DLF's real estate story

If the country's largest real estate developer DLF had been listed on the bourses over the past four years, it would have delivered a return unparalleled in the history of Indian stock markets.

Promoter K P Singh opted to delist the company in its earlier avatar as DLF Universal from the Delhi Stock Exchange in September 2003 by buying back the public holding, valuing the company at Rs 112 crore (Rs 1.12 billion). Over the past 45 months, DLF has seen an annualised appreciation of over 500 per cent going by the valuation it is commanding for its latest initial public offer.

The 10-odd per cent public shareholders would have potentially amassed wealth of over Rs 8,500 crore (Rs 85 billion) by now had the company remained listed. In a dramatic reversal though, the ace builder is now offering to dilute 10.26 per cent stake earlier bought back by the promoters dirt cheap -- for less than Rs 50 crore (Rs 500 million), for a minimum of Rs 8,750 crore (Rs 87.50 billion).

"The market would not have forgiven a smaller company for this act but here we are talking about one of India's largest private enterprises and that too at a time when global investors are queuing up to get a share of booming real estate market," says a leading fund manager on the condition of anonymity.

After controversies relating to a small group of minority shareholders who had remained invested in the stock even after the delisting, DLF was forced to withdraw its application for public offer from the capital market regulator last year.

Even as the book building for the IPO constituting 17.5 crore (Rs 175 million) equity shares of Rs 2 each priced in the band of Rs 500-550 begins today, it appears that the delay has ironically played out in favour of DLF with market sentiment much better than a year ago.

The company has utilised the additional time fruitfully by changing its corporate structure and strategy that has helped it inflate profits for the past year over ten times and make it less difficult to justify its aggressive projections.

Valued at the higher end of the price band, the company would be the eighth largest by market capitalisation, post-listing. With negative cash flows and current earnings abysmally low compared with future projections, the company is demanding its price relying solely on its vast land holdings, the value of which is not clear.

Here is the promise. Armed with 10,000-odd acres, DLF plans to build over the next 10 years more than double the area it has developed over the past 60 years. In the next three years, DLF has a target of developing over 70 million square feet or triple the area it has developed till the last calendar.

As a result, investment bankers are forecasting the company's sales at Rs 20,000 crore (Rs 200 billion) in fiscal 2009, up from Rs 2,600 crore (Rs 26 billion) achieved in the last fiscal, and net profit in excess of Rs 11,000 crore (Rs 110 billion), roughly six times that for the year gone-by.

The grand plan

DLF has outlined a three-pronged growth strategy, which includes strengthening its pan-India presence, building up land reserves at strategic locations, and leveraging its real estate capabilities in related areas be it special economic zones or hospitality.

The company will primarily be a developer and sell its properties retaining limited assets to be leased out. The money raised through the IPO would go towards buying more land (Rs 3,500 crore -- Rs 35 billion), developing existing projects and repayment of loans.

Going by the scale of development done so far, DLF is the largest real estate player in the country with land reserves of 10,255 acres or about 574 million square feet (msf) of developmental area. Of this, 171 msf is located in or near developed urban areas while 404 msf is urbanisable.

"About 90 per cent of the total land bank is available as large contiguous plots enabling large integrated development", says, chief executive officer Rajiv Singh.

After being centered around Delhi for many years, the company now has a nation-wide presence across 31cities and towns. It has developed 29 msf of residential, commercial and retail projects and integrated townships spread over 3,000 acres in Gurgaon so far. Currently, some 44 msf of development is under progress and projects involving 524 acres is planned over the next few years.

The company intends to focus on its core competence while partnering with leading global players such as Nakheel (SEZs), Laing O'Rourke (construction), ESP (engineering and design), Feedback Ventures (project management) for better execution.

Right from acquiring low cost land to creating a full fledged township to realise the true potential of the land, DLF has amply demonstrated its success in Gurgaon. One key advantage is that DLF's average cost of acquisition of land is fairly low at around Rs 274 per sf which will enable it sit out the cycles and not indulge in distress sale ever.

Some key determinants of profitability for real estate companies apart from the land cost, is the developer's land acquisition and aggregation skills, relationship with the state authorities and reputation -- on all these DLF scores highly.

And with its unquestionable capabilities as a successful developer, DLF seems best placed to capitalise on the booming real estate market, which is expected to grow at 20 per cent-plus annually from the current size of $40-45 billion.

Even more, the national capital region, where the company has over 50 per cent of its land holdings, is among the fastest growing markets in the country.

Apart from the boom in retail malls and residentials owning to rising disposable income, there are several new vistas opening up for developers which DLF is planning to tap -- for instance, SEZs which offer opportunities to create integrated townships, hotels and serviced apartments, multiplexes, airports and the list goes on.

