REAL ESTATE

April 2014

REITs
TRANSPARENCY

Regulation Bill
TRANSPARENCY

Company Act 2013

OVIDERS
TRANSPARENCY AL PR
/ CAPIT
MERS
CUSTO
TORS Related party
S/RE GULA
AKER transactions
YM
POLIC OPACITY

Non-uniform
Accounting practices
OPACITY
Wilful diversion
of funds
OPACITY

Thematic: Accounting - at the crossroad

Analyst:
Krishnan ASV
+91 22 3043 3205
[email protected]
 Real Estate

CONTENTS

SECTOR
Executive summary…………………………………………………………………………….. 4

Accounting in real estate - A b lack box………………………………………………........ 6

Accounting for land - Further latitude………………………………………………………. 7

Revised guidance note (GN) strea mlines revenue recognition………………………… 10

yet not watertight

Related party transactions (RPTs) galore…………………………………………………... 14

Category mix and leverage suggest wilful d ivers ion of funds………………………….. 18

Methodology…………………………………………………………………………………... 20

Valuation - a perspective……………………………………………………………………. 25

What can investors look forward to?...................................................................... 27

- Companies Act 2013 - towards greater transparency………………………………. 28

yet onerous on real estate

- Impact of 2014 Gen eral Elections - lessons from 2009…………………………..… 30

- Real Estate Regulation Bill - pro-consumer; towards greater disclosures………….31

- Real Estate Investment Trusts (REITs) - limited eligibility;…………………………… 32

unlimited candidates

COMPANIES
Oberoi Realty (BUY): Launch pipeline crucia l……………………………………………. 35

Sobha Developers (BUY): Position of relative strength…………………………………. 57

April 23, 2014 Ambit Capital Pvt. Ltd. Page 2

 Real Estate
NEGATIVE
THEMATIC April 23, 2014

Accounting - at the crossroad Key Recommendations

Oberoi Realty BUY

The real estate sector allows considerable latitude in accounting for
revenues and cost (especially land), and thus, it is no surprise that the Target Price: 290 Upside : 30%
sector fares the worst on our accounting framework. We argue that fresh
funding needs (impending beauty parade for REITs) coupled with recent Sobha Developers BUY
changes to the accounting and regulatory framework is forcing greater
transparency amongst real estate companies. We identify Oberoi Realty, Target Price: 491 Upside : 30%
Prestige Estates and Sobha Developers among larger firms and Omaxe
and Peninsula Land among smaller firms as more transparent.

Accounting in real estate - too many black boxes Contingent Liabilities and P/B
In the absence of sector-specific accounting standards, accounting practices in CL (% of
Companies FY15 P/B
NW)
the real estate sector are non-homogenous, especially around accounting for
Large companies - mcap > US$500mn
revenues and land. Key areas that contribute to the sector’s relatively inferior
performance on accounting metrics are: (a) arbitrary revenue recognition; (b) DLF 26% 0.93
weak cash conversion; (c) expense manipulation (lack of prudent provisioning); Oberoi Realty 8% 1.46
and (d) many related party transactions. Prestige Estate Projects 43% 1.71
Need to read this
Revenue recognition harmonised yet not watertight Unitech 72% 0.37
Godrej Properties 5% 1.82
Whilst the revised guidance note (GN) prescribes a uniform threshold for firms
Phoenix Mills 25% 1.82
to begin recognising revenues from a project, our discussions with practising
auditors suggest that the revised GN is not yet completely watertight. This Sobha Developers 29% 1.46
includes instances such as developers entering into a separate ‘sale of land’ Mid-sized companies - mcap between
US$200mn and US$500mn
contract (contributing to aggressive revenue recognition), discretion exercised
Omaxe 32% 1.32
around what constitutes ‘critical approvals’ and ambiguity around JDAs.
Indiabulls Real Estate 8% 0.35
Related party transactions (RPTs) - modes of disguised lending HDIL 8% 0.27
On an average, the top-three categories of RPTs account for c.70% of the total Anant Raj 4% 0.42
related party transactions. A large proportion of RPTs are only ways of funding Sunteck Realty 0% 1.79
group entities, with most categories reversing themselves during the year and Mahindra Lifespace
3% 1.07
not earning any interest. We also argue that a bulk of construction finance Developers
(working capital loans raised for under-construction projects) raised by Puravankara Projects 4% 0.70
developers for residential projects is diverted towards either land acquisition or Small-sized companies - mcap between
stalled projects that are starved for capital (suffering from cost overruns). US$100mn and US$200mn
Parsvnath Developers 9% 0.40
Limited investible universe; Oberoi, Prestige - most transparent DB Realty 52% 0.51
Using accounting checks across four categories (P&L misstatement checks, Peninsula Land 1% 0.66
balance sheet misstatement checks, cash pilferage checks, and audit quality Hubtown 19% 0.61
checks) on a set of 21 real estate companies, we establish a pecking order of Ashiana Housing 1% 1.74
transparency and identify the investible universe of real estate stocks. Based on
Brigade Enterprises 88% 0.58
our analysis, Oberoi, Prestige and Sobha are relatively more transparent.
Kolte Patil Developers 28% 0.56
The road ahead - what can investors look forward to? Source: Bloomberg, Ambit Capital research; CL denotes
contingent liabilities; NW denotes net worth
Our discussions with senior partners and executives across the Big-4 auditors
suggest that developers are gradually undertaking a clean-up operation. Whilst
this push towards transparency is partly driven by the impending beauty parade
for fresh capital (to become REIT-friendly), experts also attribute this effort to
their desire to comply with the revised GN, the Companies Act 2013, and the
Real Estate Regulation Bill. We highlight the impending General Elections as a
key near-term business catalyst for the sector.
Analyst Details
Krishnan ASV
+91 22 30433205
[email protected]

Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital
may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.
 Real Estate

Executive summary
The BSE Realty Index has delivered returns in line with the BSE Sensex since the
beginning of 2014; however, the Indian realty sector continues to suffer from a high
credibility deficit across stakeholders, which is largely attributable to a lack of
transparency in reported financials and a lack of like-for-like (LFL) comparable
parameters across companies.

To help investors with LFL comparison, we identify 21 real estate firms, categorise
them into three separate buckets by market capitalisation and use four categories of
accounting metrics (as shown in the exhibit below) to score these firms on their
accounting quality.
Exhibit 1: Categories of accounting checks
Category Ratios
(1) CFO/EBITDA, (2) change in depreciation rate, and (3) miscellaneous expenses as a
P&L misstatement checks
proportion of total expenses
(1) Cash yield, (2) debtors more than six months as a proportion of total debtors, and (3)
Balance sheet misstatement checks
contingent liability as a proportion of net worth
(1) CWIP to gross block, (2) cost of construction to construction work-in-progress, and (3)
Cash pilferage checks
cumulative CFO plus CFI to median revenues
(1) Audit fees as a proportion of standalone revenues, (2) audit fees as a proportion of total
Audit quality checks
auditor remuneration, and (3) unaudited assets as proportion of consolidated assets
Source: Ambit Capital research

Among larger firms, Oberoi Realty, Prestige Estates and Phoenix Mills, and among
smaller firms, Omaxe, Peninsula Land and Kolte Patil, are more transparent.
Exhibit 2: The final ‘realty’ check - across accounting metrics
Balance sheet
Company P&L checks Cash pilferage checks Audit quality checks Overall score
checks
Large companies - mcap > US$500mn
DLF
Oberoi Realty
Prestige Estate Projects
Unitech
Godrej Properties
Phoenix Mills
Sobha Developers
Mid-sized companies - mcap between US$200mn and US$500mn
Omaxe
Indiabulls Real Estate
Housing Development & Infrastructure
Anant Raj
Sunteck Realty
Mahindra Lifespace Developers
Puravankara Projects
Small-sized companies - mcap between US$100mn and US$200mn
Parsvnath Developers
DB Realty
Peninsula Land
Hubtown
Ashiana Housing
Brigade Enterprises
Kolte Patil Developers

Source: Companies, Ambit Capital research; Note: Strong, Moderate, Weak

April 23, 2014 Ambit Capital Pvt. Ltd. Page 4

 Real Estate

We have deliberately refrained from using the full moon ( ) in Exhibit 2 above, given
the general lack of transparency around origination and sale transactions in the
sector.
Having established a pecking order on accounting quality, we present a valuation
approach underpinned by the cash conversion cycle and the adjusted net worth to
highlight undervalued stocks. We eliminate four outliers (on cash conversion cycle)
and map the remaining real estate developers on the consensus FY14 consolidated
P/B multiple (on the X-axis) and the six-year median cash conversion cycle (in number
of days) on the Y-axis. The size of the bubble in Exhibit 3 below indicates the
contingent liabilities (as a proportion of net worth), customer advances that are yet to
go through the P&L, and unbilled revenues.
Exhibit 3: Cash conversion cycle (in number of days) vs P/B multiple - Oberoi and Sobha cheaper than Prestige

1,200
Cash conversion cycle

1,000 Unitech Puravankara Kolte Patil

(number of days)

Godrej Properties
800
Hubtown Mahindra Lifespace
Parsvnath
600 Omaxe
Peninsula Land
Prestige Estates
400 DB Realty Oberoi Realty
DLF
200 Brigade Enterprises Ashiana Housing
Sobha Developers
0 Anant Raj
FY15 P/B
-200
- 0.5 1.0 1.5 2.0 2.5 3.0

Source: Companies, Bloomberg, Ambit Capital research; Note: X-axis denotes consensus FY14 P/B, Y-axis denotes the six-year median cash conversion cycle (in
number of days) and the s i z e of the bu bbl e de note s conti nge nt l i abi l i ti e s (as a pr opor ti on of ne t w or th)

Since not all contingent liabilities devolve on the parent entity (some are genuine), we
use a conditional adjustment factor on contingent liabilities to arrive at the adjusted
net worth. The higher the contingent liabilities, higher the adjustment factor that we
use to derive the adjusted net worth.
Exhibit 4: Deriving the adjustment factor for contingent liabilities
CL (% of NW) Deduction from NW
Less than 10% of NW 10% of CL
10% - 30% of NW 20% of CL
Over 30% of NW 30% of CL
Source: Ambit Capital research; CL denotes Contingent Liabilities; NW denotes net worth

The outliers that we have eliminated from Exhibit 3 are Phoenix Mills (significantly
Cash conversion cycle (in number
negative cash conversion cycle), Indiabulls Real Estate, HDIL and Sunteck Realty
of days) is the least common
(significantly high cash conversion cycle). The largest bubble in Exhibit 3 is equivalent
denominator for a majority of the
to 75% of net worth (Brigade Enterprises) whilst the smallest bubble is equivalent to
firms in this analysis
1% of net worth (Peninsula Land and Puravankara Projects). An ideal BUY signal
combines a low cash conversion cycle, a relatively attractive valuation and a smaller
bubble. On the other hand, the ideal SELL signal combines a high cash conversion
cycle, an expensive valuation and a large bubble.
Although the cash conversion cycle (in number of days) is the least common
We identify HDIL and Sunteck
denominator for most of the firms in this analysis, it is worth highlighting that
Realty as outliers on account of
companies with a lean P&L are unduly penalised. Given that the variables in the cash
the revenue recognition policy
conversion cycle (inventory days, debtor days and creditor days) employ P&L elements
(project completion method) and
(either revenues or cost of sales) in the denominator, the revenue recognition
hence, they are not strictly
approach, especially the project completion method, disproportionately impacts such
comparable on the cash
firms. We highlight HDIL and Sunteck Realty as outliers on account of the revenue
conversion scale
recognition policy (project completion method) and hence, they are not strictly
comparable on the cash conversion scale.

April 23, 2014 Ambit Capital Pvt. Ltd. Page 5

 Real Estate

Accounting in real estate - A black box

As highlighted in our accounting thematic dated November 2013, the ‘realty’ sector
fares the worst on our accounting framework, with an average score that is about
20% lower than the average score of the other 350 companies (within the BSE500).
Key areas that contribute to the realty sector’s relatively inferior performance on
accounting metrics are: (a) arbitrary revenue recognition; (b) weak cash conversion;
(c) expense manipulation (inadequate (imprudent) provisioning policies and deferred
depreciation); and (d) high cash pilferage. This total lack of credibility has resulted in
the realty sector continually being perceived as ‘high risk’ by all stakeholders—capital
providers, regulators, policymakers, auditors, property consultants and customers.
Real estate transactions - subjectivity in revenue recognition policies
Accounting practices in the real estate sector are non-homogenous - the industry is Real estate companies exercise
characterised with complex arrangements such as agreement to sell, flat-buyer subjectivity in revenue recognition
agreements, joint development agreements, area-sharing agreements, revenue or
profit-sharing agreements. These agreements assume various forms depending on
the nature of agreement between counterparties. One of the most critical areas of
subjectivity pertains to revenue recognition in ‘under-construction’ projects.
Real estate transactions - what drives subjectivity in revenue recognition?
In the absence of a specific Accounting Standard (AS) for recognition of income from Subjectivity lies in identifying the
real estate transactions, the complex nature of real estate transactions led to a wide applicable accounting standard
disparity in revenue recognition across firms in the sector. Issues around revenue (AS) for real estate transactions -
recognition arise because real estate developers often enter into agreements for should it be AS7 or AS9?
construction/sale of real estate before the construction is completed. The bone of
contention in accounting for such transactions is the identification of the applicable
accounting standard. Whilst one view suggests that such transactions are construction
contracts within the scope of AS7 (Construction Contract) and, hence, revenue should
be recognised as construction progresses (under the percentage completion method),
the contrary view is that the requirements of AS9 (Revenue Recognition) concerning
the sale of goods should be applicable.
Significant divergence in revenue recognition practices
The erstwhile guidance note (GN) mandated real estate companies to use the Earlier, the GN prescribed the
percentage of completion (POC) method for the purpose of revenue recognition; Percentage of Completion (POC)
however, it was silent on how developers should arrive at the POC and revenues method but left the specifics to
thereafter. As a result, there was considerable divergence in the revenue recognition interpretation
policies followed by different companies across the real estate sector.
Exhibit 5: Revenue recognition policies under the erstwhile GN - wide disparity
Threshold Minimum project sale Minimum Land cost in POC
policy criteria collection calculation
DLF 30% None No policy Considered
Godrej
20% None No policy Considered
Properties
HDIL 100% NA NA Considered
Indiabulls Real
25% None No policy Not considered
Estate
Kolte Patil 20% None No policy Considered
Mahindra
25% None Yes Considered
Lifespaces
Oberoi Realty 20% None NA Not considered
Omaxe 30% None No policy Considered
Phoenix Mills Not considered
Peninsula Land Considered
Prestige Estates 20-30% None No policy No policy
Sunteck Realty 100% NA NA Considered
Unitech Considered
Source: Companies, Ambit Capital research

April 23, 2014 Ambit Capital Pvt. Ltd. Page 6

 Real Estate

Accounting for land - further latitude

Another area that contributes to significant accounting disparity amongst real estate
companies is around accounting for land. Conventionally, for companies other than
those engaged in real estate development, land is a fixed asset and is accounted as
such. However, in the case of real estate companies, land is also a raw material,
which makes its way gradually from the balance sheet to the P&L statement.
Accounting for land depends on proposed end-use
The accounting for land depends on the proposed end-use - on the one hand, Although developers are not
residential projects treat land as inventory (in accordance with AS2) since such land is always certain of the end-use at
likely to be sold in the ordinary course of business, but on the other hand, the time of land acquisition, land
commercial projects (where developers intend to let out the project on a lease) treat has two proposed end-uses.
land as a fixed asset (in accordance with AS10), flowing through the gross block. Our When “held for sale”, land is
discussions with auditors suggest that often, companies are undecided about the end- treated as inventory (AS2); when
use at the time of land acquisition. Under such circumstances, developers often “held for lease”, land is treated
classify the land so acquired as a fixed asset; however, any subsequent re- as a capital asset (AS10)
classification can only be triggered by an external event. We believe that a bulk of the
land acquisition transactions fall in this category (companies undecided on end-use),
which translates into companies classifying land as a fixed asset at the time of
acquisition and then transferring such land to stock-in-trade (within inventory).
Exhibit 6: Accounting for land across the lifecycle of a real estate project
Balance sheet entries P&L statement entries
Stage Mix-use / Mix-use /
Held for sale Held for lease undecided Held for sale Held for lease undecided
Inventory -
Fixed assets - Fixed assets -
Construction
Capital Work-in- Capital Work-in-
Work-in-Progress Capitalised Capitalised Capitalised
Progress (+ve) Progress (+ve)
Land acquisition (+ve)
Cash (-ve) Cash (-ve) Cash (-ve)

Inventory -
Fixed assets - Fixed assets -
Construction
Capital Work-in- Capital Work-in-
Work-in-Progress
Progress (+ve) Progress (-ve)
Development / construction (+ve) Capitalised Capitalised Capitalised
(prior to revenue recognition
Cash (-ve) / Inventory -
being triggered)
Customer Cash (-ve) Construction Work-
advances (+ve) in-Progress (+ve)
Cash (-ve)
Inventory -
Fixed assets - Inventory - Cost of Sales -
Construction Cost of Sales -
gross block Construction Work- Construction Depreciation
Work-in-Progress Construction costs
Development / construction (+ve) in-Progress (-ve) costs
(-ve)
(once revenue recognition is
triggered) Cash (+ve) / Capital Work-in- Cash (+ve) /
Revenue Revenue Revenue
Debtors (+ve) Progress (-ve) Debtors (+ve)

Inventory -
Fixed assets - Inventory - Cost of Sales -
Construction Cost of Sales -
gross block Construction Work- Construction Depreciation
Work-in-Progress Construction costs
Sale is completed (risks and (+ve) in-Progress (-ve) costs
(-ve)
rewards are transferred)
Cash (+ve) Cash (+ve) Cash (+ve) Revenue

Source: Ambit Capital research

April 23, 2014 Ambit Capital Pvt. Ltd. Page 7

 Real Estate

Accounting for land as inventory - too many cost categories loaded up

The carrying value of land, when treated as inventory, is lower of cost or the net Too much ambiguity exists in the
realisable value (NRV). Given that developers expect to earn a positive return on their categories of costs that are
operations, the expected NRV is often typically higher than cost. However, there exists loaded into the cost of land,
wide disparity in cost categories that are loaded up to the carrying cost of inventory resulting in over-capitalisation
on the balance sheet. In most instances, companies are fairly ambiguous about the
cost components that are included in the carrying cost of inventory.
Exhibit 7: Accounting for land as inventory - the myriad alternatives in practice
Company Components of cost Method of valuation
Ashiana Housing Ltd. Direct materials, labour and project-specific direct and indirect expenses First-in-First-out
Land (including development rights) acquisition cost, borrowing costs,
estimated Internal development costs, external development charges,
DLF Ltd. Not disclosed
construction costs, overheads, borrowing cost, development/construction
materials
Cost of land, premium for development rights, construction costs, allocated
Godrej Properties Ltd. Not disclosed
interest and expenses incidental to the projects undertaken by the company.
Cost of land, land development rights, materials, services, borrowing costs,
Housing Development & Infrastructure Ltd. First-in-First-out
acquisition of tenancy rights and other related overheads.
Costs incurred upto the completion of the project viz. cost of land/rights, value
of floor space index (FSI), materials, services and other expenses (including
Hubtown Ltd. Average cost
borrowing costs) attributable to the projects. Cost formula used is average
cost.
Cost of land, premium for development rights, construction costs and
Mahindra Lifespace Developers Ltd. allocated interest and expenses incidental to the projects undertaken by the Weighted average cost
company.
Cost of land, development rights, rates and taxes, construction costs,
Oberoi Realty Ltd. borrowing costs, other direct expenditure, allocated overheads and other Not disclosed
incidental expenses.
Cost of land, materials, construction, services, borrowing costs and other
Omaxe Ltd. Average cost
overheads related to projects.
All costs directly related to the project and other expenditure as identified by
the management, which are incurred for the purpose of executing and
Peninsula Land Ltd. Not disclosed
securing the completion of the project (net off incidental recoveries/receipts)
up to the date of receipt of occupancy certificate from the relevant authorities.
All costs directly related to the project and other expenditure as identified by
Phoenix Mills Ltd. the management, which are incurred for the purpose of executing and Not disclosed
securing the completion of the project (net of incidental recoveries/receipts).
Aggregate of land cost, materials, contract works, direct expenses, provisions
Prestige Estate Projects Ltd. Not disclosed
and apportioned borrowing costs (net of material scrap receipts).
Cost of land, construction related overhead expenditure, borrowing costs and
Puravankara Projects Ltd. Not disclosed
other net costs incurred during the period of development.
Direct expenditure related to construction activity and other expenditure
Sobha Developers Ltd. Not disclosed
(including borrowing costs) during the construction period.
Land acquisition cost (including development rights) and initial development
Sunteck Realty Ltd. Not disclosed
cost and direct expenditure related to construction activity.
Source: Companies, Ambit Capital research

Land not meant for self-occupation to be classified as “Investment Property”

It is worth highlighting that real estate developers very rarely report details regarding Real estate companies are
the movement of inventory in their annual reports (although companies are mandated to classify land in the
mandated to report the movement in inventory under the revised Schedule VI “Investment Property” category
balance sheet format). Also, Schedule VI mandates companies to classify land which
is not meant for self-occupation (applicable to all real estate companies) under the
“Investment Property” category within non-current investments although most
developers are not yet following this classification.

April 23, 2014 Ambit Capital Pvt. Ltd. Page 8

 Real Estate

Impairment in estimated value of land is not carried out transparently

More importantly, when treated as inventory, any impairment in the estimated costs Impairment in the carrying value
is not routed through the P&L but adjusted directly against the inventory balance (in of land is not transparently routed
projects where revenue recognition is not triggered) or adjusted in the percentage of through the P&L but directly
completion (POC) component for the project (where revenue recognition is triggered). adjusted against the balance on
For instance, if the original cost of a project was estimated at `100 and the actual the balance sheet
cumulative cost incurred on the project was at `60, the POC method would imply
revenue recognition of 60% of the estimated revenues. However, during the following
year, if the cost incurred on the project is `30 (taking the cumulative cost incurred on
the project to `90) and the firm believes that a further `60 needs to be incurred to
complete the project (implying total project cost at `150), the POC method would
imply that revenue recognition remains at 60%.
This is especially the case when unreasonable estimates of unusual cost categories
Over-estimating the cost of land
are loaded up to the cost of inventory (cost of land including development rights and
results in impairment having to
cost of construction) that is carried on the balance sheet. It is worth highlighting that
be written off; under-estimating
firms have often significantly under-estimated as well as over-estimated project costs.
the cost of land results in the firm
For instance, firms often resort to write-offs after having inflated the carrying cost of
having to absorb significant cost
inventory with unconventional categories of costs. On the contrary, under-estimation
escalation thereafter
of project costs results in aggressive revenue recognition (since the 25% threshold for
revenue recognition is achieved earlier on a lower denominator), which is followed by
absorption of significant cost escalation thereafter.

