DLF IPO TRACKER
Investment Decision:
Basic Details of the offer -:
Offer Open date 11th June 2007
Offer Closing date 14th June 2007
Price Band Rs.500 – 550 per share
Face Value per Share Rs.2
Introduction
DLF, India’s largest real estate developer based on the land bank that it possesses and the size of projects that it has executed in the past is coming out with the largest ever IPO in the history of the capital market to fund its development plans at a time when the real estate sector is largely out of favour with most investors buttressed by falling real estate prices all across the country to the extent of 15-20% from their recent highs. Almost all the bellwethers of the global investment banking industry from the likes of Lehman Brothers, Citigroup Global, and DSP Merrill Lynch to Deutsche Bank and UBS have involved themselves in this issue as co book running lead managers. This by itself is a signal of the kind of rollover, block deal positions and volatility that shall be witnessed upon the listing date and during the week ahead. However even these merchant bankers are betting on the long-term potential of DLF’s integrated real estate operations. This particular issue is recommended only for high-risk investors/ High Net worth Individuals (HNI). Retail Investors in general, who would like to bolster their portfolio with the big daddy of the real estate sector should at least have a 2-3 year outlook for significant capital appreciation from this scrip due to its aggressive pricing as well as the negative sentiment prevailing in the real estate sector. Prudent risk averse investors can wait for the listing of the scrip and once the dust settles after the initial pandemonium during the listing week can always accumulate the scrip at lower levels below the offer price.
DLF Ltd.’s primary business is into the development of residential, commercial and retail properties.
Business Segments:
| Residential Business | Plots, Houses, Duplexes, apartments for high end market |
| Commercial Business | Buy , sell or lease commercial space for MNC |
| Retail Business | Develops, maintains and leases shopping malls including multiplex cinemas |
| Other verticals | Infrastructure, SEZ and Hotels |
General risk factors while investing in real estate companies:
DLF is heavily dependent on the performance of the real estate market in
Ø Lack of any regulatory authority to monitor the funds and quality of construction.
Ø Existence of a grey market (black money) where a lot of cash deals are involved which never get reported to the investing community at large. The promoters are usually found laughing all the way to the bank at the cost of the innocent investor who has put in his hard earned money in this sector.
Ø Recent trends have shown more number of traders in real estate (who buy and sell for short term gains to benefit from increasing land prices) rather than genuine buyers what with increased availability of credit from banks. This clearly shows the bubble that was in the making in this sector and also partly explains the reason why real estate stocks were quoting at exorbitant valuations just about 6 months ago.
Ø Real estate projects take a substantial amount of time to develop, and the developer could incur losses if it purchases land at high prices and is forced to sell or lease its developed projects during weaker economic periods.
Ø The real estate market is significantly affected by changes in government policies, economic conditions, demographic trends, employment and income levels and interest rates, among other factors. These factors can negatively affect the demand for and the valuation of the projects under development and future planned projects.
Ø Lower interest rates on financing from Indian banks and housing finance companies and favourable tax treatment of housing loans have helped fuel the growth of the Indian real estate market until recently. However,
Ø The recent stricter provisioning and risk weightage norms imposed by the RBI in relation to real estate loans by banks and housing finance companies, the US sub prime mortgage woes and crashing property prices across the NCR region by 20 -30% from its recent highs have already reduced investor attention towards this sector. Most real estate stocks are trading at around 50% of their 52 week highs.
Ø Land bank valuation conundrum. There is no transparency and disclosure of the valuation process.
DLF Strengths:
Ý Largest real estate company in terms of completed residential and commercial developments.
Ý Strong management bandwith with Mr.KP Singh (Chairman) and his son bringing in more than 6 decades of experience in the real estate sector. Mr.K.P Singh has been named the fifth richest Indian by Forbes in 2007.
Ý High quality of projects with excellence in engineering and design and leveraging on global expertise in the form of joint ventures with leading international players and design architects in the real estate sector.
Ý Almost 30% of the land bank of the company is located near urban areas which will provide adequate pricing power to the company.
Ý Aggressively developing /pursuing SEZ approvals for IT parks at different locations across the country.
