LANCASTER UNIVERSITY

Growth Strategy, IPO & Performance

Of INDIAN REAL ESTATE COMPANIES

RESEARCH PAPER For MA in Practicing Management

By Sharad Jhingan
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Contents 1. Introduction and Purpose 2. Chapter 1: Background 3. Chapter 2: Methodology and Performance Analysis of Sample Companies

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4. Chapter 3: Strategic Comparison and Case study of DLF Limited 5. Chapter 4: Trend Analysis, Conclusion & Need for Regulator 6. Bibliography 7. Annexure 1 Share Price Movement Chart 8. Annexure 2 DLF IPO : The Untold Story

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
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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.
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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 Ltds 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.

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 Porters thoughts. I have tried to look at Indian Real Estate Industry through Porters 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.

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. Mintzbergs (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.
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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, Ansals 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.

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:

Table-1 Indian GDP, Personal Incomes and Sector Growth Rates Year GDP at Constant Prices (Million Rs) 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 18643010 19726060 20482860 22227580 23887680 26161010 28711200 31297170 33393750 GDP Growth %age terms Year on Year 4.35% 5.81% 3.83% 8.51% 7.47% 9.52% 9.75% 9.00% 6.69% Growth in personal disposable incomes (%) Growth in Financing, Insurance and Real Estate Sector 4.06% 7.28% 7.98% 5.57% 8.69% 11.39% 13.78% 11.74% 7.81%

9.6% 10.21% 5.60% 10.52% 9.32% 12.48% 13.41% 12.87%

(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
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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.

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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.

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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.

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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
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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.

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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 Indias 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
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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.
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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
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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.

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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
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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) Market Capitalization of Realty on 04.03.2010 (Rs. Millions) Market Capitalization of Six Companies 04.03.2010 (Rs. Millions) Percentage of Realty to BSE as on 04.03.2010 Percentage of Six Companies to Realty as on 04.03.2010 56725658 1109149 793637 1.96 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.

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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.

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Table -3 DLF Performance Data

DLF LTD 2005 6332 4798 677 1425.43 331 1300 0 (Rs / Millions) 2006 30139 11450 2275 170.21 1461 4940 0 2007 67693 14295 4057 4.27 3563 9766 0 2008 83864 60584 25746 67.82 4476 35655 687 2009 96150 38390 15478 72.66 8099 26207 162

Total Debt Income PAT Book Value (Rupees per share) Interest cost EBIT Share Price (Rs.)

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
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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 DLFs IPO and Share Price Performance Table 4: DLFs IPO & Share Price
DLF LTD. DATE OF IPO LISTING

11-Jun-07 525 175000000

ISSUE PRICE : TOTAL NO OF SHARES ISSUED : TOTAL EQUITY HELD BY PROMOTERS BEFORE IPO
AFTER IPO (WITHOUT GSO) TOTAL MARKET CAPITAL OF THE COMPANY ON BASIS OF ISSUE PRICE (In Millions) (Economic Times) (As on 11.2.2010)

97.42% 87.43%

1490478440 1490478440

52110.18

ALL TIME HIGH PRICE ALL TIME LOW PRICE CURRENT MARKET PRICE

15-Jan-08 4-Feb-09 11-Feb-10

1225.00 124.15 301.75

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).
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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
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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. 2.4.1 Performance Indicators Table 5: Parsvnath Performance
2005 Total Debt (Millions) Income (Millions) PAT (Millions) Book Value (Rupees per share) Interest cost (Millions) EBIT (Millions) SHARE PRICES (Rs.) 1207 3068 656 127 11 740 0.00 2006 2358 6538 1062 20.31 27 1484 0.00 2007 10118 12610 2718 79.06 194 3673 260.50 2008 17023 17922 4087 97.65 391 6254 217.50 2009 18367 7626 1130 103.76 734 2119 34.50

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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.

