In a 27-acre housing complex that overlooks the banks of the waterless Yamuna in New Delhi, barely 7 km from Connaught Place, men and machines go about their business as if tomorrow is today. They are putting the pieces together for 34 luxury apartment blocks, whose 1,168 flats will house the 8,000 athletes and officials expected to descend on the capital in October 2010 for the 19th Commonwealth Games. On the timely completion of the Games village hangs the reputation of Emaar MGF, the real estate company in charge of this project.

The fate of Emaar MGF, though, might lie in an 851-page tome that is currently under scrutiny by the capital market regulator, Sebi (Securities and Exchange Board of India).

That tome is the draft prospectus filed by the company to raise a few thousand crore of rupees by selling shares to the public. Shravan Gupta, Executive Vice-Chairman and Managing Director and one of the promoters of Emaar MGF, is hoping that Sebi will say ‘yes’ to the initial public offer (IPO) in its current form, and that investors will follow.

If either Sebi or investors answer in the negative, Emaar MGF might end up facing some serious existential questions. Everyone is breathing down the company’s neck: the government for the Games village, buyers for the houses and offices it has promised them, lenders for the Rs 6,000-odd crore it has borrowed to make good on the first two commitments, and its private equity investors for an exit.

Today, the amount of cash being generated by the company is neither enough to deliver those projects nor meet its interest payments in time. As of March 2009, the company had a debt of Rs 6,073 crore. Its interest payment in 2008-09 amounted to Rs 691 crore—Rs 105 crore more than its income for the year.

With banks understandably reluctant to lend more, the planned IPO is, in a sense, a lifeline for the company. But even if it gets the Sebi nod for the IPO, getting investors to buy its shares won’t be easy, as there are many issues relating to the disclosures (or lack of them) in the prospectus and the vulnerable state of Emaar MGF’s business.

From Expansion To Survival

It’s not the first time Emaar MGF has moved Sebi for an IPO. It’s the third time in the last two years. Only this time the stakes for it are higher than ever before. The first time was in September 2007. Sebi said yes, but Emaar MGF couldn’t push the IPO through in the mandated period of three months.

Everyone is breathing down MD Shravan Gupta’s neck: the government for the Games Village, buyers for houses and offices, lenders for their Rs 6,000 cr, and PE funds for an exit.

The second time, it did hit the market, with an issue to raise about Rs 7,000 crore in February 2008. At that time, it hadn’t completed a single project, and was essentially looking to win investors over with its pedigree—Emaar was one of Dubai’s largest real estate developers and MGF was making a name for itself in real estate—and plans. The IPO bombed.

The offer period of the issue was from February 1-6, 2008. In an edgy market, Emaar MGF first lowered the issue price band from Rs 610-690 per share to Rs 530-630 per share. It then extended the issue closing date to February 11. But on February 8, knowing that the issue was doomed, it withdrew its IPO.

In its third attempt, going by the draft prospectus, Emaar MGF is looking to raise at least Rs 3,069 crore. In what is being seen as the return of real estate companies to the primary market, three other developers—Sahara Prime City, Lodha Developers and Ambience—have also filed draft prospectuses with Sebi. Together, these four companies hope to raise about Rs 10,000 crore. Says Satish Betadpur, Managing Director, IIR Group, a London-based agency that tracks public offers: “There appears to be a glut of real estate IPOs, that too at a time when no one has made money on real estate stocks.”
Emaar MGF hasn’t mentioned its issue price, since this is only its draft prospectus, but there might be a benchmark available. On September 25, 2009, four days before it filed the prospectus with Sebi, it issued shares to its foreign promoter, Emaar Properties, at Rs 219 per share.

The drop in valuations of 58-65% from its last attempt at selling shares to the public is reflective of the night-and-day difference in the state of the real estate sector and investor sentiment between then and now. The difference is most evident in what Emaar MGF has proposed to do with the proceeds of the issue, if there is one that is.

If the 2008 IPO attempt was all about majestic expansion, this one is about sheer survival. In 2008, Emaar MGF earmarked about Rs 3,200 crore of the Rs 7,000 crore issue to buy land and to convert agricultural land to commercial land. Another Rs 1,500 crore was towards retiring debt, and the rest for general use. Barring the debt repayment, all aggressive and expansionary objectives.

This time, the objectives of its IPO are all defensive. Not a single paisa is earmarked directly for expansion. Instead, there is about Rs 2,800 crore of the Rs 3,069 crore earmarked towards retiring debt. If the company raises anything more than that, it will go towards general use.

Need For Cash

If Sebi gives the green light, Emaar MGF will have one year from the date of approval to make the IPO. At present, Emaar MGF doesn’t have a plan B. A high-ranking official in the company who is closely associated with the IPO says the company doesn’t need one. “We are in a comfortable position,” he says. “We are in no rush to raise funds.”

The official attributes the comfort to the public response to the projects launched by the company between April and August this year. “This financial year, we have so far sold 2,800 houses at an average price of Rs 70-75 lakh,” he said. A straight multiplication shows that is about 2,000 crore. However, not all of it might come on to the company’s books in the current financial year.