The risk

A look at DLF's financial performance is hardly inspiring. Last year, the company sold its asset to a group company to get its revenues and profits to a respectable level. Sales to fully owned promoter company DLF Assets Limited (DAL) constituted almost 55 per cent of total revenues and 77 per cent of profits (See table).

DLF Vs UNITECH
(Rs crore)	DLF	Unitech
Land bank (acres)	10255	10332
Developable land (sq ft)	574	472
Net debt	9500	2600
IPO cash	8800	-
Outstanding shares (cr)	170	81
Market-cap	85200/93700	48700
Enterprise value	85900/93600	48700
EV/Square FT (rs)	1498/1631	1032

According to a newly devised strategy, the company would, instead of leasing out commercial projects, indulge in outright sale to potential buyers including DAL. This model rests on the ground that DAL would be able to garner low cost capital by tapping the alternative investment market overseas and pay a higher capitalisation rate for DLF's properties resulting in faster growth in revenues and better margins too.

THE PROJECT PROPOSAL
(Mn Sq Ft)	Completed	Under progress	Planned
Plots	195	0	46
Residential	19	7	375
Commercial	7	27	60
Retail	3	10	44
Total	224	44	526

Though swift disposal of assets can favourably alter DLF's return ratios, DAL's ability to raise cheap funds is still unclear and poses a threat to DLF's cash flows.

Even otherwise, earnings of developers tend to be less predictable with lumpy revenues and cash flows. And after the phenomenal rise in property prices over the past three to five years and the rise in interest rates, analysts expect a property price correction because of the double whammy.

Though demand for retail malls and commercial estates is currently buoyant, huge supplies are yet to hit the market with most builders planning an aggressive ramp-up, again, increasing the risk of weaker property prices.

On the residential side too currently, investors (or the secondary market) are selling residentials at a price lower than the builder's price in most parts of the country and the demand from investors could dry up if cost of funds continue to be high and properties do not turnaround around quickly.

Roughly, a 1 per cent fall in sales realisation cuts DLF's earnings by 2 per cent. If prices were to correct about 10 per cent, a fifth of its earnings could be shaved off meaning stock prices could take a considerable beating.

Is it fair?

So what is a fair price to pay for DLF? Since there is little strength in either its P&L or balancesheet, an investor is essentially betting on the ability of the management to create another Gurgaon and realise the best price for their cheap land.

To put a number to this, analysts are looking at the net asset value of the company which is essentially a measure of cash flows of the firm from its entire land bank discounted by its cost of capital (CoC) less the debt in its books.

Various analysts peg the net asset value in the range of Rs 70,000 crore (Rs 700 billion) to 95,000 crore (Rs 950 bllion). Edelweiss estimates NAV at approximately Rs 88,000 crore (Rs 880 billion) based on a CoC of 12 per cent primarily assuming that the company would develop the entire land bank only over the next 15 years as against the management projection of 10 years.

This results in fair value of Rs 512-517. First Global estimates NPV at Rs 70,000 crore or Rs 413 per share based on its base case assumptions and says that a majority of global real estate companies in Singapore and Hong Kong trade at a discount of 10-30 per cent discount to NAV.

DLF's investment bankers too estimate NAV to be in the range of around Rs 80,000 crore (Rs 800 billion) to Rs 1 lakh crore (Rs 1 trillion) but they argue that the company deserves to be traded at a premium to its NAV, an argument most domestic fund managers refuse to buy.

Property stocks in Hong Kong, China, Singapore, Japan and Australia have traded at earnings multiples upwards of 20 in their early cycle but on this metric again DLF looks grossly expensive.

Apart from property prices, another risk for DLF is that of delays in execution. Edelweiss estimates that for every one year delay in execution would drag down the net asset value by six per cent.

Says Ramdeo Agrawal, managing director, Motilal Oswal, "Although the future seems quite rosy, the stock will face several challenges going forward trying to meet the tall projections that form the basis of current valuations." He adds that there is little margin of safety in buying the stock at current valuations.

Besides, with nearly 112 related entities and the promoter's past track record concerns on corporate governance remain. Although Rajiv Singh reassured investors of good governance standards during the IPO launch, on paper (prospectus) the company has gone out of the way to state that "we cannot assure that our promoters will act to resolve any conflicts of interest (with certain other promoter-owned companies) in our favour or in the best interest of our minority shareholders," signalling that investors better be prepared for negative surprises.

Having said that, the issue looks poised to deliver good returns in the short term. Flush with liquidity from global investors, investment bankers are confident of a huge over-subscription. For the common investor on the Street it is time to make a quick buck. For in the longer term, India's largest builder appears to be on a shaky ground.