Ambit RealEstate Thematic Accounting 23apr14

April 2014
REAL ESTATE
Krishnan ASV
+91 22 3043 3205
vkrishnan@ambitcapital.com
Analyst:
Accounting - at the crossroad
REITs
TRANSPARENCY
Company Act 2013
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Accounting practices
Wilful diversion
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Related party
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TRANSPARENCY
Thematic:

Real Estate

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

CONTENTS

SECTOR
Executive summary.. 4
Accounting in real estate - A black box........ 6
Accounting for land - Further latitude. 7
Revised guidance note (GN) streamlines revenue recognition 10
yet not watertight
Related party transactions (RPTs) galore... 14
Category mix and leverage suggest wilful diversion 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 General 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 crucial. 35
Sobha Developers (BUY): Position of relative strength. 57

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.

Accounting - at the crossroad
The real estate sector allows considerable latitude in accounting for
revenues and cost (especially land), and thus, it is no surprise that the
sector fares the worst on our accounting framework. We argue that fresh
funding needs (impending beauty parade for REITs) coupled with recent
changes to the accounting and regulatory framework is forcing greater
transparency amongst real estate companies. We identify Oberoi Realty,
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
In the absence of sector-specific accounting standards, accounting practices in
the real estate sector are non-homogenous, especially around accounting for
revenues and land. Key areas that contribute to the sectors relatively inferior
performance on accounting metrics are: (a) arbitrary revenue recognition; (b)
weak cash conversion; (c) expense manipulation (lack of prudent provisioning);
and (d) many related party transactions.
Revenue recognition harmonised yet not watertight
Whilst the revised guidance note (GN) prescribes a uniform threshold for firms
to begin recognising revenues from a project, our discussions with practising
auditors suggest that the revised GN is not yet completely watertight. This
includes instances such as developers entering into a separate sale of land
contract (contributing to aggressive revenue recognition), discretion exercised
around what constitutes critical approvals and ambiguity around JDAs.
Related party transactions (RPTs) - modes of disguised lending
On an average, the top-three categories of RPTs account for c.70% of the total
related party transactions. A large proportion of RPTs are only ways of funding
group entities, with most categories reversing themselves during the year and
not earning any interest. We also argue that a bulk of construction finance
(working capital loans raised for under-construction projects) raised by
developers for residential projects is diverted towards either land acquisition or
stalled projects that are starved for capital (suffering from cost overruns).
Limited investible universe; Oberoi, Prestige - most transparent
Using accounting checks across four categories (P&L misstatement checks,
balance sheet misstatement checks, cash pilferage checks, and audit quality
checks) on a set of 21 real estate companies, we establish a pecking order of
transparency and identify the investible universe of real estate stocks. Based on
our analysis, Oberoi, Prestige and Sobha are relatively more transparent.
The road ahead - what can investors look forward to?
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.

Real Estate
NEGATIVE
THEMATIC April 23, 2014
Key Recommendations
Oberoi Realty
BUY
Target Price: 290 Upside : 30%
Sobha Developers
BUY
Target Price: 491 Upside : 30%

Contingent Liabilities and P/B
Companies
CL (% of
NW)
FY15 P/B
Large companies - mcap > US$500mn
DLF 26% 0.93
Oberoi Realty 8% 1.46
Prestige Estate Projects 43% 1.71
Unitech 72% 0.37
Godrej Properties 5% 1.82
Phoenix Mills 25% 1.82
Sobha Developers 29% 1.46
Mid-sized companies - mcap between
US$200mn and US$500mn
Omaxe 32% 1.32
Indiabulls Real Estate 8% 0.35
HDIL 8% 0.27
Anant Raj 4% 0.42
Sunteck Realty 0% 1.79
Mahindra Lifespace
Developers
3% 1.07
Puravankara Projects 4% 0.70
Small-sized companies - mcap between
US$100mn and US$200mn
Parsvnath Developers 9% 0.40
DB Realty 52% 0.51
Peninsula Land 1% 0.66
Hubtown 19% 0.61
Ashiana Housing 1% 1.74
Brigade Enterprises 88% 0.58
Kolte Patil Developers 28% 0.56
Source: Bloomberg, Ambit Capital research; CL denotes
contingent liabilities; NW denotes net worth