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2.4.2 Parsvnaths IPO and Share Price Performance Table 6: Parsvnath IPO and Share Price PARASVNATH DEVELOPERS LTD. DATE OF IPO LISTING ISSUE PRICE : TOTAL NO OF SHARES ISSUED : TOTAL EQUITY HELD BY PROMOTERS BEFORE IPO AFTER IPO (WITHOUT GSO) TOTAL MARKET CAPITAL OF THE COMPANY ON BASIS OF ISSUE PRICE (In Millions) (Economic Times) (As on 11.2.2010) ALL TIME HIGH PRICE ALL TIME LOW PRICE CURRENT MARKET PRICE 7-Jan-08 24-Mar-08 11-Feb-10 23786.59 598.00 70.20 119.40 100% 81.70% 148370400 148370400 6-Nov-06 300 36325800

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.
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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.

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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 Developers 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 developers margin, the land value of the Land Arrangements was between INR 23060 million and INR 25487 million. 2.5.1 Performance Indicators 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 Total Debt (Millions) Income (Millions) PAT (Millions) Book Value (Rupees per share) Interest cost (Millions) EBIT (Millions) SHARE PRICES (Rs.) 2233 5912 347 21.87 109 594 0.00 2006 4231 6912 886 45.63 208 1276 0.00 2007 5837 12911 1615 111.71 481 2347 722.00 2008 17631 14363 2283 135.38 615 3324 710.50 2009 19122 9917 1097 149.25 1052 2507 81.50

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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.

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2.5.2 Sobha Developers IPO and Share Price Performance Table 8: Sobha Developers Performance SOBHA DEVELOPERS LTD DATE OF IPO LISTING ISSUE PRICE : TOTAL NO OF SHARES ISSUED : TOTAL EQUITY HELD BY PROMOTERS BEFORE IPO AFTER IPO (WITHOUT GSO) TOTAL MARKET CAP OF THE COMPANY ON BASIS OF ISSUE PRICE (In Millions) (Economic Times) (As on 11.2.2010) ALL TIME HIGH PRICE ALL TIME LOW PRICE CURRENT MARKET PRICE 8-Jan-07 14-Jan-09 11-Feb-10 25937.89 1128 67.45 267.25 99.09% 87.00% 63421380 63421380 20-Dec-06 640 8893332

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.

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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. 2.6.1 Performance Indicators 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)
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Table 9: Purvankara Performance 2005 Total Debt (Millions) Income (Millions) PAT (Millions) Book Value (Rupees per share) Interest cost (Millions) EBIT (Millions) SHARE PRICES (Rs.) 1007 1510 380 135 61 465 0 2006 1622 2804 724 282 72 898 0 2007 6761 4581 1166 10.9 424 1749 0 2008 5823 6570 2109 54.98 814 2990 242 2009 7195 5451 1329 61.59 994 2349 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
34

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 Purvankaras IPO and Share Price Performance Table 10: Purvankaras IPO and Share Price PURAVANKARA PROJECTS LTD.

DATE OF IPO LISTING ISSUE PRICE : TOTAL NO OF SHARES ISSUED : TOTAL EQUITY HELD BY PROMOTERS BEFORE IPO AFTER IPO (WITHOUT GSO) TOTAL MARKET CAPITAL OF THE COMPANY ON BASIS OF ISSUE PRICE (In Millions) (Economic Times) (As on 11.2.2010) ALL TIME HIGH PRICE ALL TIME LOW PRICE CURRENT MARKET PRICE 13-Dec-07 2-Dec-08 11-Feb-10 99.99% 89.95%

30-Aug-07 400 21467610

191997840 191997840

20403.37 535 28.00 95.55

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.

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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. Purvankaras 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 31st

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. 2.7.1 Performance Indicators
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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 Total Debt (Millions) Income (Millions) PAT (Millions) Book Value (Rupees) Interest cost (Millions) EBIT (Millions) SHARE PRICES (Rs.) 914 749 147 71.10 166 340 0.00 2006 1965 4402 1139 37.00 106 1397 0.00 2007 3757 12165 5414 39.37 445 6627 0.00 2008 31127 24323 14103 169.89 1385 16064 666.00 2009 41433 18146 7212 162.46 5782 8733 76.00

Chart 6: HDIL Performance Chart

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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 HDILs IPO and Share Price Performance Table -12: HDIL IPO and Share Price HOUSING DEVELOPMENT & INFRASTRUCTURE LTD.