April 23, 2014 Ambit Capital Pvt. Ltd. Page 9

 Real Estate

Revised guidance note (GN) streamlines

revenue recognition yet not watertight
In order to achieve consistency in revenue recognition norms, the Institute of
Chartered Accountants of India (ICAI) issued a revised GN in February 2012,
which was applicable for all real estate projects commencing after 1 April
2012. Whilst the revised guidance note prescribes a set of uniform threshold
criteria for companies to begin recognising revenues from a project, our
discussions with several practising auditors suggest that the revised GN is
not yet watertight and highlight several transitional issues.
The revised GN applies to all real estate projects commencing after 1 April 2012 and
projects in which revenues are being recognised for the first time on or after 1 April
2012. The revised GN covers different types of real estate transactions such as:
 Sale of plots of land with or without development;
 Utilisation and transfer of development rights;
 Redevelopment of existing buildings and structures; and
 Joint development agreements (JDAs).
The revised GN prescribes the following conditional criteria for real estate companies
to begin recognising revenues from a project under the POC method:
 All critical approvals that are necessary for project commencement have been
obtained; The revised GN prescribes four
project-related criteria to be
 At least 25% of the estimated construction and development cost (excluding the fulfilled for revenue recognition
cost of land) has been incurred; to be triggered
 At least 25% of the estimated project revenues has been secured by binding
contracts; and
 At least 10% of the estimated revenues have been realised on each contract as of
the date of reporting.
Of the above parameters, in practice, obtaining all critical approvals and incurring
25% of the estimated costs are the critical activities within any project, since the other
two activities (securing 25% of the estimated project revenues through contracts AND
collecting 10% of the estimated revenues) have a ‘total float’.
Still leaves room for subjective judgment
Whilst the revised guidance note is far more elaborate and specific in terms of Despite the uniform criteria being
prescribing a uniform threshold for companies to begin recognising revenue from a prescribed, the revised GN is not
project, our discussions with several practising auditors suggest that the revised GN is watertight and still leaves plenty
not yet watertight. For instance, an area where real estate companies tend to exercise of scope for subjective judgment
subjectivity is around what constitutes ‘critical approvals’. Developers often begin
recognising revenues from sale of units on the 10th floor even when they have only
obtained a partial commencement certificate (say, 5 floors) in a multi-storeyed tower.
This is especially true in properties in the National Capital Region (NCR) and units
that are sold to self-funded buyers (buyers who do not opt for a bank loan).
Revised GN a prescription, not mandatory on real estate companies
Since the revised GN is not yet an
Whilst most listed real estate companies claim to comply with the revised GN in their Accounting Standard, companies
FY13 Annual Report, this practice is not being followed across all projects of a listed are not mandated to follow it
entity, since a GN is only recommendatory in nature and not an accounting standard
by itself. As a result, despite the revised guidance note being in force since 1 April
2012, Sunteck Realty (SRIN) and HDIL, both listed developers, continue to recognise
revenues under the project completion method. Similarly, the revised GN prescribes
minimum 10% collections on each contract as a pre-condition for revenue
recognition; however, companies often aggregate collections from a project and
hence, end up recognising revenues aggressively.

April 23, 2014 Ambit Capital Pvt. Ltd. Page 10

 Real Estate

Exhibit 8: Illustrative example of change in revenue recognition policies since the issuance of the revised guidance note
Company Annual Report - FY12 Annual Report - FY13*
With effect from April 1, 2012 in accordance with the Revised
Guidance Note issued by the Institute of Chartered Accountants of
India (ICAI) on “Accounting for Real Estate Transactions (Revised
Revenue from constructed properties, other than SEZ projects, is 2012)”, the company revised its Accounting Policy of revenue
recognised on the percentage of completion method. Total sale recognition for all projects commencing on or after April 1, 2012 or
consideration as per the duly executed agreement to project where the revenue is recognised for the first time on or after
sell/application forms (containing salient terms of agreement to the above date. As per this Guidance Note, the revenue has been
sell), is recognised as revenue based on the percentage of actual recognised on the percentage of completion method provided all of
DLF Ltd. project costs incurred thereon to total estimated project cost, the following conditions are met at the reporting date.
subject to such actual cost incurred being 30% or more of the (i) at least 25% of estimated construction and development costs
total estimated project cost. Project cost includes cost of land, (excluding land cost) has been incurred;
cost of development rights, estimated construction and (ii) at least 25% of the saleable project area is secured by the
development cost, borrowing cost of such properties. Agreements to sell/application forms (containing salient terms of the
agreement to sell); and
(iii) at least 10% of the total revenue as per agreement to sell are
realised in respect of these agreements.
Effective 1 April 2012, in accordance with the ‘Guidance Note on
Accounting for Real Estate Transactions (Revised 2012)’ (Guidance
Note), all projects commencing on or after the said date or projects
which have already commenced, but where the revenue is
recognised for the first time on or after the above date, construction
The company is following the ‘Percentage of Completion Method’ revenue on such projects have been recognised on the percentage of
of accounting. As per this method, revenue from sale of completion method provided the following thresholds have been
properties is recognised in the Statement of Profit and Loss in met:
proportion to the actual cost incurred as against the total (a) All critical approvals necessary for the commencement have been
Godrej Properties Ltd. estimated cost of projects under execution with the company on obtained;
transfer of significant risk and rewards to the buyer. If the actual (b) The expenditure incurred on construction and development costs
project cost incurred is less than 20% of the total estimated is not less than 25% of the total estimated construction and
project cost, no income is recognised in respect of that project in development costs;
the relevant period. (c) At least 25% of the saleable project area is secured by contracts
or agreements with buyers; and
(d) At least 10% of the agreement value is realised at the reporting
date in respect of such contracts and it is reasonable to expect that
the parties to such contracts will comply with the payment terms as
defined in the contracts.
Income from real estate sales is recognised on the transfer of all In accordance with the Guidance Note on Accounting for Real Estate
significant risks and rewards of ownership to the buyers and it is Transactions (Revised 2012), in case of projects commencing on or
not unreasonable to expect ultimate collection and no significant after 1 April 2012 or in case of projects which have already
uncertainty exists regarding the amount of consideration. commenced but where revenue is being recognised for the first time
However if, at the time of transfer substantial acts are yet to be on or after 1 April 2012, revenues will be recognised from these real
Mahindra Lifespace performed under the contract, revenue is recognised on estate projects only when:
Developers Ltd. proportionate basis as the acts are performed, i.e. on the (i) the actual construction and development cost incurred is at least
percentage of completion basis. Revenues from real estate 25% of the total construction and development cost (without
projects are recognised only when the actual project costs considering land cost) and
incurred are at least 25 % of the total estimated project costs (ii) when at least 10% of the sales consideration is realised and
including land and when at least 10% of the sales consideration (iii) where 25% of the total saleable area of the project is secured by
is realised. contracts of agreement with buyers.
(a) Project for which revenue is recognised for the first time on or
after 1 April 2012
The Institute of Chartered Accountants of India has issued Guidance
Note on Accounting for Real Estate Transactions (Revised 2012) in
connection with the revenue recognition for a real estate project
which commences on or after 1 April 2012 and also to real estate
projects which have already commenced but where revenue is being
recognised for the first time on or after 1 April 2012.
The company follows the percentage of project completion
In this scenario, the company recognises revenue in proportion to
method for its projects. Under this method, the company
the actual project cost incurred (including land cost) as against the
recognises revenue in proportion to the actual cost incurred as
Oberoi Realty Ltd. total estimated project cost (including land cost), subject to achieving
against the total estimated cost of the project under execution
the threshold level of project cost (excluding land cost) as well as
subject to completion of construction work to a certain level
area sold, in line with the Guidance Note and depending on the type
depending on the type of the project.
of project.
(b) Project for which revenue recognition has commenced prior to 1
April 2012
In this scenario, the company recognises revenue in proportion to
the actual project cost incurred (excluding land cost) as against the
total estimated project cost (excluding land cost) subject to
completion of construction work to a certain level depending on the
type of the project.

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Company Annual Report - FY12 Annual Report - FY13*

In accordance with Revised Guidance Note issued by
the Institute of Chartered Accountants of India (ICAI),
Revenue from real estate projects including on ‘Accounting for Real Estate Transactions (Revised
integrated 2012)’, revenue recognition for all real estate projects
townships is recognised on the ‘Percentage of commencing on or after 1 April 2012 or where the
Completion Method’ of accounting. Revenue is revenue is recognised first time on or after 1 April 2012,
Parsvnath Developers recognised, in relation to the sold areas only, on revenue is recognised on percentage of completion
Ltd. the method if: (a) actual construction and development cost
basis of percentage of actual cost incurred thereon (excluding land cost) incurred is 25% or more of the
including land as against the total estimated cost of estimated cost, (b) At least 25% of the saleable project
the project under execution subject to such actual area is secured by contracts or agreements with buyers
cost being 30% or more of the total estimated cost. and (c) At least 10% of the total revenue as per sales
agreement or any other legally enforceable document is realised as at the
reporting date. However, there was no such project during the year.
The company is in the business of Property
Development. Revenue from sale of properties
During the year the company adopted the guidelines prescribed by the ‘Guidance
under construction is recognised on the basis of
note on Accounting Treatment for real estate transactions (Revised 2012)’ issued
actual bookings done (provided the significant risks
by the Institute of Chartered Accountants of India, inter alia , with regard to
Peninsula Land Ltd. and rewards have been transferred to the buyer
thresholds for commencement of revenue recognition for projects and the basis for
and there is reasonable certainty of realisation of
determining percentage of completion. The adoption of the said guidelines has no
the monies) proportionate to the percentage of
significant effect in the revenues and costs recognised for projects during the year.
physical completion of construction/ development
work as certified by the architect.
Revenue from sale of properties under construction
is recognised on the basis of Registered Sale
Agreements (provided the significant risk and
Revenue from the sale of properties under construction is recognised on the basis
rewards have been transferred to the buyer and
of the Sale Agreements (provided the significant risk and rewards have been
there is reasonable certainty of realisation of the
Phoenix Mills Ltd. transferred to the buyer and there is reasonable certainty of realisation of the
monies), on the basis of the percentage completion
monies), proportionate to the percentage of physical completion of
method, determined based on the physical
construction/development work, as certified by the company’s technical personnel.
proportion of the work completed, as certified by
the company’s technical personnel after the
construction work has progressed significantly.
Revenue from real estate developmental projects under development is recognised
based on the ‘Percentage Completion Method’. The Percentage Completion
Method is applied when the stage of completion of the project reaches a
reasonable level of development. For projects that commenced on or after 1 April
2012 or where revenue on a project is being recognised for the first time on or
after that date, the threshold for ‘reasonable level of development’ is considered to
have been met when the criteria specified in the Guidance Note on Accounting for
Real Estate Transactions (Revised 2012) issued by the Institute of Chartered
Revenue from each Real Estate Developmental
Accountants of India are satisfied, i.e., when:
Projects related to real estate vested with the
(a) All critical approvals necessary for commencement of the project have been
company, is recognised based on the ‘Percentage
obtained.
Completion Method’. The percentage completion
(b) The expenditure incurred on construction and development costs is not less
method is applied on a cumulative basis in each
Prestige Estate Projects than 25 % of the construction and development costs.
accounting period to the current estimates of
Ltd. (c) At least 25% of the saleable project area is secured by contracts or agreements
contract revenue and contract costs, when the stage
with buyers.
of completion of each project reaches a significant
(d) At least 10 % of the total revenue as per the agreements of sale or any other
level, which is estimated in the range of 20% to
legally enforceable documents are realised at the reporting date in respect of each
30% of the total estimated costs of the project
of the contracts and it is reasonable to expect that the parties to such contracts will
depending on the size of the project.
comply with the payment terms as defined in the contracts.
For projects that commenced prior to 31 March 2012 and where sales have
occurred prior to that date ‘reasonable level of development’ is considered to have
occurred when the project costs (excluding land cost) incurred is in the range of
20% to 30% of the total estimated costs of the project (excluding land cost). For
computation of revenue, the stage of completion is arrived at with reference to the
entire project costs incurred including land costs, borrowing costs and construction
and development costs as compared to the estimated total costs of the project.
The Group follows completed project method of
accounting. Direct/Allocable expenses incurred
The Group follows completed project method of accounting. Direct/Allocable
during the year are debited to work-in-progress
expenses incurred during the year are debited to work-in-progress account. The
account. The revenue is accounted for as and when
revenue is accounted for as and when the significant risks and rewards of
the significant risks and rewards of ownership of
Sunteck Realty Ltd. ownership of the units in real estate are passed or deemed to have passed to the
the units in real estate are passed or deemed to
buyer and the projects get completed or substantially completed, to the extent that
have passed to the buyer and the projects get
the economic benefits will flow to the Group and the revenue can be reliably
completed or substantially completed, to the extent
measured.
that the economic benefits will flow to the Group
and the revenue can be reliably measured.
Source: Companies, Ambit Capital research; Note: * in addition to revenue recognition policy disclosed in the respective 2011-12 Annual Reports

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Simultaneously employing two accounting policies on revenue recognition

As can be seen from the above exhibit, consequent to the issuance of the revised GN, Most real estate companies are
most real estate companies are currently following two policies simultaneously. The currently following two policies
revised GN is applied to all real estate projects that commenced on or after 1 April simultaneously
2012 and also to projects that have already commenced but where revenue is
recognised for the first time on or after 1 April 2012. On the other hand, the
erstwhile guidance note is still applied to all the prior projects.
IFRS mandates revenue recognition under project completion method
Given the atypical nature of the industry, whilst the ICAI has already issued Guidance
Notes to deal with the accounting policies prevailing in the real estate sector, the
international experience on standardised accounting is no different. The International
Accounting Standards Board (IASB) issued an interpretation (IFRIC 15), Agreement for
Construction of Real Estate, to deal with accounting in real estate companies. In
general, the criteria laid down in IFRIC 15 make it difficult to recognise revenues
merely based on an agreement to sell.
Dual agreement helps bypass IFRS norms
It is worth highlighting that in the formulation of Indian accounting standards (IND-
AS), IFRIC 15 was rejected, as under IFRS, construction contracts were not applicable
to real estate developers. As a result, developers (especially those that have a large
proportion of overseas funding and hence, need to comply with IFRS norms) enter
into two separate contracts—one contract for the sale of land and the other for
development on such land—even for residential flats. Under this scenario, income
from the first contract (sale of land) is recognised upfront (in line with AS9) whilst the
income from the second contract is recognised under the POC method (consistent
with AS7).
JDAs – ‘one size fits all’ approach inappropriate
Although the revised GN mentions joint development agreements (JDAs) within its No specific guidance in the
scope, there is no specific guidance or illustration to capture accounting for JDAs. revised GN for JDAs
JDAs typically entail the plot owner granting the real estate developer permission to
construct a building; in return, the developer is compensated with part-ownership of
the building or some other pre-decided form of monetary return. Our discussions
with senior executives at the Big-4 as well as practising auditors suggest that every
JDA is unique in its structure, terms and conditions. Given the wide diversity of such
agreements, a ‘one size fits all’ approach is inappropriate to deal with JDAs.

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Related party transactions (RPTs) galore

The top-three categories of RPTs account for c.70% of the total related party
transactions on average. Most categories of RPTs employed by real estate
developers are merely ways of funding group entities, a large proportion of
which do no earn interest and tend to get reversed during the year, as
reflected in the fact that the end-period outstanding balances are typically
less than 20% of the maximum outstanding balances.
Most real estate companies are characterised by concentrated ownership, with half of
the 21 companies in this analysis having promoter ownership in excess of two-thirds
of the total shareholding and only 4 companies having promoter shareholding below
50%. This often manifests itself in complex ownership structures with a labyrinth of
layered subsidiaries, joint ventures (JVs) and associate entities.
Real estate developers in India are regulated under the Land Ceiling Act, 1976, SPVs floated by developers to
which prescribes a ceiling on the area of land that a single company can own, which comply with the Land Ceiling Act
has spawned the multitude of SPVs for the purpose of land acquisition.
Exhibit 9: Layered entities - number of related parties as of March 2013
Joint Other related
Subsidiaries Associates Remarks
ventures parties
Anant Raj Ltd. 96 11 47 Subsidiaries include 20 step-down subsidiaries
Other related parties include entities over which key
DB Realty Ltd. 20 17 4 37
management personnel exercise significant control
Other related parties includes entities over which key
DLF Ltd. 266 12 17 110
management personnel exercise significant control
Other related parties include other listed and unlisted
Godrej Properties Ltd. 15 36 5 83 entities within the Godrej Group and private equity
investment firms
Other related parties include enterprises significantly
Housing Development &
10 2 1 3 influenced and controlled by key management
Infrastructure Ltd.
personnel
Indiabulls Real Estate Ltd. 239 1 2 Other related parties include subsidiaries of associate
Includes limited liability companies and partnership
Kolte Patil Developers Ltd 14 4 4
firms
Mahindra Lifespace
12 2 1 Includes jointly controlled entities
Developers Ltd.
Oberoi Realty Ltd. 8 5 Joint ventures refer to jointly controlled entities / assets
Omaxe Ltd. 94 1
Subsidiaries include 4 step-down subsidiaries; joint
Parsvnath Developers Ltd. 19 3 4 ventures include 1 JV belonging to a step-down
subsidiary
Includes 19 step-down subsidiaries; other related
Peninsula Land Ltd. 23 3 5 8
parties includes 7 step-down entities
Phoenix Mills Ltd. 21 13 7
Prestige Estate Projects Ltd. 21 4 5 14 Other related parties include partnership firms
Puravankara Projects Ltd. 20 4 8
Sobha Developers Ltd. 10 72 Includes 6 step-down subsidiaries
Sunteck Realty Ltd. 10 10 1
Subsidiaries include 227 wholly-owned subsidiaries;
Unitech Ltd. 243 14 2 4 other related parties include entities owned or
significantly influenced by key management personnel
Source: Companies, Ambit Capital research

RPTs could be used for disproportionate transfer of wealth

One of the most common ownership structures involves pyramids and cross-holding Differences in cash and control
of shares, which contributes to a significant wedge (difference between cash and rights between group companies
control rights) between group companies. This presents controlling shareholders with provide controlling shareholders
arbitrage opportunities to transfer wealth between group entities (from one in which (read: promoters) with arbitrage
the controlling shareholder or promoter has lower cash flow rights to another in opportunities to move resources
which the promoters’ rights are higher) through related party transactions (RPTs).

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RPTs - occasionally genuine but consistently misused

As captured in our real estate accounting thematic, ‘Mirror, Mirror on the Wall’ dated
26 July 2011, RPTs can take various forms, especially given the number of special
purpose vehicles (SPVs) that are floated by real estate companies for the purchase of
land from the market (further details on page 26 of this note).
There are many genuine reasons for the existence of related party transactions. A few
such reasons are highlighted below:
 Project-specific subsidiaries (or SPVs) are floated to segregate the risk-reward
At a very basic level, there can be
dynamics of one project from that of others; this is an especially popular structure
two genuine reasons for related
with capital providers who prefer funding specific projects rather than taking
party transactions (RPTs):
exposure at a listed entity level.
(a) isolation of risks; and
 Prior to a firm listing on the BSE/NSE, transactions are carried out to sell stake in
a joint venture to an external party for a specific project to avoid sharing the (b) isolation of rewards
private group’s consolidated accounts with the JV partner (this is also a manner of
funding).
Whilst there are many genuine reasons for group structures and transactions between
group companies, there is no denying that group structures have also been used by
controlling shareholders to treat minority shareholders inequitably, often resulting in
a disproportionate transfer of wealth to the controlling shareholders.
Ideally, the operating cycle in a real estate project (from commencement to transfer
of risk) should revolve around a single entity that is responsible for land acquisition,
construction, marketing and sale/lease of properties such that cash flows can also be
mapped in a straightforward manner, as illustrated in Exhibit 10 below.
Exhibit 10: An ideal real estate operational cycle

Source: Ambit Capital research

However, in the ‘real’ world, the existence of a large number of transactions between
a company and its related parties including subsidiaries, JVs and associate companies
makes the operating cycle complex and less transparent to analyse.
Exhibit 11: Possible complexities due to related party transactions - inflated costs and
balance sheet

Source: Ambit Capital research

Given the evidence that has emerged over the past few years regarding the use (or
misuse) of related party transactions to pull cash out of listed entities, investors should
be careful about companies with:
 Excessive number of related parties (normalised for scale of business);
 Excessive funding of related parties (as a percentage of consolidated net
worth); and
 Excessive funding of related parties (as a percentage of total loans and
advances).

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Funding of related parties most frequent among RPTs

For the 21 companies in this exercise, we have mapped the three most frequently
employed categories of RPTs (maximum contribution to the total RPTs). This analysis is
based on the outstanding balance in the particular category as of March 2013.
Exhibit 12: Most prolific categories of related party transactions (RPTs) as of March 2013
RPT 1 RPT 2 RPT 3
Anant Raj Ltd. Loans and advances - subsidiaries Investments in subsidiaries Non-convertible debentures
Advance against purchase of
DB Realty Ltd. Corporate guarantees Loans given / deposits placed
shares
Advances received under
DLF Ltd. Loans and interest receivable Investments
agreement to sell
Godrej Properties Ltd. Sale of units Investment in equity Inter-corporate deposit
Investment / redemption of
HDIL Advances for projects Loans / advances paid
debentures
Hubtown Ltd.
Indiabulls Real Estate Ltd. Other payables Corporate guarantees Debtors
Kolte Patil Developers Ltd Investment in debentures Loans and advances given Preference share capital
Mahindra Lifespace Developers Ltd. Finance given Inter-corporate deposits
Oberoi Realty Ltd. Loans given Deposit received Rent income
Omaxe Ltd. Loans and advances receivable Inter-corporate deposits Trade payables
Parsvnath Developers Ltd. Advances for land purchase Borrowings Other payables
Peninsula Land Ltd. Loans to associate companies Investment in debentures
Phoenix Mills Ltd. Loans and advances given Investment in equity shares Deposits given
Loans and advances
Prestige Estate Projects Ltd. Inter-corporate deposit payable Guarantees & collaterals provided
recoverable
Puravankara Projects Ltd. Guarantees Loans given / advances paid Loans taken / advances received
Sobha Developers Ltd. Land advance Receivables Advances recoverable in cash
Sunteck Realty Ltd. Preference shares Current investment Loans and advances
Unitech Ltd. Investment in debentures Advances received Remuneration paid
Source: Companies, Ambit Capital research

It is worth highlighting that the top-three categories of RPTs account for ~70% of the
Most RPTs are merely different
total related party transactions on average. As can be seen from the above exhibit, a
modes of funding related parties
bulk of the categories of RPTs employed by real estate developers are merely ways of
including investments in
funding the related party entities. As loans and advances attract significant
equity/quasi-equity instruments
investor scrutiny, firms have resorted to other modes of providing capital
through investment in equity or quasi-equity instruments and tunnelling.
Our analysis shows that a large proportion of RPTs (especially the likes of inter-
Majority of RPTs do not earn
corporate deposits) does not earn interest and tend to get reversed during the year.
interest and reverse themselves
From the limited number of companies that disclose details around end-year
during the year, implying year-
outstanding balances as well as maximum outstanding balances during the year, we
end window dressing
observe that the end-year outstanding balances are less than 20% of the maximum
outstanding balances in a majority of the RPTs, implying year-end window dressing.
Going forward, with the notification of over 280 sections under the Companies Act
2013 (more details on pages 27 and 28 of this note), we expect real estate
developers to find it progressively difficult to engage in RPTs without an adequate
explanation that justifies the rationale for such transactions.

