India real estate research

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 Page No:

1. Introduction and Purpose 3

2. Chapter 1: Background 6

3. Chapter 2: Methodology and Performance Analysis of

Sample Companies 20

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

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

6. Bibliography 70

7. Annexure – 1 Share Price Movement Chart 71

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

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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 Ltd‟s IPO. We further analyze the performance trends on
important parameters and draw our conclusions in Chapter 4 and examine the need for a
regulatory framework to regulate real estate development industry in India.

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Chapter – 1: Background

1.1 Review of Literature

In his well known doctrine of Competitive Advantage and Five Forces Model, Micheal Porter
(1980), argues that businesses should strive to create and sustain competitive advantage, either in
terms of lower cost of production or in terms of product differentiation, which can provide
justification for the existence of the firm. In his lecture on application of competitive strategy and
five forces model for development of strategy for real estate development companies (1989), he
pointed out that this industry in America was characterized by low barriers of entry, identical
cost structures and high degree of competition. In his opinion the companies engaged in this
industry should try to deliver customer value by differentiation. He also pointed out that the
different segments which comprise real estate industry e.g. housing, retail, and commercial,
hospitals and hotels are in fact different industries, with their own separate and distinct business
models. Customers and investors in each of the above respectively, have different value
perceptions and needs. Therefore, real estate industry is virtually a sector of economy and
different segments e.g., retail, housing and commercial offices should be independently
evaluated, and business models for each of them should be created keeping in mind specific
client and investor requirements. The umbrella strategy of doing everything and being all things
to all people, adopted generally by real estate developers, does not contribute any real value. He
further underscored the absence of long term strategic vision and prevalence of “Deal Mindset”
in minds of American Developers.

This research draws inspiration from Porter‟s thoughts. I have tried to look at Indian Real Estate
Industry through Porter‟s prism of competitive advantage and long term value creation. To this
end, I have evaluated the performance of six listed real estate companies, to understand their
growth and performance historically; their strategies to become large pan India companies and
promises held out by them in the IPO document. I have also analyzed their performance after the
IPO; to look at actual delivery made on their promises, and whether the valuations claimed at the
time of IPO were justified. Lastly I have attempted to identify factors helpful in formulating long
term strategy for real estate developers in India.

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In his book “Housing Sector and the Economy: Global Experiences”, T R Venkatesh echoes
similar thoughts. R. Venkatesh (2008), in his article, Recent Trends in Real Estate Marketing in
India, writes about the contribution of IT Sector to fast growth of real estate sector in India. He
highlighted that the expansion of Indian IT industry impacted profoundly the real estate industry.
Highly paid young IT professionals led the boom by buying into high priced apartments in major
IT centers across the country. The consequential rise in prices and boom leaves him wondering
about the sustainability of the whole growth rate.

Mintzberg‟s (1987) Emergent Strategies model also underscores the need to balance the past,
present and future. Predominance of Grass-root Strategies in the portfolio increases the risk and
long term value creation becomes contingent upon the growth of the larger economy. In case of
company valuation for the IPO, the entire value was driven by Grass-root Strategies. Large land
banks and land purchase agreements, future development potential and calculation of NAVs on
the basis of future cash flows; operations being funded almost entirely by debt and very small
proportion of company valuations coming from Emergent or Deliberate Strategies or „projects
under different stages of implementation is indicative of this.

This paper finds that in India all the developers are doing almost everything, across the board
prevalence of deal mindset; lack of specialization or efforts towards creating a niche market, and
a rush for unrestricted geographical expansion without factoring in economic benefit or even
long term sustainability.

1.2 Evolution and Metamorphosis

Right from independence (15th August 1947), land has been an intensely emotional issue in
India. In order to correct the imbalances in society, symbolized by large hereditary land holdings
being concentrated in the hands of few feudal families, successive Indian Governments followed
a socialist path. „Right to Property‟ was classified as “Legal Right” as opposed to “Fundamental
Right”. Poor landless peasants and sharecroppers constituted majority of people across the
country. It was considered critical for the development of the country to mitigate the problems of
landless and poor peasantry. Land reforms were implemented to redistribute land for mitigating
poverty following adoption of socialism as the guiding principle for development of the country.

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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, Ansal‟s and Unitech in North India; Hiranandani,
Raheja and Tata Housing in West and Purvankara, Sobha etc in South India emerged as larger
development companies with project development and execution capabilities. This also
coincided with growth of housing finance providers like HDFC, ICICI, and LIC Housing
Finance etc.