Ý Innovative business strategy of developing integrated township models which incorporate the entity’s core business lines of retail, residential and commercial projects all un The company is in the process of setting up integrated townships across all major cities of the country der one roof. The company is in the process of setting up integrated townships across all major Tier 1 and Tier 2 cities like Chennai,
Ý DLF is entering the hospitality industry in a big way through its joint ventures with the renowned Hilton group and Bharat hotels to build over 500 hotels all cross the country. This kind of an ambitious scaling up in the infrastructure sector offers earnings visibility in the long run.
Ý Diversified business lines in the form of residential, retail and commercial segments and latent potential to tap the inherent opportunities that each segment has to offer in the days ahead. (Also see Page 5 for details) The company is well on it’s way to derisk its business model.
Ý Joint Venture with Prudential Insurance (US) to market insurance products in
Ý Restructuring of DLF power, a subsidiary, is under progress and captive power plants are being set up across all integrated townships developed/ to be developed by DLF. The company also has plans to diversify into wind energy in the near future.
Ý MOU with Trent Ltd. (a Tata group retail venture) and Metro to set up retail malls nationally to drive their expansion plans offers immense potential to scale up operations as a player with a pan-india presence.
Ý Debt protection ratios expected to improve in the short to medium term post IPO.
Weakness:
ß Historically high concentration in NCR region around
ß The increase in revenues and profits for fiscal 2007 were largely on account of sale of commercial properties to a promoter group company DAL private limited. This raises corporate governance issues on the mode of pricing of the sale, valuation of the properties disposed to the promoter companies and level of transparency of such related party transactions. The revenues and profits from this transaction alone accounts to 61% and 55% of the topline and bottomline respectively for FY 2006-07.
ß The company has substantial high cost debt in its books which have been utilized to finance land acquisition, construction and development of projects. The Balance sheet is highly geared at a debt equity ratio of 5.1:1. The company too has acknowledged that debt will continue to be a preferred source to fund their aggressive development plans going forward, albeit the gearing levels are expected to come down in the short term as a result of a part of the IPO proceeds being deployed to retire high cost debt.
ß Of the total indebtedness of the company, more than 75% loans have a floating interest rate component. The interest rates have increased in the last 3 quarters alone by atleast 200 basis points and with the continuing hawkish stance of the RBI, its pretty clear that the company will be shelling out more in terms of finance charges and margins will be severely impacted in the short term notwithstanding the fact that most analysts are of the view that interest rates have peaked out since economic growth is already showing a partial slowdown.
ß Only 11% of the land reserves held by DLF and its subsidiaries are owned by the entity and DLF on a stand alone basis owns only 0.5% of the reserves. Approximately 60% of the total land reserves of 10255 acres (valued at Rs.13491 crore) comprise of agricultural land whereby the certificate for change of land use has not been obtained. Most of the land reserves are held in the name of third parties with whom DLF has development agreements.
ß Negative Cash flows from operations to the tune of Rs.40 Billion for fiscal 2007. Cash flows from non operational sources to the tune of Rs.19 billion along with increased borrowings supported cash balances for the year ended 2007. When most real estate stocks are trading at 40-50% of their 52 week highs and the sector as such suffering from a bear onslaught, it’s ironical that the largest company in the sector has priced its public issue aggressively without leaving anything for investors on the table.
ß Existence of multilayered transactions with promoter/group companies casts a shadow on propriety issues. The performance of these companies also does not evince promise with most of them having negative book value.
Real Estate Sector:
Historically, the real estate sector in
Ø The absence of a centralised title registry providing title guarantee
Ø Lack of uniformity in local laws and their application
Ø Non-availability of bank financing, high interest rates and transfer taxes and the lack of transparency in transaction values.
However in recent years piggybacking on various regulatory reforms and initiatives by the government, the real estate sector in
Ø Government support for the repeal of the Urban Land Ceiling Act, with nine state governments having already repealed the Act.
Ø Modifications in the Rent Control Act to provide greater protection to homeowners wishing to rent out their properties
Ø Rationalisation of property taxes in a number of states
Ø The proposed computerisation of land records.
