Oberoi Realty IPO Analysis

Oberoi Realty, promoted by Vikas Oberoi, is engaged in the business of real estate development with major/strong focus on the Mumbai market. The company is focused on the premium residential segment of real estate development and also develops office space, retail, hospitality and social infrastructure projects in mixed use and single segment developments.



Unlike residential realty development, which is on sale model, the company follows a lease model for a portion of its office space. The rental income accounted for about 10.35% of its consolidated revenue for FY 2010 and about 15.69% for the quarter ended June 2010. End of June 30, 2010, the company owned completed office/retail space of about 976679 sq ft of saleable area including 58898 sq ft occupied by itself. Similarly, the company has completed hospitality projects (with a saleable area of about 381820 sft) under operating agreement model. It has developed The Westin Mumbai-Garden City, a 269-room hotel. It is operated and managed by Starwood Asia Pacific Hotels and Resorts Pte. (Starwood) according to the operating services agreement between the company and Starwood. It currently plans to develop two additional hotels, which will be owned by it but operated and managed by third parties. Similarly, it is also developing the Oberoi International School, which is leased to and operated by the Oberoi Foundation on a revenue share basis.

Land reserves of the company end June 30, 2010 aggregated approximately 113.96 acres located in and around Mumbai and Pune. The company has ongoing or planned projects on all of its land reserves. Currently it has 13 ongoing and 11 planned projects with an aggregate saleable area of approximately 20.25 million sq ft as of June 30, 2010. The 13 ongoing project aggregate to about 10.12 millions sq ft and the 11 planned projects accounts for about another 10.13 million sq ft. The residential business segment constituted approximately 60.91% of the total estimated saleable area, out of the ongoing and planned projects. Further the ongoing and planned projects include the Sangamwadi (Pune) project, which was developed by Sangam City Township, a special purpose vehicle (SPV), where the company holds 31.67% interest and the 2.1 million sq ft mixed use project at Worli (Mumbai) developed by Oasis Realty, an unincorporated joint venture between OCPL, a wholly-owned subsidiary of the company, Skylark Build and Shree Vrunda Enterprises.

The company's developments are mixed use by integrating residential projects with office space, retail, hospitality or social infrastructure projects. By this, it seeks to create destination developments, which it believes will enhance the desirability of its residential units. Substantial portion of the land for its currently completed, ongoing and planned projects were acquired between 2002 and 2005.

SSIII, a company owned by a real estate fund advised by a wholly-owned subsidiaries of Morgan Stanley Inc., invested Rs 675 crore in the company, comprising Rs 596.7 crore by way of equity shares and Rs 78.3 crore by way of non-convertible preference shares in January 2007.

The company intends to use the issue proceeds to a) fund construction of ongoing projects to the tune of Rs 741 crore; b) acquisition of land development rights to the tune of Rs 22.5 crore and c) general corporate purposes.

Strengths

The company is an established player with strong brand name and reputation in the Mumbai realty market, especially in the upscale/premium residential segment. Strong brand name enables the company to command premium over its competitors.

Quality land bank/reserve with all of the development sites it owns are fully paid for as on end of June 30, 2010. Of the total land bank, about 77.46% is owned by the company directly or its subsidiaries. Further it has sole development rights for 16.75% of the land reserve.

The company was debt-free as of June 30, 2010 and it has about Rs 482.58 crore as cash and cash equivalents as end of the same period. This gives room for leverage of its balance sheet to take advantage of favourable business cycle or market opportunity.

The company out-sources construction services as well as architecture, thus leaving the management for identification of suitable projects and marketing them.

The company's adoption of the own-and-lease model for certain portion of the commercial space developed provides sustained cash flow and potential capital appreciation for future monetisation opportunity.