With growth in economy, gradual opening up of society and spread of media networks,
consumer sophistication, demand and expectations also changed. Favorable demographic
composition, phenomenal growth of IT industry and general economic growth placed huge
purchasing power in the hands of youth. This provided the boost to real estate sector and laid the
groundwork for the real estate boom of 2001 to 2007.

1.3 Industry Characteristics Observed in Last Decade:

Indian real estate industry witnessed a historical boom during the period 2002 – 2007. Revenues,
volume, profitability and prices of properties skyrocketed. Developers announced a chain of
projects and expanded operations exponentially across the country. Foreign investment was
virtually locked out of this sector, Government of India liberalized direct foreign investment
policy for real estate sector, and billions of dollars were invested in projects across the country.

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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:

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

Year GDP at GDP Growth Growth in Growth in
Constant personal Financing,
Prices %age terms disposable Insurance and
Year on Year incomes (%) Real Estate
(Million Rs) Sector

2000-01 18643010 4.35% 9.6% 4.06%

2001-02 19726060 5.81% 10.21% 7.28%

2002-03 20482860 3.83% 5.60% 7.98%

2003-04 22227580 8.51% 10.52% 5.57%

2004-05 23887680 7.47% 9.32% 8.69%

2005-06 26161010 9.52% 12.48% 11.39%

2006-07 28711200 9.75% 13.41% 13.78%

2007-08 31297170 9.00% 12.87% 11.74%

2008-09 33393750 6.69% 7.81%

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

As seen from above table, a consistent 8-9% growth rate was returned by the economy during the
period 2003-04 to 2007 -08. Personal Disposable Incomes grew at correspondingly higher rate
over this period. As a result growth in Financing, Insurance and Real Estate Sector was also very
high. In fact as evidenced in the chart, this sector mirrored the growth in personal disposable
Income. We can see that there is a marked decline in Growth Rates after 2006-07. GDP Growth
rate fell from a high of 9.75% in 2006-07 to 9.00% in 2007-08 and further to 6.69% in 2008 –
09. Smaller but visible decline was also observed in Personal Disposable Incomes. However, the
rate of growth of Finance, Insurance and real Estate Sector declined quite sharply from a high of
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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 India‟s housing shortage from 19.4 million units in 2004 to 22.4 million units in 2005
-06 stating that is expected to rise further. They further mentioned that the retail market for
mortgages grew by 30% in second quarter of 2004 and is further expected to grow at a CAGR of
17% from USD 16 billion in 2006 to USD 30 billion in 2009. Indian Council of Applied
Economic Research has estimated that the number of households with annual incomes between
Rs 2 million per year to Rs 10 million or more per year is expected to increase by 23 % to 28%,
between fiscal 2002 and fiscal 2010.

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

The growth in commercial real estate segment followed the growth pattern of services sector led
by IT/ITES and BPO growth. In the twelve year period between 1994 and 2006, Services sector
grew fastest. As per estimates of Centre for Monitoring Indian Economy, during this period
Agriculture grew by 35%, Industry by 123% and Services by 157% (Monthly review of Indian
Economy – April 2006).

The commercial segment comprises of Office Spaces, Retail Malls, Multiplexes and
Entertainment Facilities. With growing urbanization there is a spurt in growth of all of these
segments. Organized retail requires modern retailing premises. New housing colonies drive
development of Malls and neighborhood shopping centers. New format of retailing e.g.
departmental shops, supermarkets and hypermarkets have come to India. Restaurant chains, hotel
chains, brand marketers, large format stores and mixed use integrated development are major
drivers of commercial real estate.

This segment also saw the introduction of Special Economic Zone concept by the Government of
India. Modeled on the Chinese experience, idea behind the SEZs was to provide a fillip to
exports, by creating islands within the domestic tariff area and providing incentives to units
located within the SEZ. In order to enable large scale private sector participation, and ensure
rapid development, lots of incentives were announced for SEZ developers. Almost all the real
estate developers made a beeline and obtained a number of licenses. Some even sought

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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

20

5. Housing Developments and Infrastructure Limited (HDIL)

6. Unitech Limited

Even on the basis of current market prices the market cap of the sample companies covers more
than 71% of the realty market cap (Ref: Table -2).