Analyst Details
Krishnan ASV
+91 22 30433205
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
P&L misstatement checks
(1) CFO/EBITDA, (2) change in depreciation rate, and (3) miscellaneous expenses as a
proportion of total expenses
Balance sheet misstatement checks
(1) Cash yield, (2) debtors more than six months as a proportion of total debtors, and (3)
contingent liability as a proportion of net worth
Cash pilferage checks
(1) CWIP to gross block, (2) cost of construction to construction work-in-progress, and (3)
cumulative CFO plus CFI to median revenues
Audit quality checks
(1) Audit fees as a proportion of standalone revenues, (2) audit fees as a proportion of total
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
Company P&L checks
Balance sheet
checks
Cash pilferage checks Audit quality checks Overall score
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
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
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 bubbl e denotes conti ngent l i abi l i ti es (as a pr opor ti on of net wor 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
negative cash conversion cycle), Indiabulls Real Estate, HDIL and Sunteck Realty
(significantly high cash conversion cycle). The largest bubble in Exhibit 3 is equivalent
to 75% of net worth (Brigade Enterprises) whilst the smallest bubble is equivalent to
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
denominator for most of the firms in this analysis, it is worth highlighting that
companies with a lean P&L are unduly penalised. Given that the variables in the cash
conversion cycle (inventory days, debtor days and creditor days) employ P&L elements
(either revenues or cost of sales) in the denominator, the revenue recognition
approach, especially the project completion method, disproportionately impacts such
firms. We highlight HDIL and Sunteck Realty as outliers on account of the revenue
recognition policy (project completion method) and hence, they are not strictly
comparable on the cash conversion scale.
Parsvnath
DB Realty
Peninsula Land
Hubtown
Ashiana Housing
Brigade Enterprises
Kolte Patil
Oberoi Realty
Anant Raj
Prestige Estates
Sobha Developers
Omaxe
Mahindra Lifespace
Godrej Properties
DLF
Unitech Puravankara
-200
0
200
400
600
800
1,000
1,200
- 0.5 1.0 1.5 2.0 2.5 3.0
FY15 P/B
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Cash conversion cycle (in number
of days) is the least common
denominator for a majority of the
firms in this analysis
We identify HDIL and Sunteck
Realty as outliers on account of
the revenue recognition policy
(project completion method) and
hence, they are not strictly
comparable on the cash
conversion scale
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 sectors 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 stakeholderscapital
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
characterised with complex arrangements such as agreement to sell, flat-buyer
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
real estate transactions, the complex nature of real estate transactions led to a wide
disparity in revenue recognition across firms in the sector. Issues around revenue
recognition arise because real estate developers often enter into agreements for
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
percentage of completion (POC) method for the purpose of revenue recognition;
however, it was silent on how developers should arrive at the POC and revenues
thereafter. As a result, there was considerable divergence in the revenue recognition
policies followed by different companies across the real estate sector.
Exhibit 5: Revenue recognition policies under the erstwhile GN - wide disparity
Threshold
policy
Minimum project sale
criteria
Minimum
collection
Land cost in POC
calculation
DLF 30% None No policy Considered
Godrej
Properties
20% None No policy Considered
HDIL 100% NA NA Considered
Indiabulls Real
Estate
25% None No policy Not considered
Kolte Patil 20% None No policy Considered
Mahindra
Lifespaces
25% None Yes Considered
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
Real estate companies exercise
subjectivity in revenue recognition
Subjectivity lies in identifying the
applicable accounting standard
(AS) for real estate transactions -
should it be AS7 or AS9?
Earlier, the GN prescribed the
Percentage of Completion (POC)
method but left the specifics to
interpretation
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,
residential projects treat land as inventory (in accordance with AS2) since such land is
likely to be sold in the ordinary course of business, but on the other hand,
commercial projects (where developers intend to let out the project on a lease) treat
land as a fixed asset (in accordance with AS10), flowing through the gross block. Our
discussions with auditors suggest that often, companies are undecided about the end-
use at the time of land acquisition. Under such circumstances, developers often
classify the land so acquired as a fixed asset; however, any subsequent re-
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
Stage
Balance sheet entries P&L statement entries
Held for sale Held for lease
Mix-use /
undecided
Held for sale Held for lease
Mix-use /
undecided
Land acquisition
Inventory -
Construction
Work-in-Progress
(+ve)
Fixed assets -
Capital Work-in-
Progress (+ve)
Fixed assets -
Capital Work-in-
Progress (+ve)
Capitalised Capitalised Capitalised
Cash (-ve) Cash (-ve) Cash (-ve)
Development / construction
(prior to revenue recognition
being triggered)
Inventory -
Construction
Work-in-Progress
(+ve)
Fixed assets -
Capital Work-in-
Progress (+ve)
Fixed assets -
Capital Work-in-
Progress (-ve)
Capitalised Capitalised Capitalised
Cash (-ve) /
Customer
advances (+ve)
Cash (-ve)
Inventory -
Construction Work-
in-Progress (+ve)
Cash (-ve)
Development / construction
(once revenue recognition is
triggered)
Inventory -
Construction
Work-in-Progress
(-ve)
Fixed assets -
gross block
(+ve)
Inventory -
Construction Work-
in-Progress (-ve)
Cost of Sales -
Construction
costs
Depreciation
Cost of Sales -
Construction costs
Cash (+ve) /
Debtors (+ve)
Capital Work-in-
Progress (-ve)
Cash (+ve) /
Debtors (+ve)
Revenue Revenue Revenue
Sale is completed (risks and
rewards are transferred)
Inventory -
Construction
Work-in-Progress
(-ve)
Fixed assets -
gross block
(+ve)
Inventory -
Construction Work-
in-Progress (-ve)
Cost of Sales -
Construction
costs
Depreciation
Cost of Sales -
Construction costs
Cash (+ve) Cash (+ve) Cash (+ve) Revenue
Although developers are not
always certain of the end-use at
the time of land acquisition, land
has two proposed end-uses.
When held for sale, land is
treated as inventory (AS2); when
held for lease, land is treated
as a capital asset (AS10)
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
realisable value (NRV). Given that developers expect to earn a positive return on their
operations, the expected NRV is often typically higher than cost. However, there exists
wide disparity in cost categories that are loaded up to the carrying cost of inventory
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
DLF Ltd.
Land (including development rights) acquisition cost, borrowing costs,
estimated Internal development costs, external development charges,
construction costs, overheads, borrowing cost, development/construction
materials
Not disclosed
Godrej Properties Ltd.
Cost of land, premium for development rights, construction costs, allocated
interest and expenses incidental to the projects undertaken by the company.
Not disclosed
Housing Development & Infrastructure Ltd.
Cost of land, land development rights, materials, services, borrowing costs,
acquisition of tenancy rights and other related overheads.
First-in-First-out
Hubtown Ltd.
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
borrowing costs) attributable to the projects. Cost formula used is average
cost.
Average cost
Mahindra Lifespace Developers Ltd.
Cost of land, premium for development rights, construction costs and
allocated interest and expenses incidental to the projects undertaken by the
company.
Weighted average cost
Oberoi Realty Ltd.
Cost of land, development rights, rates and taxes, construction costs,
borrowing costs, other direct expenditure, allocated overheads and other
incidental expenses.
Not disclosed
Omaxe Ltd.
Cost of land, materials, construction, services, borrowing costs and other
overheads related to projects.
Average cost
Peninsula Land Ltd.
All costs directly related to the project and other expenditure as identified by
the management, which are incurred for the purpose of executing and
securing the completion of the project (net off incidental recoveries/receipts)
up to the date of receipt of occupancy certificate from the relevant authorities.
Not disclosed
Phoenix Mills Ltd.
All costs directly related to the project and other expenditure as identified by
the management, which are incurred for the purpose of executing and
securing the completion of the project (net of incidental recoveries/receipts).
Not disclosed
Prestige Estate Projects Ltd.
Aggregate of land cost, materials, contract works, direct expenses, provisions
and apportioned borrowing costs (net of material scrap receipts).
Not disclosed
Puravankara Projects Ltd.
Cost of land, construction related overhead expenditure, borrowing costs and
other net costs incurred during the period of development.
Not disclosed
Sobha Developers Ltd.
Direct expenditure related to construction activity and other expenditure
(including borrowing costs) during the construction period.
Not disclosed
Sunteck Realty Ltd.
Land acquisition cost (including development rights) and initial development
cost and direct expenditure related to construction activity.
Not disclosed
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
the movement of inventory in their annual reports (although companies are
mandated to report the movement in inventory under the revised Schedule VI
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.
Too much ambiguity exists in the
categories of costs that are
loaded into the cost of land,
resulting in over-capitalisation
Real estate companies are
mandated to classify land in the
Investment Property category
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
is not routed through the P&L but adjusted directly against the inventory balance (in
projects where revenue recognition is not triggered) or adjusted in the percentage of
completion (POC) component for the project (where revenue recognition is triggered).
For instance, if the original cost of a project was estimated at `100 and the actual
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
are loaded up to the cost of inventory (cost of land including development rights and
cost of construction) that is carried on the balance sheet. It is worth highlighting that
firms have often significantly under-estimated as well as over-estimated project costs.
For instance, firms often resort to write-offs after having inflated the carrying cost of
inventory with unconventional categories of costs. On the contrary, under-estimation
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.
Impairment in the carrying value
of land is not transparently routed
through the P&L but directly
adjusted against the balance on
the balance sheet
Over-estimating the cost of land
results in impairment having to
be written off; under-estimating
the cost of land results in the firm
having to absorb significant cost
escalation thereafter
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;
At least 25% of the estimated construction and development cost (excluding the
cost of land) has been incurred;
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
prescribing a uniform threshold for companies to begin recognising revenue from a
project, our discussions with several practising auditors suggest that the revised GN is
not yet watertight. For instance, an area where real estate companies tend to exercise
subjectivity is around what constitutes critical approvals. Developers often begin
recognising revenues from sale of units on the 10
th
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
Whilst most listed real estate companies claim to comply with the revised GN in their
FY13 Annual Report, this practice is not being followed across all projects of a listed
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.
The revised GN prescribes four
project-related criteria to be
fulfilled for revenue recognition
to be triggered
Despite the uniform criteria being
prescribed, the revised GN is not
watertight and still leaves plenty
of scope for subjective judgment
Since the revised GN is not yet an
Accounting Standard, companies
are not mandated to follow it
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*
DLF Ltd.
Revenue from constructed properties, other than SEZ projects, is
recognised on the percentage of completion method. Total sale
consideration as per the duly executed agreement to
sell/application forms (containing salient terms of agreement to
sell), is recognised as revenue based on the percentage of actual
project costs incurred thereon to total estimated project cost,
subject to such actual cost incurred being 30% or more of the
total estimated project cost. Project cost includes cost of land,
cost of development rights, estimated construction and
development cost, borrowing cost of such properties.
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
2012), the company revised its Accounting Policy of revenue
recognition for all projects commencing on or after April 1, 2012 or
project where the revenue is recognised for the first time on or after
the above date. As per this Guidance Note, the revenue has been
recognised on the percentage of completion method provided all of
the following conditions are met at the reporting date.
(i) at least 25% of estimated construction and development costs
(excluding land cost) has been incurred;
(ii) at least 25% of the saleable project area is secured by the
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.
Godrej Properties Ltd.
The company is following the Percentage of Completion Method
of accounting. As per this method, revenue from sale of
properties is recognised in the Statement of Profit and Loss in
proportion to the actual cost incurred as against the total
estimated cost of projects under execution with the company on
transfer of significant risk and rewards to the buyer. If the actual
project cost incurred is less than 20% of the total estimated
project cost, no income is recognised in respect of that project in
the relevant period.
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
revenue on such projects have been recognised on the percentage of
completion method provided the following thresholds have been
met:
(a) All critical approvals necessary for the commencement have been
obtained;
(b) The expenditure incurred on construction and development costs
is not less than 25% of the total estimated construction and
development costs;
(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.
Mahindra Lifespace
Developers Ltd.
Income from real estate sales is recognised on the transfer of all
significant risks and rewards of ownership to the buyers and it is
not unreasonable to expect ultimate collection and no significant
uncertainty exists regarding the amount of consideration.
However if, at the time of transfer substantial acts are yet to be
performed under the contract, revenue is recognised on
proportionate basis as the acts are performed, i.e. on the
percentage of completion basis. Revenues from real estate
projects are recognised only when the actual project costs
incurred are at least 25 % of the total estimated project costs
including land and when at least 10% of the sales consideration
is realised.
In accordance with the Guidance Note on Accounting for Real Estate
Transactions (Revised 2012), in case of projects commencing on or
after 1 April 2012 or in case of projects which have already
commenced but where revenue is being recognised for the first time
on or after 1 April 2012, revenues will be recognised from these real
estate projects only when:
(i) the actual construction and development cost incurred is at least
25% of the total construction and development cost (without
considering land cost) and
(ii) when at least 10% of the sales consideration is realised and
(iii) where 25% of the total saleable area of the project is secured by
contracts of agreement with buyers.
Oberoi Realty Ltd.
The company follows the percentage of project completion
method for its projects. Under this method, the company
recognises revenue in proportion to the actual cost incurred as
against the total estimated cost of the project under execution
subject to completion of construction work to a certain level
depending on the type of the project.
(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.
In this scenario, the company recognises revenue in proportion to
the actual project cost incurred (including land cost) as against the
total estimated project cost (including land cost), subject to achieving
the threshold level of project cost (excluding land cost) as well as
area sold, in line with the Guidance Note and depending on the type
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.
Real Estate

