.3 NET Profit after Tax (%age):

Table – 18: Net Profit (After Tax)%age

NET PROFIT (AFTER TAX ) PERCENTAGE CHART

2005 2006 2007 2008 2009

DLF LMITED 14.11 19.87 28.38 42.5 40.32

UNITECH 0 10.32 37.83 34.71 30.13

PARASVNATH 21.38 16.24 21.55 22.80 14.82

SOBHA DEVELOPERS 5.87 12.82 12.51 15.90 11.06

PURVANKARA 25.17 25.82 25.45 32.10 24.38

HDIL 19.63 25.87 44.50 57.98 39.74

SAMPLE AVG. 17.23 22.19 34.04 41.20 32.09

51

Chart – 10: Net Profit (After Tax) %age

The Chart No 10, is prepared on the basis of net profit expressed as a percentage of total

income. It is a chart which displays profitability as opposed to profit as a number. We can see

that the profitability for each of these companies is different. If we analyze and compare the

numbers (Ref: Table - 18) it is clear that Sobha, Parsvnath, Purvankara, Unitech, DLF and HDIL

are increasingly more profitable. In fact if we compare the profitability with sample average we

find that other than HDIL almost all the other companies are below average. Some like DLF,

HDIL and Parsvnath display sharper spikes and troughs, whereas other like Unitech, Purvankara

and Sobha did not fall that sharply. The main reason for the sudden spurt in profitability is sharp

increase in land prices which, when factored in prices of apartments and built up spaces, allowed

these companies to report above normal profit percentages. The historical cost of acquisition of

these land banks was very low, and due to rise in price of properties, the companies were able to

realize these capital gains. The increase in cost of construction was marginal in comparison to

increase in land price. This is also the reason why HDIL is more profitable than the others.

Unlike other companies HDIL is exclusively focused in Mumbai region. The cost of properties

52

in Mumbai is relatively much higher than the cost of construction. Therefore the inherent

profitability of HDIL is much higher.

4.1.4 Receivables

Table – 19: Receivables

RECEIVABLES CHART 2005 2006 2007 2008 2009

DLF LMITED 35 255 1738 9301 2129

UNITECH 0 765 975 7397 7930

PARASVNATH 434 638 4226 11302 10433

SOBHA DEVELOPERS

364 803 1577 5452 3553

PURVANKARA 200 446 459 824 1146

HDIL 7 774 3103 558 1654

SAMPLE AVG. 208 736 2416 6967 5369

Chart – 11: Receivables

Receivables are a very important indicator of fiscal health. Not only does it indicate a healthy

cash pipeline, it further ensures regular profits. As soon as a sale agreement is executed by a

developer, the proportionate amount of money can be debited to client account as a

“Receivable”. A fall in receivable may indicate slow execution of projects or lack of new

projects in the pipeline of developer. Continuous fall in this number can indicate possible cash

flow problems down the line. A continuous rise may also indicate poor recoveries from

53

customers and risk of defaults in a big way. We require company specific information to be more

specific. In our sample we find all kinds of trends, for DLF, Sobha and to some extent Parsvnath

the receivables display a fall, however in case of HDIL and Purvankara they display a rise (Refer

Table – 19; Chart – 11).

Different companies are present in different markets and hence have different customer profiles.

This also indicates that not all the real estate developers have similar projects or customer

profiles and market dynamics also play a role.

4.1.5 Net Worth:

Table – 20: Net Worth

NET WORTH (RUPEES IN MILLIONS)

2005 2006 2007 2008 2009

DLF LMITED 4989 6434 6528 112792 123748

UNITECH 0 2245 11610 21438 28596

PARASVNATH 1016 2011 14627 18066 19196


PURVANKARA 540 1128 2092 11711 13118

HDIL 711 1850 7087 36357 44677

SAMPLE AVG. 1582 3007 10020 42049 48046

54

Chart – 12: Net Worth

Net worth of all the companies displayed sharp year on year growth which peaked at the time of

IPO and tapered thereafter. It is evident that pace of growth slowed and hence the line charts

display this characteristic with a tapering slope. In fact Unitech does not display any spike, there

was no IPO by Unitech hence, the absence of spike in Net Worth ( Refer Table – 20; Chart – 12).

