Vascon Engineers IPO Review

Many revenue streams

The company earns from EPC services, reality development and also from hospitality, multiplexes, and rental income. But most of this is from Maharashtra

Vascon Engineers (VEL) is a construction company focused on verticals such as factories, hospitals, hotels, residential and commercial complexes (retail, office, IT park). The company, promoted In January 1986 by R Vasudevan, a civil engineer with vast experience, started as an EPC services player. But in 1998 it ventured into realty development. The company provides its EPC services for third parties as well as for its own and its other development entities.

As of December 31, 2009, VEL had completed 181 construction contracts worth Rs 888.87 crore, out of which 157 EPC contracts worth Rs 640 crore were for third parties. In terms of saleable area for its real estate development projects, VEL has constructed over 4.99 million square feet. In addition, it has sold land and land development rights aggregating 2.04 million square feet in saleable area. In 2008-09, the EPC services business accounted for about 86.3% of the operating income with the contribution from realty business at 5.5%, with the balance accounted for by revenue from hospitality, multiplexes, rental income, etc. However, the share of real estate increased to 13.7% in the H1 FY 2010 while that of EPC services stood at 81.4%.

VEL also owns, operates and manages certain hospitality and commercial projects subsequent to their completion. Currently, the company has equity stakes in six such projects. Of these, about 5 are hospitality projects. Three are operational, aggregating 183 keys, while the balance 2 are under construction. While the company wholly owns and operates the 47-room Vista Do Rio, a resort at Goa, it owns 43.83% and 50% equity stake through its subsidiaries and development entities in Royal Orchid Galaxy Resorts, a 65-room property in Goa, and Royal Orchids Golden Suites, a 71 studio and one bedroom service apartment complex in Pune, respectively. The two hospitality properties, which are under construction, are in Pune in Maharashtra. Of these, one will be operated under the Holiday Inn brand and the other through an entity in which VEL holds a 26% equity stake.

The company also has a 50% equity stake in Marigold Premises, which owns and operates the Mariplex mall and office complex. Additionally, the company is involved in developing a multi-level car parking for Delhi International Airport.

VEL currently holds 24% equity interest in Vascon Infrastructure, a company that intends to focus on infrastructure development such as roads in India. Moreover the company has also entered into a Memorandum of Understanding (MoU) with Kohinoor Cargo And Warehousing in Pune for acquiring 40% of the shares in Kohinoor for Rs 4.82 crore million on or before June 30, 2010. Kohinoor has represented that it has obtained permission from the Directorate of Industries, Government of Maharasthra, for purchase of 210.46 acres of land located at Karawadwai, Taluka Khandala, Satara, to establish industrial estate for small and medium enterprises. It proposes to acquire and develop such lands by the amount obtained through the sale of the 40% stake in Kohinoor to VEL. Similarly, it also signed an MoU with Rising Ventures, a partnership firm that owns 22 acres of land at Ahire in Satara, and proposes to acquire another 32 acres of contiguous land at Ahir itself for acquisition of 40% stake before June 30, 2009, at a cost of Rs 87 lakhs.

The proceeds from the issue will be used to meet the construction costs of two mall projects of the company, one each at Pune (Zenith) and Belgaum (Nucleus), amounting to Rs 115 crore, and repayment of debts amounting Rs 39.63 crore. The balance will be used for general corporate purposes and to meet issue expenses.

Strengths

Strong and diverse EPC order backlog of Rs 3227.08 crore spread over 70 projects/ contracts as of December 31, 2009. Of the total order backlog, about 37.6% (or Rs 1214.74 crore in 47 projects) are third party contracts and the balance 62.4% are captive contracts from the realty business, amounting to Rs 2012.34 crore, spread over 23 projects.

Strong EPC capability across various verticals/geography along with high quality delivery track record over the last three decades have given strong client base that includes names such as Cipla, Kirloskar Brothers, Suzlon and Symbiosis. About 37% of the third party order backlog is from verticals such as hospitals, educational institutions and urban infrastructure, where the downturn is minimal, bringing in much better business stability and visibility.