Company Annual Report - FY12 Annual Report - FY13*
Ltd.
Revenue from real estate projects including
integrated
townships is recognised on the Percentage of
Completion Method of accounting. Revenue is
recognised, in relation to the sold areas only, on
the
basis of percentage of actual cost incurred thereon
including land as against the total estimated cost of
the project under execution subject to such actual
cost being 30% or more of the total estimated cost.
In accordance with Revised Guidance Note issued by
the Institute of Chartered Accountants of India (ICAI),
on Accounting for Real Estate Transactions (Revised
2012), revenue recognition for all real estate projects
commencing on or after 1 April 2012 or where the
revenue is recognised first time on or after 1 April 2012,
revenue is recognised on percentage of completion
method if: (a) actual construction and development cost
(excluding land cost) incurred is 25% or more of the
estimated cost, (b) At least 25% of the saleable project
area is secured by contracts or agreements with buyers
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.
Peninsula Land Ltd.
The company is in the business of Property
Development. Revenue from sale of properties
under construction is recognised on the basis of
actual bookings done (provided the significant risks
and rewards have been transferred to the buyer
and there is reasonable certainty of realisation of
the monies) proportionate to the percentage of
physical completion of construction/ development
work as certified by the architect.
During the year the company adopted the guidelines prescribed by the Guidance
note on Accounting Treatment for real estate transactions (Revised 2012) issued
by the Institute of Chartered Accountants of India, inter alia , with regard to
thresholds for commencement of revenue recognition for projects and the basis for
determining percentage of completion. The adoption of the said guidelines has no
significant effect in the revenues and costs recognised for projects during the year.
Phoenix Mills Ltd.
Revenue from sale of properties under construction
is recognised on the basis of Registered Sale
Agreements (provided the significant risk and
rewards have been transferred to the buyer and
there is reasonable certainty of realisation of the
monies), on the basis of the percentage completion
method, determined based on the physical
proportion of the work completed, as certified by
the companys technical personnel after the
construction work has progressed significantly.
Revenue from the sale of properties under construction is recognised on the basis
of the Sale Agreements (provided the significant risk and rewards have been
transferred to the buyer and there is reasonable certainty of realisation of the
monies), proportionate to the percentage of physical completion of
construction/development work, as certified by the companys technical personnel.
Ltd.
Revenue from each Real Estate Developmental
Projects related to real estate vested with the
company, is recognised based on the Percentage
Completion Method. The percentage completion
method is applied on a cumulative basis in each
accounting period to the current estimates of
contract revenue and contract costs, when the stage
of completion of each project reaches a significant
level, which is estimated in the range of 20% to
30% of the total estimated costs of the project
depending on the size of the project.
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
Accountants of India are satisfied, i.e., when:
(a) All critical approvals necessary for commencement of the project have been
obtained.
(b) The expenditure incurred on construction and development costs is not less
than 25 % of the construction and development costs.
(c) At least 25% of the saleable project area is secured by contracts or agreements
with buyers.
(d) At least 10 % of the total revenue as per the agreements of sale or any other
legally enforceable documents are realised at the reporting date in respect of each
of the contracts and it is reasonable to expect that the parties to such contracts will
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.
Sunteck Realty Ltd.
The Group follows completed project method of
accounting. Direct/Allocable expenses incurred
during the year are debited to work-in-progress
account. The revenue is accounted for as and when
the significant risks and rewards of ownership of
the units in real estate are passed or deemed to
have passed to the buyer and the projects get
completed or substantially completed, to the extent
that the economic benefits will flow to the Group
and the revenue can be reliably measured.
The Group follows completed project method of accounting. Direct/Allocable
expenses incurred during the year are debited to work-in-progress account. The
revenue is accounted for as and when the significant risks and rewards of
ownership of the units in real estate are passed or deemed to have passed to the
buyer and the projects get completed or substantially completed, to the extent 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
Real Estate

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 currently following two policies simultaneously. The
revised GN is applied to all real estate projects that commenced on or after 1 April
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 contractsone contract for the sale of land and the other for
development on such landeven 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
scope, there is no specific guidance or illustration to capture accounting 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.
Most real estate companies are
currently following two policies
simultaneously
No specific guidance in the
revised GN for JDAs

Real Estate


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,
which prescribes a ceiling on the area of land that a single company can own, which
has spawned the multitude of SPVs for the purpose of land acquisition.
Exhibit 9: Layered entities - number of related parties as of March 2013

Subsidiaries
Joint
ventures
Associates
Other related
parties
Remarks
Anant Raj Ltd. 96

11 47 Subsidiaries include 20 step-down subsidiaries
DB Realty Ltd. 20 17 4 37
Other related parties include entities over which key
management personnel exercise significant control
DLF Ltd. 266 12 17 110
Other related parties includes entities over which key
management personnel exercise significant control
Godrej Properties Ltd. 15 36 5 83
Other related parties include other listed and unlisted
entities within the Godrej Group and private equity
investment firms
Housing Development &
Infrastructure Ltd.
10 2 1 3
Other related parties include enterprises significantly
influenced and controlled by key management
personnel
Indiabulls Real Estate Ltd. 239

1 2 Other related parties include subsidiaries of associate
Kolte Patil Developers Ltd 14 4 4

Includes limited liability companies and partnership
firms
Mahindra Lifespace
Developers Ltd.
12 2 1

Includes jointly controlled entities
Oberoi Realty Ltd. 8 5

Joint ventures refer to jointly controlled entities / assets
Omaxe Ltd. 94 1

Parsvnath Developers Ltd. 19 3 4

Subsidiaries include 4 step-down subsidiaries; joint
ventures include 1 JV belonging to a step-down
subsidiary
Peninsula Land Ltd. 23 3 5 8
Includes 19 step-down subsidiaries; other related
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

Unitech Ltd. 243 14 2 4
Subsidiaries include 227 wholly-owned subsidiaries;
other related parties include entities owned or
significantly influenced by key management personnel
RPTs could be used for disproportionate transfer of wealth
One of the most common ownership structures involves pyramids and cross-holding
of shares, which contributes to a significant wedge (difference between cash and
control rights) between group companies. This presents controlling shareholders with
arbitrage opportunities to transfer wealth between group entities (from one in which
the controlling shareholder or promoter has lower cash flow rights to another in
which the promoters rights are higher) through related party transactions (RPTs).

