Standing still

In business, a good first impression goes a long way. Nobody knows this better than real estate developers, who often operate out of plush offices — a grand extension of the structures that they build.

Vipin Bansal’s office, though, is a study in contrast. The chief executive officer of DB Realty works out of a small cabin in the basement of a complex in Goregaon, a distant Mumbai suburb. Going by its low ceiling height, his office could well have been a garage in its previous avatar. Bansal heads a company that has been a pretty aggressive acquirer of land in Mumbai, so why is he keeping a low profile? Co-workers say Bansal doesn’t care for a ritzy office because he is constantly on the move. Every day, he shuttles between his basement ‘office’ and the company’s residential projects in the city. Countless trips to the state secretariat to get work done are also de rigueur.

Insiders say Bansal wants to make up for lost time — the last two years have been particularly tough for the company. In early 2011, the firm’s promoters Shahid Balwa and Vinod Goenka were arrested by the Central Bureau of Investigation (CBI) in relation with the 2G spectrum scam. DB Realty firm, Swan Telecom, had been allotted 2G spectrum licences for 15 circles and it was alleged that DB used its partnership firm Dynamix Realty to transfer over ₹200 crore to television channel Kalaignar TV, owned by DMK chief M Karunanidhi’s wife and daughter.

The CBI and the Enforcement Directorate suspect that this investment was a quid pro quo for getting spectrum allotted through the then DMK telecom minister A Raja. While the real estate business itself is not bereft of shady elements, DB’s competitors crib that it leverages its proximity to the powers-that-be to its benefit, and gets project files cleared quickly. That perceived heft, however, couldn’t stop the Maharashtra government from scrutinising many deals after the promoters got enmeshed in the spectrum imbroglio.

In February 2011, chief minister Prithviraj Chavan stopped DB from redeveloping a plot of land on which the Yerwada police station stood. Despite protests from the Pune police department, the plot was to be re-developed on a public-private partnership basis by DB and the state home ministry. In return, DB was to relocate the police station to a plot on the Pune-Ahmednagar Road and build quarters for the policemen. Several other projects got nixed or ran into rough weather as well. DB’s plan to redevelop 35 acres of Mumbai’s infamous red-light district Kamathipura, a JV township in Pune and the redevelopment of a 100-acre government colony at Bandra.

Shaky ground

The scam allegations hit DB Realty pretty hard. its stock fell from around ₹450 in February 2010 to as low as ₹45 by December 2011. While the company was still reeling from the shock of the arrests of its promoters, it was hit by another crisis in the form of new development control regulations (DCR) for Mumbai. Because of the uncertainty surrounding DCR guidelines, developers slowed down the pace of execution of ongoing projects, which in turn affected their revenue recognition. Since receivables from customers are linked to the construction progress achieved, cash inflow was impacted too. 

Bansal believes that the 2G scam allegations didn’t affect the company as much as the change in DCR did. When he took over as CEO in September 2012, one of the first things he did was chase approvals for the company’s projects. “The government announced the DCR amendments in early 2012, but clarity came only during the middle of 2012. My first priority was to get things moving,” says Bansal.

Amit Anwani, a real estate analyst with KC Securities, says while DCR guidelines did affect developers, the slowdown in launches by developers, including DB, was more because of falling sales and cash flow problems. “It is not like developers didn’t launch projects at all. We saw Oberoi Realty and others launch projects. The ones who held back launches did so because of other problems like oversupply in the market, slowdown in sales or their own cash flow issues.”

It’s been a little over a year since Bansal came on board post his stint at Indiabulls Real Estate, and in that period, construction has started on five projects. DB’s latest project is Orchid Heights, a 1.5 million sq ft development in which IL&FS real estate fund has a 50% stake. IL&FS has invested about $200 million of its total corpus of $2 billion. “We have invested both at the entity and the project level,” says Mahesh Iyer, senior vice president, IL&FS. Iyer mentions that the scam involving the promoters set the fund back by a year but now things are back on track. “We are back in business and are working closely with the company to ensure timely completion,” he adds.

DB expects sales of ₹5,000 crore from the Orchid Heights project. Another ₹2,000 crore is expected to be realised from soon-to-be-launched premium projects in Mumbai and Pune. “We expect ₹7,000 crore of revenue realisation from these projects. If we assume a ₹2,000 crore cost of construction, that gives us at least ₹5,000 crore of cash flow,” says Bansal.

Double counting

Essentially then, faster execution of existing projects and pushing supply through new launches are the twin pillars on which DB’s turnaround strategy is based. Murky real estate accounting is also expected to play its part. The percentage completion method allows real estate developers to book revenue once a certain portion of the construction cost has been sunk in. The threshold for DB is 25% and the joke is that revenue can be booked even when not received. No wonder then that Bansal is gung ho about pushing execution past the 25% mark so that the topline gets a boost. He says, “The problem is that unless you cross the threshold of 25-30% of construction cost incurred on the project, revenue does not get recognised despite sales and cash flows. We have ₹30,000 crore of inventory. The main cost involved is construction cost, which is around 30%. The rest 70% is cash flow. Once our projects hit the revenue recognition phase, the numbers will begin to change.” 

Bansal maintains that DB is a “sleeping giant”, which after waking up will silence critics and competitors alike. “In India’s most expensive market, we have a 90 million sq ft land bank. Our cheapest inventory sells at ₹10,000 per sq ft, so you can imagine what we are worth,” he says. This confidence seems a little brazen, as investor sentiment is a variable that the company cannot control. On its part, DB can keep pushing supply into the market but there has to be buyer appetite.