The company would have, at best, received a booking amount towards those 2,800 houses. That would be 5-10% of the price of the house. Even assuming 10%, that’s only Rs 200 crore—not exactly a fortune changer of the magnitude Emaar MGF is looking for. Even that sum of Rs 200 crore may not come on to its books this year. A real estate company can recognise revenues towards a project only after it has completed 30% of the construction. There’s still a question mark over whether the new-project houses sold between April and August would make the cut this year.

“In the last fiscal, our cash flow from sales was higher than our reported income,” says the Emaar MGF official. Essentially, he’s pointing to the fact that the company has received payments for projects that have not crossed the 30% limit to be recognised as revenues. “We hope to sell projects worth Rs 9,000 crore over the next three years, with more projects crossing the 30% threshold,” says the official.

As of March 2009, it had a debt of Rs 6,073 cr. Its interest payment in 2008-09 amounted to Rs 691 cr—Rs 105 cr more than its income for the year!

In 2007-08, Emaar MGF recorded income of Rs 1,074 crore and a net profit of Rs 186 crore. In 2008-09, income halved to Rs 586 crore, and the company posted a loss of Rs 98 crore. The company official pins it down to revenue recognition norms. “Two years back, we sold plots in Mohali, where income is upfront and the margins higher,” he says. “At present, built-up unit sales contribute a major portion.”

For the money to keep coming, Emaar MGF needs to be keep building. And to keep building, it needs cash. Lots of it. Quickly. That’s where the IPO becomes critical. If the company was indeed in a comfortable place, as the official says, why did it delay repayment of Rs 278 crore to financial institutions in 2008-09? Why isn’t it able to meet a share buyback commitment of about Rs 229 crore made to Citigroup Venture Capital International (CVCI) Ebene, a private equity fund of Citigroup (See box: Issue #2)? Why did it ask for a bailout, to the tune of Rs 767 crore, on the Commonwealth Games project (See box: Issue #4)? The simple answer: it doesn’t have cash.

Between The Numbers

The worry now is not the Games Village, which has the government’s attention due to its national importance, but Emaar MGF’s other projects. According to the offer document, the company had 29 projects under construction, 25 of which were residential. These will need cash to move forward. As will the new projects.

But land for new projects is an issue. According to the prospectus, as of August 2009, Emaar MGF had total land reserves of 11,340 acres, for which it has paid Rs 6,800 crore; further, 96% of its reserves are fully paid for. That makes for good reading.

But the feel-good factor disappears with the fine print. Of the total land reserves, 1,520 acres (14% of the total) is under litigation. Some are frivolous cases, which don’t stop construction. Some are disputes over title, which do stop Emaar MGF from building on that patch of land. Also, while the land under litigation is 14% of the total, the price paid by Emaar MGF for this land is 80% of the total (Rs 5,511 crore of Rs 6,800 crore). In other words, its costliest land is under litigation. Much of this was bought after 2006, when it entered the market amid a blitz of purchases, advertising and marketing.

About 14% of Emaar MGF’s land reserves is under litigation. The price it has paid for this land amounts to 80% of its total payout of Rs 6,800 cr.

There’s more. About 75% of its total land reserves is still classified as ‘agricultural land’. Such land cannot be developed unless a certificate of change of land use is obtained from the local authorities. Emaar hasn’t given the cost of conversion. However, in the previous prospectus, the company had said it would cost Rs 1,826 crore to convert 1,214 acres of agricultural land. Extrapolating from that, Emaar MGF will need Rs 12,500 crore for the land conversion.

Prithvi Haldea, Chairman and Managing Director of PRIME Database, which tracks and maintains data on IPOs, has read the Emaar MGF prospectus, and is mostly disgusted with it. “The current economic value of the land is not known,” he says. “Expressing the disputed amount as a percentage of the current value of the total land bank would give a better picture to investors.” The company official refused to share these figures.

“Material risks need to be disclosed in plain English,” says Jayant R Varma, professor at the Indian Institute of Management (IIM), Ahmedabad and ex-Sebi member, without specifically referring to Emaar MGF. “This is a big problem on how to deal with risk factors. Can it be determined by the regulator or should the companies take up the responsibility?”

The IPO Lifeline

Even as the question of responsibility is being debated, Emaar MGF has gone ahead and essentially given its Dubai parent a status of first among equals. In March 2009, Emaar Properties, through a subsidiary, invested $50 million each towards an equity stake in two real estate subsidiaries of Emaar MGF, on preferential terms.

Should Sebi determine the risk factors or should companies take up the responsibility?Jayant R Varma, Ex-Sebi member

Under the terms, Emaar Properties is assured a “minimum guaranteed return” on its investment of 10% a year, which is compounded and is payable at the end of five years. Further, Emaar MGF has to bring in two other investors within six months, with contributions of at least $5 million each. If it doesn’t manage to, the return payable to Emaar Properties will increase to 15% a year.