SPVs floated by developers to
comply with the Land Ceiling Act
Differences in cash and control
rights between group companies
provide controlling shareholders
(read: promoters) with arbitrage
opportunities to move resources

Real Estate


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
dynamics of one project from that of others; this is an especially popular structure
with capital providers who prefer funding specific projects rather than taking
exposure at a listed entity level.
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
private groups 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

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

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).

At a very basic level, there can be
two genuine reasons for related
party transactions (RPTs):
(a) isolation of risks; and
(b) isolation of rewards

Real Estate


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
DB Realty Ltd. Corporate guarantees
Advance against purchase of
shares
Loans given / deposits placed
DLF Ltd. Loans and interest receivable
Advances received under
agreement to sell
Investments
Godrej Properties Ltd. Sale of units Investment in equity Inter-corporate deposit
HDIL
Investment / redemption of
debentures
Advances for projects Loans / advances paid
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
Prestige Estate Projects Ltd. Inter-corporate deposit payable
Loans and advances
recoverable
Guarantees & collaterals provided
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
It is worth highlighting that the top-three categories of RPTs account for ~70% of the
total related party transactions on average. As can be seen from the above exhibit, a
bulk of the categories of RPTs employed by real estate developers are merely ways of
funding the related party entities. As loans and advances attract significant
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-
corporate deposits) does not earn interest and tend to get reversed during the year.
From the limited number of companies that disclose details around end-year
outstanding balances as well as maximum outstanding balances during the year, we
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.

Most RPTs are merely different
modes of funding related parties
including investments in
equity/quasi-equity instruments
Majority of RPTs do not earn
interest and reverse themselves
during the year, implying year-
end window dressing

Real Estate


Category mix and leverage suggest wilful
diversion of funds
Our analysis of the category mix (asset classes within the real estate sector) and firm-
level leverage suggests a significant diversion of debt towards land acquisition. As
residential formats account for ~80% of the Indian real estate market and given the
self-financing economics of residential real estate (developers can generate pre-sales
at the launch/pre-launch stage that should help cover the bulk of the working capital
requirements), we find the sector-level leverage intriguing. Hence, we believe that a
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

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 BOLD 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
With residential formats
accounting for 80% of Indias real
estate market, the reported
aggregate sector-level leverage
suggests diversion of construction
finance towards land acquisition
Construction finance from banks
remains the cheapest source of
funds for real estate developers;
however, relatively greater
scrutiny of banks exposure limits
and end-use monitoring of funds
provide NBFCs with a significant
regulatory arbitrage
Bank
Real estate company
Bank
Housing finance
company (HFC)
Real estate company
Bank
Other NBFC
Real estate company
Sensitive sector - hence,
greater regulatory
scrutiny
Relatively lower
regulatory scrutiny leads
to arbitrage

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)
on exposure to the real estate sector. In fact, bank exposure to commercial real estate
(CRE) is mandatorily classified under sensitive sector exposure as part of banks
statutory reporting. Another area that contributes to the regulatory arbitrage between
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 Dec13
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
term loans have been applied for the purposes for which they were
obtained/secured.
According to the information and explanations given to us and on an overall
examination of the balance sheet of the company, we report that no funds raised
on short-term basis have been used for long-term investment.
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.

NBFCs are capitalising on
regulatory arbitrage and fulfilling
most incremental funding needs
in the form of last mile funding
Statutory auditors, in nearly every
case, certify purpose compliance
and maturity matching (the fact
that short-term funds are not
being diverted towards creation
of long-term assets)
Real Estate

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
P&L misstatement checks
(1) CFO/EBITDA, (2) change in depreciation rate, and (3)
miscellaneous expenses as a proportion of total expenses
Balance sheet misstatement checks
(1) Cash yield, (2) debtors more than six months as a proportion
of total debtors, and (3) contingent liability as a proportion of
net worth
Cash pilferage checks
(1) CWIP to gross block, (2) Cost of construction to construction
work-in-progress, and (3) cumulative CFO plus CFI to median
revenues
Audit quality checks
(1) Audit fees as a proportion of standalone revenues, (2) audit
fees as a proportion of total auditor remuneration, and (3)
unaudited assets as proportion of consolidated assets
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
Company P&L checks
Balance sheet
checks
Cash pilferage checks Audit quality checks Overall score
DLF
Oberoi Realty
Unitech
Godrej Properties
Phoenix Mills
Sobha Developers
Omaxe
Anant Raj
Sunteck Realty
DB Realty
Peninsula Land
Hubtown
Ashiana Housing
Brigade Enterprises
Real Estate

I - P&L misstatement checks
CFO/EBITDA: This ratio assesses a companys 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 firms 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
Company CFO / EBITDA
Change in
depreciation rate
Miscellaneous expenses
(% of total expenses)
Overall score
DLF
Oberoi Realty
Unitech
Godrej Properties
Phoenix Mills
Sobha Developers
Omaxe
Anant Raj
Sunteck Realty
DB Realty
Peninsula Land
Hubtown
Ashiana Housing
Brigade Enterprises
Real Estate

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
DLF
Oberoi Realty
Unitech
Godrej Properties
Phoenix Mills
Sobha Developers
Omaxe
Anant Raj
Sunteck Realty
DB Realty
Peninsula Land
Hubtown
Ashiana Housing
Brigade Enterprises
Source: Companies, Ambit Capital research; Strong, Moderate, Weak
Real Estate

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 firms six-year median revenues.
Given that a real estate companys 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
Company
CWIP-to-
gross block
Construction costs to
Inventory (land)
Free cash flows Overall score
DLF
Oberoi Realty
Unitech
Godrej Properties
Phoenix Mills
Sobha Developers
Omaxe
Anant Raj
Sunteck Realty
DB Realty
Peninsula Land
Hubtown
Ashiana Housing
Brigade Enterprises
Real Estate

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 auditors 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
Company Audit fees
Auditors
remuneration
Scope of statutory audit Overall score
DLF
Oberoi Realty
Unitech
Godrej Properties
Phoenix Mills
Sobha Developers
Omaxe
Anant Raj
Sunteck Realty
DB Realty
Peninsula Land
Hubtown
Ashiana Housing
Brigade Enterprises
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.
Real Estate

Valuation - a perspective
Having compared these companies on a range of accounting metrics, we present a
valuation approach underpinned on the cash conversion cycle and the adjusted net
worth to identify undervalued stocks.
Critical valuation driver 1: Cash conversion cycle
Given that cash generation is the single most critical driver of valuation in real estate
firms, we derive the cash conversion cycle for each of the past six years (FY08-13).
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
finance. Similarly, lower the cash conversion cycle, lesser the need for working capital
finance and lesser the idle capital employed.
Critical valuation driver 2: Adjusted net worth
Given that the P/B multiple-based approach is often used as an alternative to DCF-
based valuation (the ideal approach), we argue that it is critical to adjust a firms
net worth for contingent liabilities, customer advances and unbilled revenues
to derive a fair P/B multiple.
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 22: Deriving the adjustment factor for contingent liabilities
CL (% of NW)
Adjustment factor (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
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
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 bubbl e denotes conti ngent l i abi l i ti es (as a pr opor ti on of net wor th)
Parsvnath
DB Realty
Peninsula Land
Hubtown
Ashiana Housing
Brigade Enterprises
Kolte Patil
Oberoi Realty
Anant Raj
Prestige Estates
Sobha Developers
Omaxe
Mahindra Lifespace
Godrej Properties
DLF
Unitech
Puravankara
-200
0
200
400
600
800
1,000
1,200
- 0.5 1.0 1.5 2.0 2.5 3.0
FY15 P/B
C
a
s
h

c
o
n
v
e
r
s
i
o
n

c
y
c
l
e

(
n
u
m
b
e
r

o
f

d
a
y
s
)
Deriving adjusted net worth
Company
Adjusted NW (%
of reported NW)
Anant Raj 92%
Ashiana Housing 131%
Brigade Enterprises 86%
DB Realty 100%
DLF 80%
Godrej Properties 118%
HDIL 115%
Hubtown 108%
Indiabulls Real Estate 121%
Kolte Patil
Developers
127%
Mahindra Lifespace
Developers
102%
Oberoi Realty 116%
Omaxe 155%
Parsvnath
Developers
88%
Peninsula Land 99%
Phoenix Mills 105%
Prestige Estate
Projects
133%
Puravankara Projects 102%
Sobha Developers 97%
Sunteck Realty 426%
Unitech 87%
NW denotes Net Worth