Table – 2: Coverage of Sample

Market Capitalization of BSE on 04.03.2010 (Rs Millions) 56725658

Market Capitalization of Realty on 04.03.2010 (Rs. Millions) 1109149
Market Capitalization of Six Companies 04.03.2010 (Rs.
Millions) 793637

Percentage of Realty to BSE as on 04.03.2010 1.96

Percentage of Six Companies to Realty as on 04.03.2010 71.55

We can see from the above table (Table-2) that Realty comprises almost 2% of the market cap of
all listed stocks. The sample companies comprise almost 72% of the BSE realty index. This
means that we are able to cover nearly 3/4th of the realty sector by analyzing performance of
these companies.

I decided to study last 5 years performance data of these six companies. Long period of time
enabled me to look at the long term performance, and helped in identifying common trends. In
addition to analysis of numbers, the Draft Red Herring Prospectus (DRHP) of each of these
companies (barring Unitech, since it was listed some time back) were also studied and important
points related to their strategy compared. Line charts were plotted to highlight and compare
trends displayed by these companies. This in turn was compared with stock market prices and
sample average trend line to draw inferences and conclusions.

21

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.

22

Table -3 DLF Performance Data

DLF LTD (Rs / Millions)

2005 2006 2007 2008 2009
Total Debt 6332 30139 67693 83864 96150
Income 4798 11450 14295 60584 38390
PAT 677 2275 4057 25746 15478
Book Value 4.27 67.82 72.66
(Rupees per share) 1425.43 170.21
Interest cost 331 1461 3563 4476 8099
EBIT 1300 4940 9766 35655 26207
Share Price (Rs.) 0 0 0 687 162

Chart – 2: DLF Performance Chart

We can see from the DLF Performance Chart (Chart – 2) that the Income and PAT went up
sharply between 2005 and 2008 (IPO Year), declining sharply thereafter. In 2005 the Income
was Rs 4798 Million which went up to Rs 60584 million in 2008 and declined sharply to 38390
million in 2009. Total debt and interest however continued to rise the total debt in 2005 was Rs
23

6332 million which went up to Rs 96150 million and the total interest cost went up to Rs 8099
million in 2009 from Rs 339 million in 2005. The sharp decline in Income and PAT highlights
the degree of uncertainty regarding achievability of future projections related to very high
growth and unreasonable profit margins.

2.3.3 DLF’s IPO and Share Price Performance

Table 4: DLF’s IPO & Share Price

DLF LTD.
DATE OF IPO LISTING 11-Jun-07
ISSUE PRICE : 525
TOTAL NO OF SHARES ISSUED : 175000000
TOTAL EQUITY HELD BY
PROMOTERS
BEFORE IPO 97.42% 1490478440
AFTER IPO (WITHOUT GSO) 87.43% 1490478440
TOTAL MARKET CAPITAL OF THE COMPANY
ON BASIS OF ISSUE PRICE (In Millions)
(Economic Times) (As on 11.2.2010) 52110.18
ALL TIME HIGH PRICE 15-Jan-08 1225.00
ALL TIME LOW PRICE 4-Feb-09 124.15
CURRENT MARKET PRICE 11-Feb-10 301.75

In June 2007, DLF Limited issued 175 million shares of Rs 2 each at a price of Rs 525 per share
comprising of 10.26% of its fully diluted share capital after the issue. The issue was
oversubscribed 3.23 times. Rs. Total amount raised was Rs 9187.5 million. It was the largest
public issue of shares by any company in India till then. The share opened at a strong note
delivering 25% gains to investors, and in January /February 2008 touched a high of Rs 1225 per
share. Thereafter it has been a story of consistent underperformance. The current market price is
in the range of Rs 300 to Rs 350 per share. The share price trend line can be seen in „Chart no.
18‟ in Annexure -1.

In the preceding table-4, the key data related to IPO, market price of shares and market
capitalization can be seen. The current market price almost 3 years after the IPO (Rs 302 per
share) is almost 60% of the issue price (Rs 525 per share).