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Category mix and leverage suggest wilful

diversion of funds
Our analysis of the category mix (asset classes within the real estate sector) and firm- With residential formats
level leverage suggests a significant diversion of debt towards land acquisition. As accounting for 80% of India’s real
residential formats account for ~80% of the Indian real estate market and given the estate market, the reported
self-financing economics of residential real estate (developers can generate pre-sales aggregate sector-level leverage
at the launch/pre-launch stage that should help cover the bulk of the working capital suggests diversion of construction
requirements), we find the sector-level leverage intriguing. Hence, we believe that a finance towards land acquisition
large proportion of construction finance (working capital loans for under-construction
projects) raised by developers for residential projects is diverted towards either land
acquisition or stalled projects that are starved for capital.
It is worth highlighting that Indian banks are not allowed to lend to real estate
companies for the purpose of land acquisition. However, given the regulatory
arbitrage (around exposure limits, extent of scrutiny, and stricter end-user
classification) between banks and NBFCs lending to real estate companies, the NBFC
route is conveniently exploited. In fact, we argue that a significant proportion of what
appears to be non-bank debt to real estate companies is also bank lending to the
sector, albeit in an indirect manner.
Exhibit 13: Regulatory arbitrage between bank lending and non-bank lending

Sensitive sector - hence, Relatively lower

greater regulatory regulatory scrutiny leads
scrutiny to arbitrage Construction finance from banks
remains the cheapest source of
funds for real estate developers;
however, relatively greater
Bank Bank Bank scrutiny of banks’ exposure limits
and end-use monitoring of funds
provide NBFCs with a significant
regulatory arbitrage
Housing finance
Real estate company Other NBFC
company (HFC)

Real estate company Real estate company

Source: Ambit Capital research

Based on our analysis (captured in Exhibit 14), we argue that real estate companies
have only two primary sources of funding: banks and High Net-worth Individuals
(HNIs and ultra HNIs).
Exhibit 14: Major channels of real estate funding in India
Pre-2005 2005-2007 2008-2009 2010-2011 2012-2013
Offshore listing Offshore listing Offshore listing Offshore listing Offshore listing
IPO IPO IPO IPO IPO
QIP QIP QIP
PE funds PE funds PE funds PE funds
ECBs ECBs ECBs ECBs
NBFC lending NBFC lending NBFC lending NBFC lending NBFC lending
Bank lending Bank lending Bank lending Bank lending Bank lending
Private lending Private lending Private lending Private lending Private lending
Source: JLL publications; Note: Cells highlighted in BOL D indicate very high levels of activity in that channel
during the period, cells highlighted in Red indicate average levels of activity in the channel during the period

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 Real Estate

As captured in the exhibit above, bank funding (direct) to the real estate sector has
been sporadic. On the other hand, the NBFC channel and private lending channel
have consistently seen high levels of activity nearly every year. This is reflective of the
existing regulatory arbitrage between banks and NBFCs lending to real estate.
Banks are under far greater regulatory scrutiny from the Reserve Bank of India (RBI)
NBFCs are capitalising on
on exposure to the real estate sector. In fact, bank exposure to commercial real estate
regulatory arbitrage and fulfilling
(CRE) is mandatorily classified under sensitive sector exposure as part of banks’
most incremental funding needs
statutory reporting. Another area that contributes to the regulatory arbitrage between
in the form of ‘last mile funding’
banks and NBFCs lending to real estate companies is the prevalent laxity in end-user
classification at NBFCs, where exposure to real estate is often camouflaged as MSME
(Medium, Small and Micro industries) exposure or unsecured personal lending
(whereby HNIs and ultra-HNIs leverage themselves to fund special purpose vehicles).
Given this regulatory arbitrage, banks find it easier to lend to real estate companies
through intermediaries like NBFCs, as captured in Exhibit 13. Also, given the NBFC
dependence on bank funding (80%), a large proportion of NBFC lending in Exhibit 14
is, in fact, disguised bank lending. It is worth highlighting that growth in bank lending
to NBFCs has been consistently north of the headline credit growth being reported by
the banking system and also does not undergo as much regulatory scrutiny as bank
lending to other end-user industries (like infrastructure).
Exhibit 15: Growth in loan book - reflecting regulatory arbitrage
YoY growth trends (%) 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14*
Non-food credit growth 16.8 21.3 16.6 13.3 14.8
Real estate -0.3 5.8 15.6 11.9 9.2
Housing 7.7 19.3 12.3 14.0 17.6
Housing (priority sector) 10.5 10.5 10.7 0.3 10.2
NBFCs 14.8 62.3 23.9 12.6 17.6
HDFC Ltd 16.7 15.0 19.6 20.3 20.7 17.0
LIC Housing Finance 26.2 37.6 34.2 23.5 23.4 17.0
Source: RBI, Companies, Ambit Capital research; Note: * 2013-14 indicates YoY growth as of Dec’13

However, it is also worth highlighting that the statutory auditors, in every case, certify
the following (or a variant of this version) in the listed companies’ Annual Reports:
 In our opinion and according to the information and explanations given to us, the
Statutory auditors, in nearly every
term loans have been applied for the purposes for which they were
case, certify purpose compliance
obtained/secured.
and maturity matching (the fact
 According to the information and explanations given to us and on an overall that short-term funds are not
examination of the balance sheet of the company, we report that no funds raised being diverted towards creation
on short-term basis have been used for long-term investment. of long-term assets)
Whilst the first certification amounts to covenant compliance (this is especially critical
for banks to monitor whether the borrower is fulfilling the conditions under which the
loans were granted), the second certification is a clean chit being given by an auditor
to a firm that short-term funding is not being funnelled into creation of long-term
assets (presumably land acquisition).
Our discussions with senior chartered accountants suggest that covenant compliance,
although mandatory, is only offered in passing reference by banks. Checks around
end-use or purpose compliance are nearly non-existent in the system, as auditors
tend to treat these as mere check boxes that need to be ticked.

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Methodology
We identify 21 real estate firms and categorise them into three separate buckets by
market capitalisation. We use the following 12 accounting ratios, categorised into
four buckets, to score the real estate firms based on their accounting quality.
Exhibit 16: Key categories of accounting checks
Category Ratios
(1) CFO/EBITDA, (2) change in depreciation rate, and (3)
P&L misstatement checks
miscellaneous expenses as a proportion of total expenses
(1) Cash yield, (2) debtors more than six months as a proportion
Balance sheet misstatement checks of total debtors, and (3) contingent liability as a proportion of
net worth
(1) CWIP to gross block, (2) Cost of construction to construction
Cash pilferage checks work-in-progress, and (3) cumulative CFO plus CFI to median
revenues
(1) Audit fees as a proportion of standalone revenues, (2) audit
Audit quality checks fees as a proportion of total auditor remuneration, and (3)
unaudited assets as proportion of consolidated assets
Source: Ambit Capital research

Whilst we have detailed the accounting ratios under each of these categories over the
next few pages, we summarise our observations in Exhibit 17 below.
Exhibit 17: The final ‘realty’ check - across accounting metrics
Balance sheet
Company P&L checks Cash pilferage checks Audit quality checks Overall score
checks
Large companies - mcap > US$500mn
DLF
Oberoi Realty
Prestige Estate Projects
Unitech
Godrej Properties
Phoenix Mills
Sobha Developers
Mid-sized companies - mcap between US$200mn and US$500mn
Omaxe
Indiabulls Real Estate
Housing Development & Infrastructure
Anant Raj
Sunteck Realty
Mahindra Lifespace Developers
Puravankara Projects
Small-sized companies - mcap between US$100mn and US$200mn
Parsvnath Developers
DB Realty
Peninsula Land
Hubtown
Ashiana Housing
Brigade Enterprises
Kolte Patil Developers

Source: Companies, Ambit Capital research; Note: Strong, Moderate, Weak

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I - P&L misstatement checks

CFO/EBITDA: This ratio assesses a company’s ability to convert EBITDA (which can be
relatively easily manipulated) into operating cash flows (more difficult to manipulate).
We evaluate the extent to which these companies are cash-generative based on the
ratio of cumulative operating cash flows (post working capital changes) to cumulative
EBITDA over the six-year period of FY08-13. We penalise seven companies that have
not generated positive operating cash flows even on a cumulative basis over the six-
year period. We find that larger companies are significantly better at cash conversion
as compared to the mid-sized and smaller real estate companies.
Going forward, with many real estate firms beginning to comply with new revenue
recognition norms (in accordance with the revised GN), cash flows from a project are
likely to precede the earnings from a project. However, for companies with a portfolio
of projects, we believe that this ratio will continue reflecting a firm’s cash-generative
ability as long as revenue recognition does not significantly lag cash collections.
Change in depreciation rate: Given the prevalent practice of real estate companies
overcapitalising expenses, we calculate change in depreciation rates for each of the
past six years (FY08-13). Companies with the smallest change in depreciation rate
receive the best score. The rationale is to penalise companies that witness undue
volatility in their depreciation rate on a YoY basis, implying volatility in the underlying
asset base (this happens on account of over-capitalisation).
Miscellaneous expenditure as proportion of total costs: We use ‘miscellaneous
expenses’ as reported by companies (not categorised under specific expense head) in
their annual reports as a percentage of their total costs. A high ratio implies that
many cost categories are unclassified and get loaded onto ‘miscellaneous expenses’.
We use a six-year median for this measure.
Exhibit 18: P&L misstatement checks - small-sized companies better off than mid-sized companies
Change in Miscellaneous expenses
Company CFO / EBITDA Overall score
depreciation rate (% of total expenses)
Large companies - mcap > US$500mn
DLF
Oberoi Realty
Prestige Estate Projects
Unitech
Godrej Properties
Phoenix Mills
Sobha Developers
Mid-sized companies - mcap between US$200mn and US$500mn
Omaxe
Indiabulls Real Estate
Housing Development & Infrastructure
Anant Raj
Sunteck Realty
Mahindra Lifespace Developers
Puravankara Projects
Small-sized companies - mcap between US$100mn and US$200mn
Parsvnath Developers
DB Realty
Peninsula Land
Hubtown
Ashiana Housing
Brigade Enterprises
Kolte Patil Developers

Source: Companies, Ambit Capital research; Note: Strong, Moderate, Weak

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II - Balance sheet misstatement checks

Cash yield: This ratio is calculated as the yield earned on cash, investments and
deposits. A low ratio could be a cause for concern, as it could mean that either the
balance sheet is being inflated or that the cash is being mismanaged. We use a six-
year median for this measure.
Debtors greater than six months as a proportion of total debtors: We have
conventionally considered provisioning prudence as one of the accounting metrics in
our analysis (as measured by provision for doubtful debtors as a proportion of
debtors greater than six months). For instance, it is considered prudent to provide
completely towards debtors greater than six months (just to put this in perspective, in
the banking context, banks are mandated to provide for accounts that are overdue by
over three months). However, some real estate companies make a further judgmental
distinction within this, between good and doubtful debtors. As a result, real estate
companies only provide towards debtor balances that they classify as doubtful within
their books of accounts (which is fraught with a subjective bias).
To eliminate this subjective bias, we use an alternate ratio measuring ageing debtor
balances (over six months) as a proportion of total debtors. A high ratio raises the
spectre of aggressive revenue booking significantly ahead of collections. We use a
six-year median for this measure.
Contingent liabilities as a proportion of net worth: This metric measures off-
balance-sheet liabilities. A high ratio raises concerns on the balance sheet strength of
a firm in the event that the contingent liabilities materialise. Given the nature of
capital structures prevalent in the real estate sector (equity infused in step-down
subsidiaries with assured returns), we include guarantees and capital commitments
whilst arriving at the contingent liabilities. We use a six-year median for this measure.
Exhibit 19: Balance sheet misstatement checks
Company Cash yield Debtors over 6m Contingent liabilities Overall score
Large companies - mcap > US$500mn
DLF
Oberoi Realty
Prestige Estate Projects
Unitech
Godrej Properties
Phoenix Mills
Sobha Developers
Mid-sized companies - mcap between US$200mn and US$500mn
Omaxe
Indiabulls Real Estate
Housing Development & Infrastructure
Anant Raj
Sunteck Realty
Mahindra Lifespace Developers
Puravankara Projects
Small-sized companies - mcap between US$100mn and US$200mn
Parsvnath Developers
DB Realty
Peninsula Land
Hubtown
Ashiana Housing
Brigade Enterprises
Kolte Patil Developers

Source: Companies, Ambit Capital research; Strong, Moderate, Weak

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III - Cash pilferage checks

CWIP to gross block: We calculate the proportion of capital work-in-progress to
gross block for each of the last six years and take a median. A high ratio is penalised;
the idea is to punish firms that show consistently high CWIP relative to gross block, as
this may indicate either unsubstantiated capital expenditure or deferred depreciation
expense. We use a six-year median for this measure.
Cost of construction to construction work-in-progress: As highlighted on pages 7
and 8 of this note (Accounting for land), land held for sale is held as inventory and
makes its way through the construction cost line item in the P&L. Using a six-year
median, we evaluate how much of construction work-in-progress reflects cost of land
(including development rights) and construction costs. A relatively low ratio suggests
over-capitalisation of expenses (including estimated internal and external
development costs), which should be expensed in the normal course of business. A
low ratio also suggests possible direct write-downs (impairment/adjustments) from
inventory (on the balance sheet), as a result of which a lower proportion is routed
through the P&L statement.
Cumulative CFO plus CFI to median revenues: We compute this ratio by summing
up six-year cumulative cash flow from operations and six-year cumulative cash flows
from investing activities and normalise this to a firm’s six-year median revenues.
Given that a real estate company’s return profile is typically driven by the quality of
its investments (or capital employed), this ratio helps assess how efficiently a real
estate company is re-deploying its operating cash flows. The idea is to penalise firms,
which over such a long period have failed to either generate positive operating cash
flows or have significantly stretched themselves by over-investing.
Exhibit 20: Cash pilferage checks
CWIP-to- Construction costs to
Company Free cash flows Overall score
gross block Inventory (land)
Large companies - mcap > US$500mn
DLF
Oberoi Realty
Prestige Estate Projects
Unitech
Godrej Properties
Phoenix Mills
Sobha Developers
Mid-sized companies - mcap between US$200mn and US$500mn
Omaxe
Indiabulls Real Estate
Housing Development & Infrastructure
Anant Raj
Sunteck Realty
Mahindra Lifespace Developers
Puravankara Projects
Small-sized companies - mcap between US$100mn and US$200mn
Parsvnath Developers
DB Realty
Peninsula Land
Hubtown
Ashiana Housing
Brigade Enterprises
Kolte Patil Developers

Source: Companies, Ambit Capital research; Note: Strong, Moderate, Weak

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IV - Audit quality checks

Audit fees as a proportion of standalone revenues: We calculate standalone
audit fees as a proportion of standalone revenues over FY08-13 and derive the
median for this metric. Firms with a lower ratio receive a high score on this metric as
we penalise firms that are overpaying their auditors relative to their scale. DLF,
Omaxe, Sobha and Prestige rank amongst the best companies on this metric.
Audit fees as a proportion of total auditor’s remuneration: We derive the six-
year median to measure the proportion of total auditor remuneration that has been
paid out as audit fees. A low proportion suggests that the share of audit in the total
business that the auditor derives from the firm is low and the auditor is compensated
for services other than statutory audit.
Assets audited by non-statutory auditors as a proportion of total
consolidated assets: Multiplicity of related parties and the magnitude of related
party transactions portend possible diversion of cash away from the listed entity. We
use a three-year median to assess the extent to which an auditor relies on
information furnished by the management (auditors outside the statutory auditor and
other unaudited financials of entities that are subsequently consolidated). The higher
this ratio, the weaker is the audit framework given the extent to which these numbers
fall outside the ambit of the audited consolidated numbers.
Exhibit 21: Audit quality checks
Auditors’
Company Audit fees Scope of statutory audit Overall score
remuneration
Large companies - mcap > US$500mn
DLF
Oberoi Realty
Prestige Estate Projects
Unitech
Godrej Properties
Phoenix Mills
Sobha Developers
Mid-sized companies - mcap between US$200mn and US$500mn
Omaxe
Indiabulls Real Estate
Housing Development & Infrastructure
Anant Raj
Sunteck Realty
Mahindra Lifespace Developers
Puravankara Projects
Small-sized companies - mcap between US$100mn and US$200mn
Parsvnath Developers
DB Realty
Peninsula Land
Hubtown
Ashiana Housing
Brigade Enterprises
Kolte Patil Developers

Source: Companies, Ambit Capital research; Note: Strong, Moderate, Weak

Cumulating scores: We cumulate scores across these 12 parameters to arrive at the

final accounting score for each firm. Based on these parameters, we rank 21 firms on
accounting quality in this exercise.

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Valuation - a perspective Deriving adjusted net worth

Having compared these companies on a range of accounting metrics, we present a Company
Adjusted NW (%
valuation approach underpinned on the cash conversion cycle and the adjusted net of reported NW)
worth to identify undervalued stocks. Anant Raj 92%
Ashiana Housing 131%
Critical valuation driver 1: Cash conversion cycle
Brigade Enterprises 86%
Given that cash generation is the single most critical driver of valuation in real estate
DB Realty 100%
firms, we derive the cash conversion cycle for each of the past six years (FY08-13).
DLF 80%
We then use a six-year median as our first critical driver in this valuation approach.
The higher the cash conversion cycle, the longer a developer needs working capital Godrej Properties 118%
finance. Similarly, lower the cash conversion cycle, lesser the need for working capital HDIL 115%
finance and lesser the idle capital employed. Hubtown 108%
Critical valuation driver 2: Adjusted net worth Indiabulls Real Estate 121%
Kolte Patil
Given that the P/B multiple-based approach is often used as an alternative to DCF- 127%
Developers
based valuation (the ideal approach), we argue that it is critical to adjust a firm’s Mahindra Lifespace
102%
net worth for contingent liabilities, customer advances and unbilled revenues Developers
to derive a fair P/B multiple. Oberoi Realty 116%
Omaxe 155%
Since not all contingent liabilities devolve on the parent entity (some are genuine), we
Parsvnath
use a conditional adjustment factor on contingent liabilities to arrive at the adjusted Developers
88%
net worth. The higher the contingent liabilities, higher the adjustment factor that we Peninsula Land 99%
use to derive the adjusted net worth.
Phoenix Mills 105%
Exhibit 22: Deriving the adjustment factor for contingent liabilities Prestige Estate
133%
Adjustment factor (deduction Projects
CL (% of NW)
from NW) Puravankara Projects 102%
Less than 10% of NW 10% of CL Sobha Developers 97%
10% - 30% of NW 20% of CL Sunteck Realty 426%
Over 30% of NW 30% of CL Unitech 87%
Source: Ambit Capital research; CL denotes Contingent Liabilities; NW denotes net worth Source: Ambit Capital research
NW denotes Net Worth
Methodology
In Exhibit 22, we eliminate four outliers (on the cash conversion cycle) and map the
remaining real estate companies on consensus FY15 consolidated P/B multiple (on
the X-axis) and the six-year median cash conversion cycle (in number of days) on the
Y-axis. The size of the bubble denotes contingent liabilities (as a proportion of net
worth).
Exhibit 23: Cash conversion cycle (in number of days) vs P/B multiple - Oberoi and Sobha cheaper than Prestige

1,200
Cash conversion cycle

1,000 Unitech Puravankara Kolte Patil

Godrej Properties
(number of days)

800
Hubtown Mahindra Lifespace
Parsvnath
600 Omaxe
Peninsula Land
Prestige Estates
400 DB Realty Oberoi Realty
DLF
200 Brigade Enterprises Ashiana Housing
Sobha Developers
0 Anant Raj
FY15 P/B
-200
- 0.5 1.0 1.5 2.0 2.5 3.0

Source: Companies, Bloomberg, Ambit Capital research; Note: X-axis denotes consensus FY14 P/B, Y-axis denotes the six-year median cash conversion cycle (in
number of days) and the s i z e of the bu bbl e de note s conti nge nt l i abi l i ti e s (as a pr opor ti on of ne t w or th)

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Exhibit 24: Large-sized real estate companies

2,000 The largest bubble in Exhibit 24

Oberoi Realty pertains to Unitech (58% of net
Unitech Godrej Properties
1,000 DLF worth)
Cash conversion cycle

Prestige Estates
(number of days)

0
Sobha Developers
-1,000

-2,000

-3,000
Phoenix Mills
-4,000
FY15 P/B
-5,000
(0.50) - 0.50 1.00 1.50 2.00 2.50

Source: Companies, Bloomberg, Ambit Capital research; Note: X-axis denotes consensus FY14 P/B, Y-axis
denotes the six-year median cash conversion cycle (in number of days) and the size of the bubble de note s the
conti nge nt l i abi l i ti e s (as a pr opor ti on of ne t w or th)

Exhibit 25: Mid-sized real estate companies

8,000 The largest bubble in Exhibit 25

pertains to Indiabulls Real Estate
7,000
Sunteck Realty (18% of net worth)
Cash conversion cycle

6,000
(number of days)

5,000
4,000
HDIL
3,000
2,000 Indiabulls
1,000 Puravankara
Mahindra Life Omaxe
0 Anant Raj
FY15 P/B
-1,000
(0.50) - 0.50 1.00 1.50 2.00 2.50

Source: Companies, Bloomberg, Ambit Capital research; Note: X-axis denotes consensus FY14 P/B, Y-axis
denotes the six-year median cash conversion cycle (in number of days) and the s i ze of the bubble de note s the
conti nge nt l i abi l i ti e s (as a pr opor ti on of ne t w or th)

Exhibit 26: Small-sized real estate companies

1,200 The largest bubble in Exhibit 26

pertains to Brigade Enterprises
1,000 Kolte Patil (75% of net worth)
Cash conversion cycle
(number of days)

800 Parsvnath
Hubtown
600
Peninsula
400 DB Realty

200 Ashiana Housing

Brigade Enterprises

0
FY15 P/B
-200
(0.50) - 0.50 1.00 1.50 2.00 2.50 3.00

Source: Companies, Bloomberg, Ambit Capital research; Note: X-axis denotes consensus FY14 P/B, Y-axis
denotes the six-year median cash conversion cycle (in number of days) and the s i ze of the bubble de note s the
conti nge nt l i abi l i ti e s (as a pr opor ti on of ne t w or th)

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What can investors look forward to?