4.1.6 Debt Equity Ratio:

Table – 21: Debt Equity Ratio

DEBT EQUITY RATIO

2005 2006 2007 2008 2009

DLF LMITED 0.83 3.99 1.63 0.41 0.58

UNITECH 0 2.43 2.03 2.14 1.74

PARASVNATH 1.19 1.05 0.51 0.68 0.80


PURVANKARA 1.77 1.35 2.69 0.40 0.43

HDIL 0.57 1.06 0.53 0.54 0.92

SAMPLE AVG. 1.35 2.44 1.61 1.08 1.17

55

Chart – 13: Debt Equity Ratio

Almost all the companies in our sample were highly leveraged till the IPO. Post IPO debt equity

ratio improved, however, with falling Income and profits and increasing levels of total debt and

interest cost, the ratio again started to rise in 2009. It would be interesting to observe this trend

over a longer period of time to understand how these companies manage their leveraging and

debts. We can make out a clear case of companies not being able to generate sufficient cash to

finance/sustain their growth. This also increases the risk perception of investor, share prices

therefore, are liable to witness wild swings (Refer Table – 21; Chart – 13).

56

4.1.7 Total Borrowings

Table – 22: Borrowings

TOTAL DEBTS CHART

2005 2006 2007 2008 2009

DLF LMITED 6332 30139 67693 83864 96150

UNITECH 0 6382 31578 72162 67757

PARASVNATH 1207 2358 10118 17023 18367


PURVANKARA 1007 1622 6761 5823 7195

HDIL 914 1965 3757 31127 41433

SAMPLE AVG. 2339 9339 25149 45526 50005

Chart – 14: Total Debts

This is very important indicator of how the growth of a company is funded. If we read this

together with Debt Equity Ratio and Profitability, we will find that the level of cushion available

to these companies for absorbing fiscal shocks has worsened post financial crisis. Debt Equity

Ratio improved for these companies due to infusion of capital at the time of IPO, but these

companies have not been able to reduce their reliance on external debt. The operating cash flows

57

of these companies are unable to sustain the operations or growth. This increases the risk

perception inherent in the numbers (Refer Table – 22; Chart – 14).

4.1.8 Interest Cost

Table: 23 Interest Cost

INTEREST COST 2005 2006 2007 2008 2009

DLF LMITED 331 1461 3563 4476 8099

UNITECH 0 325 1588 3584 6854

PARASVNATH 11 27 194 391 734


PURVANKARA 61 72 424 814 994

HDIL 166 106 445 1385 5782

SAMPLE AVG. 136 440 1339 2253 4703

Chart – 15: Interest Cost

58

The most interesting aspect here is that the interest cost continued to increase at virtually the

same rate. This implies that operating cash flows have not helped in reducing the rate of growth

of borrowings and companies are still heavily dependent on debt to finance their operations. In

case a company has large debt and consequent high interest cost burden, its fortunes are

susceptible to even small changes in interest rates. If interest rates go down the share prices of

such highly leveraged companies go up and in an atmosphere of rising interest cost they may

become depressed.

4.1.9 Return on Net Worth

Table – 24 : Return on Net Worth

RETURN ON NET

WORTH

2005 2006 2007 2008 2009

DLF LMITED 13.57 35.36 62.15 22.83 12.51

UNITECH 0.00 31.00 84.71 48.08 25.86

PARASVNATH 64.57 52.81 18.58 22.62 5.89


PURVANKARA 70.37 64.18 55.74 18.01 10.13

HDIL 20.68 61.57 76.39 38.79 16.14

SAMPLE AVG. 44.42 61.93 63.47 34.69 16.12

59

Chart – 16: Return on Net Worth

We need to carefully look the preceding Table - 24 and Chart- 16. RONW peaked in 2007 for 5

companies (just before the IPO), sharply falling thereafter. Parsvnath was the first company to go

for the IPO, its profitability peaked in 2005, continuously falling thereafter. Profitability of the

companies could not be maintained on an expanded capital base. This could be one of the

reasons why the share prices peaked between December 2007 and January 2008. In fact, once

third quarter results were announced, markets factored out that the companies will not be able to

consistently improve or even deliver the RONW; and share prices of these companies never

recovered thereafter.