The company's realty business follows joint development/Joint venture business model, which minimizes the upfront cash outflow unlike the realty business model that involves outright purchase of land. This allows the company to put to use the cash in construction/ development of realty project rather than binding it in land. About 90% of the company's total land reserve of 55.36 million square feet of developable area is through joint development/joint venture, with the balance either owned or owned by subsidiaries.

Revenue stream of the company is diverse, i.e., income from EPC services, income from realty development and income through asset ownership (hospitality, multiplex, lease rentals). Strong EPC business and ramping up of non-realty and non-captive business recently have helped the company to insulate its revenue from the recent downturn of the realty industry in a better way. The share of the realty business to the total operating income, which was about 44% in FY 2008, crashed to 5.5% in FY 2009. But that was largely compensated by growth in the EPC business. Similarly, though the EPC business gives a low margin of around 12%, it gives steady growth. The realty business brings in the cream, given its high margin nature.

In its nearly 11 years of realty operation, it has built up strong brand and reputation, especially in Pune.

Weaknesses

A major portion of the company's current operation is geographically concentrated with the state of Maharashtra, which accounts for about 73.51% of the current order backlog spread over 70 ongoing EPC contracts and 84.58% of the realty space (developable) under development/ proposed to be developed. Of the total land reserve (developable space), about 44.58% is accounted by Pune and 34.2% is in Thane. The balance is largely in Tier II and Tier III cities such as Belgaum, Coimbatore, Madurai and Nashik etc. Though the realty market in the country has seen renewed demand especially in Tier I cities of Mumbai, National Capital Region of Delhi, Bangalore etc., the Pune market is still subdued and the heavy reliance of the company on the Pune market is a cause of concern. Similarly, the company's project mix of about 15.7 million square feet of commercial space out of its land reserve of 55.36 million square feet of developable space is a cause of concern as the commercial market is yet to pick up unlike the residential market, which rebounded on pent-up demand, at least in major Tier I markets. Moreover, the company's land holdings are largely in Tier II & III cities, where conditions are still subdued and heavy concentration of land reserve in this segment will not contribute much to the growth in near term.

The company's order backlog is largely made of fixed price contracts and, hence, any upward cost push in construction and input services will impact the margin affecting profitability.

One of the directors of the company i.e. Ameet Hariani, was the director of a company declared as a will-full defaulter by the RBI. There are 12 legal cases against Vasudevan R, the promoter of the company, including one criminal revision. But there is no monetary claim. Also, Sansara Hotels (India) has initiated an arbitration proceeding against the company, Marigold Premises, Just Homes (India) and Just Homes Associates on February 23, 2009 on the basis of a rescindment of a development agreement dated March 21, 2007.

VEL has signed a MoU with Sitalakshmi Mills for joint development of 28.2 acres at Pasumalai in Madurai and it has also picked up a 26% stake in the latter. However, Sitalakshmi Mills was subsequently declared sick and if the status does not change, the realty development project might be delayed.

Valuation

Income from operation of the company for the fiscal ended March 2009 stood at Rs 519.47 crore (down 16%) impacted by the realty downturn. Its net profit was lower by 49% to Rs 30.64 crore. The adjusted EPS for FY 2009 was Rs 2.1. However, the pick-up in demand for realty has improved the profitability of the company and thus annualized EPS for the half year ended September 2009 was Rs 5.2. On the price band of Rs 165-185, the P/E works out to 78.8 to 88.1 times of its FY 2009 earnings. However, the PE works out to 31.7-35.6 times of its annualized H1 FY 2010 earnings.

In comparison, Sobha Developers, which is a south based realty builder for third parties, quotes at a P/E of 25.9 times of its FY 2009 consolidated earning, and BL Kashyap, an EPC service player, quotes at a PE of 13.3 times of its FY 2009 consolidated earnings. Though the high margin and high realty business may give a push to the margin and profitability, the asking price seems steep compared to listed realty players as well as EPC service players of similar size.