What caused the flash crash at HDIL?

Mumbai-based property developer HDIL's stock, once the darling of investors, came crashing down last month.

It lost nearly 40 per cent of its value from Rs 120.85 on January 21 to Rs 74.65 on January 24 as investors worried about the ability of the company to sort out its finances.

The fall had the company’s vice-chairman and managing director, Sarang Wadhawan, burning up the phone lines as he tried to calm anxious investors by addressing their concerns. But the damage was done.

The immediate trigger for the fall was Wadhawan's decision to sell 1 per cent, or 5 million shares, of HDIL to raise Rs 57 crore (Rs 570 million) in order to meet the payment obligations for land bought in south Mumbai in 2010.

While on the face of it, it may seem like an innocuous move, there were plenty of other factors at work here.

Collateral damage

For one, why did the promoter have to sell shares for a paltry Rs 57 crore? Was the company facing a financial crunch? Then there was the larger issue of promoters pledging their shares.

The promoters have pledged almost 98 per cent of their shares to banks and financial institutions as collateral in exchange of loans or working capital, raising concern about the company’s high debt.

“If 10 to 20 per cent stake is pledged, it is normal, but when 98 per cent is pledged, it becomes a problem,” says AK Prabhakar, senior vice-president (equity research) at Anand Rathi Financial Services.

Investors, therefore, went into a tizzy with the likes of Citigroup and Credit Suisse off-loading major chunks of their shares.

Macquarie Equities Research, which hosted the conference call after the crash, says: "We hosted the management call where 140 clients dialled in to seek answers. While the management has tried to give a rational explanation, our interaction with investors reveals that they need more clarity before confidence is restored.”

What went wrong? The real estate sector has been struggling with uncomfortably high debts and slowing sales for some years now.

Among large companies, the promoters of Parsvnath Developers have pledged over 93 per cent of their shares, while the promoters of Unitech have pledged 76.71 per cent as on December 2012.

HDIL, analysts say, is facing its own peculiar problems: delay in getting cash from buyers, lower launches, delays in the MIAL (Mumbai International Airport Project) project and high debt.

Payments from pre-sales are often delayed, which means the company is booking sales, but money isn't coming into its coffers.

Mostly developers pre-sell property to fund projects and, therefore, any delay in payments hurts their cash-flows and forces them to borrow more.

As a result, HDIL had Rs 868 crore (Rs 8.68 billion) debtors (mostly dues from customers) on inventories worth Rs 11,671 crore (Rs 116.71 billion).

For a company whose annual turnover was Rs 2,006 crore (Rs 20.06 billion) in FY 2012, the amount of debtors and inventories is unusually high.

It has a consolidated debt of around Rs 4,000 crore (Rs 40 billion). Its cash flows was at Rs 814 crore (Rs 8.14 billion) in FY 2012, and it spent Rs 624 crore (Rs 6.24 billion) on interest payment and Rs 953 crore (Rs 9.53 billion) towards payment of long-term debt.

Sectoral woes

Among the bigger Mumbai realty companies, with the exception of Indiabulls Real Estate, HDIL's inventories and debtors is the highest.

Indiabulls had a debt of Rs 930 crore (Rs 9.30 billion), inventories of Rs 5,110 crore (Rs 51.10 billion) and net sales of Rs 1,391 crore (Rs 13.91 billion) in FY 2012.

The country’s largest developer, DLF, had inventories worth Rs 16,175 crore (Rs 161.75 billion) and debtors of Rs 1,765 crore (Rs 17.65 billion) on total sales of Rs 9,629 crore (Rs 96.29 billion) in FY 2012.

Poor

cash collection has been at the centre of HDIL's problems, says Param Desai, an analyst with Nirmal Bang Securities.

He says even in selling land parcels (called FSI sales), the company faced the same problem as payments are linked to approvals.

The company was selling land parcels in various parts of the city in the last two years to generate cash flows and reduce debt. But the delay in approvals by the municipal authorities and the overall slowdown in the market have crimped cash generation.

HDIL was able to launch less than 1.8 million sq ft in Mumbai metropolitan region as against six to seven million sq ft in FY 2010 and FY 2011.

However, the company is hopeful that with the improvement in the approval process in Mumbai, its launches and receivables will improve.

At the conference call, it had said that the recent launches at Kurla in Mumbai and Virar had seen 30 per cent sales.

“Three of our projects are nearing completion which will get cash flows of Rs 250 crore (Rs 2.5 billion),” Hari Prakash Pande, vice-president, finance, had said at the conference call.

However, that may not be enough to pull the company out of the abyss.

Its main cash cow, the MIAL project, where it is rehabilitating slum dwellers and getting transferable development rights (TDR) has been stuck forever as the government is yet to come out with the eligibility criteria for the resettlement of slum dwellers and the slum dwellers have not shifted to the residential units allotted to them in lieu of their land.

Companies get TDRs in lieu of rehabilitation and redevelopment of slums, which they are free to use for development or sell in the market. HDIL hopes to get additional 30-40 million sq ft of TDR from the project, say analysts.

However, the size of the project may get curtailed and if that happens, it will hit the company's TDR generation, says international brokerage Nomura in a recent report.

There are headwinds on the revenue side too. TDR prices have fallen from over Rs 3,000 per sq ft in third quarter of FY 2011 to little above Rs 2,000 per sq ft as of third quarter of FY 2012.

“Their balance sheet is leveraged and MIAL is a long gestation project which is squeezing the liquidity when pick up is not happening,” says Rikesh Parikh, vice-president, markets strategy and equities at Motilal Oswal Securities.

“They have to monetize assets and show execution,” Parikh adds.

The company is working to reduce its debts by 15-20 per cent by March 2013, but its success hinges on its ability to improve cash collection from FSIs.

“Net debt has only declined marginally over the last twelve months even though bulk of the monies on the FSI (floor space index) sale at Goregaon and Popular Car Bazaar has already been received,” says a November 12 report by Jefferies analyst Anand Agarwal.

The story is no different for its peers. For instance, DLF, has earned net cash flows of Rs 2,519 crore (Rs 25.19 billion) in FY 2012, but spent Rs 3,012 crore (Rs 30.12 billion) on interest payments and Rs 5,053 crore (Rs 50.53 billion) on long-term payments.

However, analysts are keenly awaiting the third quarter results to get a sense of where the company is headed.

"In our view, visibility on how critical it is to do the land purchase during what seems to be a lean liquidity period for the company will be key in determining the outcome. Most of these details will probably be out only in the 3Q results," wrote JP Morgan analysts in a report last week.

Image: HDIL vice chairman and managing director Sarang Wadhawan