In the following pages, we highlight the potential impact of key policy developments
(likely catalysts) facing the real estate sector over the next 24 months:
 Companies Act 2013
 2014 General Elections
 Real Estate Regulation and Development Bill 2013
 Real Estate Investment Trusts (REITs)
Each of these four policy initiatives is likely to drive greater operational transparency
in real estate companies. Given the extent of financial duress that a majority of the The impending beauty parade for
real estate companies find themselves under and a dangling carrot in the shape of fresh funding drives a push
potential fresh funding from REITs, our discussions with senior partners and senior towards greater transparency
executives across the Big-4 auditors suggest that developers are gradually
undertaking a massive clean-up operation. Whilst this push towards transparency is
partly driven by the impending beauty parade for fresh capital (to become REIT-
friendly), experts also attribute this effort to their desire to comply with the revised
guidance note and the Companies Act 2013.
As a result, some of the large developers are beginning to appoint one of the Big-4 in
an advisory capacity to help align customer sales/payment contracts with the revised
revenue recognition norms. These consulting assignments are aimed at structuring a
developer’s payment/sales contracts with its clients so that the cash collections are
closely aligned with the revised revenue recognition norms.
We analyse the impact of each of these policy measures on the real estate sector in
chronological order (in the order in which these are likely to occur) from page 27 to
page 33).
Exhibit 27: Key catalysts for the real estate sector over the next 18 months
Catalysts Key highlights Likely impact
Consolidated financial statements
Consolidation of land-owning entities Likely to introduce greater disclosures and
Companies Act 2013
Mandatory rotation of auditors transparency into the sector

Restriction on related party transactions

Streamlining of approvals Will influence supply-side variables ahead of the
2014 General Elections
Incremental job creation demand-side variables

Mandatory project registration

Real Estate Regulation and Standard project-related disclosures Enhances developer accountability and safeguards
Development Bill, 2013 customer interests
Ring-fencing of customer advances in escrow account (at
least 70% purpose compliance)
Minimum REIT asset size at `10bn
Mandatory listing of REITs within 18 months of registration Likely to restrict entry to serious and large players,
Real Estate Investment Trusts (REITs) At least 90% of the REIT assets to be invested in completed broad-base the shareholding and enhance price
and rent-generating assets discovery
At least 90% of the net income to be distributed to unit
holders
Source: Ambit Capital research

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Companies Act 2013 - towards greater transparency

yet onerous on real estate
We expect the notification of over 280 sections under the Companies Act 2013
to raise the compliance burden on real estate companies, especially in terms
of the nature and scope of related party transactions (RPTs), mandatory
rotation of audit firms and layered subsidiaries. Whilst these norms will force
greater transparency in the sector (towards better long-term health), we
expect the entire sector to feel the impact of higher compliance costs.
The Ministry of Corporate Affairs (MCA) notified 183 sections of the Companies Act
2013 on 26 March 2013. Together with the 98 sections that were notified earlier on
12 September 2013, the MCA has now notified 283 sections of the 470 sections
proposed in the Companies Act. The key aspects of the Companies Act 2013 that will
have a significant bearing on real estate companies (from a transparency perspective)
are the relatively watertight definitions of “control”, “subsidiary”, “independent
director” and “related party”. We highlight the following aspects of the Companies
Act 2013 that will impose an onerous compliance cost on the real estate sector:
Consolidation of land-owning entities
In India, real estate developers are regulated under the Land Ceiling Act, which
prescribes a maximum limit (ceiling) on the area of land that a single company can
own. As a result, it is common practice for developers to float multiple special
purpose vehicles (SPVs) that purchase land from the market. SPVs are structured in
either of the following formats:
 Real estate firms own, directly or indirectly, 100% or a majority share in the
equity capital in such SPVs and/or have majority representation on the Board of
Directors of such SPVs.
 Share capital of SPVs, a small quantum in itself, is held by a third party, which
also controls the governing body of the SPVs. In such cases, the real estate
companies are involved with the SPVs in various other transactions, such as
lending, giving exclusive rights to develop land, providing guarantee against
funds borrowed by SPVs and guaranteeing a minimum return to capital providers,
which may restrict the decision-making powers of the SPV.
The more stringent definitions of “control” and “subsidiary” under the Companies Act
2013 will impact the “related party” disclosure requirement.
Preparation of consolidated financial statements (CFS)
The preparation of CFS has become mandatory for all companies, which operate
through subsidiaries, joint ventures or associates. Our discussions with senior
executives at the Big-4 auditors suggest that companies that do not operate through
subsidiaries but through joint ventures (JVs) and associates may also have to prepare
CFS. This compares with the current practice of unlisted companies not having to
prepare CFS. Given the structure of a typical real estate firm in India (as explained
above), this requirement will impose a higher compliance cost on real estate
companies.
Dividend restrictions on companies relying on public deposits
The Companies Act 2013 prescribes that a company cannot declare any dividend if it
fails to comply with the provisions related to the acceptance and repayment of
deposits. Thus, if a real estate company accepts a deposit and is unable to fulfil the
provisions related to the acceptance or repayment of such deposits, the Companies
Act 2013 prohibits shareholder payback in the form of dividend. Of the 21 companies
in our analysis, we find that Godrej Properties relies heavily on public deposits.
Related party transactions - under greater scrutiny
Although at some deviation from the prevailing AS18, the Companies Act 2013, for
the first time, carries a definition of “related party” and “related party transactions”.
Instead of the erstwhile practice of securing approval from the Central Government

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for entering into related-party transactions (RPTs), companies will now need to pass a
special resolution at the general shareholder meeting, wherein interested members
will not be entitled to vote on such resolutions. Whilst this provision is likely to ensure
closer scrutiny of related-party transactions by shareholders (hence, less possibility of
stealth), minority shareholders may continue to be silent spectators if shareholder
activism remains weak.
Even assuming arm’s-length related-party transactions, such transactions will need to
be referred to in the Board’s report to shareholders alongside an explanation for
entering into such transactions. This disclosure requirement is also likely to cover
non-cash transactions involving directors, if they are entered with a related party.
Against the backdrop of real estate developers increasingly entering into JDAs with
land owners, such SPVs also may come within the ambit of “related party”
transactions.
Limit imposed on layered subsidiaries (Section 2 Explanation (d) of clause 87)
The definition of “subsidiary” as included in the Companies Act 2013 prohibits certain
class or classes of holding company (to be prescribed) from having multiple layers of
subsidiaries beyond such numbers as may be prescribed. With such a restrictive
section, it appears that a holding company will no longer be able to hold subsidiaries
beyond a specified number. In the absence of any specific rules (conditions or sub-
clauses), this is likely to have a meaningful implication on real estate developers on
account of the multi-layered subsidiaries that are typical of the sector.
Mandatory rotation of auditors/audit firms (Section 139)
The Act mandates rotation of audit firms for all companies (with the exception of
small companies and single-person companies). All real estate companies (provided
they do not qualify as either small companies or single-person companies) will now
have to appoint an audit firm for a term of 5 or 10 years, with a mandatory annual
ratification by shareholders. Real estate companies are specifically impacted because
of the usual long-term relationship that they enjoy with audit firms, which will now
face mandatory rotation.
It is worth highlighting that other than Sobha Developers, none of the other
mainstream real estate companies are audited by the Big-4. Whilst this is especially
reflective of the well-entrenched nexus between the audit firms and the real estate
companies, this is also a damning indictment of the lack of transparency in the sector.
Mandatory debenture redemption reserve (Section 71 clause 4)
The Companies Act 2013 mandates that debenture-issuing companies need to create
a debenture redemption reserve (DRR) account out of its available surplus, which can
only be used towards redeeming such debentures. The DRR should comply with the
following conditions:
 Minimum DRR corpus of 50% of the value of debentures issued;
 Minimum 15% of the amount of debentures maturing by March of next year
(“current portion” of the outstanding debentures) to be invested or deposited in
specified securities by April 30 every year
This is especially critical for the real estate sector since most developers have milked
non-convertible debentures (NCDs) as an instrument given the difficulties in securing
construction finance from banks in recent times. Whilst the minimum DRR corpus will
reduce the distributable surplus available to shareholders (for dividend payout), the
minimum 15% investment/deposit clause will reduce investible surplus and hence,
drag the investment returns for real estate companies. Most real estate developers
have a sizeable exposure (in excess of 5% of their net worth) to NCDs, a bulk of
which is unsecured and short term in nature. However, developers also carry a DRR
on their balance sheet, covering about 20% of the value of the debentures, on an
average.

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Impact of 2014 General Elections - lessons from 2009

As highlighted in our strategy thematic published on 11 March 2014, a political reset
synchronised with a fresh economic ideology has historically driven higher economic
growth and higher shareholder returns. As the race for the 2014 General Elections
enters its final leg, investors are looking to add beta to their portfolios to benefit from
India’s ‘Fourth Wave’. Whilst the real estate sector is an obvious beta play on the
economy, we argue that investors should be selective in the exposure that they take
within the sector for sustainably high returns.
As captured in the ‘valuation’ section of this note, the core competency for real estate
Real estate companies that can
firms emerges from how well a developer capitalises on the factors of production,
best exploit the factors of
viz., land, labour and capital. These factors of production can be genuinely exploited
production (land, labour and
as a source of sustainable competitive advantage, as reflected in Exhibit 28.
capital) will have a sustainable
Exhibit 28: Operating cycle for real estate companies competitive advantage over their
peers
Ability to generate cash Ability to identify viable Ability to execute (project
and / or raise capital projects (deployment) development) and launch

Ability to market / sell and

collect receivables

Source: Ambit Capital research

With opinion polls pointing to an NDA coalition winning the most number of seats in
the forthcoming General Elections, the fundamental catalysts are likely to be
impacted in the following manner:
 Streamlining of approvals (single-window clearances or expedited approvals)
 Incremental job creation led by faster economic growth
Between the two catalysts outlined above, the election outcome is likely to have an The election outcome is likely to
immediate impact on the supply side (streamlining of approvals), resulting in a impact the supply variables
further build-up in inventory levels and a medium- to long-term impact on the ahead of the demand variables
demand side (faster income generation, better affordability and higher absorption
rates). We argue that an improvement in the demand-side variables is more critical to
the fundamental performance of the sector, as demonstrated in Exhibit 29.
Exhibit 29: Sales and inventory build-up since 2009 General Elections in top-3 cities

The first few quarters after the

2009 General Elections (May
2009) saw a double-digit QoQ
growth in inventory but was offset
by a very high absorption rate
driven by a revival in sales
momentum

Source: Liases Foras, Bloomberg, Ambit Capital research; Note: Sales denotes quarterly run rate (in million
square feet) in India’s top-three cities (Delhi/NCR, Mumbai/MMR and Bengaluru) with the March 2009
observation indexed to 100; Inventory (number of quarters) is scaled to RHS

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 Real Estate

For the purpose of this analysis, we have cumulated the sales and inventory data for
The quarterly sales run rate
India’s top-three real estate markets viz. Delhi (NCR), Mumbai (MMR) and Bengaluru.
(demand proxy) has increased
The sales run rate (the red column in Exhibit 29) has been on a consistently upward
from 20msf (March 2009 quarter)
curve since the March 2009 quarter. To put this in perspective, the quarterly run rate
to 49msf (December 2013
of sales in these three markets has grown from 20msf during the March 2009 quarter
quarter)
to 49msf during the December 2013 quarter. Put differently, the average quarterly
run rate of sales since the March 2009 quarter (between the June 2009 quarter and
the December 2013 quarter) is at about 44msf.
Our analysis indicates two things: whilst on the one hand it demonstrates the March
However, the inventory build-up
2009 quarter as an outlier (at the lower end), it also proves that the sales momentum
(supply proxy) has contributed
has been steady through the past 19 quarters. Hence, we argue that the real estate
more to the current crisis for real
sector is in a crisis despite steady quarterly sales because of the equally steady rise in
estate companies
inventory and consequently, lower absorption levels, as reflected in the inventory
pile-up (black line in Exhibit 29).
Against this backdrop, we argue that the results of the 2014 General Elections are
likely to impact the supply-side inventory ahead of the demand-side sales
momentum.

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Real Estate Regulation Bill - pro-consumer; towards

greater disclosures
Like many of its counterparts, the Real Estate Regulation and Development Bill 2013
is primarily aimed at enhancing developer accountability and safeguarding consumer
interests. The key clauses of the Bill are as follows:
 Mandatory registration of real estate agents
Key clauses in the Bill include:
 Compulsory registration of projects with a real estate regulatory authority, the
(a) Mandatory project
absence of which prohibits sale, booking or even offer to sell. Developers will
registration;
need to disclose standard project details and identify the brokers who will
represent the project. Developers can begin sales from a project only after all the (b) Standard project-related
necessary approvals are in place and the project has been registered with the disclosures; and
authority. The regulatory authority will need to decide on project approvals
(c) Ring-fencing of customer
(clearance or rejection) within 15 days
advances in a separate escrow
 Developers need to open a separate bank account (escrow account) for each account (minimum 70% purpose
project and will have to ring fence 70% of the customer advances to be used only compliance)
towards the completion of that particular project
 To eliminate inordinate delays in delivery, the Bill empowers buyers to cancel
booking and claim the full amount plus interest for project delays
 To enhance accountability, the Bill proposes penalties of 5-10% of project cost
and imprisonment of up to three years for misrepresentation of facts to customers
or non-compliance with regulatory norms
As with many other policy measures that involve Parliament intervention (for approval
and passing through both Houses), we expect this Bill to be enacted only once a
stable government is in place at the Centre.
Merits of the escrow mechanism
Whilst our discussions with experts suggest heavy lobbying by developers on this Bill, The escrow mechanism is likely to
if enacted in its current form, the Real Estate Regulation and Development Bill 2013 is introduce greater transparency in
likely to mitigate the risk of diversion of funds (as highlighted on pages 16 and 17, project cash flows and mitigate
funds borrowed against one project are often deployed in another project). Such ring- the risk of diversion of funds
fencing would make cash less fungible and result in greater transparency in project
cash flows, a welcome development, especially from the perspective of capital
providers. Whilst the escrow mechanism benefits capital providers in terms of greater
transparency and reduced risk of diversion of funds, it is possible that the lower risk
profile is reflected in lower cost of capital for developers.
Demerits of the escrow mechanism
However, the escrow mechanism will pose an impediment for purchase of new land
since banks are not permitted to lend towards land acquisition. This is likely to drive a
business model shift with developers increasingly leaning on JDAs (joint development
agreements) instead of buying land on their own accord.
Although the Bill prescribes 70% of customer advances to be ring-fenced, the precise
70% threshold proposed in the
percentage of customer advances to be set aside for project-specific expenses will be
Bill is too onerous on developers -
decided by local bodies (within each state). Our discussion with the Big 4 auditors
hence, local bodies may need to
suggests that developers who have already deployed considerable capital in
prescribe a lower threshold
acquisition of land will find the 70% threshold (as prescribed in the Bill) onerous.

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 Real Estate

Real Estate Investment Trusts (REITs) - limited

eligibility; unlimited candidates
As discussed in an earlier section in this note (pages 17 and 18), real estate, being a In a move universally welcomed
capital-intensive sector, faces a burgeoning need for capital, especially in the form of by industry observers, the SEBI
long-term institutional capital. During October 2013, given the paucity of institutional published draft REIT guidelines,
sources of funding (aside from banks) for real estate companies in India, the setting the stage for introduction
Securities and Exchange Board of India (SEBI), India’s capital markets regulator, of REITs over the next 18 months
published a draft consultation paper on REIT (Real Estate Investment Trust) guidelines.

The global experience with REITs - organised investment vehicles

Globally, REITs are pooled investment entities that predominantly invest in completed,
revenue-generating real estate assets and distribute a major portion of the earnings
amongst their investors. Typically, a majority of these investments are in completed
projects that provide investors with a regular stream of income from rentals derived
from such properties. About 30 countries, including most of the developed nations,
now have laws governing REITs. REITs globally have recorded a 13% CAGR in market
capitalisation from US$300bn (in 2003) to over US$1trn (in 2013).
Exhibit 30: Global REIT landscape – most of the listings are in the US
Year of Aggregate market
Country / Number of REITs % of global REIT Permissible gearing Profit distribution
introduction of capitalization (US$
jurisdiction (#) market ratio (%) obligation#
REITs mn)
Thin capitalisation
Australia 1985 52 86,169 8.0 100%
rules
Canada 1994 50 48,526 4.5 No restriction 100%*
Thin capitalisation 85% of tax-exempt
France 2003 37 68,193 6.3
rules profits
90% of the net
Germany 2007 4 1,657 0.2 45%
income
90% of audited
Hong Kong 2003 11 23,925 2.2 45% annual net income
after tax
>90% of distributable
Japan 2000 41 64,414 6.0 No restriction
profits
90% of taxable
Singapore 1999 32 45,538 4.2 35%-60%
income
90% of tax-property
United Kingdom 2007 23 49,007 4.6 Interest cover test
rental profits
90% of taxable
United States 1960 163 621,924 57.7 No restriction
ordinary income
Source: EPRA, Ambit Capital research; Note: * Canada imposes full tax on any undistributed surplus - hence, in practice, 100% of the profits get distributed; # the
profit distribution obligation is usually imposed on the REIT’s ordinary income (excluding capital gains)

A look at Exhibit 30 suggests that a REIT market needs at least a decade of operations
to mature both in terms of market depth (the number of REITs) as well as capturing
investor appetite (market capitalisation as a percentage of the global REIT market).
With the exception of the United Kingdom, which has seen rapid acceptance of REITs,
most other countries gain only about 20-30bps of the global market capitalisation
share every year during the evolution stage of REITs.
Globally, REITs typically invest in real estate formats such as business parks, industrial
parks, hotels, retail space, office space, serviced apartments (between 80% and 95%
of the investible capital is employed in these formats) whilst the residential asset class
accounts for less than one-fifth of the REIT assets.

April 23, 2014 Ambit Capital Pvt. Ltd. Page 32

 Real Estate

REITs in India - draft guidelines broadly borrowed from Singapore

Our analysis of the SEBI’s draft circular suggests that the REIT guidelines are broadly
mirrored on the regulations governing REITs in Singapore. We highlight the following
key eligibility criteria from the draft REIT guidelines as published by the SEBI:
 REITs to be set up as trusts and to register themselves with the SEBI
 Mandatory listing within 18 months of registration with the SEBI Eligibility criteria on minimum
 Minimum REIT asset size at `10bn REIT asset size will attract
only serious and large players
 Sponsor to have minimum consolidated net worth of `200mn
 Sponsor to have minimum experience of five years in real estate
 Sponsor lock-in of 25% for the first three years and 15% thereafter
Following are the key investment criteria:
 At least 90% of the REIT assets should be invested in completed (post issuance of
occupancy certificate) and rent-generating assets (projects that are at least 75%
rented or leased out) in India
 Remaining 10% allowed to be invested in developmental properties, government 90% of the REIT assets to be
securities, listed or unlisted corporate debt, equity shares of real estate invested in completed and
companies rent-generating assets;
 Entire corpus can be invested in one project remaining 10% permitted to
be invested in under-
 Not allowed to invest in vacant land or agricultural land construction properties
 At least 90% of the net income to be distributed to unit holders
 Leverage (gearing ratio) capped at 50%; credit rating from SEBI-registered credit
rating agency and approval of unit holders mandatory in case leverage is in
excess of 25%
Exhibit 31: SEBI’s draft REIT guidelines - key clauses
Criteria Prescribed value Impact
Minimum initial offer size (` mn) 2,500 Likely to broad-base
shareholding and enhance
Minimum public float (%) 25 price discovery
Minimum subscription size (`) 200,000 Will restrict initial participation
Minimum value of single REIT unit to be traded (`) 100,000 to HNIs
Will attract only serious and
Minimum asset size under REITs (` mn) 10,000
large players
Source: SEBI, Ambit Capital research

April 23, 2014 Ambit Capital Pvt. Ltd. Page 33

 Real Estate

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April 23, 2014 Ambit Capital Pvt. Ltd. Page 34

 Oberoi Realty
BUY
COMPANY INSIGHT OBER IN EQUITY April 23, 2014

Launch pipeline crucial Real Estate

Oberoi Realty emerged as the highest bidder for a 25-acre land parcel Recommendation
in the western suburbs of Mumbai, which has put to rest any concerns Mcap (bn): `74/US$1.2
around the re-deployment of its surplus capital. We factor in net debt of 6M ADV (mn): `46/US$0.8
0.3x (to fund this land acquisition), and we expect the launch of at least CMP: `224
three projects during FY15 to revive Oberoi’s operating cash flows from TP (12 mths): `290
` 1.7bn in FY14E to ` 9bn by FY15E. Using a project-based DCF approach, Upside (%): 30
we value Oberoi at ` 290, implying 7.3x FY15E FCFE.
Flags
Competitive position: STRONG Changes to this position: POSITIVE Accounting: GREEN
Predictability: AMBER
New launches critical for revival in operating cash flows Earnings Momentum: GREEN

Excessive cash-guzzling projects (due to the delayed pace of construction) and a

deficit of cash-generating assets (due to weak incremental sales and delayed Catalyst
launches) led to negative operating cash flows of `4.2bn during 9MFY14. With  Partial launch of Worli project by 1QFY15
cash collections from the existing under-construction projects ahead of the stage
 Completion of Borivali land acquisition
of completion, the company’s proposed launches in Worli and Mulund during
1HFY15 are critical to revive operating cash flows.  Part-launch in Mulund project by 1HFY15

Accretion to land bank adds crucial growth opportunity

Oberoi has emerged as the highest bidder for 25 acres of land in Borivali that Performance (%)
was put on the block by Tata Steel, with a bid of `11.55bn. With 10% of the bid 140
amount already paid out as earnest money deposit (EMD), we expect the 120
balance 90% to be paid out during 1QFY15 (funded by debt of ~`8bn). Our 100
calculations suggest a saleable area of c.4 million square feet (msf), which is a
80
~50% accretion to Oberoi’s existing inventory of ongoing projects.
60
Gearing for land acquisition likely to remain comfortable at ~0.3x 40
Apr-13

Jun-13

Sep-13
Jul-13

Oct-13
Nov-13

Feb-14
Mar-14
May-13

Aug-13

Dec-13
Jan-14
We expect Oberoi to have paid the EMD of `1.15bn on the Borivali land from its
existing cash balance (of `4.5bn as of December 2013). Given that banks are
not allowed to lend towards land acquisition, we expect the balance land cost Sensex OBER IN
(`10bn) to be funded through discounting of cash flows from its annuity assets Source: Bloomberg, Ambit Capital research

(including two upcoming annuity projects). We expect Oberoi to be cash-positive

by end-FY15 on the back of the Worli and Mulund launches.