Weaknesses

Operations of the company are heavily concentrated in the Mumbai realty market, thus making its more vulnerable to geographical risks. Low cost land bank acquired prior 2005 is the major reason for the high operating margin of around 60% clocked by the company in the last two fiscal. Given the modest land reserve the sustainability of this high margin has to be seen. This stems from high land replenishment cost the company has to incur given the limited land supply in the Mumbai realty market and intense competition for the same pushing up the prices as well as the inability of the realty players to pass on the incremental land cost beyond certain levels as it hurts demand.

Higher commercial realty exposure at about 36.16% in ongoing projects, that is of total 10.12 mln sq ft spread in 13 projects. Unlike residential realty development, the commercial realty development is capital intensive and given the current subdued commercial market scenario, the company might continue to invest for longer than expected. Moreover of the 5 ongoing commercial projects, two, Commerz II Phase I (0.72 mln sft) and Commerz II Phase II (of 1.66 mln sft), are on own-&-lease model.

Since the company is a minority partner in Oasis Realty, the JV Company, as well as in the Pune project, there may exert inherent potential conflicts of interests between joint venture partners and decisions, which may adversely impact the interest of the company.

Typically, the company enters into turnkey contracts with its contractors and agrees to procure the cement and steel required for its projects. This exposes the company to commodity (i.e. steel, cement etc) price risks.

Some of the promoter and directors of the company as well as related entities hold interests in other real estate development companies. Certain of the promoter group entities, namely R. S. Estate Developers, Beachwood Properties, Oberoi Estates, New Dimension Consultants, I-Ven Realty, Envision Realty, R.S. Associates, R.S Constructions, R.S.V. Associates, and Wellworth Developers have similar main objects clauses as that of the company in their respective memoranda of association or partnership agreements, as applicable, and are engaged in development of real estate and, hence, may compete with the company. However, the promoter has executed an undertaking dated December 23, 2009 (the Non-Compete Undertaking) to address conflicts of interest between him and the company. Pursuant to that non-compete undertaking, Vikas Oberoi has agreed not to undertake the development or execution of any new real estate projects under the brand name Oberoi or any other brand name with certain exceptions, i.e., a) the completion of all ongoing and currently under planning projects under the brand name Oberoi or under any other brand, whether he holds an interest in the same directly or indirectly; b) the completion of the planned project at Worli, Mumbai by I-Ven Realty; c) pursuing existing / planned projects by (i) R. S. Estate Developers; (ii) Shrivatsa Realty; and (iii) Beachwood Properties.

The company has been declared the highest bidder in relation to a hotel in Goa and made 25% of the bid amount amounting Rs 15.35 crore. However, it could not complete the transaction as there was a litigation in the court praying to declare the bidding null and void. Thus the company may not able to complete the project on time or take up at ever depending on the judgment. Moreover, it may be required to pay interest on the balance payment of 75% at the prime-lending rate from April 19, 2010 until the date of the balance payment.

Some of the land parcels out of the land reserves of the company are not having clear development rights but subject to litigation etc. For instance, the Oberoi Exotica development site located at Mulund, Mumbai, has been declared as a private forest under the provisions of the Maharashtra Private Forest (Acquisition Act), 1975, by the Government of Maharashtra subsequent to its acquisition by the company.

Valuation

Consolidated sales for the fiscal ended March 2010 was up by 77% to Rs 805.50 crore and the net profit was up 81% to Rs 457.62 crore. Thus, the EPS for FY 2010 was Rs 13.9. The PE at the offer price band of 253-260 works out to 18.2-18.7 times. In comparison some of the Mumbai focused realty players such as HDIL, Orbit Corporation. DB Realty and Godrej Properties quote at a PE of 20.3 times, 15 times, 39.6 times and 42.5 times of their FY 2010 consolidated earnings, respectively. While HDIL focuses on large- scale slum rehabilitation projects, Godrej Properties works largely on joint development.

Oberoi Realty's price to Book Value (on the upper price band of Rs 260) pre-IPO is 3.9 times but post issue it works out to 2.9 times. In comparison the Price/ Book Value of Orbit Corp, DB Realty, HDIL and Godrej Properties is 1.6 times, 3.2 times, 1.6 times and 6.2 times.