Sobha Developers IPO Analysis

Premium price for a premium company

Promoted by NRIs P.N.C. Menon and Sobha Menon, Sobha Developers (SDL) is one of the leading south-based real estate development and construction companies with a strong presence in Bangalore’s premium real-estate market. The company has developed and constructed 21 residential projects in Bangalore covering approximately 2.98 million square feet, 75 contractual projects in eight Indian states comprising around 8.42 million square feet, and two commercial projects aggregating 0.11 million square feet.

SDL has executed projects such as convention centres, software development blocks, multiplex theatres, hostel facilities, guest houses, food courts, restaurants, educational and research centers and club houses for Infosys Technologies. The company signed an MoU with Reliance Energy (REL) in May 2006 to participate in a consortium in response to an expression of interest invited by Andhra Pradesh Industrial Infrastructure Corporation for the development of a business district and trade towers in Hyderabad. REL and SDL have agreed to form a special purpose vehicle (SPV) in future for this specific purpose and invest up to 26% of the share capital of the SPV.
SDL is coming out with an IPO to finance its existing projects, land acquisition, repayment of loans and meeting general corporate expenses.

As on 30 September 2006, SDL had land reserves of 2,747 acres and land arrangements of 3,373 acres. On 7 July 2006, Cushman & Wakefield had estimated the net present value of the land reserves to be about Rs 7035.6 crore - Rs 7776.2 crore. After deducting the developer’s margin, the value of the land reserves stand between Rs 3971.7 crore - Rs 4389.8 crore. The company plans to develop land in seven -10 years. The per share present value of land, based on Cushman & Wakefield valuation after deducting the developer’s margin, works out to about Rs 545 – Rs 602. After subtracting the amount to be paid in future, the value works out to Rs 360- Rs 418.
SDL has entered into land arrangements (contractual agreements) with third party to procure land located in and around Cochin, Pune and Chennai at or below certain prices on its behalf. The net present value of the land arrangements is estimated to be approximately Rs 4347.8 crore - Rs 4805.4 crore. After deducting the developer’s margin, the land value of the land arrangements is approximately Rs. 2306 crore - Rs 2548.7 crore. The per share present value of land arrangements, based on Cushman & Wakefield valuation after deducting the developer’s margin, works out to about and Rs 316- Rs 350. After subtracting the amount to be paid in future, the higher cap end is Rs 217-Rs 250 and lower end Rs 284-Rs 317.
SDL has backward integrated by venturing into activities such as concrete block making, metal and glazing, and interiors and woodwork. The company can deliver in-house a project from conceptualisation to completion. Being in the premium segment, backward integration enables the company to maintain the required quality of products and services required for the development and construction of a project, meet its quality standards, and deliver in a timely manner.

SDL is presently developing 15 residential projects in Bangalore aggregating about 4.97 million square feet of super built-up area comprising 26,820 apartments. In addition, the company has proposed to develop 13 residential projects in Bangalore, aggregating approximately 5.17 million square feet of super built-up area comprising 3,055 apartments. From the date of commencement, it ideally takes about two years for a company to complete residential projects. As per the management, the current average realisation in the segment in which the company operates is in the range of Rs 2500- Rs 2750 per square feet and the cost of construction is in the range of Rs 1300-1700 per square feet. Going ahead, real estate prices are likely to increase by 12-15% in Bangalore.
SDL is currently executing 23 contractual projects for various corporate and other entities such as a school, a hospital and software development blocks in various states amounting to about Rs 529.19 crore. Historically, the company’s EBITDA margin was about 17-18% in contractual projects.

Valuation

Between FY 2004 to FY 2006, revenue shot up from Rs 195.09 crore to Rs 596.62 crore and net profit from 8.88 crore to Rs 89.23 crore Out of the total revenue, the share of contractual projects was 58%, 64% and 34%, respectively, for the past three years (from FY 2004 to FY 2006). The balance was contributed by residential and commercial projects.

Annualised EPS for the first half of current financial year works out to Rs 14.8. At the offer price band of Rs 550- Rs 640, the PE range is 37-43. Comparable but much smaller companies like D S Kulkarni Developers and Ansal Housing trade at PE of 18 and 15 times their first-half annualsied EPS.

Real-estate is currently the hottest industry in the stock market and likely to remain so till DLF completes its impending huge IPO. In such a scenario, its natural for premium companies like Shobha Developers to charge premium valuation.