60

4.1.10 Return on Capital Employed (ROCE %)

Table: 25 Return on Capital Employed

RETURN ON CAPITAL

EMPLOYED

2005 2006 2007 2008 2009

DLF LMITED 5.98 6.22 5.47 13.09 7.04

UNITECH 0.00 8.07 22.77 11.01 7.68

PARASVNATH 29.51 24.31 10.98 11.65 3.01


PURVANKARA 24.56 26.33 13.17 12.03 6.54

HDIL 9.05 29.86 49.93 20.90 8.38

SAMPLE AVG. 16.22 22.12 22.77 15.40 7.26

Chart – 17: Return on Capital Employed

ROCE measures the effectiveness with which the company deploys the capital available.

Efficient companies display high ROCEs. In case of our sample of real estate companies we can

observe that the ROCEs peaked between 2007 and 2008 and declined thereafter. The efficiency

61

of these companies took a big hit. And they were unable to maintain the profitability of their

operations. (Refer Table – 25, Chart : 17)

4.2 Discussions and Conclusion

4.2.1 Identical Growth Pattern

If we take a look at the growth of the six companies in our sample, we can immediately spot the

identical pattern displayed by trend lines in the run up to the IPO. All the companies reported a

sharply rising Income and Profit numbers which sharply fell after 2008. Profit after Tax (PAT)

and Return on Capital Employed (ROCE) also display similar pattern. Companies were

borrowing heavily and the Debt Equity Ratio could improve only for a short period after IPO.

Borrowings and Total Interest Cost continued to increase even after the crash. All these factors

indicate that the real estate developers were carrying a very high risk on their balance sheet.

4.2.2 Unsustainable Project Pipeline and Land Banks

All the companies in our sample grew very fast. Total number of projects under execution, at the

time of reporting in their DRHP, was many times more than what they had hitherto executed.

The number of projects that were being planned was larger still. This can be best illustrated by

the following excerpt from preceding Chapter -:

As on April 2007 DLF had 7 million sq. ft. of residential properties, 27 million sq. ft. of

commercial properties and 10 million sq. ft. of Retail properties (cumulative total 44 million sq.

ft.) under development. Whereas, till then i.e. over more than a 15 year period they had delivered

a total of 30 million sq. ft. comprising of 19 million sq. ft. of Residential, 7 million sq. ft. of

commercial properties and 3 million sq. ft. of Retail properties.

In its DRHP Sobha Developers stated that they had launched their First Residential Project in

1997 and till Sept-2006 they had completed and delivered 21 Residential Projects comprising of

1552 apartments and 2.98 million sq. ft. area.

We can contrast this historical performance with their potential developable area, which

according to their DRHP, as on June‟ 2006 Land Reserves were 2593 acres of land, with

potentially developable area of 118 million sq. ft. in 78 locations in 7 cities across India.

62

Additionally they had made land arrangements aggregating to 3456 acres of land representing a

development potential of 117 million sq. ft., over 13 locations in 3 cities across India.

Even assuming historical cost of development and working capital requirements, it does not take

much to realize that just to execute such large number of projects, and achieve this scale of

development in a reasonable time frame; all these companies would actually require many times

their existing capital and other resources.

4.2.3 Identical Product Mix (Absence of Specialization)

Reading the growth strategy and intention as expressed in the DRHP, I became immediately

aware of the fact that all these companies were trying to develop almost all types of projects

simultaneously across a huge geographical area. India is a continent size country with low per

capital income. Creating an organization which can simultaneously develop a variety of large

real estate projects under the same set up is an extremely expensive proposition.

This expansion binge implied large increases in salaries, wages and construction overheads. It

also resulted in increases in cost of operations, large corporate staff and other overheads.

Moreover, geographical expansion meant that all the large developers were virtually competing

with each other in all the major markets across India with similar products. With very little to

distinguish or differentiate, huge advertising and marketing spends were made to achieve sales.

This further pushed the cost of marketing. Critical shortfall in housing development in India is

considered to be the major driver of growth of real estate industry. Yet we find that marketing

costs were substantially high and kept getting higher. This was due to the fact that most of these

developers expanded in most of the major cities with similar products.

4.2.4 Overleveraging

In order to finance acquisition of such large land banks the developers relied on borrowings. The

basic assumption was that the rising property prices will enable monetization of projects

profitably at a later date. All such calculations were made without taking into account the

absorption capacities of the various micro markets, competition and number of projects being

planned by other developers in the nearby locations.