24

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
25

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

Including the above mentioned 11 projects, the DRHP mentions a total of 24 Residential projects
with a total saleable area of 18.93 million sq. mts., and capital outlay of INR 25963.54million. In
addition to the residential projects a total of 15 Commercial projects with a total saleable area of
2.17 million sq. ft involving a capital outlay of INR 5536.53 million; 11 DMRC projects in Delhi
involving construction of Malls having a saleable area of 1.77 million sq. mts. and capital
outlay of INR 5796.71 million; 19 Integrated townships with a total saleable area of 74.10
Million sq. mts involving capital outlay of INR 74461 million; 13 Hotel projects having a
saleable area of 2.06 million sq. mts and capital outlay of INR 6329 million; 3 IT Parks
involving a saleable area of 3.08 million sq. mts. and capital outlay of INR 4077 million.

In addition to foregoing, two residential projects in Delhi and Faridabad, involving Saleable area
of 1.7 million sq. mts (50% interest in JV), and 9 proposed SEZs comprising of a total area of
20 million sq. mts., was also proposed to be developed by them.


Table 5: Parsvnath Performance

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

26

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.

27

2.4.2 Parsvnath’s IPO and Share Price Performance

Table 6: Parsvnath IPO and Share Price

PARASVNATH DEVELOPERS LTD.
DATE OF IPO LISTING 6-Nov-06
ISSUE PRICE : 300
PROMOTERS
BEFORE IPO 100% 148370400
TOTAL MARKET CAPITAL OF THE
COMPANY ON BASIS OF ISSUE PRICE
(In Millions) (Economic Times) (As on
11.2.2010) 23786.59
ALL TIME HIGH PRICE 7-Jan-08 598.00
ALL TIME LOW PRICE 24-Mar-08 70.20

In November 2006, Parsvnath Developers issued 33.238 million shares of face value Rs 10 each
and share premium of Rs 290 per share, at a price of Rs 300 per share, aggregating Rs 9971.4
million, comprising of 18.30% of its fully diluted share capital after the issue. The issue was
oversubscribed 56.2661 times. The issue also included a Green shoe option of 3.087 million
shares issued at Rs 300 aggregating Rs 926.4 million. The total issue size was Rs 10897.74
million. After a strong opening the share touched all time high price of Rs 598 in January 2008.
Thereafter it has been a story of consistent underperformance. The current market price is in the
range of Rs 100 to Rs 150 per share. The share price trend line can be easily seen from the Chart
-19 in Annexure 1, the movements mirroring those of DLF Ltd.

28

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.

29

As per Cushman & Wakefield, as on July 2006 the NPV of the Land Reserves was between INR
70356 million to INR 77762 million and after deducting the Developer‟s margin, the land value
of the Land Reserves was between INR 39717 million and INR 43898 million; and the NPV of
the Land Arrangements was between INR 43478 million and INR 48054 million, and after
deducting developer‟s margin, the land value of the Land Arrangements was between INR 23060
million and INR 25487 million.


We can see from the following 5 year performance Table-7 that like its peers, Sobha displays
sharp increase in the amount of Debt and interest cost. Income and PAT increased between 2005
and 2008, falling sharply thereafter.
Table 7: Sobha Developers Performance

2005 2006 2007 2008 2009
Total Debt
(Millions) 2233 4231 5837 17631 19122
Income
(Millions) 5912 6912 12911 14363 9917
PAT
(Millions) 347 886 1615 2283 1097
Book Value
(Rupees per share) 21.87 45.63 111.71 135.38 149.25
Interest cost
(Millions) 109 208 481 615 1052
EBIT
(Millions) 594 1276 2347 3324 2507
SHARE PRICES
(Rs.) 0.00 0.00 722.00 710.50 81.50

30

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.

31

2.5.2 Sobha Developers’ IPO and Share Price Performance

Table 8: Sobha Developers Performance

SOBHA DEVELOPERS LTD
DATE OF IPO LISTING 20-Dec-06
ISSUE PRICE : 640
PROMOTERS
BEFORE IPO 99.09% 63421380
TOTAL MARKET CAP OF THE
11.2.2010) 25937.89
ALL TIME HIGH PRICE 8-Jan-07 1128
ALL TIME LOW PRICE 14-Jan-09 67.45

Sobha Developers went public in December 2006, issued 8.89 million shares of Rs 10 each at a
price of Rs 640 per share including a premium of Rs 630 per share, comprising of 12.20% of its
fully diluted share capital after the issue. The issue was oversubscribed 113.93 times. Total
amount raised was Rs 5691.73 million. The share opened strongly and in January /February 2008
reached a high of Rs 1128 per share. Thereafter it has been a story of consistent decline and
underperformance. The current market price is in the range of Rs 200 to Rs 250 per share. The
share price trend line can be easily seen from the Chart no 20 in Annexure -1; the broad trend
displayed by DLF and Parsvnath is also reflected by this stock.

