f o r    m a n a g i n g    t o m o r r o w
NOV. 19, 2006
 Cover Story
 BT Special
 Back of the Book

Rural-Urban Divide
The rural-urban divide continues despite a high growth rate. According to the 61st round of the National Sample Survey, apart from rural-urban wage differentials, gender differentials are very much a part of the present-day Indian economy. The urban regular wage earner earned Rs 194 a day, which was one-and-a-half times the rural average of Rs 134 a day in 2004-05. Interestingly, the wage gap is most pronounced among graduates. An analysis.

The Asian Agenda
Is a region-wide free-trade area a realistic goal? So far, 183 free trade agreements have either been signed or are being proposed or negotiated across Asia. The share of intra-regional trade has risen to about 55 per cent last year from 40 per cent in the early 1990s. Aside from trade in goods, there is a need to focus on free trade in services. Given the stalled WTO talks, it is vital for Asian countries to pursue further market opening and structural reforms.
More Net Specials
Business Today,  November 5, 2006
Unitech's Skyscraper

In a little over a year, Unitech's average market cap has risen from Rs 465 crore to an astonishing Rs 14,786 crore. Can Unitech sustain the valuation?

Hitting pay dirt: Sanjay Chandra (R) with his father Ramesh Chandra

On April 7 this year, within minutes of the stock market opening, Unitech shares hit the 5 per cent circuit breaker on the upper side. The stock price jumped to Rs 3,064.90 before trade in the scrip was halted for the rest of the day from its previous close of Rs 2,918.95. (A price circuit break is a safety mechanism that limits the price movement either way in a single trading session.) Nothing unusual there. It was news in the air acting on a relatively illiquid stock. The volumes traded were a relatively modest 23,246 shares on NSE, largely because of the limited free float in the stock (promoters, the Chandras, owned 60 per cent of the company at that time, with private corporate bodies holding another 24 per cent and the public 11 per cent).

In the days that followed, the story was repeated. Meanwhile on May 12, the company approved a bonus issue and a stock split. The frenzy, however, continued. On May 16, the stock fell 5 per cent, yet again within minutes of the market opening, locking out investors from trade.

Even after the stock split became effective June 23, Unitech continued to hit the circuit breaker every day, easing somewhat only in August when the price had risen to Rs 13,100 (adjusted for bonus and stock split). However, during this spectacular rise, the volume of trade sometimes was as low as 690 shares. The situation today could not be more different. Average volumes are up to 10-20 lakh shares per day.

Naturally, then, the Delhi-based real estate company Unitech has managed an astonishing 2,000 per cent-plus increase in its average market value to Rs 14,786 crore in the first half of this financial year compared with the same period last year.

If anything announces the arrival of the real estate sector at the gate, this does. Not just Unitech, which is the biggest gainer in terms of percentage among this year's BT 500 companies, but other stocks such as Ansal Property and Infrastructure and Mahindra Gesco have also been on an upswing. Paradoxically, despite the increase in Unitech and other real estate (re) stocks, their combined contribution to the total market cap of Indian equities is just around 1 per cent-way below the 25-30 per cent in economies such as Singapore and Hong Kong.

What has helped Unitech is a 20-year-history of remaining listed with a clear, defined corporate structure

Ugly Duckling to Stock Market Darling

In India, real estate companies have traditionally either not listed on the bourses or if they have, then found the discipline required for quarterly reporting of earnings a bit too much. Remember, the other National Capital Region or NCR-based real estate giant DLF delisted from the Bombay Stock Exchange in 1982 and from the Delhi Stock Exchange in 2003. And even the few that remained listed, such as Unitech (it has been listed for 20 years now), attracted poor investor interest. In other words, few scrips, low free floats coupled with the overall opaqueness of the sector and restrictive policies made real estate stocks backbenchers in market performance. Indeed, the Unitech stock was languishing between Rs 100 and Rs 300 for most of 2004.