63

This debt overhang, and rising interest cost, impacted the bottomlines of the companies and at

the same time reduced operating cash flows. This resulted in „Asset Heavy” and “Cash Poor”

balance sheets, whereas development of real estate projects requires cash heavy balance sheets.

This fact was also underscored by Michael Porter in his lecture upon real estate (annexure…).

4.2.5 Company Valuations and Pricing of Shares

I have compared the IPO Price, Book Value and PE Ratios at the time of going to IPO to find out

how companies have tried to justify pricing of shares.

Table: 26 Share Price Valuation

Company 12 months

trailing

EPS as

per

DRHP

P/E Ratio

At IPO

price

NAV Per Share

As Per DRHP

(Rs)

IPO Price

(Rs/Per

Share)

Market Cap at

IPO price

(Million Rs)

DLF 12.80 41.01 26.22 525.00 895000

Parsvnath 7.21 41.61 13.56 300.00 54481

Sobha 13.96 45.85 29.97 640.00 46654

Purvankara 6.79 58.91 11.55 400.00 85380

HDIL 30.45 16.42 40.68 500.00 107219

We can see from the above chart that the shares were issued at a very high PE Ratio. Potentially

high future growth rate, on the basis of large land banks amassed by these developers, formed the

justification for claiming such high market caps. If we take a look at the ROCE figures, it

becomes amply clear that even in the best of times such high market caps could not be justified.

Essentially, the companies wanted to use IPO proceeds to pay for Land Banks. Catch being, that

the entire future profits from these land holdings were already capitalized in the share prices,

leaving very little upside for the investors in equity shares. Immediately after crisis, investors

realized this fact, hence this brutal correction in stock prices.

64

4.2.6 Lack of Transparency

Real Estate Development is essentially an activity which comprises of aggregating land,

conceiving a project thereupon, mobilizing resources, get the licenses and approvals for

construction and marketing the project to the targeted clientele. Profitability of a real estate

developer is the aggregate profitability of all its projects, at the corporate level cash flow of the

development company is the net aggregate cash flow from all its projects as adjusted for

corporate expenses and interest payments. Total assets can comprise of all kind of land

development agreements, receivables, even liability for subvention payments on certain home

loans. The quantitative project wise cost, profitability, receivables and stock reports do not form

part of the published accounts. We have no way of knowing whether a project is delayed, being

implemented on time, profitable, unprofitable etc. etc. The numbers do not tell us the impact of

cost over runs, contingent liability on account of delays and defaults etc. It is extremely difficult

in such circumstances to formulate a clear picture about the future growth of a real estate

development company. Companies are also not required to disclose project wise cash flows and

whether and to what extents fund have been diverted to other projects or activities like land

acquisition. All this create a virtual opaque wall around the operational and fiscal health of a real

estate developer. In such a situation objective judgment becomes a casualty.

4.2.7 Promoter Driven Companies

All the real estate developers are closely held promoter driven outfits, not withstanding a lineup

of highly paid professionals on their rolls. Promoters divested, what were very small stakes

(between 10% -20%), to the public (Refer Table – 15). As a result outside shareholders had very

little impact on day to day working of these companies. Companies continued to remain

promoter driven, Board of Directors were mostly ornamental. Shareholders democracy and

transparency was ignored. Result was continuation of the old practices, albeit with a slight

difference to meet the minimum listing guidelines and SEBI rules. All these companies took no

advantage of this opportunity by refusing to broad base their Boards or change their style of

functioning. Investors punished these companies by moving out of their stock and not returning

even when the broader market improved.

65

4.2.8 Emerging Future Trends

In order to benefit from the foregoing discussions, I have tried to identify various trends which

have emerged or which may emerge in future.

Real estate markets in developed economies are highly structured, and have matured into a

clearly outlined „Investor – Developer - Owner – Manager‟ structure. Additionally, financing

institutions play a major role in providing capital for real estate projects. Developers are mostly

specialized in a particular segment of real estate development.

In India specialization amongst developers may emerge, albeit very slowly, over a period of

time. As seen from the foregoing research, almost all the developers are developing every

possible class of real estate; townships, condominiums, commercials, retail malls, hotels,

hospitals etc.). Gradually developers may find it more profitable and efficient to, and hence

gravitate towards, specialize in one or more class of development.