32

2.6 Purvankara Projects Limited

Incorporated in 1986 in Mumbai the operational base of Purvankara was subsequently shifted to
Bengaluru. Till the time of filing the DRHP it had completed 14 Residential Projects with a total
saleable area of 3.59 million sq. ft. and 1 Commercial project comprising of approx 0.18 million
sq, ft of saleable area.

Revenues increased from INR 1510 million in 2005 to INR 4581 million in 2007 (CAGR of
78%) and PAT has, increased from 380 million (year 2003) to 1166 million (year 2007) (CAGR
of 111.69%) (Ref : Table – 9)

The company has presence in South Indian states of Karnataka, Kerala, Andhra Pradesh and Tamilnadu.
Specifically the cities of Bengaluru, Chennai and Kochi,

Purvankara Projects focused on development of residential and commercial/retail properties. They
announced different steps that they would take, in pursuance of their growth strategy, in their DRHP these
included inter-alia; Increase land bank in strategic locations across India(as of July 2007 MOUs/Joint
Development Agreements entered for 43.56 million sq. ft of land near Chennai, not included in the land
bank); Promote and expand the Brand by focusing on quality and innovation; Increase the scale of
operations by proposing to develop more than 30 million sq. ft land in JV with Keppel; diversification by
developing Hotels, commercial projects and going into other locations across India; enter into JV and
Partnerships, expand overseas operations, and in the process they had taken up project in Colombo, Sri
Lanka.

The company held approximately 874 Acres or 38.07 million sq. ft of land at 8 cities in India and in
Colombo, Sri Lanka. The total saleable area on this land would have amounted to 106.80 million sq. ft. Out
of the above the company was, at the time of filing the DRHP, developing 12.20 million sq. ft. saleable
area in Bangalore, Chennai and Kochi. Balance 94.60 million sq. ft saleable area being located across
Bangalore, Chennai, Kochi, Hyderabad, Mysore, Coimbatore, Kolkata and Colombo.


We can see that the trends of rising incomes and profits till 2008, and a sharp fall in income and
profitability thereafter, is consistently returned by all the companies. Total debt and interest cost
display a rising trend over the 5 year period. (Ref: Chart – 5)
33

Table – 9: Purvankara Performance

2005 2006 2007 2008 2009
Total Debt
(Millions) 1007 1622 6761 5823 7195
Income
(Millions) 1510 2804 4581 6570 5451
PAT
(Millions) 380 724 1166 2109 1329
Book Value
(Rupees per share) 135 282 10.9 54.98 61.59
Interest cost
(Millions) 61 72 424 814 994
EBIT
(Millions) 465 898 1749 2990 2349
SHARE PRICES
(Rs.) 0 0 0 242 41

Chart – 5: Purvankara Performance

After displaying a rising trend from 2005 to 2008, the Income EBIT and PAT numbers dipped
sharply in 2009. Total Debt however kept rising; it reached Rs 7195 million in 2009 from 1007
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 Purvankara’s IPO and Share Price Performance

Table – 10: Purvankara’s IPO and Share Price

PURAVANKARA PROJECTS LTD.

DATE OF IPO LISTING 30-Aug-07
ISSUE PRICE : 400
PROMOTERS
BEFORE IPO 99.99% 191997840
11.2.2010) 20403.37
ALL TIME HIGH PRICE 13-Dec-07 535
ALL TIME LOW PRICE 2-Dec-08 28.00

Purvankara projects issued 21.467 million shares of Rs 5 each at a price of Rs 400 per share
including share premium of Rs 395 per share comprising of 10.03% of its fully diluted share
capital after the issue. The IPO was oversubscribed 1.9233 times. Due to poor response the
original price band of Rs 500 to Rs 525 was reduced to Rs 400 to Rs 425 per share. The shares
were allotted in August 2007 and total amount raised was Rs 8562.75 million.

35

The share reached its peak of Rs 535 in December 2007. Thereafter it has been a story of decline.
The current market price is in the range of Rs 100 per share. The share price trend line can be
easily seen from the Chart No 21 in Annexure -1. Purvankara‟s share price trend also mirrors the
previous three companies.