Bansal apparently doesn’t worry about dipping buyer appetite or oversupply. He is banking on Mumbai’s supply constrained status and believes prices can only go higher. The icing on the cake is his expectation of low interest rates. Bansal is also nonchalant about the fact that in his company’s case, the sales volume doesn’t matter because the cost of construction is low. “Usually, the cost of construction is 25-30% of selling price,” mentions Bansal. Anwani of KC Securities points out that the cost of construction in Mumbai has gone up by 25-30% in the past two years and that DB’s projected cost of construction looks to be on the lower side. “In fact, almost every developer has been talking about how the increase in cost of construction is eating into their margins, so it’s surprising that DB says cost of construction is low.”

Bansal goes so far as to say that his company has more real estate assets (number of projects) than Lodha Developers, one of the leading builders in Mumbai, and even DLF. But the reality is that DB has 37 projects, nearly equal to what Lodha has and 28 less than what DLF has. Further, Lodha has a landbank of 274 million sq ft and that of DLF is 314 mn sq ft (more than DB’s 90 mn sq ft).

The other aspect that Bansal gloats about is low leverage. “We have low debt compared with other players, who have fewer assets. Land is already paid for, so unlike other developers, who need to sell fast to meet their land payments and other commitments, I have no such worries.” On the surface, the debt may appear low, but even that advantage is starting to fade. In the latest quarter, long-term debt has risen to ₹552 crore from ₹366 crore six months ago. In fact, the company incurred an interest cost of ₹22 crore in the first six months of FY14 compared with ₹18 crore for entire FY13. Receivables, too, have fallen from ₹1,866 crore to ₹1,504 crore, indicating slow new sales. Then there is a bunch of selective non-disclosures that have been highlighted in the limited review by auditor Haribhakti & Co. It mentions, “A subsidiary company and six step-down subsidiaries have not been considered in the consolidated financial statement, which is not in compliance with Accounting Standard 21 “consolidated financial statement”. The impact of this is not quantifiable.”

Castle in the air

While the management believes that it is on the brink of something big, the investor community seems oblivious. DB’s FY13 consolidated profit was ₹3.3 crore, compared with ₹86 crore in FY12, and the picture continues to be cloudy in FY14. Analysts don’t track the company because they say it doesn’t interact with them. Bansal denies this and adds that he hasn’t been holding calls with analysts because he is waiting for things to improve. “I will talk to investors when I have something to highlight. Right now, we are trying to get things back on track.” A senior official with a private equity firm says the company’s lack of transparency has always been a problem. “When Godrej Properties holds investor calls, it is not just for analysts but also for investors, who have put money into the company. Such transparency always helps,” he says.

KC Securities’ Anwani, is one of the few who used to track the company. “We have limited access to the company, so we have suspended coverage.” According to Anwani, the company needs to focus on execution to make up for delays in the past. “We feel they have not done enough to speed up construction. Sales volume needs to pick up so that their cash flows improve.”

Being a relative newcomer, DB Realty doesn’t have much of an execution track record. The company has so far completed only a few residential projects that were much smaller in cost and complexity. The scrutiny that the company’s projects came under after the 2G scam halted its meteoric rise and also led to a delay in projects. Even Orchid Woods, which was launched in February 2007, was to be completed by June 2011. In its defence, the company says the project is in the final stages of completion. Another project, Ozone, which was to be delivered by September 2012, has been delayed as well.

Here, too, while ground reality suggests otherwise, the company insists that about 350,000 sq ft has been constructed and the project is close to completion. Bansal is adamant that on-time completion of projects has taken precedence for the company since revenue recognition is contingent on speedy completion of projects. “We ensure that our execution is on track by hiring the best names in the industry. We have a tie-up with L&T’s construction arm, IL&FS Engineering, and several architect firms to make sure that our projects are delivered on time,” he blusters.

The reality is that like all other developers, DB too is asset-rich and cash flow starved. Not only have DB’s promoters pledged more than 2/3^rd of their 61% stake, the auditor notes, “Guarantees issued and securities provided to banks and financial institutions on behalf of various entities aggregate ₹3,040 crore which are significant in relation to the net-worth of the company.” This cash-starved state has also pushed the management to focus only on residential construction and hence its earlier focus on commercial and hotel projects has been considerably diluted.

Even its Ascot Centre residential project was earlier intended to be a commercial development and the Residence was planned as a hotel. While it has retained two hotels, one in Mumbai and another in Goa, the company has decided not to take up any new hospitality projects. “We will retain our existing projects and those in the pipeline will either undergo change of use to residential or will get divested,” says Bansal.

Like most real estate companies, DB has its share of litigation and apart from the ongoing 2G spectrum case, the biggest cloud is weak demand. Ramesh Nair, COO, Jones Lang LaSalle India, says, “Being a regional player, DB’s future is dependent on how the Mumbai market will perform. Everything will depend on DB’s ability to execute after getting approvals.” In a worst-case scenario, the management might be forced to sell their land holdings in a piecemeal fashion or lenders might end up taking possession in case of a debt default.

With projects in prime locations, DB’s land parcels should be a magnet for cash-rich suitors. Bansal, though, has no such worries. He is more preoccupied thinking about the cash flow windfall that he is expecting. Brimming with confidence that the next few years will be DB’s best, he says, “Even as we speak, we have ₹300 crore of free cash flow. Our biggest worry now is how to utilise our free cash flows.” It is a pleasant worry, one that his competitors will be happy to have.