Realty firms immune to takeovers

The downturn has drastically lowered valuations of Indian real estate firms but the promoters face virtually no threat of takeovers as they are sitting on stakes in excess of 70-80 per cent of equity.

At the same time, the fall in the share price has severely crimped their ability to raise funds through stake sales to private equity and strategic investors.

The real estate sector, which was doing well till January, is in the midst of what many feel will be a prolonged downturn. In a scenario where most companies are heavily leveraged and that too at high interest rates (as regulatory restrictions do not allow them to access cheap capital and the equity route has all but dried up), analysts say the smaller firms could be up for acquisition.

"If the depressed market takes a longer time to rebound, then anything is possible including mergers and acquisitions," says Anshuman Magazine, managing director, CB Richard Ellis. "Companies with high levels of debt may be forced to sell some stake to bigger players in order to survive."

Some industry executives suggest that if the downturn persists for some more months, smaller firms may be up for grabs. But others disagree with this view.

Although valuations of major developers have come down due to the negative market sentiment, most companies are in a comfortable position as the huge land bank they own was bought at much cheaper rates than the present market value," said Pradeep Jain, chairman, Parsvnath Developers Ltd.

Jain adds that developers who have the ability to hold on could manage to ride over the crisis even if they manage to sell one or two of premium priced projects.

The equity holding pattern of listed Indian realty firms shows that Indian promoters hold an overwhelming majority in their firm, which gives them enough space to dilute their stake and ride over the current shortage of funds.

A senior DLF executive said if the downturn continues for a longer period of time, the market is likely to see some mergers. "All firms, including the smaller ones, will try and hold on as long as possible."

Analysts point out that the real estate sector is suffering from high valuation expectations of promoters on one hand and the reluctance of fund managers to take exposures on the other. "Since many companies are currently trading at 30 to 40 per cent of their peak share price levels, the promoters are reluctant to divest. As a result, there is a huge gap in expectation and reality," they added.

The valuation dynamics have also undergone a major change. Developers are still looking at land bank and its value as the intrinsic value of their stock, while fund managers are looking at cash flow and the ability to deliver and sell actual products in the market in the next 12 to 24 months.

However, Parvsnath's Jain does not agree with this analysis. Pointing out that the average land cost for the firm's land bank of 211 million sq feet was Rs 217 per sq feet as of March this year, he says: "I feel that just two of our projects combined together will have more valuation than the company's market cap".

Even analysts say that the actual acquisition cost of these land is much cheaper than the current "so called" market value. Regulatory guidelines prohibit companies from disclosing the market value of their land bank.

Analysts add that real estate firms are sitting on assets that are much more than their current market cap (see chart).

However, it is clear that the land banks are of no use unless the companies have adequate liquidity to develop projects. "All developers have enough land with them, what they lack is the money to complete their projects," said a Mumbai-based analyst.