Valuation at ` 290/share; we retain BUY

We use a project-based DCF approach to arrive at a valuation of `290/share
(revised upwards from `277/share). The upgrade is largely driven by the
addition of the Borivali project. Given that Oberoi is likely to restore its cash
surplus by end-FY15E on the back of its launch pipeline, we find the stock
attractively priced at 7.3x FY15E FCFE, leaving enough room for Oberoi to scout
for other opportunistic land acquisitions.

Key financials
Year to March FY12 FY13 FY14E FY15E FY16E
Net Revenues (` mn) 8,247 10,476 8,599 11,742 14,370
Operating Profits (` mn) 4,836 6,121 4,218 6,832 8,347
Net Profits (` mn) 4,630 5,048 3,205 4,810 6,540
Diluted EPS (`) 14.1 15.4 9.8 14.7 19.9
Analyst Details
RoE (%) 13.6 13.7 7.9 11.0 13.5
Krishnan ASV
P/E (x) 16.0 14.6 23.0 15.4 11.3
+91 22 3043 3205
P/B (x) 2.1 1.9 1.8 1.6 1.4 [email protected]
Source: Company, Ambit Capital research

Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital
may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.
 Oberoi Realty

Snapshot of company financials

Profit and Loss Company Background
Year to March (` mn) FY13 FY14E FY15E FY16E
Oberoi currently operates predominantly in Mumbai, with a
Revenue from residential
projects
7,813 5,469 7,110 9,243 diverse spread of premium developments including
Hospitality services 956 1,146 2,336 2,453
residential, commercial, retail, hospitality and social
infrastructure projects. Whilst the group’s promoters have
Rentals and related income 1,398 1,504 1,798 2,096
been developing real estate since 1983, the principal
Property and project
management income
250 330 391 485 business operations of various group entities was
Other operating income 58 150 107 92
consolidated into one group in 2006. The group was listed
in 2010 raising `10.3bn through its IPO proceeds. Oberoi
Total operating Income 10,476 8,599 11,742 14,370
has an ongoing project slate of 7.1msf under-construction
Operating costs (3,715) (3,698) (4,110) (5,029) and a planned project portfolio of 10.4msf, predominantly
Total SG&A (640) (684) (800) (994) consisting of residential properties. Whilst the ongoing
Total operating expenditure (4,355) (4,381) (4,910) (6,023) project portfolio is relatively more concentrated (71%
EBITDA 6,121 4,218 6,832 8,347
residential; 20% commercial), the portfolio of planned
projects is comparatively better diversified (65% residential;
PBT 6,830 4,644 6,972 9,478
25% commercial).
PAT 5,048 3,205 4,810 6,540
EPS (`) 15.4 9.8 14.7 19.9

Balance Sheet Cash flow

Year to March (` mn) FY13 FY14E FY15E FY16E Year to March (` mn) FY14E FY15E FY16E
Shareholders’ funds 38,968 41,685 45,763 51,308
Total pre-tax CF 2,546 13,049 14,181
Loan funds 0 8,000 8,000 0
Net Fixed assets 10,714 10,423 10,626 12,297 Tax (840) (4,306) (4,680)

Investments 0 4,000 0 0 CFO 1,706 8,743 9,501

Cash 10,725 9,886 6,418 280
FCFE 2,443 10,220 10,961
Working capital 17,528 25,375 36,719 38,730
Book value per share (`) 118.7 127.0 139.4 156.3 Changes in WC 7,847 11,344 2,011

Strong launch pipeline to revive operating cash flows Launches to stimulate free cash flow generation

Year / Property Format Area (sft) Likely launch

35.0% 32.1%
FY15
30.0% 26.1% 26.8%
Worli Residential 1,783,928 1QFY15 22.3% 21.4% 23.1%
25.0%
Worli Hospitality 336,375 1QFY15 20.0%
Mulund Phase I Residential 1,600,690 2QFY15 15.0%
10.0% 5.9%
Splendor Phase III Residential 274,550 4QFY15 5.0%
Commerz II - Phase I Commercial 725,769 4QFY15 0.0%
FY16 FY14E FY15E FY16E FY17E FY18E FY19E FY20E

Splendor Phase IV Residential 118,986 FCFE (% of net worth)

Borivali Residential 1,846,876

Source: Bloomberg, Ambit Capital research

April 23, 2014 Ambit Capital Pvt. Ltd. Page 36

 Oberoi Realty

Two new project launches by 1HFY15

Launches to help revive operating cash flows
Excessive cash-guzzling projects (due to the delayed pace of construction)
and a deficit of cash-generating assets (weak incremental sales and delayed
launches) have resulted in Oberoi’s operating cash flows receding by ` 4bn
(about 40% of opening balance) during 9MFY14. With cash collections from
the existing under-construction projects running ahead of the pace of
progress, the proposed launches in Worli and Mulund during 1HFY15 are
critical for a revival in Oberoi’s operating cash flows.
Oberoi Realty’s volume sales and cash collections remained weak during 9MFY14 on Weak volumes during 9MFY14
account of a combination of limited inventory available for sale in the ongoing on account of limited inventory in
projects and lack of new project launches. The limited availability of inventory was ongoing projects and lack of new
driven by: launches
 Delay in obtaining regulatory approvals to resume construction in Oberoi Esquire;
 Availability limited to high-ticket-sized inventory in Oberoi Exquisite; and
 Inventory exhaustion in completed projects, Splendor and Splendor Grande.
The limited availability of inventory has contributed significantly not only towards
weak unit sales (Part A - Exhibit 1) but also towards sluggish cash collections (Part C -
Exhibit 1).
Exhibit 1: Quarterly project-wise snapshot - limited inventory contributing to weakness in unit sales during 3QFY14
Project-wise quarterly run rate 4QFY12 1QFY13 2QFY13 3QFY13 4QFY13 1QFY14 2QFY14 3QFY14
PART A: Area sold (sft)
Oberoi Exquisite 27,950 28,600 27,820 39,630 41,600 21,960 16,250 10,790
Oberoi Esquire 74,715 58,065 70,410 52,680 46,095 25,180 22,985 17,560
Oberoi Seven 5,650 5,650 0 5,650 0 0 0 0
Oberoi Splendor Grande 41,860 23,660 20,020 18,200 10,920 1,820 0 0
Oberoi Splendor 20,727 7,896 11,844 7,896 19,740 0 0 0
Oasis Residential# 0 0 0 0 0 0 114,744 0
Total area sold (sft) 170,902 123,871 130,094 124,056 118,355 48,960 153,979 28,350
PART B: Value of area sold (` mn)
Oberoi Exquisite 441.9 495.2 488.3 781.2 739.6 477.6 384.7 225.7
Oberoi Esquire 1,036.2 926.6 1,099.5 783.5 780.4 411.0 433.1 348.9
Oberoi Seven 80.0 90.0 0.0 90.0 0.0 0.0 0.0 0.0
Oberoi Splendor Grande 650.6 374.2 345.2 310.7 202.0 36.1 0.0 0.0
Oberoi Splendor 455.9 190.2 287.0 198.5 504.6 0.0 0.0 0.0
Oasis Residential# 0.0 0.0 0.0 0.0 0.0 0.0 3,178.9 0.0
Total area sold (sft) 2,665 2,076 2,220 2,164 2,227 925 3,997 575
PART C: Cash collections (` mn)
Oberoi Exquisite 708.2 660.7 585.9 560.1 1,401.9 848.2 829.8 222.7
Oberoi Esquire 333.6 384.5 325.7 365.8 242.7 81.2 121.5 75.4
Oberoi Seven 80.0 90.0 0.0 90.0 0.0 0.0 0.0 0.0
Oberoi Splendor Grande 414.0 742.5 462.4 363.3 200.2 130.9 91.5 7.0
Oberoi Splendor 259.9 382.0 189.4 294.5 413.2 110.8 0.0 0.0
Oasis Residential# 0.0 0.0 0.0 0.0 0.0 0.0 770.7 0.0
Total cash collections (` mn) 1,796 2,260 1,563 1,674 2,258 1,171 1,814 305
Source: Company, Ambit Capital research; Note: # figures are cumulative until 9MFY14, as per management disclosures and include collections related to
transfers from another joint venture (with ICICI Ventures) that were originally sold during 2006-07.

April 23, 2014 Ambit Capital Pvt. Ltd. Page 37

 Oberoi Realty

Too many cash guzzlers; not enough cash generators

Our analysis of project-wise cash flows suggests that cash flows from the completed Inventory exhausted in completed
projects (Seven, Splendor and Splendor Grande) have been exhausted, leaving little projects; slow-moving ‘under-
headroom for incremental collections in the absence of fresh sales in these projects. construction’ projects not yet
All of these three projects are nearly fully sold out, resulting in negligible incremental cash-generative
inflows.
Exhibit 2: Project-wise outstanding collections - cash collections running significantly ahead of project progress
Collections outstanding by project (` mn) 4QFY12 1QFY13 2QFY13 3QFY13 4QFY13 1QFY14 2QFY14 3QFY14
Oberoi Exquisite
Cumulative sales (` mn) 10,205.4 10,700.6 11,188.9 11,970.1 12,709.7 13,187.3 13,572.0 13,797.7
Cumulative cash collected (` mn) 7,901.5 8,562.2 9,148.1 9,708.2 11,110.1 11,958.3 12,788.1 13,010.8
Collection outstanding (` mn) 2,303.9 2,138.4 2,040.8 2,261.9 1,599.6 1,229.0 783.9 786.9
Collection (% of sales) 77.4% 80.0% 81.8% 81.1% 87.4% 90.7% 94.2% 94.3%
Percentage of completion (%) 47.1% 51.0% 57.0% 64.0% 71.0% 78.0% 83.0% 88.0%
Oberoi Esquire
Cumulative sales (` mn) 8,537.0 9,463.6 10,563.1 11,346.6 12,127.0 12,538.0 12,971.1 13,320.0
Cumulative cash collected (` mn) 3,036.1 3,420.6 3,746.3 4,112.1 4,354.8 4,436.0 4,557.5 4,632.9
Collection outstanding (` mn) 5,500.9 6,043.0 6,816.8 7,234.5 7,772.2 8,102.0 8,413.6 8,687.1
Collection (% of sales) 35.6% 36.1% 35.5% 36.2% 35.9% 35.4% 35.1% 34.8%
Percentage of completion (%) BTL BTL BTL BTL BTL BTL BTL BTL
Oberoi Seven
Cumulative sales (` mn) 320.0 410.0 410.0 500.0 500.0 500.0 500.0 500.0
Cumulative cash collected (` mn) 320.0 410.0 410.0 500.0 500.0 500.0 500.0 500.0
Collection outstanding (` mn) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
Collection (% of sales) 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Percentage of completion (%) 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Oberoi Splendor Grande
Cumulative sales (` mn) 2,876.6 3,250.8 3,596.0 3,906.7 4,108.7 4,144.8 4,144.8 4,144.8
Cumulative cash collected (` mn) 2,147.0 2,889.5 3,351.9 3,715.2 3,915.4 4,046.3 4,137.8 4,144.8
Collection outstanding (` mn) 729.6 361.3 244.1 191.5 193.3 98.5 7.0 0.0
Collection (% of sales) 74.6% 88.9% 93.2% 95.1% 95.3% 97.6% 99.8% 100.0%
Percentage of completion (%) 62.3% 69.0% 82.0% 92.0% 95.0% 98.0% 100.0% 100.0%
Oberoi Splendor
Cumulative sales (` mn) 14,538.9 14,729.1 15,016.1 15,214.6 15,719.2 15,719.2 15,719.2 15,719.2
Cumulative cash collected (` mn) 11,731.6 12,113.6 12,303.0 12,597.5 13,010.7 13,121.5 13,121.5 13,121.5
Collection outstanding (` mn) 2,807.3 2,615.5 2,713.1 2,617.1 2,708.5 2,597.7 2,597.7 2,597.7
Collection (% of sales) 98.5% 99.8% 99.2% 99.8% 99.3% 100.0% 100.0% 100.0%
Percentage of completion (%) 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Oasis Residential#
Cumulative sales (` mn) 0.0 0.0 0.0 0.0 0.0 0.0 3,178.9 3,178.9
Cumulative cash collected (` mn) 0.0 0.0 0.0 0.0 0.0 0.0 770.7 770.7
Collection outstanding (` mn) 0.0 0.0 0.0 0.0 0.0 0.0 2,408.2 2,408.2
Collection (% of sales) NA NA NA NA NA NA 24.2% 24.2%
Percentage of completion (%) NA NA NA NA NA NA BTL BTL
Source: Company, Ambit Capital research; Note: # figures are cumulative until 9MFY14, as per management disclosures and include collections pertaining to
transfers from a joint venture (with ICICI Ventures) that were originally sold during 2006-07; BTL indicates below threshold level

On the other hand, cash collected from under-construction projects (Exquisite, Esquire
and Oasis) are running significantly ahead of the progress (percentage of completion)
in each of these projects. We expect Exquisite and Esquire to remain net consumers of
cash at least until 1QFY15 whilst Oasis is likely to be cash-surplus upon launch.

April 23, 2014 Ambit Capital Pvt. Ltd. Page 38

 Oberoi Realty

Strong launch pipeline across formats lends visibility to FY15 cash flows
We expect Oberoi to launch at least three incremental projects (across formats) over
the course of FY15. We ascribe a relatively higher probability to the launch of the
Worli project and the first phase of the Mulund project by 1HFY15.
Exhibit 3: Launch pipeline - ideal feedstock for the cash flow engine
Year / Property Format Area (sft) Likely launch
FY15
Worli Residential 1,783,928 1QFY15
Worli Hospitality 336,375 1QFY15
Mulund Phase I Residential 1,600,690 2QFY15
Splendor Phase III Residential 274,550 4QFY15
Commerz II - Phase I Commercial 800,000 4QFY15
FY16
Splendor Phase IV Residential 118,986
Borivali Phase I Residential 1,846,876
Source: Company, Ambit Capital research

We expect the launch of Commerz II - Phase I to be contingent upon a revival in the

fundamental demand drivers for commercial real estate (largely driven by corporate
confidence). Given that FY15 is an election year, we expect Oberoi’s potential clients
for Commerz II - Phase I to formalise their lease contracts only during 2HFY15.

April 23, 2014 Ambit Capital Pvt. Ltd. Page 39

 Oberoi Realty

Land acquisition a positive catalyst

Accretion to land bank adds crucial growth opportunity
Oberoi emerged as the highest bidder for 25 acres of land in Borivali (with a
bid of ` 11.55bn), which is likely to add saleable area of c.4msf to its
inventory, a ~50% accretion to its existing inventory. With 10% of the bid
amount already paid out as earnest money deposit (EMD), we expect the
balance 90% to be paid out during 1QFY15 (funded by debt of ` 8bn). We
expect the project to begin generating positive cash flows during FY18 and
become cumulative cash flow positive by FY20.
Oberoi has emerged as the highest bidder for 25 acres of land in Borivali that was We expect Oberoi to raise debt of
put on the block by Tata Steel, with a bid of `11.55bn. With 10% of the bid amount ` 8bn by discounting lease rentals
already paid out as earnest money deposit (EMD) by end-March 2014, we expect the from its annuity assets
balance 90% to be paid out during 1QFY15. Assuming that the company maintains a
certain quantum of cash on its balance sheet, we expect Oberoi to raise debt of `8bn
by discounting lease rentals from its annuity assets.
Pending approvals for transaction completion
For the transaction to go through, Oberoi Realty needs to obtain two major approvals
by June 2014. Oberoi needs to obtain the collector’s permission for the sale of the
Sanad land which is part of the total property and an NOC (no objection certificate)
from the labour authority. If these approvals do not come through within three
months, the MOU (Memorandum of Understanding) for the sale of land will stand
annulled.
Saleable area of 3.7msf adds crucial inventory pipeline
Our calculations suggest a saleable area of 3.7msf, a sizeable accretion to Oberoi’s
growth prospects in terms of addition to inventory.
Exhibit 4: Deriving the total construction area and total saleable area
Particulars Area (sft) Remarks
Land area 1,089,000 Converted from 25 acres
Less: Common amenities area 272,250 25% of the land area
Less: Recreation ground area 81,675 10% of net land area (adjusted for amenities)
Base FSI 735,075
Add: TDR for amenities area 272,250 25% of the original land area
Add: TDR and premium 816,750
Total FSI (before fungible FSI) 1,824,075
Add: Compensatory fungible FSI 638,426 35% of Total FSI
Total FSI (with fungible FSI) 2,462,501
Saleable area 3,693,752 Assuming 50% loading factor
Assuming super built-up area at 20% higher
Total construction area 4,432,502
than saleable area
Source: Company, Ambit Capital research

Powerful signalling mechanism

Whilst this acquisition adds crucial saleable area to Oberoi’s inventory pipeline, we
read this bid as a powerful signalling mechanism that sets a benchmark for Oberoi’s
valuation appetite in land transactions. Oberoi’s bid, at `11.55bn, for a 25-acre plot,
implies a land valuation at `4,500 per square feet (on total FSI, inclusive of fungible
FSI). From a pricing perspective, the bid provides an insight into Oberoi’s appetite for
the acquisition cost of land, especially when the land comes with a clean title, as in
this case. Our discussion with senior property consultants suggests that Oberoi’s
current bid is significantly north of Oberoi’s earlier bids for such parcels of land and is
indicative of a more serious approach towards re-deploying surplus capital, given the
relatively greater comfort around the land title.

April 23, 2014 Ambit Capital Pvt. Ltd. Page 40

 Oberoi Realty

Project likely to be launched in two phases

We expect the Borivali project to be launched in two equal phases (c.1.85msf each),
with the first phase likely to be launched during FY16 followed by a second phase
launch during FY19. We expect the project to be sold out over 7 years.
Exhibit 5: Assumptions driving the Borivali project - Phase I launch during FY16 and Phase II launch during FY19
Borivali project economics FY14E FY15E FY16E FY17E FY18E FY19E FY20E FY21E FY22E
Revenues
Sales (% of est. saleable area) 0.0% 0.0% 10.0% 15.0% 15.0% 20.0% 15.0% 15.0% 10.0%
Average realisation (`/sft) 15,848 13,000 14,040 15,163 15,921 16,717 17,553 18,431
YoY chg in realisation (%) 8.0% 8.0% 5.0% 5.0% 5.0% 5.0%
Cash collections (%) 0.0% 0.0% 5.0% 10.0% 15.0% 15.0% 20.0% 20.0% 15.0%
Costs
Land cost (% incurred) 10.0% 90.0%
Fungible FSI + TDR costs (% incurred) 5.0% 10.0% 25.0% 25.0% 20.0% 15.0%
Percentage of completion (%) 10.0% 20.0% 35.0% 55.0% 75.0% 90.0% 100.0%
Average construction cost (`/sft) 4,097 3,500 3,675 3,859 4,052 4,254 4,467 4,690
YoY chg in construction cost (%) 5.0% 5.0% 5.0% 5.0% 5.0% 5.0%
Source: Ambit Capital research

Project to become cumulative cash flow positive by FY20

Assuming a Phase I launch during FY16, we expect the project to begin generating
positive cash flows from FY18 onwards. Assuming a Phase II launch during FY19, we
expect the project to become cumulative cash flow positive by FY20.
Exhibit 6: Cash flows from the Borivali project
Borivali project cash flows (` mn) FY14 FY15E FY16E FY17E FY18E FY19E FY20E FY21E FY22E
Inflows (A) 240 1,647 4,408 8,440 12,569 16,668 14,568
Cash collections 240 1,647 4,408 8,440 12,569 16,668 14,568
Outflows (B) (1,125) (10,262) (1,826) (2,316) (3,252) (4,141) (4,184) (2,970) (2,079)
Land cost incurred (1,125) (10,125)
Fungible, TDR (137) (275) (687) (687) (549) (412)
Construction cost incurred (1,551) (1,629) (2,566) (3,592) (3,771) (2,970) (2,079)
Net cash flow (A-B) (1,125) (10,262) (1,586) (669) 1,155 4,299 8,386 13,698 12,489
Source: Company, Ambit Capital research

Lease rental discounting (LRD) appears to be the best financing option

We expect the net cash outflow (towards earnest money deposit for land acquisition)
during FY14 to be funded largely from the existing cash on books as of December
2013. We expect the FY15 payouts (remaining 90% towards cost of land and
payments towards development rights and fungible FSI) to be funded partly through
internal accruals and debt of `8bn. Our calculations suggest that Oberoi can raise
debt by discounting the lease rentals from its annuity assets.
Exhibit 7: Financing project debt for the Borivali land parcel - lease rent discounting (LRD) the best option
Cash flows from annuity assets (` mn) FY15E FY16E FY17E FY18E FY19E FY20E
Free cash flows from operating annuity assets (A) 1,875 1,940 2,024 2,089 2,159 2,167
Free cash flows from upcoming annuity assets (B) 335 623 1,433 1,760 2,020 2,176
Free cash flows from all annuity assets (A+B) 2,209 2,563 3,457 3,850 4,179 4,343
Source: Company, Ambit Capital research

Our channel checks suggest that lenders currently offer lease rental discounting at
about 13-13.5%. We believe that Oberoi, on account of its well-capitalised balance
sheet, is likely to raise debt at the lower end of this price band.
As demonstrated in Exhibit 7, assuming Oberoi can only discount lease rentals from
its existing annuity assets (Commerz I, Westin, Oberoi Mall and Oberoi International

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 Oberoi Realty

School), Oberoi will need to securitise its receivables for the next six years. On the
other hand, if Oberoi is able to discount lease rentals even from the upcoming
annuity assets (subject to similarly stable tenancy), receivables from FY15-18 are
adequate to finance this debt.
If cash remains fungible (as against a proposal in the Real Estate Regulation Bill that
calls for ring-fencing of 70% of cash flows from a project), we expect Oberoi to repay
the project debt of `8bn by end-FY16, subject to project launches at Worli and
Mulund by 1HFY15.
CARE assigns top rating for ` 8.5bn facility
As per Oberoi’s recent filings, CARE, a rating agency, has assigned the highest rating
for a combination of short-term and long-term facilities for `8.5bn to be availed by
Oberoi. The long-term rating has been assigned to Incline Realty Private Limited, a
wholly-owned subsidiary of Oberoi Realty, recently floated exclusively for developing
the Borivali land parcel.
Exhibit 8: Top ratings secured for facilities worth `8.5bn
Instrument Rating Maturity pattern Amount (` mn)
Commercial paper A1+ Less than 1 year 1,000
Non-convertible debentures AA+ (SO) Long-term (3-5 years) 7,500
Source: Company, Ambit Capital research

Potential for valuation upgrade to Borivali project

Our estimates for the Borivali project build in the following key assumptions:
 Saleable area of ~3.7msf
 Phase II launch during FY19
 Average per square foot realisation of `15,500 through the project life-cycle
 Average per square foot construction cost of `4,100 through the project life-cycle
 Cost of debt at 13%
Media reports estimate the saleable area on the Borivali land parcel ranging between
3.6msf and 4msf (the upper end of this range is ~8% higher than our saleable area
assumptions on this project). Faster-than-anticipated execution of the project (say, a
Phase II launch in FY18), higher realisations through the project life-cycle (from better
sales velocity) and lower-than-anticipated cost of debt (on account of superior credit
profile benefiting from better debt servicing) pose an upside risk to our project cash
flow assumptions. Such upside risks would impact our project valuation (excluding
land cost) by ~40% and the overall SOTP valuation by ~10% (`29) net of land cost.