Real Estate


Exhibit 24: Large-sized real estate companies

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 denotes the
conti ngent l i abi l i ti es (as a pr opor ti on of net wor th)
Exhibit 25: Mid-sized real estate companies

denotes the six-year median cash conversion cycle (in number of days) and the s i ze of the bubble denotes the
Exhibit 26: Small-sized real estate companies

denotes the six-year median cash conversion cycle (in number of days) and the s i ze of the bubble denotes the

DLF
Oberoi Realty
Prestige Estates
Unitech
Godrej Properties
Phoenix Mills
Sobha Developers
-5,000
-4,000
-3,000
-2,000
-1,000
0
1,000
2,000
(0.50) - 0.50 1.00 1.50 2.00 2.50
FY15 P/B
C
a
s
h

c
o
n
v
e
r
s
i
o
n

c
y
c
l
e

(
n
u
m
b
e
r

o
f

d
a
y
s
)
Omaxe
Indiabulls
HDIL
Anant Raj
Sunteck Realty
Mahindra Life
Puravankara
-1,000
0
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
(0.50) - 0.50 1.00 1.50 2.00 2.50
FY15 P/B
C
a
s
h

c
o
n
v
e
r
s
i
o
n

c
y
c
l
e

(
n
u
m
b
e
r

o
f

d
a
y
s
)
Parsvnath
DB Realty
Peninsula
Hubtown
Ashiana Housing
Brigade Enterprises
Kolte Patil
-200
0
200
400
600
800
1,000
1,200
(0.50) - 0.50 1.00 1.50 2.00 2.50 3.00
FY15 P/B
C
a
s
h

c
o
n
v
e
r
s
i
o
n

c
y
c
l
e

(
n
u
m
b
e
r

o
f

d
a
y
s
)
The largest bubble in Exhibit 24
pertains to Unitech (58% of net
worth)
pertains to Indiabulls Real Estate
(18% of net worth)
pertains to Brigade Enterprises
(75% of net worth)

Real Estate


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
real estate companies find themselves under and a dangling carrot in the shape of
potential fresh funding from REITs, our discussions with senior partners and senior
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
developers 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
Companies Act 2013
Consolidated financial statements
Likely to introduce greater disclosures and
transparency into the sector
Consolidation of land-owning entities
Mandatory rotation of auditors
Restriction on related party transactions
2014 General Elections
Streamlining of approvals
Will influence supply-side variables ahead of the
demand-side variables
Incremental job creation
Real Estate Regulation and
Development Bill, 2013
Mandatory project registration
Enhances developer accountability and safeguards
customer interests
Standard project-related disclosures
Ring-fencing of customer advances in escrow account (at
least 70% purpose compliance)
Real Estate Investment Trusts (REITs)
Minimum REIT asset size at `10bn
Likely to restrict entry to serious and large players,
broad-base the shareholding and enhance price
discovery
Mandatory listing of REITs within 18 months of registration
At least 90% of the REIT assets to be invested in completed
and rent-generating assets
At least 90% of the net income to be distributed to unit
holders

The impending beauty parade for
fresh funding drives a push
towards greater transparency

Real Estate


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

Real Estate


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 arms-length related-party transactions, such transactions will need to
be referred to in the Boards 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.

Real Estate


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
Indias 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
firms emerges from how well a developer capitalises on the factors of production,
viz., land, labour and capital. These factors of production can be genuinely exploited
as a source of sustainable competitive advantage, as reflected in Exhibit 28.
Exhibit 28: Operating cycle for real estate companies

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
immediate impact on the supply side (streamlining of approvals), resulting in a
further build-up in inventory levels and a medium- to long-term impact on the
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

Source: Liases Foras, Bloomberg, Ambit Capital research; Note: Sales denotes quarterly run rate (in million
square feet) in Indias 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
Ability to generate cash
and / or raise capital
Ability to identify viable
projects (deployment)
Ability to execute (project
development) and launch
Ability to market / sell and
collect receivables
Real estate companies that can
best exploit the factors of
production (land, labour and
capital) will have a sustainable
competitive advantage over their
peers
The election outcome is likely to
impact the supply variables
ahead of the demand variables
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

Real Estate


For the purpose of this analysis, we have cumulated the sales and inventory data for
Indias top-three real estate markets viz. Delhi (NCR), Mumbai (MMR) and Bengaluru.
The sales run rate (the red column in Exhibit 29) has been on a consistently upward
curve since the March 2009 quarter. To put this in perspective, the quarterly run rate
of sales in these three markets has grown from 20msf during the March 2009 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
2009 quarter as an outlier (at the lower end), it also proves that the sales momentum
has been steady through the past 19 quarters. Hence, we argue that the real estate
sector is in a crisis despite steady quarterly sales because of the equally steady rise in
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.

The quarterly sales run rate
(demand proxy) has increased
from 20msf (March 2009 quarter)
to 49msf (December 2013
quarter)
However, the inventory build-up
(supply proxy) has contributed
more to the current crisis for real
estate companies

Real Estate


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
Compulsory registration of projects with a real estate regulatory authority, the
absence of which prohibits sale, booking or even offer to sell. Developers will
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
necessary approvals are in place and the project has been registered with the
authority. The regulatory authority will need to decide on project approvals
(clearance or rejection) within 15 days
Developers need to open a separate bank account (escrow account) for each
project and will have to ring fence 70% of the customer advances to be used only
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,
if enacted in its current form, the Real Estate Regulation and Development Bill 2013 is
likely to mitigate the risk of diversion of funds (as highlighted on pages 16 and 17,
funds borrowed against one project are often deployed in another project). Such ring-
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
percentage of customer advances to be set aside for project-specific expenses will be
decided by local bodies (within each state). Our discussion with the Big 4 auditors
suggests that developers who have already deployed considerable capital in
acquisition of land will find the 70% threshold (as prescribed in the Bill) onerous.

Key clauses in the Bill include:
(a) Mandatory project
registration;
(b) Standard project-related
disclosures; and
(c) Ring-fencing of customer
advances in a separate escrow
account (minimum 70% purpose
compliance)
The escrow mechanism is likely to
introduce greater transparency in
project cash flows and mitigate
the risk of diversion of funds
70% threshold proposed in the
Bill is too onerous on developers -
hence, local bodies may need to
prescribe a lower threshold

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
capital-intensive sector, faces a burgeoning need for capital, especially in the form of
long-term institutional capital. During October 2013, given the paucity of institutional
sources of funding (aside from banks) for real estate companies in India, the
Securities and Exchange Board of India (SEBI), Indias capital markets regulator,
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$1trn (in 2013).
Exhibit 30: Global REIT landscape most of the listings are in the US
Country /
jurisdiction
Year of
introduction of
REITs
Number of REITs
(#)
Aggregate market
capitalization (US$
mn)
% of global REIT
market
Permissible gearing
ratio (%)
Profit distribution
obligation#
Australia 1985 52 86,169 8.0
Thin capitalisation
rules
100%
Canada 1994 50 48,526 4.5 No restriction 100%*
France 2003 37 68,193 6.3
Thin capitalisation
rules
85% of tax-exempt
profits
Germany 2007 4 1,657 0.2 45%
90% of the net
income
Hong Kong 2003 11 23,925 2.2 45%
90% of audited
annual net income
after tax
Japan 2000 41 64,414 6.0 No restriction
>90% of distributable
profits
Singapore 1999 32 45,538 4.2 35%-60%
90% of taxable
income
United Kingdom 2007 23 49,007 4.6 Interest cover test
90% of tax-property
rental profits
United States 1960 163 621,924 57.7 No restriction
90% of taxable
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 REITs 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.