Presently, real estate is dominated by individual or corporate ownership in India. Unlike matured

markets, India does not yet have collective ownership vehicles e.g., REITs or Real Estate Mutual

Funds or Tenants in Common Partnerships, Fractional Ownership is virtually unknown.

Existence of such collective ownership vehicles enables pooling of large amount of capital and

brings greater transparency in the financing of the development process. We may witness a

movement towards Institutional Ownership for high cost projects

We can clearly identify the need for a broad based and effective regulatory framework to control

the real estate development activity. The regulation should preferably prescribe entry criteria to

start development business. It should also prescribe mandatory disclosures regarding progress of

projects and cash flow positions. This would enable the customers and buyers understand how

their money is being utilized. Since all the developers utilize advance payments from customers,

to fund the construction process, customers have a right to know how their money is being

utilized and the progress of the project in which they have invested the money. This would also

help increase the transparency in the trade.

All the assured return and minimum guarantee assured return projects should be brought within

the ambit of deposit control regulations and effectively monitored and disclosed in the balance

sheets.

66

In view of global warming and effect on environment, need to migrate towards environmentally

friendly construction practices, is increasingly being felt. We need to encourage development of

green buildings and townships and use of locally available construction materials for low cost

housing by giving tax breaks wherever feasible.

Market segmentation has started to become more prevalent after the crash e.g. low cost housing,

middle class housing, and premium office space. To mitigate acute housing shortage

Government is providing interest cost subsidy on budget housing for lower middle class. This

has prompted almost all the developers to innovate and reduce the cost of property to qualify for

this segment.

4.2.9 Conclusion:

During the course of this paper I have analyzed the environment and industry context in which

Real Estate Industry operates in India. We have also tried to catch a glimpse of future as it may

unfold. It can be inferred from the foregoing analysis that real estate industry operates in a

dynamic and high risk environment. It is susceptible to changes in macroeconomic environment.

The developers and investors alike will have to take steps to mitigate and insulate themselves

from this risk.

The risk mitigation will, to a large extent, depend upon disciplined and close monitoring of cash

flows. If the cash flows from some projects are not self sustaining, and they put pressure on the

corporate cash budgets, it may be preferable to delay the implementation of such projects.

Moreover, this also implies treating each project as an independent cost/profit centre which is

also responsible for generating its own cash, once seed capital in the form of land, licensing,

mobilization capital etc is put in place. This would insulate the cash flow problems and localize

them to particular projects.

Developers should focus on time bound deliveries, and development of existing projects. Faster

development will prove the ability of the company to scale up its operations and deliver quality

products. This is likely to add to the premium, if and when it goes public. Moreover, this would

also help unlock the value embedded in the assets and increase velocity of asset turnover.

I will try to summarize the key points which have evolved out of foregoing discussion. These

should be kept in mind whenever major project commitments are pledged.

67

1. In a dynamic and high risk environment, effective risk management is the key source

of competitive advantage.

2. Close cash flow monitoring and focus on cash flow neutral (to the extent possible)

project development cycle is critical for health of a large real estate development

company.

3. A real estate developer should formulate growth strategy after closely evaluating the

business model vis-à-vis opportunities in the market and decide on long term

competitive positioning of the company.

4. Positioning and differentiation will enable higher value capture by developers and

appreciation in brand value.

5. Share valuation is a function of profitability and consistent growth. It is extremely

difficult to justify very high share prices for a futuristic business model, driven by

leveraging and very high fixed interest cost.

4.3 Need for Real Estate Regulator

During the course of this paper we have taken a close look at the growth and development of real

estate industry in India. We have also analyzed factors which led to unprecedented boom in

fortunes and valuations of real estate companies and caused an equally loud crash. We have seen

the practices followed by the industry and to what extent they are geared towards suiting the

desires of the promoters of the company and their hunger for quick money.

In this rush for faster growth a couple of fundamentally important aspects related to the industry

get completely sidelined. One relates to protecting the interest of the consumers and the other

equally important aspect relates to protection of public interest. In the absence of an institutional

framework to regulate the industry, and the ensuing free for all environment, both these

extremely important aspects get ignored completely.