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 Oberoi Realty

Project details
Oberoi has an ongoing project slate of 7.1msf under-construction and a planned
project portfolio of 10.4msf, predominantly consisting of residential properties. Whilst
the ongoing project portfolio (see Exhibit 8) is relatively more concentrated, the
portfolio of planned projects (see Exhibit 9) is comparatively better diversified.

Exhibit 9: Under-construction projects (7.1msf) Exhibit 10: Planned projects (10.4msf)

Hospitality,
Social infra,
4.7%
16.1%
Office
space,
23.4% Retail, 2.7%

Hospitality,
12.4%

Office Residential,
space, 3.6% 65.2%
Residential,
71.9%

Source: Company, Ambit Capital research Source: Company, Ambit Capital research

Residential projects
Excluding the Borivali land that was acquired towards the end of March 2014, Oberoi
has an ongoing residential project portfolio of about 5.1msf.
Exhibit 11: Key residential projects - approval / launch / completion / sale status
Percentage of Time to
Saleable area Clearances / Unsold inventory
Properties under development Launch completion completion
(sft) approval status (%)
(POC) (months)
OC for floors 31 to
Oberoi Exquisite 1,535,670 October 2009 88% 6 months 33%
50 pending
Partial CC until the
Oberoi Esquire 1,504,815 February 2011 BTL 36 months 35%
30 th floor
Oasis Residential 1,783,928 Not yet launched BTL 48 months NA
Mulund project (Exotica) 3,201,380 Not yet launched BTL 48 months NA
NOC from trade
Borivali project 3,693,752 Land acquired NA NA
union pending
Splendor - Phase III 274,550 Not yet launched
Sangamcity, Pune 773,951 Not yet launched NA
Source: Company, Ambit Capital research; Note: BTL - below threshold level; OC - occupancy certificate; CC - commencement certificate

Although the projects enumerated in Exhibit 10 have relatively greater visibility, other
properties (such as Oberoi’s Khar project and Phase IV of Splendor) have relatively
lower project-level visibility.
Given our assumptions around area sales run rate and cash collections (detailed
separately in the valuation section of this note), we expect the current pipeline of the
ongoing residential projects to be completely sold out by FY23E. We expect cash
collections from residential projects to peak during FY17E-19E.

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 Oberoi Realty

Annuity projects
Oberoi currently has four operational annuity assets, which account for 35% of the
company’s total operating revenues (during 9MFY14). Although the contribution of
annuity assets appears exaggerated on account of the extremely weak residential
project launches and sales during 9MFY14, the annuity assets have consistently
contributed north of 15% to the company’s operating revenues since FY10. Whilst this
is partly on account of the relative maturity of the properties (all of these have been
in existence for over five years), the strong fundamentals of these properties are also
a function of the company’s strategy to develop residential townships centred on
commercial properties.
Exhibit 12: Movement in key metrics in Oberoi’s annuity projects - higher occupancy at the cost of easing rentals
Properties 4QFY12 1QFY13 2QFY13 3QFY13 4QFY13 1QFY14 2QFY14 3QFY14
Office space - Commerz I
Occupancy (%) 79.0% 79.5% 80.7% 80.6% 83.4% 83.4% 85.8% 85.8%
Realisation (`/sft/month) 128 129 129 130 131 132 128 128
EBITDA margin (%) 93.7% 95.8% 97.6% 98.2% 96.7% 97.7% 99.2% 99.8%
Retail property - Oberoi Mall
Occupancy (%) 94.3% 93.5% 94.3% 94.6% 95.1% 99.4% 99.1% 98.0%
Realisation (`/sft/month) 125 128 124 129 125 126 137 137
EBITDA margin (%) 96.0% 96.5% 95.5% 95.9% 94.2% 97.1% 96.0% 94.4%
Hospitality project - Westin
Occupancy (%) 72.3% 66.8% 65.1% 67.8% 74.6% 72.5% 76.2% 73.1%
RevPAR (`) 5,886 4,637 4,761 5,606 6,085 5,599 5,659 6,185
EBITDA margin (%) 37.7% 24.6% 21.7% 33.8% 34.1% 30.8% 28.4% 28.5%
Source: Company, Ambit Capital research

Currently, Mumbai’s total office space stock is 101msf, of which 78msf is occupied,
resulting in a vacancy level of 23%. Vacancy levels have been increasing consistently
since 2009 when they were at 12%, due to the massive influx of nearly 38msf of new
supply since 2009.
Against this backdrop, Oberoi, despite its strategy of developing townships around a
central commercial property, is likely to be only marginally less vulnerable to the
effects of a general economic slowdown. Oberoi, has one operational office-use
property (Commerz I, 0.36msf) and is slated to launch another (Phase I Commerz II,
0.7msf) later this year.
Exhibit 13: Office-use projects - key metrics
Estimated Occupancy Lease rent EBITDA
Commercial properties Launch
area (sft) (%) (` /sft/mth) margin (%)
Commerz I 364,888 85.8% 128 99.86%
Commerz II - Phase 1 725,769 4QFY15 NA NA NA
Commerz II - Phase 2 1,661,650 FY16 NA NA NA
Source: Company, Ambit Capital research

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 Oberoi Realty

Valuation
We use a project-based DCF approach to arrive at a valuation of `290/share (revised
upwards from `277/share), implying a 33% upside. A little over 70% of this valuation
is contributed by residential properties whereas office and retail properties contribute
a further 20% to the sum-of-the-parts valuation.

Exhibit 14: FY15 mix of cash inflows (%) Exhibit 15: FY15 sum-of-the-parts valuation (%)

Hospitality, Social infra, Hospitality, Social infra,

7% 3% 6% 2%

Retail, 7%

Retail, 16%

Office, 13%

Residential,
Office, 9% 65%
Residential,
71%

Source: Ambit Capital research Source: Ambit Capital research

We use project-specific assumptions (detailed subsequently) to derive the discounted

project-specific cash flows to arrive at our sum-of-the-parts (SOTP) valuation. We
adjust our SOTP valuation for unallocated overheads that are not apportioned to any
specific project and the net cash (debt) position as at end-FY15. We assume the debt
of `8bn to be completely repaid during FY16, assuming that cash continues to remain
fungible, implying that surplus proceeds from the Mulund and Worli launches will be
used to repay the loan borrowed towards the Borivali land acquisition.
Exhibit 16: Sum-of-the-parts (SOTP) valuation for Oberoi Realty (`/share)

350
16 7 2
300
21
250 39
208
200

150

100

50
-5
0
Residential Office Retail Hospitality Social infra Other Net cash
-50 income less
SG&A

Source: Ambit Capital research

Beyond FY15, we expect Oberoi to maintain 15-25% of its balance sheet size in the
form of cash with any surplus deployed towards investments that earn the company
annual returns of 7.5% on an average. We build in a gradually declining contribution
from customer advances, as ongoing projects progress towards completion. We
expect Oberoi’s funding of vendors and sub-contractors (through loans and advances
on the current assets) to progressively increase as the project moves towards
completion.

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 Oberoi Realty

Assumptions around valuation parameters

Cost of equity: We have assumed a 15% cost of equity in our calculations. Given
that Oberoi has a larger proportion of residential projects in its slate of ongoing and
planned projects and since residential projects are typically funded by customer
advances, we believe that it is appropriate to use cost of equity to discount cash flows
(as against using the weighted average cost of capital).
Since Oberoi is debt-free (aside from the debt that the company will need to raise for
the recent Borivali land acquisition), we believe that using cost of equity is a
conservative measure to arrive at the net asset value for each individual project.
The two most sensitive project-level variables in our assumptions are: (a) the sales
run rate; and (b) the average blended realisations. To put this in perspective, if each
of Oberoi’s under-construction residential projects is delayed by 12 months (beyond
the delay that we are already building in), our valuation is likely to be dragged by
~15%. More importantly, slower-than-anticipated sales (hence, slower-than-
anticipated cash inflows) would potentially translate into Oberoi either having to
assume a larger quantum of debt or delaying the construction/launch of some of its
projects, all of which are likely to pull the company further into a vicious ‘cash-burn’
cycle.

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 Oberoi Realty

Residential properties
 Annual run rate of area sales: For under-construction projects that are yet to
be launched, we build in a period of 8-10 years for a project to move from the
‘launch’ stage to the ‘stock-out’ stage. For projects that are likely to be sold out
over 8 years, we assume c.50% of the total saleable area to be sold by Year 3
(from launch) and the remaining 50% to be sold over the next 5 years. For
projects that are likely to be sold out over 10 years, we factor in c.50% of the
total saleable area to be sold by Year 4 (from the time of launch) and the balance
50% to be sold over the next 6 years. For all projects, the ‘completely sold out’
stage is triggered at least 1-3 years from the time of project completion.
Exhibit 17: Cumulative sales from the time of launch (% of saleable area)

100%

80%

60%

40%

20%

0%
Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10

Project sold in 10 years Project sold in 8 years

Source: Ambit Capital research

Our assumptions around the sales run rate are consistent with a typical project
lifecycle in which sales are high during the initial phase (after the project launch) and
gather fresh momentum as the project nears completion (pull factor on account of
customers looking for ‘ready-to-move-in’ properties). However, the run rate of sales
tapers off in the interim.
 Growth in average realisation rates in ongoing projects: For FY15, in the
case of ongoing projects, we have benchmarked average realisation rates based
on price discovery in recent transactions and anonymous channel checks with
Oberoi’s sales team at each project location. In general, we assume c.8% YoY
increase in average realisations between FY15E and FY18E followed by 5% YoY
increase in average realisations thereafter until the project is completely sold out.
 Growth in realisation rates in upcoming projects: For upcoming projects, we
have assumed c.8% YoY increase in average realisation for the first two years
after the launch followed by a 5% YoY increase in average realisations thereafter
until the project is completely sold out. Our base realisation (pricing at the time of
launch of such projects) is at a 5-10% discount to the prevailing pricing for
comparable projects in the relevant micro-market.
 Outflow pertaining to construction costs: For under-construction projects, we
have assumed that: (a) construction costs are distributed over the construction
period proportionate to the percentage of completion; and (b) the project is
delayed by 1-2 years relative to the management’s targeted completion schedule
on account of labour shortage.
We have individually projected the construction costs for each residential project
from FY14E (or the time of launch, whichever is earlier) until project completion,
using the percentage of completion approach. We use an average construction
cost (per sft) of `3,500 for Exquisite and Esquire and `7,500 for Oasis (as it is a
super-premium project).

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 Oberoi Realty

 Rise in input costs of construction: For all the under-construction projects, we

have assumed an 8% YoY increase in the cost of construction (per sft) during the
first 4 years of a project and 5% thereafter until project completion. Our
assumptions around YoY cost inflation are based on trends around indexed
building construction costs published by the Construction Industry Development
Council (CIDC). Our estimates around a rise in input costs are conservative, given
that the cost of building construction increased ~4% in Mumbai and ~5% each in
Delhi and Bangalore over the past 5 years (between January 2009 and March
2014). Concomitant with our assumptions around growth in blended realisation
rates, we believe that Oberoi will recover its pricing power on select projects only
post FY18E.
Exhibit 18: YoY movement in building construction costs in major real estate markets

18%
16%
14%
12%
10%
8%
6%
4%
2%
0%
Oct-08

Apr-09

Apr-10

Apr-11

Apr-13

Apr-14
Jul-09
Oct-09

Jul-10
Oct-10

Jul-11
Oct-11

Apr-12
Jul-12
Oct-12

Jul-13
Oct-13
Jan-09

Jan-10

Jan-11

Jan-12

Jan-13

Mumbai Delhi Bangalore Jan-14

Source: CIDC, Ambit Capital research

 Cash collections from upcoming projects: We assume construction-linked cash

collections for each of Oberoi’s upcoming projects (ongoing and planned) subject
to the following clauses:
(a) 20% down payment at the time of booking for new launches; and
(b) final 5-10% of the consideration payable at the time of possession.
Exhibit 19: Cumulative project-wise cash flows (% of value of area sold)
Cumulative project cash flows FY14E FY15E FY16E Launch Stock-out
Oberoi Exquisite 92% 94% 95% Oct 2009 FY17E
Oberoi Esquire 34% 77% 94% Feb 2011 FY17E
Oasis Residential 24% 36% 47% FY15E FY22E
Mulund project 0% 20% 35% FY15E FY23E
Borivali project 0% 0% 40% FY16E FY23E
Source: Ambit Capital research

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 Oberoi Realty

Commercial / retail / hospitality projects

 Rental rates for annuity projects: Currently, Mumbai’s total office space stock
is 101msf, of which 78msf is occupied, resulting in a vacancy level of 23%.
Vacancy levels have been increasing consistently since 2009 when they were at
12%, due to the massive influx of nearly 38msf of new supply since 2009.
Exhibit 20: Movement in lease rentals and absorption levels in Mumbai

3.0 102
100
2.5
98
2.0
96
1.5 94
92
1.0
90
0.5
88
0.0 86
3QCY12 4QCY12 1QCY13 2QCY13 3QCY13

Total area transacted (msf) Average lease rent (Rs/sft/mth) (RHS)

Source: Knight Frank Office Traction November 2013, Ambit Capital research

Lease rentals in Mumbai have either been steady or declining over the past few
quarters (dotted line in Exhibit 20) although absorption levels have remained healthy
(the red column in Exhibit 20). Although the blended lease rentals in Mumbai are at
sub-`100 levels, Oberoi’s incremental office inventory is being added in Goregaon,
which corresponds to SBD West.
Exhibit 21: Business district-wise lease rent in Mumbai (`/sft/month)
Business district 1QCY12 3QCY12 4QCY12 1QCY13 3QCY13 Average
CBD & Off CBD 250 240 245 240 218 239
ABD 245 275 260 265 265 262
Central Mumbai 128 175 135 139 165 148
SBD West 89 110 90 92 102 97
SBD Central 90 90 92 90 85 89
PBD 44 50 44 42 48 46
Source: Knight Frank Office Traction November 2013, Ambit Capital research; Note: CBD & Off CBD corresponds to Nariman Point, Cuffe Parade, Ballard Estate,
Fort, Mahalaxmi, Worli micro-markets; ABD corresponds to BKC, Bandra (E), Kalanagar and Kalina micro-markets; Central Mumbai consists of Parel, Lower Parel,
Dadar and Prabhadevi micro-markets; SBD West consists of Andheri, Jogeshwari, Goregaon and Malad micro-markets; SBD Central corresponds to Chembur,
Kurla, Ghatkopar, Vikhroli, Kanjurmarg, Powai and Bhandup micro-markets; PBD consists of Thane, Airoli, Vashi and Belapur micro-markets

A typical lease rental agreement on Oberoi’s commercial projects lasts for 5-7 years
embedded with a rent reset clause every three years. However, given the ongoing
sluggishness in the broader economic environment and supply outstripping demand
for commercial properties (reflected in rising vacancies), we assume a 1% YoY decline
in lease rental rates for all of Oberoi’s office projects. Any recovery in the office space
segment, with a potential turnaround in absorption levels, poses an upside risk to our
estimates on lease rent.
We assume a 3% YoY rise in the average rentals for Oberoi Mall (retail property) and
a 5% YoY rise in RevPAR (revenue per available room), the key operating metric for
the company’s hospitality projects (Westin and Oasis).
 Occupancy rates for retail/commercial/hospitality projects: Given the
continued weakness in the broader economic environment, we expect the
demand for commercial office space to remain sluggish over the near term.
Therefore, for upcoming office-use projects, we assume occupancy levels at 25%
during Year 1, 50% during Year 2, 75% during Year 3 and gradually plateauing
at a steady-state 85% over the next 10 years. Although the overall vacancy levels

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 Oberoi Realty

in Mumbai are at an all-time high of over 20%, our analysis suggests that SBD
West, the micro-market corresponding with Oberoi’s upcoming office space
projects, consistently absorbs about one-third of the inventory every quarter (see
Exhibit 22).
Exhibit 22: Business district-wise absorption in Mumbai (%)
Business district 1QCY12 3QCY12 4QCY12 1QCY13 2QCY13 3QCY13
CBD & Off CBD 1% 2% 4% 0% 3% 1%
ABD 6% 14% 3% 3% 6% 16%
Central Mumbai 17% 43% 29% 4% 34% 7%
SBD West 30% 13% 47% 47% 31% 32%
SBD Central 28% 18% 2% 15% 4% 14%
PBD 18% 10% 15% 31% 22% 30%
Source: Knight Frank Office Traction November 2013, Ambit Capital research; Note: CBD & Off CBD corresponds to Nariman Point, Cuffe Parade, Ballard Estate,
Fort, Mahalaxmi, Worli micro-markets; ABD corresponds to BKC, Bandra (E), Kalanagar and Kalina micro-markets; Central Mumbai consists of Parel, Lower Parel,
Dadar and Prabhadevi micro-markets; SBD West consists of Andheri, Jogeshwari, Goregaon and Malad micro-markets; SBD Central corresponds to Chembur,
Kurla, Ghatkopar, Vikhroli, Kanjurmarg, Powai and Bhandup micro-markets; PBD consists of Thane, Airoli, Vashi and Belapur micro-markets

We assume occupancy rates for retail projects (Oberoi Mall) to continue at 99%. For
hospitality projects, we assume an average occupancy rate of 75% for the Westin
project (FY15E-19E) and 25-50% for the Worli project, due to the higher supply of
five-star hotels in Worli as compared to a scarcity premium for such hotels in
Goregaon.
Exhibit 23: Assumptions around occupancy levels (%) in Oberoi’s non-residential projects
Occupancy levels (%) FY14E FY15E FY16E FY17E FY18E FY19E FY20E FY21E FY22E FY23E FY24E FY25E FY26E
Office space
Commerz I 85% 85% 85% 88% 88% 88% 90% 90% 90% 93% 93% 93% 95%
Commerz II - Phase 1 25% 50% 75% 80% 85% 85% 85% 85% 85% 85% 85% 85%
Commerz II - Phase II 0% 0% 25% 35% 45% 50% 55% 60% 65% 70% 75% 80%
Retail property
Oberoi Mall 99% 99% 99% 99% 99% 99% 99% 99% 99% 99% 99% 99% 99%
Hospitality projects
Westin 75% 75% 75% 75% 75% 75% 80% 80% 80% 80% 80% 80% 80%
Oasis Hospitality 25% 35% 45% 55% 65% 70% 75% 75% 75% 75% 75% 75%
Source: Ambit Capital research

 EBITDA margin in non-residential projects: Given that a typical office space

lease agreement mandates the lessee to incur most of the maintenance
expenses, we build in higher EBITDA margins in the office space segment.
Exhibit 24: EBITDA margin (%) assumptions for Oberoi’s non-residential projects
EBITDA margin (%) FY14E FY15E FY16E FY17E FY18E FY19E FY20E FY21E FY22E FY23E FY24E FY25E FY26E
Office space
Commerz I 99% 99% 99% 99% 99% 99% 99% 99% 99% 99% 99% 99% 99%
Commerz II - Phase 1 90% 90% 90% 90% 90% 90% 90% 90% 90% 90% 90% 90%
Commerz II - Phase II 90% 90% 90% 90% 90% 90% 90% 90% 90% 90%
Retail property
Oberoi Mall 95% 95% 95% 95% 95% 95% 95% 95% 95% 95% 95% 95% 95%
Hospitality project
Westin 29% 30% 30% 30% 30% 30% 25% 25% 25% 25% 25% 25% 25%
Oasis Hospitality 10% 15% 20% 25% 25% 25% 25% 25% 25% 25% 25% 25%
Source: Ambit Capital research

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 Oberoi Realty

For the hospitality projects, we assume a maintenance cost of 10% (of operating
revenues) on the Westin project and 15% (of operating revenues) on the Worli project
(in line with the branded residency theme), undertaken in the form of construction
expenditure. Taken alongside our EBITDA margin assumptions, this would imply that
10% of the operating revenues from the Westin project and 15% of the operating
revenues from the Worli project are being re-invested in the respective projects every
year.
 Ancillary revenues from hospitality projects: We factor in a meaningful
contribution of ancillary revenues to the overall revenues from both of Oberoi’s
hospitality projects. We have assumed that the Worli (Oasis) hospitality project,
on account of its competitive positioning, will take about 10 years to match the
ancillary revenue contribution of the Westin project.
Exhibit 25: Ancillary revenue (% of total revenue) assumptions for Oberoi’s hospitality projects
Ancillary revenues (%) FY14E FY15E FY16E FY17E FY18E FY19E FY20E FY21E FY22E FY23E FY24E FY25E FY26E
Hospitality project
Westin 50% 50% 50% 50% 50% 50% 50% 50% 50% 50% 50% 50% 50%
Oasis Hospitality 40% 40% 40% 40% 40% 40% 45% 45% 45% 45% 45% 50%
Source: Ambit Capital research

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 Oberoi Realty

Catalysts for our BUY stance

Launch of Worli project by 1QFY15: We expect Oberoi to launch Oasis, its mixed-
use Worli project, by 1QFY15. Oasis, proposed as a branded residency, consists of
1.8msf (million square feet) of residential and ~0.3msf of hospitality area.
Completion of Borivali land acquisition: For the Borivali 25-acre land acquisition
transaction to go through, Oberoi Realty needs to obtain two major approvals by
June 2014. Oberoi needs to obtain the collector’s permission for the sale of the
Sanad land that forms a part of the total property and an NOC (no objection
certificate) from the labour authority. If these approvals do not come through within
three months, the MOU (Memorandum of Understanding) for the sale of land will
stand annulled. Any potential annulment of this MoU, on any grounds, will be a
significant negative for the visibility on Oberoi’s growth prospects.
Launch of Mulund project by 1HFY15: As highlighted in this note, timely launches
are critical to reviving Oberoi’s sales run rate and consequently, its cash generation.
The company secured the Supreme Court’s permission to begin construction, and
thus, we expect the first phase of the Mulund project (1.6msf) to be launched by
2QFY15.