In a move universally welcomed
by industry observers, the SEBI
published draft REIT guidelines,
setting the stage for introduction
of REITs over the next 18 months

Real Estate


REITs in India - draft guidelines broadly borrowed from Singapore
Our analysis of the SEBIs 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
Minimum REIT asset size at `10bn
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
securities, listed or unlisted corporate debt, equity shares of real estate
companies
Entire corpus can be invested in one project
Not allowed to invest in vacant land or agricultural land
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: SEBIs draft REIT guidelines - key clauses
Criteria Prescribed value Impact
Minimum initial offer size (` mn) 2,500
Likely to broad-base
shareholding and enhance
price discovery
Minimum public float (%) 25
Minimum subscription size (`) 200,000
Will restrict initial participation
to HNIs
Minimum value of single REIT unit to be traded (`) 100,000
Minimum asset size under REITs (` mn) 10,000
Will attract only serious and
large players
Source: SEBI, Ambit Capital research

Eligibility criteria on minimum
REIT asset size will attract
only serious and large players
90% of the REIT assets to be
invested in completed and
rent-generating assets;
remaining 10% permitted to
be invested in under-
construction properties

Real Estate


This page has been intentionally left blank


Launch pipeline crucial
Oberoi Realty emerged as the highest bidder for a 25-acre land parcel
in the western suburbs of Mumbai, which has put to rest any concerns
around the re-deployment of its surplus capital. We factor in net debt of
0.3x (to fund this land acquisition), and we expect the launch of at least
three projects during FY15 to revive Oberois operating cash flows from
`1.7bn in FY14E to `9bn by FY15E. Using a project-based DCF approach,
we value Oberoi at `290, implying 7.3x FY15E FCFE.
Competitive position: STRONG Changes to this position: POSITIVE
New launches critical for revival in operating cash flows
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
launches) led to negative operating cash flows of `4.2bn during 9MFY14. With
cash collections from the existing under-construction projects ahead of the stage
of completion, the companys proposed launches in Worli and Mulund during
1HFY15 are critical to revive operating cash flows.
Accretion to land bank adds crucial growth opportunity
Oberoi has emerged as the highest bidder for 25 acres of land in Borivali that
was put on the block by Tata Steel, with a bid of `11.55bn. 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). Our
calculations suggest a saleable area of c.4 million square feet (msf), which is a
~50% accretion to Oberois existing inventory of ongoing projects.
Gearing for land acquisition likely to remain comfortable at ~0.3x
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
(`10bn) to be funded through discounting of cash flows from its annuity assets
(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.

Oberoi Realty
BUY
COMPANY INSIGHT OBER IN EQUITY April 23, 2014
Real Estate
Recommendation
Mcap (bn): `74/US$1.2
6M ADV (mn): `46/US$0.8
CMP: `224
TP (12 mths): `290
Upside (%): 30
Flags
Accounting: GREEN
Predictability: AMBER
Earnings Momentum: GREEN
Catalyst
Partial launch of Worli project by 1QFY15
Completion of Borivali land acquisition
Part-launch in Mulund project by 1HFY15
Performance (%)

Source: Bloomberg, Ambit Capital research

Analyst Details
Krishnan ASV
+91 22 3043 3205

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Sensex OBER IN
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
RoE (%) 13.6 13.7 7.9 11.0 13.5
P/E (x) 16.0 14.6 23.0 15.4 11.3
P/B (x) 2.1 1.9 1.8 1.6 1.4
Source: Company, Ambit Capital research

Oberoi Realty


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

Balance Sheet Cash flow
Year to March (` mn) FY13 FY14E FY15E FY16E
Shareholders funds 38,968 41,685 45,763 51,308
Loan funds 0 8,000 8,000 0
Net Fixed assets 10,714 10,423 10,626 12,297
Investments 0 4,000 0 0
Cash 10,725 9,886 6,418 280
Working capital 17,528 25,375 36,719 38,730
Book value per share (`) 118.7 127.0 139.4 156.3
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

Strong launch pipeline to revive operating cash flows Launches to stimulate free cash flow generation
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 725,769 4QFY15
FY16

Splendor Phase IV Residential 118,986
Borivali Residential 1,846,876

5.9%
22.3%
21.4%
32.1%
26.1%
26.8%
23.1%
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
30.0%
35.0%
FY14E FY15E FY16E FY17E FY18E FY19E FY20E
FCFE (% of net worth)

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 Oberois 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 Oberois operating cash flows.
Oberoi Realtys volume sales and cash collections remained weak during 9MFY14 on
account of a combination of limited inventory available for sale in the 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.
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.

Weak volumes during 9MFY14
on account of limited inventory in
ongoing projects and lack of new
launches

Oberoi Realty


Too many cash guzzlers; not enough cash generators
Our analysis of project-wise cash flows suggests that cash flows from the completed
projects (Seven, Splendor and Splendor Grande) have been exhausted, leaving little
headroom for incremental collections in the absence of fresh sales in these projects.
All of these three projects are nearly fully sold out, resulting in negligible incremental
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

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
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
Oberoi Splendor Grande

Collection outstanding (` mn) 729.6 361.3 244.1 191.5 193.3 98.5 7.0 0.0
Oberoi Splendor

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
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.

Inventory exhausted in completed
projects; slow-moving under-
construction projects not yet
cash-generative

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

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 Oberois potential clients
for Commerz II - Phase I to formalise their lease contracts only during 2HFY15.

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
put on the block by Tata Steel, with a bid of `11.55bn. With 10% of the bid amount
already paid out as earnest money deposit (EMD) by end-March 2014, we expect the
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 collectors 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 Oberois
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
Total construction area 4,432,502
Assuming super built-up area at 20% higher
than saleable area
Powerful signalling mechanism
Whilst this acquisition adds crucial saleable area to Oberois inventory pipeline, we
read this bid as a powerful signalling mechanism that sets a benchmark for Oberois
valuation appetite in land transactions. Oberois 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 Oberois 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 Oberois
current bid is significantly north of Oberois 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.
We expect Oberoi to raise debt of
`8bn by discounting lease rentals
from its annuity assets

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%
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
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
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

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 Oberois 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
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.

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)

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
Properties under development
Saleable area
(sft)
Launch
Percentage of
completion
(POC)
Clearances /
approval status
Time to
completion
(months)
Unsold inventory
(%)
Oberoi Exquisite 1,535,670 October 2009 88%
OC for floors 31 to
50 pending
6 months 33%
Oberoi Esquire 1,504,815 February 2011 BTL
Partial CC until the
30
th
floor
36 months 35%
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
Borivali project 3,693,752 Land acquired NA
NOC from trade
union pending
NA
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 Oberois 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.

Residential,
71.9%
Office
space,
23.4%
Hospitality,
4.7%
Residential,
65.2%
Office
space, 3.6%
Hospitality,
12.4%
Retail, 2.7%
Social infra,
16.1%

Oberoi Realty


Annuity projects
Oberoi currently has four operational annuity assets, which account for 35% of the
companys 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 companys 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 companys strategy to develop residential townships centred on
commercial properties.
Exhibit 12: Movement in key metrics in Oberois 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%
Currently, Mumbais 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
Commercial properties
Estimated
area (sft)
Launch
Occupancy
(%)
Lease rent
(`/sft/mth)
EBITDA
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

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 (%)

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)

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 Oberois funding of vendors and sub-contractors (through loans and advances
on the current assets) to progressively increase as the project moves towards
completion.

Residential,
65% Office, 9%
Retail, 16%
Hospitality,
7%
Social infra,
3%
Residential,
71%
Office, 13%
Retail, 7%
Hospitality,
6%
Social infra,
2%
208
39
21
16
7
2
-5
-50
0
50
100
150
200
250
300
350
Residential Office Retail Hospitality Social infra Other
income less
SG&A
Net cash

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 Oberois 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.