DATE OF IPO LISTING ISSUE PRICE TOTAL NO OF SHARES ISSUED : TOTAL EQUITY HELD BY PROMOTERS BEFORE IPO AFTER IPO (WITHOUT GSO) TOTAL MARKET CAPITAL OF THE COMPANY ON BASIS OF ISSUE PRICE (In Millions) (Economic Times) (As on 11.2.2010) ALL TIME HIGH PRICE ALL TIME LOW PRICE CURRENT MARKET PRICE 10-Jan-08 9-Mar-09 11-Feb-10 73.08% 61.45%

28-Jun-07 500 34155000

131772000 131772000

108075.84 1432 62.50 307.10

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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.

2.8.1 Performance Indicators 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.
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Table 13: Unitech Performance Indicators

2005 Total Debt (Millions) Income (Millions) PAT (Millions) Book Value (Rupees per share) Interest cost (Millions) EBIT (Millions) SHARE PRICES (Rs.) 0 2006 6382 2007 31578 2008 72162 0 0 0 0 0 0.00 6747 696 2.76 325 1406 0.00 25996 9835 14.3 1588 15036 0.00 29697 10307 13.21 3584 17239 301.50 2009 67757 24548 7396 17.62 6854 16420 31.00

Chart -7: Unitech Performance

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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 ALL TIME HIGH PRICE ALL TIME LOW PRICE CURRENT MARKET PRICE 29-May-07 28-Nov-08 11-Feb-10 623.60 21.80 72.15

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.

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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 DRHPs 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.
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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 31st 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

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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.

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3.1.7 Promoters Shareholding Table-15 Promoters Shareholding Company DLF Parsvnath Sobha Purvankara HDIL Holding %age before IPO 97.42 100 99.09 99.99 73.08 Holding %age after IPO 87.43 81.70 87 89.95 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.

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3.2 Note on DLFs 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
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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%).

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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 DLF LMITED UNITECH PARASVNATH SOBHA DEVELOPERS PURVANKARA HDIL SAMPLE AVG. 5912 1510 749 3207 6912 2804 4402 7771 12911 4581 12165 16512 14363 6570 24323 30692 9917 5451 18146 20816 2005 4798 0 3068 2006 11450 6747 6538 2007 14295 25996 12610 2008 60584 29697 17922 2009 38390 24548 7626

Chart 8: Income

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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 677 0 656 347 380 147 441.40 2006 2275 696 1062 886 724 1139 1356.40 2007 4057 9835 2718 1615 1166 5414 4961.00 2008 25746 10307 4087 2283 2109 14103 11727.00 2009 15478 7396 1130 1097 1329 7212 6728.40

DLF LMITED UNITECH PARASVNATH SOBHA DEVELOPERS PURVANKARA HDIL SAMPLE AVG.

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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 14.11 0 21.38 5.87 25.17 19.63 17.23 2006 19.87 10.32 16.24 12.82 25.82 25.87 22.19 2007 28.38 37.83 21.55 12.51 25.45 44.50 34.04 2008 42.5 34.71 22.80 15.90 32.10 57.98 41.20 2009 40.32 30.13 14.82 11.06 24.38 39.74 32.09

DLF LMITED UNITECH PARASVNATH SOBHA DEVELOPERS PURVANKARA HDIL SAMPLE AVG.

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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

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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 DLF LMITED UNITECH PARASVNATH SOBHA DEVELOPERS PURVANKARA HDIL SAMPLE AVG. 2005 35 0 434 364 200 7 208 2006 255 765 638 803 446 774 736 2007 1738 975 4226 1577 459 3103 2416 2008 9301 7397 11302 5452 824 558 6967 2009 2129 7930 10433 3553 1146 1654 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
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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 4989 0 1016 656 540 711 1582 2006 6434 2245 2011 1369 1128 1850 3007 2007 6528 11610 14627 8155 2092 7087 10020 2008 112792 21438 18066 9883 11711 36357 42049 2009 123748 28596 19196 10895 13118 44677 48046

DLF LMITED UNITECH PARASVNATH SOBHA DEVELOPERS PURVANKARA HDIL SAMPLE AVG.