Easing of policy and regulatory bottlenecks changed the scenario. Allowing foreign direct investment (FDI) in real estate projects was the most crucial driver of a re-rating of the entire sector. In February 2005, the government decided to allow FDI up to 100 per cent under the automatic route in townships, housing, built-up infrastructure and construction projects.

Sanjay Chandra, Unitech's 34-year-old Managing Director, sums up the change: "Till a year ago, real estate was a totally ignored sector. We never used to get any investor meeting requests. Now, we have a full-fledged investor relations department since there are at least 30-40 requests per month, mostly from foreign institutional investors." Another issue that provided fillip to the sector was the high-decibel marketing of the abortive IPO of Unitech's competitor and peer in NCR, DLF. "Whenever there is a large public issue in a sector, there is a rub-off on other sector stocks as well," says S. Ramesh, coo, Kotak Investment Bank, who was involved with the now-postponed DLF initial public offer.

Ansal's market value has soared, too, but not as much as Unitech's. One reason, say analysts, is a lack of sufficient information
Sushil Ansal, Chairman, Ansal Properties & Infrastructure

However, a more fundamental reason driving up these stocks was the inherent growth story. "Indian real estate sector is likely to continue to grow over the next four-five years backed by strong economic growth," says Ramesh Sanka, Group CFO, DLF. According to the industry thumbrule, real estate grows two to three times the GDP growth of a country. With India growing at 8 per cent per annum, a 20-25 per cent growth in real estate is not unexpected. Low supplies of developed real estate coupled with rising demand, increasing salaries and aspirations make real estate sector a good investment opportunity.

The sector advantages apart, a few company-specific details have made Unitech shine. A 20-year-history of remaining listed with a clear, defined corporate structure helped. The company has some 100-odd subsidiaries for land acquisition, but the promoters do not have companies for land acquisition that they privately own. Not the case with most of its fellow competitors. "We are the only real estate company that does 100 per cent of the business in the company itself. As a family, we do not own any real estate asset other than the house in which we live," says Chandra.

The Valuation Enigma

However, the pace of sectoral re-rating has left many investors breathless-wondering about the realism and the sustainability of the valuations. For instance, Unitech's average market capitalisation in the first half of the current financial rose to over Rs 14,786 crore, up from Rs 645 crore last year. How realistic are these valuations? It is tough to take a call given the complex models and valuation metrics of real estate companies, believe most market participants. "Location is key to valuations as it decides pricing. The rest, like construction costs, are international commodities," says DLF's Sanka. So, valuations can vary significantly for different companies depending on the areas of operation. Sanka, however, adds that institutions are fast learning the intricacies of valuing the real estate business.

Normally for real estate companies, step-ups in valuation are available at each stage of development-land aggregation, regulatory approvals and then the construction of the property. The valuations are mostly linked to the sale prices of the completed projects and how they can be valued in the current context. Final sale prices are often dependent on multiple macro-economic factors such as interest costs.

With nearly 70 per cent of the margins coming at the consolidation stage, different companies adopt different methods for acquisition-directly from farmers, from aggregators, government land auctions or a public-private model. Unitech, for instance, stays away from government auctions since it considers them expensive.

Kotak Mahindra Bank's Ramesh says that investors are more comfortable using net asset value (NAV) as a valuation benchmark rather than price-to-earnings (PE) ratio. And NAVs are more sensitive to the final sale prices of the real estate developments. A recent report by foreign brokerage CLSA pegs Unitech's valuation at $7.5 billion (or Rs 34,500 crore) based on the value of its land bank, without including the sez projects. This works out to a per share value of Rs 429. Typically, companies in similar economies trade at a 20-25 per cent discount to the net present value or NPV (see How Analysts Value Unitech).