The trend towards greater organisation and transparency has contributed to the development of reliable indicators of value and organized investment in the real estate sector by domestic and international financial institutions and has consequently resulted
in the greater availability of financing for real estate developers. FDI investment in real estate has also been permitted at 100% and has been conducive for further increased investments in the Indian real estate sector. The mortgage to GDP ratio in
The nature of demand is also changing with heightened consumer expectations that are influenced by higher disposable incomes, increased globalisation and the introduction of new real estate products and services. The substantial recent growth in the Indian economy has stimulated demand for land and developed real estate, hotel accommodation and improved infrastructure. Creation of SEZ’s have also reinforced the demand in this sector due to the accompanying tax and other benefits for stakeholders.
Until early 2002, the real estate sector was in a bear stranglehold (that had manifested itself since 1995-96) when things started looking up for the various players within the space. The year 2006 has been a gold rush of sorts for the sector with some of the biggest deals spotted in the sector at skyrocketing prices. “Buy land, they are not making it anymore” said Mark twain and the Indian real estate players have followed his dictum in letter and spirit in the last 4 years. The domestic real estate market is estimated to be worth $16 billion and with the market growing at 30% per annum, the value is expected to touch $60 billion by 2010. Companies like Unitech and Anantraj Industries have given fantastic returns of more than 6000 per cent in the last 4 years. With a huge land bank and soaring prices, the real estate companies made a great fortune and as a result companies that were never noticed before became the hot favourites of FII’s and HNI’s. Another reason for this sector to hot up among the investing community was the lack of choice, out of 8500 companies listed on the bourses as at early 2006, only five were real estate companies. The situation was clearly one of too much money chasing too few stocks leading to mind boggling valuation. 3 new real estate players tapped the market in 2006 and 37 issues including DLF are making the beeline in 2007. But as all good stories have to come to an end, the real estate bubble that had overheated by 2006 end had to burst. With the real estate inflation having reached its peak, RBI had to act by sucking out the excess liquidity from the system through the sterilization process and thereby slow down demand to cool of the overshooting prices. But still inspite of rising interest rates and negative sentiments prevailing in the real estate sector, property demand has remained firm and prices have remained stable albeit a little bit of softening to the extent of 15-20%. Then why is it that the stock prices of real estate counters that had an excellent opening at the time of listing and commanded superior premiums not been able to sustain such valuations in the medium to long term? The reason can be attributed to overpricing of such issues. Even a fundamentally sound company with robust operating and financial metrics may not be attractive if the pricing is too aggressive.
The current negative sentiments hurting the real estate sector are interest rate hikes, higher provisioning by banks for realty lending, restriction on overseas funding, withdrawal of 80IB deduction under the IT act and service tax on commercial rentals to name a few.
Valuation Process:
Real estate companies are valued by merchant bankers based on the NPV (Net Present Value) approach which factors in certain issues like:
· Execution capability
· Projects under execution
· Expected trend in property prices
· Projected investments in land bank and expansion plans
Once the NPV per share is arrived at after giving effect to the following factors, a premium is charged on the NPV while offering the shares to the public. If we take DLF’s case as an example the NPV of the company as per a Cushman & Wakefield report has been arrived at Rs.425 per share. The company is offering its share at a price band of Rs.500-550, which translates into a premium of 30% at the upper price band. NPV is considered to be a better valuation indicator when compared to PE ratio or EBITDA multiple primarily because of two reasons:
1. The financials of realty companies are mainly driven by movement in property prices. Most companies had seen terrific growth in revenues and bottomline supported by increasing property prices in the last two years alone leading to manifold growth in financial parameters. Therefore using historical comparison of performance or earnings multiple as a base for valuation becomes irrelevant in these cases due to the cyclical nature and inherent lumpiness in the sector. The sector has become more of a commodity asset class exposed to vagaries in price movements. This kind of volatility that the sector has been witness to, explains the underlying reason for the stocks to command a high beta value (signifies high risk)
2. NPV is a method that factors in future price movements in the form of plausible assumptions and all the timeline for execution of a project. NPV figures are made available by real estate consultants once in a quarter in public domain. Though there is no disclosure of the valuation report and method of computation, such valuation figures are indeed popular among the traders and investors for assigning a fair value to the property stocks being traded on the bourses. Therefore if in the current economic scenario if property prices are seen moving up, the stocks will trade at a premium to the NPV and if prices start to fall the stocks also trade at a discount to the NPV.