Builders typically try to maximize efficiency by constructing as much as possible on a piece of

land. In this process they also adopt some unfair practice like charging buyers on the basis of

super built area (SUA), whereas they deliver carpet area to apartment owners. There is no

68

standard definition of this Super Area concept, the result being different projects in different

locations are loaded with different multiplying factors to compute super area. In cities like

Mumbai almost 50% loading is made on account of projections, common areas and balconies for

claiming such high super area.

In case of group housing projects, developers charge for all facilities from the customers and try

to retain many assets like parking, club, common areas and services in their control. These

practices give rise to disputes after new inhabitants move in and also cause exploitation.

Some of the common consumer complaints against developers relate to registering of the same

property in the names of two or more buyers, not delivering the promised built-up area and

amenities, besides defaulting on refunds, and delaying delivery. Some even charged interest for

belated payments while not following the same when it came to delays at their end. A few

builders even cancelled allotments on flimsy pretext after collecting large amounts as advance

payments.

On top of all this builders have been known to encroach on public land, violate building norms,

illegally construct and sell properties, damage the environment, draw ground water without

obtaining approvals and pollute the environment by adopting outdated construction technologies.

To prevent all this and regulate the trade the need for a regulatory authority is acutely felt. Land

being a state subject in India, Central Government can only enact model regulatory provisions to

guide State Governments and persuade them to follow and enact similar laws. More transparency

in disclosures by developers about use of money collected from customers, sale and purchase of

apartments on the basis of carpet area and following the building norms and protection of

environment can be achieved by such a framework.

Enabling flow of institutional money to creating infrastructure, and development of habitable and

environment friendly cities and towns, require progressive legislation aimed at facilitating

mobilization of public money through REITs, REIMFs and structures like Tenants in Common

Partnerships. These would enable legislation keep pace with developments on ground and help

regulate the growth of business in the overall interest of all stakeholders.

69

The Government of India has recently brought about a model bill called the Real Estate

(Regulation of Development) Act, with a view to establish a Regulatory Authority and an

Appellate Tribunal to:

1. Regulate, control and promote planned and healthy development and construction, sale,

transfer and management of colonies, residential buildings, apartments and other similar

properties

2. Host and maintain a website containing all project details, with a view to:

Protect public interest in relation to the conduct and integrity of promoters and other

persons engaged in the development of such colonies and

Facilitate the smooth and speedy construction and maintenance of such colonies,

residential buildings, apartments and properties and for matters connected therewith or incidental

thereto.

The Bill has Seven Chapters. Chapter II provides for Regulation of Development of Colonies

and Promotion of Construction, Sale and Transfer of Residential Buildings, Apartments and

Other Similar Properties. Under this provision, all developers and promoters are required to

compulsorily register with the Regulatory Authority before they can market or develop projects.

Registration of promoters by the authority can be cancelled if anybody makes a complaint

against them for violations against the provisions of this act. Chapter III casts a responsibility of

the Promoter to make available for inspection, all documents and information to persons

intending to take plot or building or apartment in the real estate project. Chapter IV provides for

the creation of a Regulatory Authority.

70

Bibliography

1. Competitive Strategy for Real Estate Development : Speech by Michael Porter to

Harvard Business School Real Estate Symposium, 1989

2. Growth Strategy for Real Estate Business of Vatika Limited- Reflection paper by

Sharad Jhingan for Module 2, IMPM Cycle 12.

3. Competitive Strategy : Techniques for Analyzing Industry and Competitors by

Michael Porter 1980

4. Competitive Advantage : Creating and Sustaining Superior Performance by Michael

Porter 1985

5. Crafting Strategy : Henry Mintzberg Harvard Business Review 1987

6. Indian Real Estate: Opportunities and Returns: Knowledge Paper by Ernst & Young

for FICCI (Federation of Indian Chambers of Commerce and Industry) September

2006.

7. Expert Group on Informal Sector Statistics (Delhi Group) : Paper by G. Raveendran

8. India Property Sector Outlook a Research Report by CLSA Asia Pacific Markets

dated 25th

January 2007

9. Company Research Report on DLF by CLSA Asia Pacific Markets dated 5th

September 2007

10. Draft Red Herring Prospectus of 5 Companies i.e., DLF, Parsvnath, Sobha

Developers, Purvankara Projects and HDIL.