Risks to our BUY stance and our estimates

Delayed launches: We have assumed project launches during each of the first two
quarters of FY15. A delay of one quarter in launching the residential projects at Worli
and Mulund will significantly drag the company’s cash flows on account of a larger
portfolio of assets continuing to guzzle cash and an inadequate portfolio of annuity
assets generating cash.
Borivali land acquisition falling through: Oberoi’s bid for the Borivali land has
not only enhanced Oberoi’s growth prospects but has also acted as a powerful signal
of Oberoi’s intent to deploy its cash meaningfully in accumulating inventory. Whilst
timely launches are crucial to revive the company’s operating cash flows, these cash
flows are meaningless without a pipeline of inventory. In fact, timely launches without
any new land acquisition would further compound Oberoi’s problems by generating
surplus cash without any avenue for re-deployment.

Forensic accounting flags

Exhibit 26: Explanation for our forensic accounting flags on the front page
Segment Score Comment
Despite a sluggish 9MFY14 (in terms of fresh sales and cash flows), Oberoi boasts of a superior cash
Accounting GREEN conversion ratio relative to its peers as well as a very strong balance sheet (zero leverage).
Although Oberoi’s two key projects (Worli and Mulund) have been subject to exogenous factors (litigation
and regulatory bottlenecks), resulting in inordinate delays in the launch of both properties. The company
Predictability AMBER has been unable to guide investors realistically and it has made inadequate documented disclosures
around the status of approvals and clearances.
Oberoi recently emerged as the highest bidder for the Borivali land (put on the block by Tata Steel); the
Earnings momentum GREEN stock has witnessed sharp upgrades to its earnings contingent on the land acquisition transaction going
through.
Source: Bloomberg, Ambit Capital research

April 23, 2014 Ambit Capital Pvt. Ltd. Page 52

 Oberoi Realty

Revision in estimates
Exhibit 27: Revision in FY14E/FY15E/FY16E estimates
FY14E FY15E FY16E
Changes in estimates Old New % change Old New % change Old New % change
Operating income 10,221 8,599 -15.9% 11,800 11,742 -0.5% 15,074 14,370 -4.7%
EBITDA (` mn) 5,699 4,218 -26.0% 6,846 6,832 -0.2% 8,844 8,347 -5.6%
Net profit (` mn) 4,231 3,184 -24.7% 5,526 4,733 -14.3% 7,404 6,371 -14.0%
EPS (`) 12.9 9.7 -24.8% 16.8 14.4 -14.2% 22.6 19.4 -14.1%
BVPS (`) 129.2 126.9 -1.7% 142.5 139.2 -2.3% 161.5 155.6 -3.6%
Source: Ambit Capital research

Changes to FY14E estimates

Our estimates for FY14E have undergone a sharp downward revision on account of a
combination of limited inventory available for the sale in ongoing projects and lack of
new project launches. The limited availability of inventory was driven by:
 Delay in obtaining regulatory approvals to resume construction in Oberoi Esquire;
 Availability limited to high-ticket-sized inventory in Oberoi Exquisite; and
 Inventory exhaustion in completed projects - Splendor and Splendor Grande
Given Oberoi’s high operating leverage and zero leverage, the downward revision in
our revenue estimates translates directly to a relatively sharper downgrade to our
FY14E earnings estimates.

Changes to FY15E / FY16E estimates

Our revenue estimates for FY15E/FY16E have been revised downwards (though not
pulled down as sharply as our FY14E forecasts) as a result of our relatively
conservative assumptions around project sales run rate and lower growth in
realisation rates for the upcoming projects. The spill-over of project launches from
FY14 into FY15E partially offsets this downward revision. However, our FY15E/ FY16E
earnings estimates are more sharply impacted due to the interest burden from the
debt that Oberoi would need to raise to fund the Borivali land acquisition.

April 23, 2014 Ambit Capital Pvt. Ltd. Page 53

 Oberoi Realty

SWOT analysis
Exhibit 28: Oberoi Realty - SWOT analysis
Strengths Weaknesses
 Strong brand with a reputation for reliable execution in Mumbai  High project concentration risk with 90% of projects exposed to Mumbai
 Net cash of `5bn as of December 2013 as against the average  Inability to adhere to launch timelines on account of regulatory delays (at
gearing of 0.6x-0.7x for its closest peers (Sobha and Prestige) least three projects stuck in litigation)
 Strong pipeline of ongoing (7.1msf) and planned projects (10.4msf)
across formats (excluding the recent land acquisition at Borivali)
 Best-in-class construction / architectural tie-ups with Samsung C&T,
L&T and KPF
 Stable stream of cash flows from annuity assets (commercial and
hospitality segments), contributing north of 25% to operating income

Opportunities Threats

 Deployment of surplus cash towards opportunistic land acquisition  Further delay in launches that drain surplus cash from the balance sheet
such as the recent Borivali land acquisition  Desperation to generate returns may force the company towards
 Strategic flexibility to bid for land parcels on the back of negligible acquiring land at unviable prices
leverage

Source: Company, Ambit Capital research

April 23, 2014 Ambit Capital Pvt. Ltd. Page 54

 Oberoi Realty

Balance Sheet
Year to March (` mn) FY12 FY13 FY14E FY15E FY16E
Shareholders’ funds 34,688 38,968 41,685 45,763 51,308
Loan funds 0 0 8,000 8,000 0
Net Fixed assets 9,850 10,714 10,423 10,626 12,297
Investments 0 0 4,000 0 0
Cash 12,934 10,725 9,886 6,418 280
Working capital 11,904 17,528 25,375 36,719 38,730
Book value per share (`) 105.7 118.7 127.0 139.4 156.3
Source: Company, Ambit Capital research

Income statement
Year to March (` mn) FY12 FY13 FY14E FY15E FY16E
Revenue from residential projects 5,768 7,813 5,469 7,110 9,243
Hospitality services 897 956 1,146 2,336 2,453
Rentals and related income 1,289 1,398 1,504 1,798 2,096
Property and project management income 229 250 330 391 485
Other operating income 63 58 150 107 92
Total operating Income 8,247 10,476 8,599 11,742 14,370
Operating costs (2,958) (3,715) (3,698) (4,110) (5,029)
Total SG&A (452) (640) (684) (800) (994)
Total operating expenditure (3,411) (4,355) (4,381) (4,910) (6,023)
EBITDA 4,836 6,121 4,218 6,832 8,347
PBT 6,060 6,830 4,644 6,972 9,478
PAT 4,630 5,048 3,205 4,810 6,540
EPS (`) 14.1 15.4 9.8 14.7 19.9
Source: Company, Ambit Capital research

Cash Flow statement

Year to March (` mn) FY14E FY15E FY16E
Total pre-tax CF 2,546 13,049 14,181
Tax (840) (4,306) (4,680)
CFO 1,706 8,743 9,501
FCFE 2,443 10,220 10,961
Changes in WC 7,847 11,344 2,011
Source: Company, Ambit Capital research, Note: All financials pertain to IFRS consolidated accounts

Ratio Analysis
Year to March (` mn) FY12 FY13 FY14E FY15E FY16E
P/E (x) 16.0 14.6 23.0 15.4 11.3
P/BV (x) 2.1 1.9 1.8 1.6 1.4
P/FCF 43.4 8.5 7.8
P/FCFE 30.3 7.2 6.8
ROE % 13.6 13.7 7.9 11.0 13.5
Net Debt/equity -0.37 -0.28 -0.14 0.03 -0.01
EBITDA margin (%) 58.6 58.4 49.1 58.2 58.1
Net margin % 47.5 44.0 34.3 36.4 41.3
Dividend yield % 1.0 1.0 0.7 1.0 1.3
Source: Company, Ambit Capital research

April 23, 2014 Ambit Capital Pvt. Ltd. Page 55

 Oberoi Realty

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April 23, 2014 Ambit Capital Pvt. Ltd. Page 56

 Sobha Developers
BUY
COMPANY INSIGHT SOBHA IN EQUITY April 23, 2014

Position of relative strength Real Estate

With a growing diversified presence across key southern geographies, Recommendation

especially in NRI-rich cities, Sobha has gradually positioned itself in a Mcap (bn): `37/US$0.6
sweet spot. The company is focused on further penetrating the southern 6M ADV (mn): `83/US$1.4
markets beyond Bangalore (its primary market). In addition, it has a CMP: `376
tight collection system. Thus, we expect a quarterly launch run rate of TP (12 mths): `490
2msf to translate into a strong pre-sales run rate in excess of 4msf in Upside (%): 30
FY15E/FY16E. We are BUYers with a sum-of-the-parts valuation of ` 490,
implying 9.6x FY15E P/FCFE. Flags
Accounting: AMBER
Competitive position: STRONG Changes to this position: POSITIVE Predictability: AMBER
Earnings Momentum: GREEN
FY14 guidance disappointment transitory; well poised for FY15
During FY14, Sobha disappointed on its guidance with volume sales at 3.6msf Catalyst
(vs guidance of 4.2msf) and value sales at `23.4bn (vs guidance of `26bn)  OMR (Chennai) project launch in 1HFY15
primarily due to delayed launches. However, with a 20% QoQ increase in pre-
sales during 4QFY14, unrecognised revenues from sold units at `23bn (100% of  Gurgaon project launch during 1HFY15
its December 2013 net worth) and three large projects launched towards end-  Launch of APMC project in Bangalore
March 2014, we expect Sobha to regain its sales momentum in FY15.

Cash inflows (net of interest payout) strong; FY15 refinancing crucial

Performance (%)
Sobha generated a steady stream of cash inflows from its real estate segment 140
(quarterly run rate of `4.5bn) and its contracted projects (quarterly run rate of 120
`1.7bn) during 9MFY14. During 9MFY14, Sobha averaged `0.7bn-0.8bn of 100
quarterly net cash from operations (CFO), net of interest payouts. With net debt 80
to equity at 0.6x, Sobha is exposed to a manageable refinancing risk with over 60
`8.5bn (0.3x net worth) due for repayment during FY15. 40
Apr-13

Jun-13

Sep-13

Mar-14
Jul-13

Oct-13
Nov-13

Feb-14
May-13

Aug-13

Dec-13
Jan-14
Backward integration and strong launch pipeline imply sweet spot
Sobha’s backward-integrated business model has consistently helped achieve
timely execution of projects (annual development run rate of over 6msf since Sensex SOBHA IN
FY08) whilst maintaining the highest quality standards for contracted projects as Source: Bloomberg, Ambit Capital research

well as its own projects. Concomitant with its backward-integrated business

model, a visible pick-up in sales momentum, steady cash conversion and a
strong launch pipeline, Sobha is in a sweet spot.

Valuation at ` 490/share; remain BUYers

We use a project-based DCF approach to arrive at a valuation of `490/share,
implying a 30% upside, valuing the company at 9.6x FY15E FCFE. As Sobha
predominantly operates through joint development agreements (JDAs), a
capital-light business model, P/FCFE is an ideal measure for valuing a stable-
debt Sobha. A higher-than-expected interest rate environment and lower-than-
anticipated cash inflows are key risks to our BUY stance.
Key financials
Year to March FY12 FY13 FY14E FY15E FY16E
Net Revenues (` mn) 14,079 18,645 20,931 24,500 29,765
Operating Profits (` mn) 4,666 5,483 5,905 7,300 8,995
Net Profits (` mn) 2,060 2,172 2,245 2,845 3,675
Diluted EPS (`) 21.0 22.1 22.9 29.0 37.5 Analyst Details
RoE (%) 10.7 10.5 10.5 12.7 14.7
Krishnan ASV
P/E (x) 17.8 16.8 16.3 12.9 9.9 +91 22 3043 3205
P/B (x) 1.8 1.7 1.6 1.5 1.3 [email protected]
Source: Company, Ambit Capital research

Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital
may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.
 Sobha Developers

Snapshot of Company Financials

Profit and Loss Company Background
Year to March FY13 FY14E FY15E FY16E
Sobha Developers (Sobha), one of India’s foremost real
Revenues from property
development
13,092 15,762 17,984 21,754 estate developers, is focused on residential formats (c.40%)
Revenues from sale of land & and contractual projects (c.60%) with a sizeable exposure
1,020 0 0 0
TDR (90% of 61msf in completed projects) to the relatively stable
Revenue from sale of south Indian market. Sobha has an ongoing real estate
1,477 1,725 2,187 2,766
manufactured products
Revenues from contractual
project slate of 18.9msf under construction (55% in
3,013 3,390 4,261 5,160 Bangalore) and a contract portfolio of 9.5msf (60%
projects
Other operating income 43 54 67 84 contracted by Infosys). Whilst the portfolio of ongoing real
Total income 18,645 20,931 24,500 29,765
estate projects is relatively more concentrated in Bangalore
(56%), the portfolio of contracts is comparatively better-
Operating costs (9,103) (10,252) (12,356) (14,957)
diversified (32% exposure to Bangalore). With its backward-
Total SG&A (incl. employee
costs)
(4,060) (4,101) (4,942) (5,983) integrated business model and an under-construction area
EBITDA 5,483 5,905 7,300 8,995
of ~36msf likely to act as feedstock for a steady stream of
launches, we expect a quarterly launch run rate of 2msf to
PBT 3,239 3,257 4,312 5,376
translate into a strong pre-sales run rate in excess of 4msf
PAT 2,172 2,245 2,845 3,675 in FY15E/FY16E.
EPS (`) 22.1 22.9 29.0 37.5

Balance Sheet Cash flow

Year to March FY13 FY14E FY15E FY16E Year to March FY14E FY15E FY16E
Shareholder’s fund 21,234 22,819 24,948 27,793
Total pre-tax CF 6,558 7,710 10,582
Debt 13,787 14,787 15,787 16,787
Minority interest 102 102 102 102 Tax (1,141) (1,496) (1,906)
Net Fixed Assets 3,169 2,634 2,127 1,644
CFO 5,417 6,214 8,677
Investments 2 2 2 2
Cash & bank balance 670 4,086 7,631 12,920 FCFE 3,203 3,773 5,875
Working capital 31,283 30,986 31,078 30,115
Changes in WC 297 (92) 963
Book value per share (`) 216.5 231.4 252.8 279.7

Pre-sales (` mn) - 4QFY14 witnessing an uptick Cost of debt benefiting from rating upgrades

8,000 540 14.5%

7,000 520 14.0%
500 14.1%
6,000
13.5%
480 13.5% 13.7% 13.6%
5,000
13.0%
4,000 460
12.9%
3,000 440 12.7% 12.5%

2,000 420 12.0%

1Q12

2Q12

3Q12

4Q12

1Q13

2Q13

3Q13

4Q13

1Q14

2Q14

3Q14

1,000
0
Finance cost (Rs mn)
1Q12

2Q12

3Q12

4Q12

1Q13

2Q13

3Q13

4Q13

1Q14

2Q14

3Q14

4Q14

Blended cost of debt (annualized) (%) (RHS)

Source: Bloomberg, Ambit Capital research

April 23, 2014 Ambit Capital Pvt. Ltd. Page 58

 Sobha Developers

FY14 - guidance miss but exit on a high

4QFY14 signals meaningful sequential turnaround
Sobha delivered FY14 volume sales at 3.6msf (guidance: 4.2msf) and value
sales at ` 23.4bn (guidance: ` 26bn). However, with a 20% QoQ increase in
pre-sales during 4QFY14, unrecognised revenues from sold units at ` 23bn
(100% of its December 2013 net worth) and strong demand for large projects
launched towards the end of March 2014, we expect Sobha to regain its sales
momentum during FY15.
Despite falling short of its FY14 volume and value sales guidance, Sobha saw a Volume recovery during 4QFY14
visible turnaround in sales momentum by end-FY14, as reflected in a 20% sequential on the back of launches in south
pick-up in pre-sales during 4QFY14 (at `6bn) as compared to a sub-par 3QFY14 (at India and more affordable units
`5bn). The recovery comes on the back of 3.6msf of launches in south India during in Bangalore
the March quarter that garnered strong demand after a sluggish 3QFY14 (when sales
volumes dipped to a ten-quarter low of 0.74msf).

Exhibit 1: Pre-sales (` mn) - turnaround during 4QFY14 Exhibit 2: Area sold (sft) - 4QFY14 witnessing an uptick

8,000 1,200,000
7,000
1,000,000
6,000
800,000
5,000
4,000 600,000
3,000
400,000
2,000
200,000
1,000
0 0
1Q12

2Q12

3Q12

4Q12

1Q13

2Q13

3Q13

4Q13

1Q14

2Q14

3Q14

4Q14

1Q12
2Q12
3Q12
4Q12
1Q13
2Q13
3Q13
4Q13
1Q14
2Q14
3Q14
4Q14
Source: Company, Ambit Capital research Source: Company, Ambit Capital research

We attribute the sales momentum to Sobha’s strategy of focusing on lower ticket sizes
in the `7.5mn-15mn price bracket that continues to see stable demand. Given the
strong reception to its recent project launches, we believe that Sobha will be able to
deliver volume sales north of 4msf in FY15/FY16E on the back of a relatively strong
pipeline of launches in south India.
Reducing concentration risk; benefiting from diversified presence
At the end of March 2014, Sobha has a real estate presence in 9 cities (up from 4 as
of March 2011). Sobha’s primary market remains Bangalore (accounting for c.68% of
volumes and 73% of value sales on an average), which ranks extremely high on the
employment creation and affordability metrics. By FY16, we expect the contribution of
Bangalore to Sobha’s volume sales to decline to c.60%.
Exhibit 3: Contribution of newly added locations to overall volumes (% of total sft)
Average contribution
Location Launch debut
to area sold (%)
Mysore 1QFY12 1.9%
NCR 2QFY12 9.6%
Chennai 4QFY12 8.2%
Kozhikode 2QFY14 4.9%
Cochin 4QFY14 1.8%
Source: Company, Ambit Capital research

April 23, 2014 Ambit Capital Pvt. Ltd. Page 59

 Sobha Developers

Our discussion with the management team suggests that the company is looking to
nearly double its new sales volume from ~3.6msf (as of FY14) to ~7msf over the next
five years (FY19), with the contribution of Bangalore likely to drift lower to 50%. Even
within Bangalore, Sobha is focused on gradually moving towards smaller-sized units
(from 3BHK formats of 1,800sft-2,000sft to 2BHK formats of 1,350sft) to reduce the
unitary ticket size and enhance its offerings in the affordable segment.
Exhibit 4: Location-wise breakdown of volume sales (sft) - growing contribution from NRI-rich locations
1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14
Bangalore 520,080 590,438 591,216 682,629 603,055 674,622 503,708 630,947
Thrissur 44,096 118,306 88,407 93,034 149,194 103,270 49,064 58,458
Coimbatore 26,005 10,631 19,574 7,160 0 15,871 17,124 40,171
Pune 30,639 38,621 23,124 45,324 22,912 12,716 24,433 23,395
NCR 135,721 137,600 103,098 132,732 36,255 30,892 23,522 38,114
Chennai 72,083 42,323 67,350 106,377 99,963 86,869 53,523 62,195
Mysore 6,975 8,209 9,881 4,015 9,300 22,128 26,538 19,547
Cochin NP NP NP NP NP NP NP 16,252
Kozhikode NP NP NP NP NP 56,661 42,293 32,193
Total 835,599 946,128 902,650 1,071,271 920,679 1,003,029 740,205 921,272
Source: Company, Ambit Capital research; Note: NP indicates no projects on offer in the city during that quarter

Sobha’s volume sales, although a function of the exogenous economic environment,

are also a function of increasing penetration into newer cities as well as a stronger
launch pipeline in its traditional markets.
Exhibit 5: New geographies - contribution from Bangalore likely to decline further

10
74.0%
72.0% 9

70.0% 8
68.0% 7
66.0%
6
64.0%
62.0% 5

60.0% 4
1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14

Number of cities (RHS) Area sold in Bangalore (% of total sft)

Source: Company, Ambit Capital research

Our discussions with the management team and independent consultants suggest
that Sobha is actively scouting for land parcels in the southern city of Hyderabad
(either outright acquisition or through the joint development agreement route) to add
to its slate of 9 locations.