Opportunities for DLF across its business lines
Residential real estate
Ý The growth in residential real estate sector has been largely driven by rising disposable incomes, low interest rates, urbanization and fiscal incentives.
Ý
Ý As per Cushman and Wakefield’s latest report on the real estate outlook, 400 township projects are expected to come up across 30-35 cities in the next five years with an aggregate project value of US $ 40 billion and DLF is well placed and is expected to be front ended in tapping such opportunities given its expertise in developing integrated townships
Ý “The Great Indian Middle Class” of today prefers luxury/ super luxury residential homes stemming from an ostentatious desire to form part of the “High Income Households.”
Ý DLF has completed most of its major developments in residential real estate at DLF city within Gurgaon. Within DLF city, the company has established 25 residential developments.
Ý RBI in its recent monetary policy review in April 2007 has gone soft on home loans and has allowed banks to soften up rates by 50 to 100 basis points for housing finance. This is a positive move for the real estate sector despite the otherwise hawkish stance of the authorities on overheating in the sector.
Commercial Real Estate
Ý The demand for commercial real estate has been fuelled by increased revenues in IT and ITES sectors leading to increased demand for commercial space. Established IT players are setting up centres in Tier 2 and 3 cities where property prices are comparatively lower and employee attrition rates are also less. These destinations will soon become hotspots for real estate companies.
Ý India continues to lead the AT Kearney Offshore Location Attractiveness Index and the same can be explained in the form of the beeline that multinational companies are making to set up development centres across various cities in the country.
Ý DLF has already completed 13 commercial properties across Kolkata, Gurgaon and
Retail Real Estate Development
Ý Organized retail accounts for only 3% of the total retail spend in
Ý Entry of major business groups like Reliance, Bharti, Aditya Birla Nuvo, RPG, and foreign retailers like Walmart, Metro is huge positive for organized retailing and real estate developers like DLF. MOU’s with Metro and
Ý Requirement of 74 Million square feet of floor space at a staggering investment of Rs.36000 crore in real estate alone over the next five years offers immense potential for realty players in the country.
Ý Residential and retail property markets work in tandem. They share a close symbiotic relationship between each other.
Hotels
Ý The recent growth in hotel sector is mainly on account of robust economic growth and the resultant business travel and tourism. The hotel industry is expected to grow at a CAGR of 10% over the next five years with steady increase in Average room rents (ARR) year on year. The average occupancy rate across the country continues to remain strong in the range of 75% -80%.
Ý Investments in the hotel sector to the tune of 9000 crore have been planned by various players over the next 5 years.
Ý The outlook for the Hotel industry continues to exude confidence with increased demand for rooms and limited availability of quality accommodations.
SEZ
Ý DLF has its presence in all forms of SEZ development namely Integrated , Service and Sector specific SEZ’s.
Ý SEZ’s have come to stay in the current economic scenario with most expansion plans of corporates being planned in these duty free enclaves. Near 100 SEZ’s have been approved and are under establishment by various real estate developers and DLF being a fully integrated real estate developer has a lot of projects on the anvil.
Multiplex Cinemas
Ý Entertainment industry in
Ý Consumer preference for mutiplex viewing has increased due to various reasons like increasing disposable incomes, demographic changes, quality of movies and comfort levels, strong growth in organized retail etc
Ý Multiplex operators also find it feasible in terms of operations due to better capacity utilization, economies of scale and tax benefits that are on offer. Multiplexes provide the distributors the opportunity to maximize the revenue potential of the movie through flexible allocation of screens based on demand.