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)

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
Oberois 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 managements 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).

0%
20%
40%
60%
80%
100%
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

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

Source: CIDC, Ambit Capital research
Cash collections from upcoming projects: We assume construction-linked cash
collections for each of Oberois 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

0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
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-
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-
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-
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-
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A
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-
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Mumbai Delhi Bangalore

Oberoi Realty


Commercial / retail / hospitality projects
Rental rates for annuity projects: Currently, Mumbais 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

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, Oberois 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 Oberois 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 Oberois 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 companys 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
86
88
90
92
94
96
98
100
102
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3QCY12 4QCY12 1QCY13 2QCY13 3QCY13
Total area transacted (msf) Average lease rent (Rs/sft/mth) (RHS)

Oberoi Realty


in Mumbai are at an all-time high of over 20%, our analysis suggests that SBD
West, the micro-market corresponding with Oberois 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 Oberois 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%
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 Oberois 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%

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 Oberois
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 Oberois 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%

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 collectors 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 Oberois growth prospects.
Launch of Mulund project by 1HFY15: As highlighted in this note, timely launches
are critical to reviving Oberois sales run rate and consequently, its cash generation.
The company secured the Supreme Courts 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 companys 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: Oberois bid for the Borivali land has
not only enhanced Oberois growth prospects but has also acted as a powerful signal
of Oberois intent to deploy its cash meaningfully in accumulating inventory. Whilst
timely launches are crucial to revive the companys 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 Oberois 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
Accounting GREEN
Despite a sluggish 9MFY14 (in terms of fresh sales and cash flows), Oberoi boasts of a superior cash
conversion ratio relative to its peers as well as a very strong balance sheet (zero leverage).
Predictability AMBER
Although Oberois 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
has been unable to guide investors realistically and it has made inadequate documented disclosures
around the status of approvals and clearances.
Earnings momentum GREEN
Oberoi recently emerged as the highest bidder for the Borivali land (put on the block by Tata Steel); the
stock has witnessed sharp upgrades to its earnings contingent on the land acquisition transaction going
through.

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%

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 Oberois 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.

Oberoi Realty


SWOT analysis
Exhibit 28: Oberoi Realty - SWOT analysis
Strengths Weaknesses
Strong brand with a reputation for reliable execution in Mumbai
Net cash of `5bn as of December 2013 as against the average
gearing of 0.6x-0.7x for its closest peers (Sobha and Prestige)
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

High project concentration risk with 90% of projects exposed to Mumbai
Inability to adhere to launch timelines on account of regulatory delays (at
least three projects stuck in litigation)

Opportunities Threats
Deployment of surplus cash towards opportunistic land acquisition
such as the recent Borivali land acquisition
Strategic flexibility to bid for land parcels on the back of negligible
leverage

Further delay in launches that drain surplus cash from the balance sheet
Desperation to generate returns may force the company towards
acquiring land at unviable prices

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

Income statement
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
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
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

Oberoi Realty


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Position of relative strength
With a growing diversified presence across key southern geographies,
especially in NRI-rich cities, Sobha has gradually positioned itself in a
sweet spot. The company is focused on further penetrating the southern
markets beyond Bangalore (its primary market). In addition, it has a
tight collection system. Thus, we expect a quarterly launch run rate of
2msf to translate into a strong pre-sales run rate in excess of 4msf in
FY15E/FY16E. We are BUYers with a sum-of-the-parts valuation of `490,
implying 9.6x FY15E P/FCFE.

Competitive position: STRONG Changes to this position: POSITIVE
FY14 guidance disappointment transitory; well poised for FY15
During FY14, Sobha disappointed on its guidance with volume sales at 3.6msf
(vs guidance of 4.2msf) and value sales at `23.4bn (vs guidance of `26bn)
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
its December 2013 net worth) and three large projects launched towards end-
March 2014, we expect Sobha to regain its sales momentum in FY15.
Cash inflows (net of interest payout) strong; FY15 refinancing crucial
Sobha generated a steady stream of cash inflows from its real estate segment
(quarterly run rate of `4.5bn) and its contracted projects (quarterly run rate of
`1.7bn) during 9MFY14. During 9MFY14, Sobha averaged `0.7bn-0.8bn of
quarterly net cash from operations (CFO), net of interest payouts. With net debt
to equity at 0.6x, Sobha is exposed to a manageable refinancing risk with over
`8.5bn (0.3x net worth) due for repayment during FY15.
Backward integration and strong launch pipeline imply sweet spot
Sobhas backward-integrated business model has consistently helped achieve
timely execution of projects (annual development run rate of over 6msf since
FY08) whilst maintaining the highest quality standards for contracted projects as
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.

Sobha Developers
BUY
COMPANY INSIGHT SOBHA IN EQUITY April 23, 2014
Key financials
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
RoE (%) 10.7 10.5 10.5 12.7 14.7
P/E (x) 17.8 16.8 16.3 12.9 9.9
P/B (x) 1.8 1.7 1.6 1.5 1.3
Real Estate
Recommendation
Mcap (bn): `37/US$0.6
6M ADV (mn): `83/US$1.4
CMP: `376
TP (12 mths): `490
Upside (%): 30
Flags
Accounting: AMBER
Predictability: AMBER
Earnings Momentum: GREEN
Catalyst
OMR (Chennai) project launch in 1HFY15
Gurgaon project launch during 1HFY15
Launch of APMC project in Bangalore
Performance (%)


Analyst Details
Krishnan ASV
+91 22 3043 3205

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Sobha Developers


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

Balance Sheet Cash flow
Year to March FY13 FY14E FY15E FY16E
Shareholders fund 21,234 22,819 24,948 27,793
Debt 13,787 14,787 15,787 16,787
Minority interest 102 102 102 102
Net Fixed Assets 3,169 2,634 2,127 1,644
Investments 2 2 2 2
Cash & bank balance 670 4,086 7,631 12,920
Working capital 31,283 30,986 31,078 30,115
Book value per share (`) 216.5 231.4 252.8 279.7
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

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

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Finance cost (Rs mn)
Blended cost of debt (annualized) (%) (RHS)

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
visible turnaround in sales momentum by end-FY14, as reflected in a 20% sequential
pick-up in pre-sales during 4QFY14 (at `6bn) as compared to a sub-par 3QFY14 (at
`5bn). The recovery comes on the back of 3.6msf of launches in south India during
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

We attribute the sales momentum to Sobhas 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). Sobhas 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 Sobhas volume sales to decline to c.60%.
Exhibit 3: Contribution of newly added locations to overall volumes (% of total sft)
Location Launch debut
Average contribution
to area sold (%)
Mysore 1QFY12 1.9%
NCR 2QFY12 9.6%
Chennai 4QFY12 8.2%
Kozhikode 2QFY14 4.9%
Cochin 4QFY14 1.8%

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Volume recovery during 4QFY14
on the back of launches in south
India and more affordable units
in Bangalore

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
Sobhas 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

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.

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64.0%
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70.0%
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74.0%
1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14
Number of cities (RHS) Area sold in Bangalore (% of total sft)

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 Sobhas net debt-to-equity has been stable at 0.6x over the past eight
quarters, the cost of debt has been trending lower during the corresponding period
(in an increasing interest rate environment), primarily on the back of upgrades from
rating agencies (ICRA and Brickworks) during FY14.
Exhibit 6: Net debt-to-equity stable at 0.6x

Exhibit 7: Cost of debt benefiting from rating upgrades

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. Sobhas 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

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Net debt (Rs bn) Net debt-to-equity (x) (RHS)
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13.9%
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Real estate Contracts Monetization of land
Cost of debt down by ~80bps in
the past eight quarters, benefiting
from rating upgrades by ICRA
and Brickworks during FY14
Rising contribution of operating
cash inflows from recurring cash
flows (contract projects)

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 `13bn) is up for repayment during FY15. Although Sobha has matching
undrawn sanctioned limits for its ongoing and planned projects, the disbursement of
incremental debt is contingent upon the timely launch and progress of these projects.
Also, one of Sobhas proposed launches over the next four quarters is the
development of a commercial project awarded by APMC (Agricultural Produce Market
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
We expect Sobha to launch its commercial project during 2HFY15 to manage its cash
flows better (operating cash inflows are likely to be relatively slower from the
commercial project vis--vis the residential properties). During the early part of FY15,
we believe Sobha will be more aggressive on its residential launches, especially in
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).

