Valuation Re-valued

By Ubaid Parkar

Once upon a time, a long time ago (in the June 30th 2007 edition of Accommodation Times) it was reported that an ideal investment in the Realty Sector should be in a company with “…consistent growth and not a manipulated figure. The persistent growth in sales and profits must be checked. Net owned funds and Return on Investment must also be considered. The capacity of the company must also be judged to construct as promised in the prospectus.”

It is said ignorance is bliss but with valuation information seemingly abundant through Red Herring Prospectuses, it not only undermines the assessment of the potential shareholder with a shower of numbers but also creates a misleading picture of a company’s potential to deal with unforeseen circumstances.
Real estate, it is to be remembered, is related directly to the financial market with a generous attribute, of both builders and home seekers alike to persuade their monetary needs from it.

Premiums: a high cholesterol snack
The table below lists the Issue Price of the shares of some companies:

Listing Date

Face Value Rs

Dividend %

Issue Price Rs

Parsvnath Developers

30-Nov-06

10

30

300

Sobha Developers

20-Dec-06

10

65

640

DLF

5-Jul-07

2

100

525

HDIL

24-Jul-07

10

30

500

Omaxe

9-Aug-07

10

25

310

The Dividend, the miniscule glimmer of assurance, is based on the Face Value and not on the Issue Price. For instance, if a 100 Akruti City shares are purchased, the dividend would amount to Rs. 70. But the cost of purchasing the 100 shares (where the Premium Amount is also accounted for) would be Rs. 54,000. So you earn Rs. 70 for an investment of Rs. 54,000, which seems drastically unfair and abysmal.

Valuation of Land Banks

These premiums are based on valuations of the companies issuing their IPOs. Akruti City Limited in Mumbai, Parsvnath Developers Limited in Delhi and Sobha Developers Limited in Begaluru have benevolent Land Banks and anticipated their shares to reflect their management capabilities. But then again the definition of Land Banks can be contentious. Land can interpreted through ownership rights, leasing rights, developmental rights and to quantify its worth through one of these or more than one can be outright erroneous or inappropriate to say the least, either way an anomaly of numbers. Furthermore, the Opportunity Cost is even harder to ascertain even if one of the few rights are finalized upon. This is because the value of land today may differ from the operations it carries.

In Real estate, land is a stock and should be valued at the Cost Price (i.e. the value of a property can be estimated by summing the land value and the depreciated value of any improvements done on it, including the cost of the improvement) and not at the Market Value. But then again land can be purchased at inflated rates due to high liquidity and the resultant speculative transactions running amok.

Real estate is a litigation oriented industry. Conversely, however, there is no national market as laws differ from state to state in regards to property and land.

Current listed companies

A value of a company can be subjective, inherent to the method of valuations. But then again, as seen in the HDIL Red Herring prospectus, figures jumped from Rs. 210,951 million in mid-December 2006 (by Knight Frank) to Rs. 220,394 million in mid-January 2007 (by Cushman and Wakefield). A colossal leap of Rs. 9,443 million in almost a month, with the same evaluation method.

Let us, for instance, evaluate DLF. DLF had filed its prospectus with SEBI thrice before releasing its IPO. This was accredited to SEBI’s concern on land valuation and other factors. DLF has been in the scene for quite some time and has only recently gone public (mid 2007). But a corporate today has multiple entities. DLF on a similar latter, entered with only one entry, although it pockets construction, townships, hospitality, IT infrastructure and asset management among others. This means that the liquidity it accumulates from the public may be utilized under any of its arms. It infers that a developer can shine profit in one entity, raise enough liquidity through it and curtain the rest.

The company is currently headed by Indian billionaire Kushal Pal Singh, who according to the Forbes listing of richest billionaires in 2008 stands as the 8th richest man in the world.

There have been no restrictions on Premiums and coupled with the absence of auditors for valuators, premiums are determined at run away prices and consequent disastrous results. The picture is painted and tainted below:

Current Value Rs

% Drop from Issue Price

Parsvnath Developers

38.9

-87.03

Sobha Developers

84

-86.88

DLF

185

-64.76

HDIL

103.7

-79.26

Omaxe

51.2

-83.48

Note: Above values as in mid-February 2009

There has been a drop in the share values by almost eighty percent in most of the listed companies.

Evaluations: How and Why?

With the advent of consultancy firms like Knight Frank and Cushman and Wakefield, there came about an attempt to institutionalize and professionalize businesses. But the same firms are relied upon by Merchant Bankers. The key advisors for valuations are these Merchant Bankers who ensure that the values that are produced are inflated. This in turn keeps the evaluated company content, guaranteeing a subscription of all their shares if not over-subscribing them through over trading. This not only results the company in concern lathered in liquidity but also books the Merchant Bankers and the consultancy firms for the company’s future assignments. In the market, additional liquidity is a certainty when the promoters of such shares create its scarcity ensuring a demand-supply mismatch which further pumps up the value of the shares from its already inflated premiums.

This cycle spins and spins its deceitful web.

The success story of this inflated premium can be endorsed only when there is a high liquidity in the market. These factors collude against the investor or shareholder creating a dark veneer holistically, which may grant short term fortitude but more often collapses in the long run for the investor. And this effect can trickle down. Once the secondary market collapses the primary follows suit.

Read the fine print

Should premiums be done away with or reevaluated? The question is difficult to answer. But it can be looked through the eyes of a shareholder, who notices that in spite of the company doing relatively better than its tumbling share values, feels the need for a system of checks and balances which would surmount extreme negatives and consequential bankruptcies and suicides.

The problem today is the need of an instant liquidity gratification that arises due to runaway growth. With enough liquidity in the market, valuations capitalize on it without considering a buffer stock for a bad month or as in the current scenario, bad months.

The mere fact these are figures, inflated or otherwise, can merely quantify worth, it does not, however, quantify the shield it would represent against unforeseen scenarios like the current recession or the gimmickry of the stock market. It is easy to blame market sentiments, but then again the company was not founded on one. Couple everything with the foible of India, financial indiscipline, lack of corporate culture and the effervescent nexus between builders, bureaucrats and politicians it completes a dismal picture.

Edwin Armstrong, an American engineer and inventor, once said, “I could never accept findings based almost exclusively on mathematics. It ain’t ignorance that causes all the trouble in this world. It’s the things people know that ain’t so.”





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