Ý DLF operates its multiplex complexes under the name “DT cinemas” and is aggressively expanding in
Financials
| DLF Consolidated Financial Summary | | ||||
| | | 31-Mar-07 | 31-Mar-06 | 31-Mar-05 | |
| Net Sales | Rs. Crore | 2,616 | 1,154 | 608 |
|
| Operating Income | Rs. Crore | 2,724 | 1,214 | 625 |
|
| OPBDIT | Rs. Crore | 1,602 | 536 | 183 |
|
| PAT | Rs. Crore | 634 | 192 | 87 |
|
| Net Cash Accruals | Rs. Crore | 1,999 | 228 | 120 |
|
| Equity Share Capital | Rs. Crore | 306 | 38 | 4 |
|
| Cash Flow from Operations | Rs. Crore | (4,020) | (581) | 506 |
|
| Tangible Networth | Rs. Crore | 2,133 | 107 | 699 |
|
| Total Debt | Rs. Crore | 10,883 | 4,132 | 968 |
|
| | | | | | |
| OPBDIT Margins | % | 58.8 | 44.1 | 29.3 | |
| Net Profit Margins | % | 23.3 | 15.8 | 13.9 | |
| ROCE | % | 33.0 | 17.5 | 9.4 | |
| | | | | | |
| PBDIT / Int. & Finance Charges | Times | 9.47 | 3.34 | 4.74 | |
| Net Cash Accruals / Total Debt | Times | 0.18 | 0.06 | 0.12 | |
| Total Debt / Tangible Networth | Times | 5.10 | 38.76 | 1.38 | |
| Total Debt / PBDIT | Times | 3.74 | 7.34 | 5.24 | |
| Current Ratio | Times | 0.98 | 0.67 | 0.80 | |
Notes to Accounts:
- The analyst has considered the consolidated financials of DLF and its subsidiaries given the interlinkages between the group and its size and nature of operations.
- Sales Revenue for FY 2007 includes recognition of sale of properties previously leased out to subsidiaries for Rs.880 crore. Therefore excluding this sale within the group, the revenues have grown 50% year on year.
- PAT for FY 2007 has been computed after excluding one time extraordinary income of Rs.1310 crore arising on transfer of properties to its subsidiary and divestment of investment in subsidiaries. Adjusted PAT for FY 2007 has increased more than three fold on account of increased real estate prices, renting out of newly leased properties at higher rates and increasing demand for quality real estate.
Inter Firm Comparison
| Particulars | | DLF | Unitech | Parsvnath | Sobha Developers | Mahindra Gesco | AnantRaj |
| Market Cap | Rs.Crore | 93,500 | 40,009 | 5,872 | 6,056 | 2,138 | 3,745 |
| Market Price | Rs.per share | 550 | 493 | 318 | 831 | 535 | 1,046 |
| Landbank | Acres | 10,255 | 10,765 | NA | 2,593 | 3,600 | NA |
| Saleable Area (Sq ft terms) | MillionSquare feet | 574 | 469 | 120 | 118 | 60 | 48 |
| Sales | Rs.Crore | 2,616 | 2,504 | 1,236 | 1,195 | 156 | 167 |
| Operating Margins | % | 59 | 56 | 29 | 22 | 13 | 84 |
| Net Profit | Rs.Crore | 634 | 984 | 272 | 162 | 14 | 106 |
| Net Profit Margins | % | 23 | 39 | 22 | 14 | 9 | 63 |
| Market Cap/ Sales | Times | 36 | 16 | 5 | 5 | 14 | 22 |
| EPS | Times | 4 | 12 | 15 | 22 | 4 | 30 |
| Book Value | | 13 | 3 | 68 | 102 | 38 | 58 |
| Price to Book Value | Times | 44 | 176 | 5 | 8 | 14 | 18 |
| Equity Capital | Rs.Crore | 341 | 162 | 185 | 73 | 40 | 36 |
| No. of Equity Shares | Quantity | 170 | 81 | 18 | 7 | 4 | 4 |
| Current NPV/ share | Rs per share | 425 | 447 | NA | NA | 1,003 | 1,709 |
SEBI Norms on the real estate sector
The strong economic growth has resulted in excess liquidity in the system. It is not only driving the stock market valuations but also the valuations of commodities and other asset classes like real estate. The government and policy makers are concerned about the diversion of excess money into sectors like real estate.