2.7 Housing Development and Infrastructure Limited (HDIL)

Incorporated in 1996, HDIL had developed 24 projects comprising of 11.287 million sq. ft. of
saleable area till the time of filing its DRHP, this includes Residential Area of 2.07 million sq. ft.
Commercial Area of 0.667 million sq. ft., Retail area of 0.533 million sq. ft. Land development
of 5.7 million sq. ft. Slum Rehabilitation of 2.2 million sq. ft of under slum rehabilitation scheme
of Slum Rehabilitation Authority (SRA).

Total Income has increased from INR 337.07 million for the year ended 31st March 2003 to INR
20964.22 million for the year ended 31st March 2007 and PAT has grown from INR (-28.64)
million for the year ended 31st March 2003 to INR 5481.72 million for the year ended 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.


36

Like all the other real estate companies HDIL also shows rising incomes and profit till 2008,
sharp correction in both these indicators in 2009. Debt and interest cost continue to rise all the
while.

Table – 11: HDIL Performance

2005 2006 2007 2008 2009
Total Debt
(Millions) 914 1965 3757 31127 41433
Income
(Millions) 749 4402 12165 24323 18146
PAT
(Millions) 147 1139 5414 14103 7212
Book Value
(Rupees) 71.10 37.00 39.37 169.89 162.46
Interest cost
(Millions) 166 106 445 1385 5782
EBIT
(Millions) 340 1397 6627 16064 8733
SHARE PRICES
(Rs.) 0.00 0.00 0.00 666.00 76.00

Chart – 6: HDIL Performance Chart

37

It is interesting to observe from the above Table-11 and Chart-6 that in 2008 Total Debt
(Rs31127 million) surpassed Income (Rs 24323 million). While the Income dipped sharply to
Rs18146 million in 2009, the Total Debt reached Rs 41433 million, with proportionate increase
in Interest Cost. In 2009 the Interest cost was Rs 5782 million i.e. 31.3 % of Income. The impact
upon share prices was catastrophic.

2.7.2 HDIL’s IPO and Share Price Performance

Table -12: HDIL IPO and Share Price

HOUSING DEVELOPMENT & INFRASTRUCTURE
LTD.

DATE OF IPO LISTING 28-Jun-07
ISSUE PRICE 500
PROMOTERS
BEFORE IPO 73.08% 131772000
11.2.2010) 108075.84
ALL TIME HIGH PRICE 10-Jan-08 1432
ALL TIME LOW PRICE 9-Mar-09 62.50

38

HDIL issued 29.7 million shares of Rs 10 each at a price of Rs 500 per share including premium
of Rs 490 per share, comprising of 13.86 % of its fully diluted share capital after the issue. The
issue was oversubscribed 5.58 times. Total amount raised was Rs 17078.0 million.

The share opened modestly and in January 2008 touched a high of Rs 1432 per share. Thereafter
it has been a story of consistent decline. The current market price is in the range of Rs 350 to Rs
400 per share. The share price trend line can be easily seen from the chart. This chart also
reflects the same trend as in the case of previous four companies.

2.8 Unitech Limited

Unitech is the second largest real estate developer in India after DLF. It started as a construction
company and then diversified into real estate development. It has a large presence in Delhi NCR
region. It is also developing projects in Kolkata and Mumbai.

Unitech was listed for quite some time; therefore we do not have as much information about
them, unlike for their peers who filed DRHP with SEBI containing history and operational
background.

Unitech has executed residential projects, integrated townships, commercial buildings, retail
malls, entertainment parks, SEZs. It further listed its subsidiary on Alternative Investment
Market of London Stock Exchange and raised USD 750 million dollars.


Unitech was able to repay some of its debt in 2009 by selling majority stake in its telecom
subsidiary. Except for this fact, all the other trends like income and PAT rising till 2008 and
falling thereafter are displayed by Unitech as well.

39

Table – 13: Unitech Performance Indicators

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

Chart -7: Unitech Performance

40

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 29-May-07 623.60
ALL TIME LOW PRICE 28-Nov-08 21.80

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.

41

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

3.1 Strategic Comparison:

On reading through the Draft Red Herring Prospectuses of all these companies, we can easily
observe a few common characteristics displayed by all these companies. Moreover, all the
DRHP‟s were identical with very little to distinguish between different offerings.