April 23, 2014 Ambit Capital Pvt. Ltd. Page 60

 Sobha Developers

Strong cash conversion to be tested

Cash inflows (net of interest payouts) to pick up pace
Net of interest payouts, Sobha has averaged ` 0.7bn-0.8bn of quarterly net
cash from operations (CFO) during 9MFY14, aided by a steady stream of cash
inflows from its real estate operations (quarterly run rate of ` 4.5bn) as well
as its contracted projects (quarterly run rate of ` 1.7bn). Net debt-to-equity is
comfortable at 0.6x, with the average cost of debt at 12.7%, gaining from an
improving credit profile (on the back of timely repayments and steady cash
flows). However, Sobha is exposed to high refinancing risk with over ` 8.5bn
(0.3x December 2013 net worth) due for repayment during FY15.
Although Sobha’s net debt-to-equity has been stable at 0.6x over the past eight Cost of debt down by ~80bps in
quarters, the cost of debt has been trending lower during the corresponding period the past eight quarters, benefiting
(in an increasing interest rate environment), primarily on the back of upgrades from from rating upgrades by ICRA
rating agencies (ICRA and Brickworks) during FY14. and Brickworks during FY14
Exhibit 6: Net debt-to-equity stable at 0.6x Exhibit 7: Cost of debt benefiting from rating upgrades

13.5 0.64 540 14.5%

13.0 0.62 520 14.0%
14.1%
12.5 500 13.9%
0.6 13.9% 13.5%
12.0 480 13.7% 13.6%
13.5% 13.6%
0.58 13.5% 13.0%
11.5 460
0.56 12.9%
11.0 440 12.5%
12.7% 12.7%
10.5 0.54 420 12.0%
1Q12

2Q12

3Q12

4Q12

1Q13

2Q13

3Q13

4Q13

1Q14

2Q14

3Q14
10.0 0.52
1Q12

2Q12

3Q12

4Q12

1Q13

2Q13

3Q13

4Q13

1Q14

2Q14

3Q14

Finance cost (Rs mn)

Net debt (Rs bn) Net debt-to-equity (x) (RHS) Blended cost of debt (annualized) (%) (RHS)

Source: Company, Ambit Capital research Source: Company, Ambit Capital research

Our discussion with rating agencies suggests that the upgrades were primarily driven
by steady cash flows on the back of healthy sales velocity in its ongoing projects and
periodic repayments of its existing debt, with the 3QFY14 volume print an exception
to the trend. Sobha’s improving credit profile has been driven by a healthy mix of
recurring cash flows from its contractual projects (~26% of total cash inflows from
operations as of 9MFY14).
Exhibit 8: Segmental cash collections - stable, recurring cash flows from contracts

7,000 Rising contribution of operating

cash inflows from recurring cash
6,000 1,037 flows (contract projects)
1,230 1,788 2,111
5,000
1,495
4,000 798
764
3,000
5,293 4,923 4,552 4,445
2,000 3,687 3,883
3,249
1,000

0
1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14

Real estate Contracts Monetization of land

Source: Company, Ambit Capital research

April 23, 2014 Ambit Capital Pvt. Ltd. Page 61

 Sobha Developers

Over ` 8.5bn (over 50% of outstanding debt) up for repayment during FY15
Our discussion with rating agencies suggests that debt of `8.5bn (of the overall net Debt of ` 8.5bn (of the overall net
debt of `13bn) is up for repayment during FY15. Although Sobha has matching debt of ` 13bn) is up for
undrawn sanctioned limits for its ongoing and planned projects, the disbursement of repayment during FY15; Sobha is
incremental debt is contingent upon the timely launch and progress of these projects. exposed to high but manageable
Also, one of Sobha’s proposed launches over the next four quarters is the refinancing risk in a high interest
development of a commercial project awarded by APMC (Agricultural Produce Market rate environment
Committee), which is likely to result in increased funding requirements.
High but manageable refinancing risk during FY15
Hence, Sobha is exposed to high refinancing risk in a high interest rate environment
(our Macro team expects a further 25-50bps hike in repo rate during 1HFY15). The
refinancing risk (potentially higher cost of debt) is further exacerbated by the fact that
the debt repayment is to be made out of customer collections, which depends on the
timing and success of its recent as well as upcoming launches.
As a result, we expect Sobha to expedite the pace of launches and front-load some of
its proposed launches (residential) during the early part of FY15 to stimulate its cash
inflows and manage the refinancing risk better.
Exhibit 9: Format-wise proposed launches during April-December 2014
Format Sobha's share of saleable area (sft)
Residential 3,323,893
Bangalore 682,143
Gurgaon (NCR) 102,420
Chennai 1,984,850
Coimbatore 206,000
Thrissur 348,480
Commercial 2,063,252
Bangalore 2,063,252
TOTAL 5,387,145
Source: Company, Ambit Capital research

We expect Sobha to launch its commercial project during 2HFY15 to manage its cash
We expect the commercial project
flows better (operating cash inflows are likely to be relatively slower from the
launch to be back-ended during
commercial project vis-à-vis the residential properties). During the early part of FY15,
FY15 for Sobha to better manage
we believe Sobha will be more aggressive on its residential launches, especially in
its cash flows
Gurgaon (offers higher realisations) and Chennai (offers relatively higher volume).
Going forward, the quantum of undrawn sanctioned limits that Sobha needs to draw
upon as well as the cost of incremental debt will be influenced by:
 Sales velocity in recently-launched and upcoming residential projects;
 Ability to maintain collection efficiency;
 Pace of execution of new launches; and
 Recurring cash flows from contracts (cash inflows).

April 23, 2014 Ambit Capital Pvt. Ltd. Page 62

 Sobha Developers

Project details
Sobha has an ongoing real estate project slate of 18.9msf under construction (55% in
Bangalore) and a contract portfolio of 9.5msf (60% contracted by Infosys). Whilst the
portfolio of ongoing real estate projects (see Exhibit 10) is relatively more
concentrated in Bangalore, the portfolio of contracts (see Exhibit 11) is comparatively
better-diversified.

Exhibit 10: Location mix of ongoing projects (18.9msf) Exhibit 11: City mix of ongoing contract projects (9.5msf)

Others Others
Kozhikode 6% 13%
3%
Jaipur Bangalore
Chennai 6% 32%
5%
Pune
7%
Thrissur
8% Bangalore
56% Mangalore
10%

Gurgaon
Hyderabad
22% Trivandrum
17%
15%

Source: Company, Ambit Capital research Source: Company, Ambit Capital research

Real estate projects

Aside from its ‘under-construction’ projects, Sobha has an undeveloped land bank of
over 2,500 acres (translating into saleable area of 227msf), with a majority of its land
bank in IT/ITeS-centric cities. Sobha’s land bank is well diversified in IT/ITeS-driven
locations that contribute 80% to the company’s land bank and 81% to its discounted
cash flow (DCF) (see Exhibit 12).
Exhibit 12: City-wise land bank - demand and valuation drivers
Location % of land bank % contribution to DCF Key buyer segments
Bangalore 38.2% 41.0% IT/ITeS
Chennai 17.0% 19.0% IT/ITeS
Coimbatore 2.7% 2.1% IT/ITeS
Gurgaon 0.0% 3.0% BPO/KPO/IT/ITeS
Hosur 15.4% 11.0% IT/ITeS
Kochi 21.3% 14.0% NRI
Kozhikode 0.2% 0.2% NRI
Mysore 0.3% 0.3% IT/ITeS
Pune 2.3% 7.0% IT/ITeS
Thrissur 2.5% 2.4% NRI
Source: Company, Ambit Capital research

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 Sobha Developers

Valuation
We use a sum-of-the-parts (SOTP) approach and arrive at a valuation of `490/share
(marginal upward revision from our earlier valuation of `486/share), implying a 30%
upside. We value the real estate business at `441/share (using a DCF approach) and
the contracts business at `49/share.

Exhibit 13: Sum-of-the-parts valuation (`/share) Exhibit 14: Valuation of real estate business (`/share)
Real estate projects valuation (` mn) 43,413 Real estate projects (` mn) 59,317
Real estate projects (`/shr) 442 Less: Unpaid land bank (` mn) 1,250
Contracts business valuation (` mn) 4,800 Less: Net debt (March 2015) (` mn) 14,654
Contracts business (`/shr) 49 Net valuation (` mn) 43,413
Total valuation (` mn) 48,213 No. of shares (mn) 98.2
SOTP Valuation (`/shr) 491 Net valuation (`/shr) 442
Source: Ambit Capital research Source: Ambit Capital research

Assumptions around valuation parameters

 Target leverage: We assume long-term target gearing at 0.7x - this compares
to 0.6x net debt-to-equity that the company has been maintaining over the past 8
quarters.
 Weighted average cost of capital: Assuming cost of equity at 18%, we arrive
at a weighted average cost of capital of 14.3%. Cost of equity at 18% is higher
than the 15% that we assume for Oberoi Realty. On the other hand, we assume
cost of debt at 14%, ~125bps higher than Sobha’s current cost of debt (12.7% as
of December 2013).

Real estate projects

Given Sobha’s discontinued disclosures around project-wise sales and project-level
progress, we cumulate the city-wise pre-sales based on management guidance and
inputs from independent consultants.
 Annual run rate of sales: For under-construction projects that are yet to be
launched, we build in about 50% of the total sales to be achieved by Year 1 after
launch and 80% of cumulative sales by Year 3. For all projects, we assume the
‘stock out’ stage is triggered about 12-18 months after project completion. For all
the upcoming projects, we build in a delay of 12-18 months in project
completion. Although Sobha claims to complete its residential projects over a
period of 2.5 years to 3.5 years, our assumptions around delays are conservative,
given the usual issues around labour shortage.
Our assumptions around sales run rate are consistent with a typical project life-cycle
in which sales are high during the initial phase (after the project launch) and gather
fresh momentum as the project nears completion (pull factor on account of customers
looking for ‘ready-to-move-in’ properties). However, the run rate of sales tapers off
during the interim.
 Growth in average realisation rates in ongoing projects: For FY15, in the
case of ongoing projects, we have benchmarked average realisation rates based
on our discussion with independent consultants. In general, we assume c.8% YoY
increase in average realisations between FY15E and FY18E followed by 5% YoY
increase in average realisations thereafter until the project is completely sold out.
 Growth in realisation rates in upcoming projects: For the upcoming projects,
we have assumed c.8% YoY increase in average realisation for the first two years
after launch followed by 5% YoY increase in average realisations thereafter until
the project is completely sold out. Our base realisation (pricing at the time of
launch of such projects) is at a 5-10% discount to the prevailing pricing for
comparable projects in the relevant micro-market.

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 Sobha Developers

 Outflow pertaining to construction costs: For projects under construction, we

have assumed that: (a) construction costs are distributed over the construction
period proportionate to the percentage of completion; and (b) project is delayed
by 1-2 years relative to the management’s targeted completion schedule on
account of labour shortage.
We have individually projected the construction costs for each residential project
from FY14E (or the time of launch, whichever is earlier) until project completion,
using the percentage of completion approach. We use an average construction
cost (per sft) of `3,000-3,600 for premium projects and `1,500-2,000 for Sobha’s
lower price band projects and projects in the smaller cities.
 Rise in input costs of construction: For all projects under construction, we have
assumed 8% YoY increase in cost of construction (per sft) during the first four
years of a project and 5% thereafter until project completion. Our assumptions
around YoY cost inflation are based on trends around indexed building
construction costs published by the Construction Industry Development Council
(CIDC). Our estimates around rise in input costs are conservative given the fact
that the cost of building construction increased ~4% in Mumbai and ~5% each in
Delhi and Bangalore over the past five years (between January 2009 and March
2014). Concomitant with our assumptions around growth in blended realisation
rates, we believe that Sobha’s pricing power is only restored on select projects
post FY18E.
Exhibit 15: YoY movement in building construction costs in major real estate markets

18%
16%
14%
12%
10%
8%
6%
4%
2%
0%
Oct-08

Apr-09

Apr-11

Apr-12

Apr-13

Apr-14
Jul-09
Oct-09

Apr-10
Jul-10
Oct-10

Jul-11
Oct-11

Jul-12
Oct-12

Jul-13
Oct-13
Jan-09

Jan-10

Jan-11

Jan-12

Jan-13

Jan-14

Mumbai Delhi Bangalore

Source: CIDC, Ambit Capital research

Exhibit 16: Key assumptions

FY14E FY15E FY16E Remarks
Volumes (msf)
We expect residential sales to record a 9% YoY growth during FY15E and a
Residential 3.59 3.91 4.37
12% YoY growth during FY16E
Given the contractual nature of projects (with relatively higher visibility), we
Contractual sales 3.41 3.98 4.53 build in a 17% YoY growth in contract volumes during FY15E and 14% YoY
growth during FY16E
Realization rates (`/sft)
Residential 6,534 6,926 7,342 We build in 6% YoY blended rise in realisation rates during FY15E and FY16E
Contracts 1,500 1,620 1,750 We build in 8% YoY rise in blended realisations during FY15E and FY16E
Pre-sales value (` mn)
The pre-sales value is driven by 9-12% rise in volumes and a 6% rise in
Residential sales 23,457 27,081 32,085
realisation rates
Contracts 5,115 6,448 7,926

Construction cost (`/sft) 1,900 2,050 2,200 We assume rise in input costs at around 8% for FY15E and 7% for FY16E
Average cost of debt (%) 12.75% 14% 14% We assume a 125bps increase in cost of debt during FY15E and FY16E
Source: Company, Ambit Capital research

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 Sobha Developers

Catalysts for our BUY stance

Launch of residential project in Chennai: We expect Sobha’s residential project
launch in Chennai during 1HFY15 to improve the company’s net cash reserves prior
to the principal repayment cycle.
Launch of residential project in Gurgaon: Whilst the Chennai projects are likely
to drive volume sales, the residential project launch in Gurgaon is likely to contribute
towards better realisations (higher unitary ticket size).
Launch of commercial project during 2HFY15: We expect Sobha to launch its
commercial project at Bangalore during 2HFY15 to better manage its cash flows and
principal repayment during the year.

Risks to our BUY stance and our estimates

Delayed launches: We have assumed project launches during each of the first two
quarters of FY15 and a front-loading of residential projects in Chennai and Gurgaon.
A delay of one quarter in launching the residential projects at Chennai and Gurgaon
will significantly drag Sobha’s cash inflows and raise its net debt-to-equity position.
Weak sales velocity in recently launched projects: As highlighted earlier, a weak
sales velocity in its recent and upcoming launches coupled with a fall in pricing power
(for Sobha) will further accentuate the need for refinancing.
Premature launch of commercial project at Bangalore: We have assumed that
Sobha would launch its commercial project at Bangalore during 2HFY15. An earlier
launch of the commercial project would imply greater strain on the expected pace of
cash inflows, which might have to be offset by higher debt at the wrong end of the
interest rate cycle.
Risk of refinancing: We have assumed that Sobha can refinance its debt maturing
during FY15 at 14% (higher than Sobha’s current cost of debt by ~120bps). A higher-
than-anticipated interest rate environment and lower-than-anticipated cash inflows
(resulting in tighter liquidity) are risks to our BUY stance.

Forensic accounting flags

Exhibit 17: Explanation for our forensic accounting flags on the front page
Segment Score Comment
Despite an improving cash conversion over the past three years (FY11-13), Sobha
ranks behind its other A-grade peers such as Oberoi Realty; relatively low cash yield;
Accounting AMBER elevated contingent liabilities as a proportion of net worth; extremely low audit fees
(as proportion of auditor remuneration).
Instances of missed guidance despite exercising relatively better control over the
Predictability AMBER supply chain.
The company launched four new projects (Bangalore, Kozhikode and Cochin) during
Earnings momentum GREEN 4QFY14, and thus, the stock has seen upgrades to its FY15E earnings.
Source: Bloomberg, Ambit Capital research

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 Sobha Developers

Revision in estimates
Exhibit 18: Revision in FY14E/FY15E/FY16E estimates
FY14E FY15E FY16E
Changes in estimates Old New % change Old New % change Old New % change
Operating income 20,559 20,931 1.8% 24,779 24,500 -1.1% 29,998 29,765 -0.8%
EBITDA (` mn) 6,205 5,905 -4.8% 7,481 7,300 -2.4% 9,058 8,995 -0.7%
Net profit (` mn) 2,318 2,245 -3.1% 3,038 2,845 -6.4% 3,870 3,675 -5.0%
EPS (`) 23.6 22.9 -3.0% 31.0 29.0 -6.4% 39.5 37.5 -5.2%
BVPS (`) 232.7 231.4 -0.6% 254.4 252.8 -0.6% 283.4 279.7 -1.3%
Source: Ambit Capital research

Changes to FY14E estimates

Our earnings estimates for FY14E have undergone a marginal downward revision
due to lower-than-anticipated pre-sales volume and lower EBITDA margin during
FY14 on account of:
 One-time write-off of `63mn on account of one-time settlement on a contract;
 Weak demand fundamentals in the Gurgaon and Pune markets; and
 Delayed launches in the southern Indian markets.

Changes to FY15E / FY16E estimates

Our revenue estimates for FY15E/FY16E have been revised marginally downwards as
a result of relatively conservative assumptions around project sales run rate and
lower growth in realisation rates in ongoing projects. However, our FY15E/ FY16E
earnings estimates are more sharply impacted on account of the higher cost of debt
that we have assumed for Sobha during FY15.

April 23, 2014 Ambit Capital Pvt. Ltd. Page 67

 Sobha Developers

SWOT Analysis
Exhibit 19: Sobha Developers - SWOT analysis
Strengths Weaknesses
 Well-located land bank in IT/ITeS-dominated cities such as Bangalore,  High concentration risk in the contracts business with 60% of orders from
its primary market, Gurgaon, Chennai and Pune, accounting for over Infosys
80% of the company’s saleable area  High refinancing risk with about `8.5bn up for principal repayment
 Sizeable presence in Kerala markets with relatively high proportion of during FY15
NRI diaspora
 Diversified presence in 9 cities (real estate projects) with contribution
from Bangalore, its primary market, gradually reducing from over 75%
to about 65%
 Infosys’ partner of choice for civil contracts (own buildings)
 Backward-integrated business model with subsidiaries engaged in
metalwork manufacturing (0.3msf), woodwork manufacturing (0.8msf),
giving Sobha better control on the supply chain

Opportunities Threats

 Expansion into formats other than residential such as commercial  Fixed-margin contract business with high client concentration
(office and retail)  Rise in net debt-to-equity in case of lower sales velocity from recently
 Expansion into newer geographies to reduce dependence on launched projects or delayed launches
Bangalore, its primary market

Source: Company, Ambit Capital research

April 23, 2014 Ambit Capital Pvt. Ltd. Page 68

 Sobha Developers

Balance Sheet
Year to March FY12 FY13 FY14E FY15E FY16E
Shareholder’s fund 19,956 21,234 22,819 24,948 27,793
Debt 12,440 13,787 14,787 15,787 16,787
Minority interest 355 102 102 102 102
Net Fixed Assets 2,810 3,169 2,634 2,127 1,644
Investments 0 2 2 2 2
Cash & bank balance 588 670 4,086 7,631 12,920
Working capital 29,352 31,283 30,986 31,078 30,115
Book value per share (`) 203.5 216.5 231.4 252.8 279.7
Source: Company, Ambit Capital research

Income statement
Year to March FY12 FY13 FY14E FY15E FY16E
Revenues from property development 8,948 13,092 15,762 17,984 21,754
Revenues from sale of land & TDR 1,365 1,020 0 0 0
Revenue from sale of manufactured
1,393 1,477 1,725 2,187 2,766
products
Revenues from contractual projects 2,348 3,013 3,390 4,261 5,160
Other operating income 25 43 54 67 84
Total income 14,079 18,645 20,931 24,500 29,765
Operating costs (4,447) (9,103) (10,252) (12,356) (14,957)
Total SG&A (incl. employee costs) (4,967) (4,060) (4,101) (4,942) (5,983)
EBITDA 4,666 5,483 5,905 7,300 8,995
PBT 3,177 3,239 3,257 4,312 5,376
PAT 2,060 2,172 2,245 2,845 3,675
EPS (`) 21.0 22.1 22.9 29.0 37.5
Source: Company, Ambit Capital research

Cash Flow statement

Year to March FY14E FY15E FY16E
Total pre-tax CF 6,558 7,710 10,582
Tax (1,141) (1,496) (1,906)
CFO 5,417 6,214 8,677
FCFE 3,203 3,773 5,875
Changes in WC 297 (92) 963
Source: Company, Ambit Capital research, Note: All financials pertain to IFRS consolidated accounts

Ratio Analysis
Year to March FY12 FY13 FY14E FY15E FY16E
P/E (x) 17.8 16.8 16.3 12.9 9.9
P/BV (x) 1.8 1.7 1.6 1.5 1.3
P/FCF 5.5 4.8 3.5
P/FCFE 9.4 8.0 5.1
ROE % 10.7 10.5 10.5 12.7 14.7
Debt/equity 0.62 0.65 0.65 0.63 0.60
EBITDA margin % 33.1 29.4 30.2 30.2 30.2
Net margin % 14.6 11.6 11.2 12.1 12.7
Dividend yield % 1.6 2.3 2.4 3.0 3.4
Source: Company, Ambit Capital research

April 23, 2014 Ambit Capital Pvt. Ltd. Page 69

 Sobha Developers

Institutional Equities Team

Saurabh Mukherjea, CFA CEO, Institutional Equities (022) 30433174 [email protected]

Research
Analysts Industry Sectors Desk-Phone E-mail
Aadesh Mehta Banking & Financial Services (022) 30433239 [email protected]
Achint Bhagat Cement / Infrastructure (022) 30433178 [email protected]
Aditya Khemka Healthcare (022) 30433272 [email protected]
Akshay Wadhwa Banking & Financial Services (022) 30433005 [email protected]
Ankur Rudra, CFA Technology / Telecom / Media (022) 30433211 [email protected]
Ashvin Shetty, CFA Automobile (022) 30433285 [email protected]
Bhargav Buddhadev Power / Capital Goods (022) 30433252 [email protected]
Dayanand Mittal, CFA Oil & Gas / Metals & Mining (022) 30433202 [email protected]
Deepesh Agarwal Power / Capital Goods (022) 30433275 [email protected]
Gaurav Mehta, CFA Strategy / Derivatives Research (022) 30433255 [email protected]
Karan Khanna Strategy (022) 30433251 [email protected]
Krishnan ASV Real Estate (022) 30433205 [email protected]
Nitin Bhasin E&C / Infrastructure / Cement (022) 30433241 [email protected]
Nitin Jain Technology (022) 30433291 [email protected]
Pankaj Agarwal, CFA Banking & Financial Services (022) 30433206 [email protected]
Pratik Singhania Real Estate / Retail (022) 30433264 [email protected]
Parita Ashar Metals & Mining / Oil & Gas (022) 30433223 [email protected]
Rakshit Ranjan, CFA Consumer / Real Estate / Retail (022) 30433201 [email protected]
Ravi Singh Banking & Financial Services (022) 30433181 [email protected]
Ritika Mankar Mukherjee, CFA Economy / Strategy (022) 30433175 [email protected]
Ritu Modi Automobile (022) 30433292 [email protected]
Tanuj Mukhija, CFA E&C / Infrastructure (022) 30433203 [email protected]
Sales
Name Regions Desk-Phone E-mail
Deepak Sawhney India / Asia (022) 30433295 [email protected]
Dharmen Shah India / Asia (022) 30433289 [email protected]
Dipti Mehta India / USA (022) 30433053 [email protected]
Nityam Shah, CFA USA / Europe (022) 30433259 [email protected]
Parees Purohit, CFA UK / USA (022) 30433169 [email protected]
Praveena Pattabiraman India / Asia (022) 30433268 [email protected]
Sarojini Ramachandran UK +44 (0) 20 7614 8374 [email protected]
Production
Sajid Merchant Production (022) 30433247 [email protected]
Sharoz G Hussain Production (022) 30433183 [email protected]
Joel Pereira Editor (022) 30433284 [email protected]
Nikhil Pillai Database (022) 30433265 [email protected]
E&C = Engineering & Construction

April 23, 2014 Ambit Capital Pvt. Ltd. Page 70

 Sobha Developers

Explanation of Investment Rating

Investment Rating Expected return

(over 12-month period from date of initial rating)
Buy >5%

Sell <5%

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