The government and SEBI are both keen on curbing the speculative interest in real estate and safeguard investor interests. Most companies that had come out with IPO’s in the recent past had made inadequate, misleading disclosures in the offer documents and had also charged exorbitant premium valuations
SEBI has over the last few months tightened the IPO norms for real estate companies and has clearly mandated that the main objective of raising funds should be to develop the existing land bank owned by the company and not for acquiring new lands and building the land bank further.
Most companies do not own the land bank and either have MOU’s or Joint Development Agreements with land owners but disclose these lands as part of their land reserves (DLF is no exception)
Previously the valuation of land bank was made based on future development value of the lands and price movements but SEBI has come down heavily on such unrealistic methods of valuation and has specified that the valuation must be based on present realizable value. SEBI is also contemplating introducing norms or guidelines for real estate consultants who are involved in the valuation process. Their valuation reports are soon going to be made available in public domain that should make them accountable to the investing community and streamline the valuation process.
Valuation of DLF : To be or not to be a shareholder
EPS (excluding extraordinary items) on post-issue equity capital of Rs 340.88 crore (170.44 crore equity shares on a face value of Rs.2) works out to Rs 3.7. At the lower price band of Rs 500, P/E stands at 135 times, and at the upper price band of Rs 550 P/E is 149 times.
Parsvnath Developers trades around Rs 320.25 giving P/E of 19 times FY 2007 consolidated earning. Unitech, quoting around Rs 604.40, trades at P/E of 37.5 of its FY 2007 consolidated earning. Notably, Unitech’s land-bank size is comparable to DLF.
While P/E is not the only criterion to compare real-estate stocks, the very high P/E shows that lot of cream has already been skimmed from this cake, specially when there are chances of the sector turning sour.
Investment in DLF is investment in its land bank. Hence, the valuation of DLF will depend on how much and how fast revenue and profit will be generated from this land bank and how fast and at what rate and locations it is adding to its land bank. This in turn depends on growth in real- estate rates, prevailing interest rates, economic growth, expansion in organised retail and flow of foreign liquidity to this sector.
Currently real-estate rates in many Indian centres are very high by global standards. This makes them commercially unattractive and beyond the average home-buyers’ capacity to pay. In spite of the government’s attempts to control bank as well as foreign fund flows to this sector, limited supply of developed real estate has been the main culprit for keeping the rates high.
Even if there is a temporary mismatch in demand-supply, which is possible as most real-estate companies led by DLF are planning massive additional supply over the next few years, there could be fall in real-estate prices, specially when investor demand has been one of the major drivers of real-estate rates in the past couple of years.
In a way real-estate stocks are like commodity stocks which go up when commodity (real-estate) prices go up and fall when they come down, irrespective of the volume growth or the current financial performance. How the interest rates will behave going forward is very crucial. Even if the current rates prevail for an extended period, it will be negative for the real-estate sector, while a fall in interest rates will be a big positive.
The IPO has finally found its way through to the primary market after being postponed for more than a year and each time the valuations/price bands have gone for a change to reflect falling real estate prices
Recommendation
Overall, investment is recommended in the DLF IPO at the lower end of the price band with a long-term outlook. It may not be possible to expect short term listing gains in this counter though the scrip may touch 600-650 levels due to frenzied listing activity. DLF is a proxy play on the Indian real estate sector and all of us are indeed bullish on the realty scenario in the long term. DLF is expected to be a major wealth creator five years down the line given its aggressive business model and with a lot of foreign funds expected to be channelised into the realty sector in the next few years through real estate mutual funds and hedge funds, the outlook for the sector remains positive in the long run.
P.S : Its advisable for traders and investors to stay away from day trading on the listing day of DLF considering the heightened volatility that will prevail in the real estate sector. The immediate impact of the DLF listing is that the share of the sectoral market capitalization of realty companies in the NIFTY is expected to move up in one stroke from the existing 1.4% to 4% (assuming a listing price of Rs.600 for DLF). The manner of DLF’s listing will be one of the major factors that determine the market sentiment in the days ahead of the listing. A phenomenal listing on the bourses may lead to a re-rating of the real estate sector as a whole.
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