3.1.1 Market Segment: Residential, Commercial and Retail development activities are carried
out by all these companies. In addition Sobha does lot of contractual work and HDIL is
engaged in Slum Rehabilitation Business. Slum Rehab is peculiar to Mumbai. DLF, and
to some extent Parsvnath, is also present in the business of entertainment. DLF has
further listed „clubs‟ and „power‟ as additional lines of business. These Real Estate
Developers therefore are what can be called „Umbrella Developers‟. They are engaged in
all kind of development activities. In fact except for Sobha, all of them are doing almost
everything. Sobha also signified its intention to diversify into other types of development.
In advanced countries generally there is a clear segregation between residential and
commercial developers. This allows specialization and institutional/public ownership
through REITs. In India however the market is yet to attain maturity and hence it is
possible for a developer to engage in all kind of activities.

3.1.2 Key Locations: We can see that the focus of DLF and Parsvnath is predominantly in
North India. More specifically in NCR and major towns near to NCR Region, e.g.,
Chandigarh, Amritsar, Jaipur etc. Sobha Developers is concentrated in Bangaluru;
Purvankara in southern states of Karnataka, Andhra Pradesh, Tamil Nadu and Kerala,
HDIL focuses exclusively on Mumbai Metropolitan Region. In addition to this DLF had
announced ambitious Pan India plans as part of its DRHP document. It acquired large
land parcels in almost all major cities across India including Mumbai, Chennai,
Bangalore, Pune, Kolkata etc. This trend of expanding to other towns and cities across
India to acquire what was termed as “Pan India Presence” is clearly demonstrated by all
the developers in our sample. Similar ambitious expansion plans to other locations were
announced by other realty players as well.

42

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 Promoter’s Shareholding

Table-15 Promoter’s Shareholding

Company Holding %age before IPO Holding %age after IPO

DLF 97.42 87.43

Parsvnath 100 81.70

Sobha 99.09 87

Purvankara 99.99 89.95

HDIL 73.08 61.45

We can see from the preceding Table-15, that all these companies were closely held by
promoters and/or their close family members. These were virtually one man or one family
company, irrespective of their size or scale of operations, and they diluted only marginally in
the IPO process. Even the most broad based of these, HDIL, had issued shares to close
business associates. Thus we have DLF in which promoters K. P. Singh and family held
97.42% shares before the IPO and HDIL in which Promoters held 73.08% of shares at the
time of going for the IPO. All the other three companies were almost entirely held by
promoters at the time of going to the IPO. Due to small divestment, after the IPO, promoters
continued to own more than 75% of shareholding, outside shareholders relegated almost to
being a fringe minority. The concept of shareholder democracy and corporate governance
was, therefore, almost entirely dependent on the intentions of promoter group.

45

3.2 Note on DLF’s IPO

We have analyzed DLF as a special case, being representative of the larger problem afflicting the
entire Real Estate Sector. Each issue gets greatly magnified due to sheer scale of operations and
size. DLF is perhaps the only developer which was able to create a pan Indian foot print; it
further diversified into all the related verticals. Due to a few peculiar issues connected with it, its
importance, and sheer scale and size, it deserves to be looked as an independent case study. DLF
Limited is the market leader and largest player in Indian real estate industry. In May 2006, it
filed a Draft Red Herring Prospectus with SEBI (the market regulator). Amongst other details
about the company, the prospectus also carried a certificate from a multinational real estate
consultant certifying the NAV of DLF to be about USD 28 - 30 billion. This valuation was based
on estimated discounted cash flow values of potential land banks owned by the company. A
couple of other real estate developers also filed similar offer documents, proposing to raise huge
amount of money, claiming high valuation of their land banks.

The stock markets crashed in 2006, realizing that it would not be possible to come out with the
IPO, DLF withdrew and filed its prospectus again in 2007. The valuation of the company has
suffered at least 30% erosion over 18 month period. Even today almost three years after the
listing, the market price is at least 40% below the issue price. After the IPO, the Chairman and
the Vice Chairman had to issue statements reaffirming their commitment to corporate
governance and to ensure protection of the interest of minority shareholders. This, to me, is a
major illustration of how, ethically questionable business practices, affect future valuation of a
business in a real life situation, even in case of a market leader like DLF. (Please refer to
Annexure -2 for a news paper report on this IPO which corroborates the major points)

3.2.1 Shareholding and Ownership Issues

Originally DLF was a listed company. Promoters held almost 85 % of shares; they decided to
buy the outstanding stock, from the market, without making the mandatory open offer to the
public. This buy out violated the then existing share buyback guidelines. As a consequence, DLF
Ltd. was penalized by market regulator. Even after delisting, a few minority shareholders chose
46

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%).