11. Guidance Note on Recognition of Revenue by Real Estate Developers- By Institute of

Chartered Accountants of India – June 2006 issue of the Institute‟s Journal

12. Annual Reports and Published Accounts of all six companies for the period 2005 to

2009.

13. News paper Reports and Articles from Times of India and Other News Papers related

to Real Estate (see annexure-3)

14. World Bank Statistics on India

15. Handbook of Statistics on the Indian Economy – Reserve Bank of India 2008-09.

16. India‟s Rising Growth Potential – Goldman Sachs Global Economics Paper no. 52 –

2007.

17. Capital Flow Outlook for India‟s Real Estate Market – Jones Lang La Salle Meghraj

2009.

18. Indian Realty Milestones – Jones Lang La Salle Meghraj

19. CB Richard Ellis – Retail Overview – 1H 2009

20. CB Richard Ellis – Office Market Review 2009

21. Deutsche Bank Research Report on Indian Real Estate Market – 2006

22. “Housing Sector and the Economy: Global Experiences”, by T R Venkatesh

23. T R. Venkatesh, 2008, Recent Trends in Real Estate Marketing in India, The Icfai

University Journal of Services Marketing, Vol. 6, No. 2, pp. 57-62, June 2008

71

Annexure – 1: Share Price Movement Charts

Chart – 18: DLF Limited

72

Chart – 19 Parsvnath Developers

73

Chart – 20: Sobha Developers Ltd.

74

Chart 21: Purvankara Projects Ltd.

75

Chart: 22 HDIL

76

Chart 23: Unitech Ltd.

77

ANNEXURE -2

Printed from

MUMBAI: All’s well that ends well. The cliché holds true for what is now India’s biggest real estate

company DLF, which listed on the bourses last week. Soon after listing, the company became the eighth

most valuable in the country and its promoters P Singh and family are now the fourth wealthiest Indians

behind the Ambani brothers and Sunil Mittal. But people who followed the issue carefully know it was one

of the most tumultuous IPOs in recent times.

Right from the time the issue was conceived in the first quarter of 2006, it was plagued by controversy. There

was intense speculation that a company with significant interests in real estate did not want DLF to get big

money from the stock markets.

An executive from the rival’s camp reportedly told close associates, “The DLF issue in its current form will

78

happen over my dead body.’’ Call it coincidence if you will. But soon after DLF filed its draft red herring

prospectus (DRHP), reports that the company had short changed its shareholders on an earlier rights issue of

debentures in November 2005 surfaced.

Public interest litigation was filed and the company received over 500 complaints from shareholders. The

company eventually allotted 1.9 million shares with retrospective effect. Around the same time, real estate

stocks started to crash on the markets. Of course, valuations of companies like Unitech and Ansal Housing had

run up rather quickly.

But this crash shaved off nearly a third of their stock prices. Suddenly, DLF started to look expensive and its

merchant bankers began to get to feel jittery. They advised against going to the market with an IPO. Even as all

of this was happening, Sebi issued a new directive.

It said that real estate companies could get land banks valued, only if a clear title deed existed. The move, on Sebi’s part, was

a well thought and fair plan to rein in errant real estate companies milking the primary markets. For DLF though, the order

took the wind out of its sails. Sources said this directive shaved off Rs 100-150 from the proposed issue price. The reason

being that when DLF’s public issue was first mooted, analysts rated the company highly for the land bank it held.

This land bank though, was held using smaller companies under different names as a front. This was because DLF reckoned

that smaller companies could negotiate a better price for land than what DLF could. They had realised that often sellers

quoted higher than market prices if DLF was the buyer.

Even as this drama was unfolding, a cabinet minister intervened on DLF’s part and warned the rival camp that some of the

permissions it was seeking from his ministry would be delayed inordinately if they didn’t back off. They did and the issue went

through. But like the rival had sworn, not in the form it was originally planned in. Though company sources would never

confirm, DLF had plans to issue shares in the region of Rs 900-1,100,when it first filed DRHP. It eventually issued stock at Rs

79

525 and reduced the shares on offer

DLF IPO: The untold story

17 Jul, 2007, 0745 hrs IST,T Surendar & Partha Sinha, TNN