First Global Report On Real Estate Developer-DLF IPO
DLF, a leading real estate company, is open for subscription with an initial public offer, IPO of 175,000,000 equity shares of Rs 2 each through a 100% book building process.
The issue would constitute 10.27% of the fully diluted post-issue capital of the Company.
First Global report on DLF IPO:
* DLF has six decades of experience and a highly qualified, dedicated management team, many of whom have over 20 years of experience in their respective fields, with Mr. K.P.Singh, Executive Chairman, leading the show. Founded in 1946, the company is credited for the development of 224 mn sq.ft., including well-known colonies such as Krishna Nagar, Greater Kailash and Hauz Khas, as well as an entire integrated 3,000 acre township – DLF City.
* The promoters hold 42.04% of the pre issue equity, the promoter group holds 55.38%, while other shareholders hold 2.57%. There will be ‘Net issue to public’ of 12.57% (175 mn.shares of face value of Rs. 2) of the post issue capital.
* The company has extensive land reserves in various regions across India totaling 10,255 acres, with a saleable area of 574 mn sq.ft., with 51% in the NCR, 23% in Kolkata and the balance 27% in the remaining 24 cities. Although the company began as a principal developer in the NCR, it has forayed into other parts of the country as well, thus making it a genuinely geographically diversified player.
* DLF’s revenues come primarily from the construction of properties/ plots and the lease rentals arising out of letting commercial office space and retail space. The former contributes 85.7% of the total revenues, the latter contributes 5.9%, while 8.4% includes the balance representing maintenance income (3.1%), power supply income (3.8%), and the remaining through property management services and cinemas operations.
* DLF has always collaborated with internationally renowned architectural consultants, such as Hafeez Contractor, The Jerde Partnership Inc. and Mohit Gujral. DLF’s clientele for commercial space include MNCs such as Canon, Nokia, IBM-Daksh, Sapient, Microsoft, etc.
* DLF’s top management is very proactive in identifying other real estate related businesses as part of the company’s growth and diversification strategy to strengthen its lateral and vertical business drivers. The company’s strategic initiatives to capitalise on emerging market opportunities include the following:
Entered into Joint venture with Laing O’Rourke for construction expertise and with Hilton for hotel development.
Acquired share interest (19%) in Feedback Ventures for management consulting services and 51% in Ananta Satellier for architectural know-how.
Signed MoU with Nakheel LLC, UAE, for two townships, each spread over 20,000 acres. And with Fortis Healthcare is to develop and manage hospitals.
Entered into Joint Venture with Prudential Insurance for developing and selling life insurance products.
Key Risks
Uncertainty of land reserves
As of April 30, 2007 the company and its subsidiaries own 1,160 acres (11.3%) of the total land bank of 10,255 acres. The company directly owns only 0.5% while the balance 10.8% is held by the subsidiaries. The remaining 9,095 acres of land reserves are subject to agreements to purchase, development rights agreements or MoUs for acquisition. So risk is inherent in these executory contracts as sellers of land often withdraw from MoUs and sale agreements if land prices go up, resulting in disputes of uncertain outcome.
Availability of real estate financing
The RBI recently issued a notification prohibiting real estate companies from raising funds through the ECB route for developing integrated townships, while revising the interest rate limits for those who are allowed to tap the foreign markets. Moreover, the government proposes to treat FII investments in pre- IPOs of real estate companies at par with FDI with a lock-in period of 3 years in line with the prevailing FDI norms. This step might keep the foreign investors at bay.
Downside risk in execution plan
DLF’s plans appear huge in comparison to its earlier developments. The company plans to make available for sale or lease 149.7 mn sq.ft. for FY07-09, while its cumulative developments, excluding plots, as of April 30, 2007, was merely 29 mn sq.ft. We view DLF’s development schedule as aggressive and carrying considerable execution risk.
Cyclical nature of the Indian real estate industry
The real estate industry is cyclical in nature, which might impact realization in property values and rental income over a period of time. The situation could become worse if property prices decline and property inventory also becomes illiquid over extended periods of time.
Investment Rationale
We have valued DLF real estate business using the NPV approach based on the company’s land bank and development estimates by discounting the project’s cash flows, plus other miscellaneous realizations of other assets on the balance sheet as reduced by the liabilities. We have not included 554 acres of land (entered into a MoU between Dec 1, 2006 and Feb 28, 2007) due to lack of further information for valuation purpose.
As per our calculations, the NPV of DLF’s business works out to Rs.413 per share, after factoring in the best-case assumption including its power business (55MW plant), which has been valued at Rs 2.2 bn. At the price band of Rs.500-550, the stock is at a premium of 21-33% to the NPV. In comparison, Unitech, which has a similar large land bank (10,332 acres), currently trades at Rs.560, while its NPV works out to around Rs.560-575 per share. As compared to this, a majority of the global real estate stocks in Hong Kong and Singapore trades at a 10-30% discount to their NPV.
All said and done, DLF appears to be a steeply priced issue. It may work. But that probability is low.