47

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

4.1 Trend Analysis: I have carried out trend analysis on various important parameters as
displayed by all the six companies and charted the same. Major findings are discussed hereafter:

4.1.1 Income

Table-16: Income

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

Chart – 8: Income

48

We can see from Table -16 and Chart - 8, that for all the six companies Income trend is secular
and common. The incomes rising fast till 2008, sharply falling thereafter. This mirrors the
economic trend displayed by the economic growth numbers of RBI. It also points to a
significant fact that it is impossible for a company to maintain the „hockey stick‟ pattern of
growth for a very long period of time, and sooner or later, the averaging out will take place in the
form of a correction. The IPO pricing and company valuation therefore has to factor in the
economic risk inherent in every business.

New Accounting standards introduced in 2006 allowed the companies to recognize revenue on
the basis of percentage completion of projects. This essentially implied that sales from a project
were reported as income from the accounting year in which at least 30% of the project was
completed. Therefore, the spike in income that we notice in 2008 is due to spurt in sales during
2006 and 2007. Most of the projects which these companies marketed in 2006 and 2007, were
under construction and advance bookings made during these two boom years were reported
partly in 2007 and in 2008(after 30% construction was completed), hence the spike in Income
numbers in 2008 and fall thereafter. This is further reinforced by falling receivables in 2009. We
will look at receivables later in this chapter.

4.1.2 Profit after tax

Table – 17: Profit After Tax

PROFIT AFTER TAX CHART (RUPEES IN
MILLIONS)

2005 2006 2007 2008 2009
DLF LMITED 677 2275 4057 25746 15478
UNITECH 0 696 9835 10307 7396
PARASVNATH 656 1062 2718 4087 1130
SOBHA DEVELOPERS 347 886 1615 2283 1097
PURVANKARA 380 724 1166 2109 1329
HDIL 147 1139 5414 14103 7212
SAMPLE AVG. 441.40 1356.40 4961.00 11727.00 6728.40

49

Chart – 9: Profit After Tax

PAT also mirrors the Income trend. We can notice the sharp spike in numbers between 2006 and
2007 (Refer Table – 17, Chart – 9). In fact 2006 - 2007 was probably the best year for property
sales and marked high point in property market. The profit numbers are also important because
the cost structures remained either same or increased due to higher interest cost. The cumulative
impact on bottomlines of these companies was greater. In fact, new accounting policies pursuant
to new guidelines pertaining to revenue recognition (Percentage Completion Method) created a
revenue overhang, which compounded the problem by making the correction appear steeper than
what it would have been.

4.1.3 NET Profit after Tax (%age):

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

NET PROFIT (AFTER TAX ) PERCENTAGE CHART

2005 2006 2007 2008 2009
DLF LMITED 14.11 19.87 28.38 42.5 40.32
UNITECH 0 10.32 37.83 34.71 30.13
PARASVNATH 21.38 16.24 21.55 22.80 14.82
SOBHA DEVELOPERS 5.87 12.82 12.51 15.90 11.06
PURVANKARA 25.17 25.82 25.45 32.10 24.38
HDIL 19.63 25.87 44.50 57.98 39.74
SAMPLE AVG. 17.23 22.19 34.04 41.20 32.09
50

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

51

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

4.1.4 Receivables

Table – 19: Receivables

RECEIVABLES
CHART 2005 2006 2007 2008 2009
DLF LMITED 35 255 1738 9301 2129
UNITECH 0 765 975 7397 7930
PARASVNATH 434 638 4226 11302 10433
SOBHA 364 803 1577
DEVELOPERS 5452 3553
PURVANKARA 200 446 459 824 1146
HDIL 7 774 3103 558 1654
SAMPLE AVG. 208 736 2416 6967 5369

Chart – 11: Receivables

Receivables are a very important indicator of fiscal health. Not only does it indicate a healthy
cash pipeline, it further ensures regular profits. As soon as a sale agreement is executed by a
developer, the proportionate amount of money can be debited to client account as a
“Receivable”. A fall in receivable may indicate slow execution of projects or lack of new
projects in the pipeline of developer. Continuous fall in this number can indicate possible cash
flow problems down the line. A continuous rise may also indicate poor recoveries from
52

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