Similarly, another sum-of-parts valuation by UBS Investment Research pegs the figure at Rs 444 based on the discounted cash flow method. This works out to a PE multiple of 19.3 based on the projected 2007-08 earnings. Unitech's Chandra himself believes that the Indian market is not yet ready to value real estate companies properly. No surprise, then, that Unitech is not too keen on raising fresh capital from the domestic market. (If guidelines are relaxed at some point, it may go in for a listing on London's aim, which is a stock market for small global companies.)

But for issues raised by its minority owners, DLF's IPO would have created one of India's most valuable real estate companies
Rajiv Singh
Vice Chairman, DLF Group

Betting on Growth

Easier policies, increased institutionalisation and robust demand have led to increased scales of the projects. That suits Unitech, which has diversified at multiple levels. Unitech's main foray into SEZs is via a three-way joint venture with Salim Group and Universal Success to develop 38,000 acres in West Bengal. Another significant project of 20,000 acres is in Haryana on the outskirts of Delhi. The company, however, is resolute in its focus on residential housing. Rising demand, easier upfront financing, quick absorption and fewer speculative positions make it sound base for the company. "For every 100 sq. ft of office space you create, you need around 500-600 sq. ft of living space," says Chandra, explaining why housing will remain the company's mainstay. With SEZs, residential housing will constitute around 60 per cent of the total usage, down from the current 70 per cent-plus. However, in line with its focus on large and integrated projects, the company has now entered into the hospitality business, where it will build and own the hotel but outsource the branding and management. In terms of geography, the company is keen on suburbs of metros where most job creation is happening. Forays in tier-II towns are restricted to places where the company can do all kinds of projects and get to be the leader as well (see The Unitech Land Bank). Unitech believes in the "build and sell" model, where it develops and then sells property to again replenish its land bank. As a result, nearly a third of its land bank is only two or three years old, with the remainder being a year old.

According to UBS Securities, the total cost of land is around Rs 5,000 crore, of which Rs 4,000 crore has yet to be paid. Chandra shrugs off concerns about the higher cost of the acquisition in recent times, saying that as parts of a large tract of land are developed, the balance continues to grow in value. "In Gurgaon, we may have acquired land at Rs 1 lakh an acre, but today we may sell a parking spot for Rs 2.5 lakh," he explains. On the Bengal expressway project, Unitech is working on a "land instead of toll" basis to drive down its acquisition costs.

Apart from housing, where the build and sell model works fine, Unitech is securitising the rental incomes from lease-based properties. "As the reit- (real estate investment trust-)like structures evolve in India, it would be possible to list them on the stock exchanges," Chandra adds. This model obviates the need for big capital requirements by Unitech. Though the sector is flush with equity funds (over $4 billion, or Rs 18,400 crore, at last count from private equity funds), Unitech would prefer debt for sometime to come. "Interest costs have gone up, but debt is still cheaper," says Chandra, adding that the company is still under-leveraged (it has about Rs 1,700 crore of debt on its books). Strategic investors are a simple no-no. "We've been there, done that. There is little value add other than capital, which is an international commodity."

Risks Remain

As construction costs go up for the industry in general, "execution will be a key risk going forward", says DLF's Sanka. Chandra agrees, adding that, "With all the construction that is happening, we need to build our internal infrastructure and we would need external support, good quality staff and contractors." And the price to pay may be heavy. According to the CLSA report, every six months of average delay will affect the net present value by Rs 35. One strategy Unitech has adopted to beat timeline and quality worries is to outsource project construction to firms such as Shapoorji Pallonji, Simplex, Nagarjuna Constructions and Unibuild. It only intends to focus on project marketing and development functions.

Tapering real estate prices is yet another risk. Here again UBS estimates a reduction of 5 per cent can dent valuations also by 5 per cent. Chandra, however, believes that the largely housing portfolio hedges this risk well. Yet, it is early days in the Indian real estate sector. Clarity on many of these would emerge once "some 10-12 more deals are done, and a few more quarters of guidance and earnings would help settle valuation issues", Kotak's Ramesh says. For the time being though, the Chandras aren't losing sleep over it.




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