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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 RATIO EQUITY 2005 0.83 0 1.19 2.37 1.77 0.57 1.35 2006 3.99 2.43 1.05 2.34 1.35 1.06 2.44 2007 1.63 2.03 0.51 0.67 2.69 0.53 1.61 2008 0.41 2.14 0.68 1.24 0.40 0.54 1.08 2009 0.58 1.74 0.80 1.41 0.43 0.92 1.17

DLF LMITED UNITECH PARASVNATH SOBHA DEVELOPERS PURVANKARA HDIL SAMPLE AVG.

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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).

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4.1.7 Total Borrowings Table 22: Borrowings

TOTAL CHART DEBTS

DLF LMITED UNITECH PARASVNATH SOBHA DEVELOPERS PURVANKARA HDIL SAMPLE AVG.

2005 6332 0 1207 2233 1007 914 2339

2006 30139 6382 2358 4231 1622 1965 9339

2007 67693 31578 10118 5837 6761 3757 25149

2008 83864 72162 17023 17631 5823 31127 45526

2009 96150 67757 18367 19122 7195 41433 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
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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 DLF LMITED UNITECH PARASVNATH SOBHA DEVELOPERS PURVANKARA HDIL SAMPLE AVG. 2005 331 0 11 109 61 166 136 2006 1461 325 27 208 72 106 440 2007 3563 1588 194 481 424 445 1339 2008 4476 3584 391 615 814 1385 2253 2009 8099 6854 734 1052 994 5782 4703

Chart 15: Interest Cost

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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 DLF LMITED UNITECH PARASVNATH SOBHA DEVELOPERS PURVANKARA HDIL SAMPLE AVG. 2005 13.57 0.00 64.57 52.9 70.37 20.68 44.42 2006 35.36 31.00 52.81 64.72 64.18 61.57 61.93 2007 62.15 84.71 18.58 19.8 55.74 76.39 63.47 2008 22.83 48.08 22.62 23.1 18.01 38.79 34.69 2009 12.51 25.86 5.89 10.07 10.13 16.14 16.12

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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.

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4.1.10 Return on Capital Employed (ROCE %) Table: 25 Return on Capital Employed

RETURN CAPITAL EMPLOYED DLF LMITED UNITECH PARASVNATH SOBHA DEVELOPERS PURVANKARA HDIL SAMPLE AVG. ON

2005 5.98 0.00 29.51 12.01 24.56 9.05 16.22

2006 6.22 8.07 24.31 15.82 26.33 29.86 22.12

2007 5.47 22.77 10.98 11.54 13.17 49.93 22.77

2008 13.09 11.01 11.65 8.30 12.03 20.90 15.40

2009 7.04 7.68 3.01 3.65 6.54 8.38 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

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of these companies took a big hit. And they were unable to maintain the operations. (Refer Table 25, Chart : 17) 4.2 Discussions and Conclusion 4.2.1 Identical Growth Pattern

profitability of their

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.
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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.
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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 12.80 7.21 13.96 6.79 30.45 P/E Ratio At IPO price NAV Per Share As Per DRHP (Rs) 26.22 13.56 29.97 11.55 40.68 IPO Price (Rs/Per Share) Market Cap at IPO price (Million Rs)

DLF Parsvnath Sobha Purvankara HDIL

41.01 41.61 45.85 58.91 16.42

525.00 300.00 640.00 400.00 500.00

895000 54481 46654 85380 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.

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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.

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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.
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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.
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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--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
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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.
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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.

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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 5 th 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 Institutes 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. Indias Rising Growth Potential Goldman Sachs Global Economics Paper no. 52 2007. 17. Capital Flow Outlook for Indias 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

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Annexure 1: Share Price Movement Charts

Chart 18: DLF Limited

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Chart 19 Parsvnath Developers

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Chart 20: Sobha Developers Ltd.

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Chart 21: Purvankara Projects Ltd.

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Chart: 22 HDIL

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Chart 23: Unitech Ltd.

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ANNEXURE -2

Printed

MUMBAI: Alls well that ends well. The clich holds true for what is now Indias 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 rivals camp reportedly told close associates, The DLF issue in its current form will

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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 Sebis 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 DLFs 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 DLFs part and warned the rival camp that some of the permissions it was seeking from his ministry would be delayed inordinately if they didnt back off. They did and the issue we nt 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

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525 and reduced the shares on offer

DLF IPO: Jul, 2007, 0745 hrs IST,T Surendar & Partha Sinha, TNN

The

untold

story

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