Debt of `8.5bn (of the overall net
debt of `13bn) is up for
repayment during FY15; Sobha is
exposed to high but manageable
refinancing risk in a high interest
rate environment
We expect the commercial project
launch to be back-ended during
FY15 for Sobha to better manage
its cash flows

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)

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. Sobhas land bank is well diversified in IT/ITeS-driven
locations that contribute 80% to the companys 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

Bangalore
56%
Gurgaon
22%
Thrissur
8%
Chennai
5%
Kozhikode
3%
Others
6%
Bangalore
32%
Hyderabad
17%
Trivandrum
15%
Mangalore
10%
Pune
7%
Jaipur
6%
Others
13%

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)
Real estate projects valuation (` mn) 43,413
Real estate projects (`/shr) 442
Contracts business valuation (` mn) 4,800
Contracts business (`/shr) 49
Total valuation (` mn) 48,213
SOTP Valuation (`/shr) 491
Exhibit 14: Valuation of real estate business (`/share)
Real estate projects (` mn) 59,317
Less: Unpaid land bank (` mn) 1,250
Less: Net debt (March 2015) (` mn) 14,654
Net valuation (` mn) 43,413
No. of shares (mn) 98.2
Net valuation (`/shr) 442
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 Sobhas current cost of debt (12.7% as
of December 2013).
Real estate projects
Given Sobhas 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.

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 managements 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 Sobhas
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 Sobhas pricing power is only restored on select projects
post FY18E.
Exhibit 15: YoY movement in building construction costs in major real estate markets

Source: CIDC, Ambit Capital research
Exhibit 16: Key assumptions
FY14E FY15E FY16E Remarks
Volumes (msf)

Residential 3.59 3.91 4.37
We expect residential sales to record a 9% YoY growth during FY15E and a
12% YoY growth during FY16E
Contractual sales 3.41 3.98 4.53
Given the contractual nature of projects (with relatively higher visibility), we
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)

Residential sales 23,457 27,081 32,085
The pre-sales value is driven by 9-12% rise in volumes and a 6% rise in
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
0%
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Mumbai Delhi Bangalore

Sobha Developers


Catalysts for our BUY stance
Launch of residential project in Chennai: We expect Sobhas residential project
launch in Chennai during 1HFY15 to improve the companys 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 Sobhas 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 Sobhas 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
Accounting AMBER
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;
elevated contingent liabilities as a proportion of net worth; extremely low audit fees
(as proportion of auditor remuneration).
Predictability AMBER
Instances of missed guidance despite exercising relatively better control over the
supply chain.
Earnings momentum GREEN
The company launched four new projects (Bangalore, Kozhikode and Cochin) during
4QFY14, and thus, the stock has seen upgrades to its FY15E earnings.

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%

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.

Sobha Developers


SWOT Analysis
Exhibit 19: Sobha Developers - SWOT analysis
Strengths Weaknesses
Well-located land bank in IT/ITeS-dominated cities such as Bangalore,
its primary market, Gurgaon, Chennai and Pune, accounting for over
80% of the companys saleable area
Sizeable presence in Kerala markets with relatively high proportion of
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

High concentration risk in the contracts business with 60% of orders from
Infosys
High refinancing risk with about `8.5bn up for principal repayment
during FY15

Opportunities Threats
Expansion into formats other than residential such as commercial
(office and retail)
Expansion into newer geographies to reduce dependence on
Bangalore, its primary market

Fixed-margin contract business with high client concentration
Rise in net debt-to-equity in case of lower sales velocity from recently
launched projects or delayed launches

Sobha Developers


Balance Sheet
Shareholders 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

Income statement
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
products
1,393 1,477 1,725 2,187 2,766
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
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
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

Sobha Developers


Institutional Equities Team
Saurabh Mukherjea, CFA CEO, Institutional Equities (022) 30433174 saurabhmukherjea@ambitcapital.com
Research
Analysts Industry Sectors Desk-Phone E-mail
Aadesh Mehta Banking & Financial Services (022) 30433239 aadeshmehta@ambitcapital.com
Achint Bhagat Cement / Infrastructure (022) 30433178 achintbhagat@ambitcapital.com
Aditya Khemka Healthcare (022) 30433272 adityakhemka@ambitcapital.com
Akshay Wadhwa Banking & Financial Services (022) 30433005 akshaywadhwa@ambitcapital.com
Ankur Rudra, CFA Technology / Telecom / Media (022) 30433211 ankurrudra@ambitcapital.com
Ashvin Shetty, CFA Automobile (022) 30433285 ashvinshetty@ambitcapital.com
Bhargav Buddhadev Power / Capital Goods (022) 30433252 bhargavbuddhadev@ambitcapital.com
Dayanand Mittal, CFA Oil & Gas / Metals & Mining (022) 30433202 dayanandmittal@ambitcapital.com
Deepesh Agarwal Power / Capital Goods (022) 30433275 deepeshagarwal@ambitcapital.com
Gaurav Mehta, CFA Strategy / Derivatives Research (022) 30433255 gauravmehta@ambitcapital.com
Karan Khanna Strategy (022) 30433251 karankhanna@ambitcapital.com
Krishnan ASV Real Estate (022) 30433205 vkrishnan@ambitcapital.com
Nitin Bhasin E&C / Infrastructure / Cement (022) 30433241 nitinbhasin@ambitcapital.com
Nitin Jain Technology (022) 30433291 nitinjain@ambitcapital.com
Pankaj Agarwal, CFA Banking & Financial Services (022) 30433206 pankajagarwal@ambitcapital.com
Pratik Singhania Real Estate / Retail (022) 30433264 pratiksinghania@ambitcapital.com
Parita Ashar Metals & Mining / Oil & Gas (022) 30433223 paritaashar@ambitcapital.com
Rakshit Ranjan, CFA Consumer / Real Estate / Retail (022) 30433201 rakshitranjan@ambitcapital.com
Ravi Singh Banking & Financial Services (022) 30433181 ravisingh@ambitcapital.com
Ritika Mankar Mukherjee, CFA Economy / Strategy (022) 30433175 ritikamankar@ambitcapital.com
Ritu Modi Automobile (022) 30433292 ritumodi@ambitcapital.com
Tanuj Mukhija, CFA E&C / Infrastructure (022) 30433203 tanujmukhija@ambitcapital.com
Sales
Name Regions Desk-Phone E-mail
Deepak Sawhney India / Asia (022) 30433295 deepaksawhney@ambitcapital.com
Dharmen Shah India / Asia (022) 30433289 dharmenshah@ambitcapital.com
Dipti Mehta India / USA (022) 30433053 diptimehta@ambitcapital.com
Nityam Shah, CFA USA / Europe (022) 30433259 nityamshah@ambitcapital.com
Parees Purohit, CFA UK / USA (022) 30433169 pareespurohit@ambitcapital.com
Praveena Pattabiraman India / Asia (022) 30433268 praveenapattabiraman@ambitcapital.com
Sarojini Ramachandran UK +44 (0) 20 7614 8374 sarojini@panmure.com
Production
Sajid Merchant Production (022) 30433247 sajidmerchant@ambitcapital.com
Sharoz G Hussain Production (022) 30433183 sharozghussain@ambitcapital.com
Joel Pereira Editor (022) 30433284 joelpereira@ambitcapital.com
Nikhil Pillai Database (022) 30433265 nikhilpillai@ambitcapital.com
E&C = Engineering & Construction

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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