Two questions arise. One, isn’t Emaar MGF giving its Dubai parent preferential treatment over other shareholders? Two, isn’t this a debt investment masked as an equity investment? If so, it would be in violation of Reserve Bank of India (RBI) rules that disallow real estate companies from raising external commercial borrowings (ECBs). “It looks more like a debt investment rather than an equity investment,” says a real estate analyst. “It is within the prescribed regulatory guidelines,” says the Emaar official.

Stating the disputed amount as a percentage of the land bank will tell investors more.Prithvi Haldea, CMD, PRIME Database

It isn’t just Emaar Properties that is seeking safeguards from Emaar MGF. Even lenders are weaving in such terms into the loan agreement. The latest loan taken by Emaar MGF, of $62 million from HSBC Bank (September 10), came against a corporate guarantee from Emaar Properties, the Dubai promoter, not against assets of Emaar MGF. If that is the kind of faith and confidence those closest to the company are placing, what does it say about the company and the state of its business?

It all comes back to the IPO. It’s the only easy and quick way lenders can get some of their loans back. It’s the only way Emaar MGF can get other shareholders to pay for CVCI Ebene’s exit. It’s the only way Emaar MGF can reduce its liabilities and oil the real estate cycle of cash, completion and sales.

The IPO is the only way the company’s promoters can recover some of the huge investments they have made. Even Rs 200 a share will be a good price, says the company official, as the MGF land bank was transferred to Emaar MGF at its historical value. “The cost of acquisition of shares for MGF and Emaar Properties is a mere Rs 1.25 and Rs 104.17 per share, respectively.” If Sebi clears the IPO. If investors buy into it. If.

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Issue #1

Debt Burden

As of March 2009, the company had borrowings of Rs 6,073 crore. Its interest payment in 2008-09 alone amounted to Rs 691 crore—Rs 105 crore more than its income for the year! Lenders are worried. They can’t turn off the taps or throw the rule book at the company, as it could precipitate a collapse. More than anyone else, lenders want the IPO. The only use of the IPO proceeds stated by the company in the prospectus is retiring debt worth about Rs 2,800 crore, led by Rs 494 crore to UTI Mutual Fund, Rs 300 crore to LIC, Rs 200 crore to HDFC and Rs 127 crore to ABN Amro Bank.

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Issue #2

Citigroup Dispute

Citigroup Venture Capital International (CVCI) Ebene, the PE arm of Citigroup, invested about Rs 229 crore in Emaar MGF, at an effective price of Rs 195 per share, in November 2006. The original agreement gave CVCI the right to sell its shares back to the company or the promoters, at the same price, after three years or three months after the IPO.

The agreement was suspended before the last IPO, in February 2008, on the condition it will be renewed if the IPO fails. The IPO failed, but the pact wasn’t renewed. CVCI initiated arbitration proceedings against Emaar MGF’s Dubai parent. Now, if this IPO too fails, CVCI can claim damages. Emaar has said it won’t contest its claim.

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Issue #3 

Land Titles

As of August 2009, Emaar MGF had total land reserves of 11,340 acres, bought for Rs 6,800 crore; further, 96% of its reserves are fully paid for. But 1,520 acres (14% of the total) is under litigation. Also, while the land under litigation is 14% of the total, the price paid by Emaar MGF for this land is 80% of the total. In other words, its costliest land is under litigation. Also, 75% of its reserves, or 8,500 acres, is still ‘agricultural land’. The conversion cost can be high: in its previous IPO filing, it had said it would cost Rs 1,826 crore to convert 1,214 acres of agricultural land.

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Issue #4

Commonwealth Games Village

Emaar MGF bagged the village from the Delhi Development Authority (DDA) in 2007 through bidding. The plan was for Emaar MGF to build 1,168 apartments, and sell them to the public after the Games. As the cash squeeze intensified and buyers stayed away, Emaar MGF called DDA for help.

In May 2009, DDA paid Emaar Rs 767 crore in return for the right to sell 333 apartments. For DDA, that’s an average acquisition cost of Rs 2.3 crore, or roughly Rs 11,000 per sq ft. Emaar MGF is currently selling its flats at record prices in Delhi: Rs 1.9 crore (two-bedroom) to Rs 4.9 crore (five-bedroom). Even as market opinion is divided on the pricing, the company claims to have sold 632 of its 790 flats here.

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Issue #5

Assured Returns On Equity For JV Partner

In March 2009, its Dubai parent Emaar Properties invested $50 million each towards an equity stake in two real estate subsidiaries of Emaar MGF. Emaar Properties is assured a “minimum guaranteed return” of 10% a year on its investment, which is compounded and is payable at the end of five years; 15% if Emaar MGF fails to bring in two more investors within six months, with contributions of at least $5 million each. Why the preferential treatment? Also, experts say, this is a debt investment in the guise of an equity investment, which violates the RBI rules that disallow real estate companies from raising external commercial borrowings (ECBs).

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With inputs from Sudipto Dey