Monday, October 06, 2008

Cash crunch at real estate companies

I am anxiously scanning the money market looking for dislocations. The closest that seems to be found is the funding crisis of real estate companies who appear to be facing a cash crunch. I have heard of interest rates going all the way to 36%. These are really attractive returns, but then there is the possibility of default.

I looked up accounting information about one such firm, Unitech, as an example. A glance at the liabilities shows a lot of leverage: net worth of Rs.2143 crore is supporting a balance sheet of Rs.17,327 crore. Current liabilities are Rs.7,069 crore, so there must be a lot of stress rolling these over. At the same time, the market value of equity is Rs.18,000 crore. From this perspective, the leverage is not particularly high (Jayanth Varma had made a similar point recently) even though the stock price has lost 67% in the latest 12 months. In a KMV/Merton model world, you wouldn't think this firm was particularly likely to go bust.

There is one problem in the measurement of accounting `equity' capital for some of these firms which needs to be borne in mind. India has capital controls against debt flows. There are many mechanisms for getting around these restrictions, for equity and debt are ultimately intimately intertwined [link, link]. One mechanism is for founders (`promoters') to sell shares to a foreign investor and have a private contract to buy these shares back at a future date. I have heard that quite a few small Indian promoters have done such deals with private equity funds and other funding sources. These transactions are really debt transactions, being disguised to look like equity transactions.

While such transactions are in flight, the accounting data for `equity' capital is overstated. And, given the drop in stock prices in recent terms, the cost of this borrowing for the promoter will prove to be very high. Such promoters must be in a tough spot looking for personal money to do the buyback, at a stock price well above the market price.

None of these particularly attenuates the stock price, though, once there is adequate stock market liquidity, for speculators on the market know all these things. So I would still maintain that by market value measures, there is a lot of equity in Unitech. If you have insights to offer on the funding crunch of real estate companies, and why they're paying as much as 36%, do tell.


  1. ndians wake up from mungerilal trance.
    Hard daya are here
    Expect major hari kari in the indian market.
    Expect indian real estate to crash to pre BUBBLE 2001 prices
    Expect major layoffs in IT/BPO.
    Expect end of so called reforms.
    Rupee Target 2009- Rs 60 - $1
    Sensex Target 2009- 3550
    welcome to real world, mungerilals

  2. IMO the real estate companies basically made a cartel & most new supply of apartments,commercial space, malls etc was tightly regulated. In order to maintain this stock it was necessary for them to have huge working capital requirements. The selling price was also tightly controlled & this notional price was the benchmark of the so called NAV of the land bank they held. Basically a big scam & most intelligent people fell for it. - Ashok Thakwani

  3. For how long can a company service high r@i for its stock, especially under these tight conditions in a market with no takers. Doubtful, then in what circumstance pay such a high r@i?
    Thinking avoiding an EOD on equity financing is driving the acceptance to pay such rates.

  4. I have no insights on funding crunch of real estate market but I was wonder about the seniority of privately placed stock sale and buy back agreement - which apparently is equivalent to debt. Does it have seniority over public stock?

  5. With Bleeding money markets , downturn in capital markets days are not far when RBI may have to bail out few retail companies which have already taken money from potential home buyer in advance but not starting the construction activities due to tight liquidity and huge current liabilities .

  6. Whats the distress sale value of a share like unitech in these market - not more than 20-40% of the current price. Thats the value creditors will attribute if the shares are used to take debt.
    The main problem is that real estate is a black-listed sector , so whatever may be the merits of the case , no one will lend them. "No one got fired to buy IBM " . Further the distress sale value of the assets in the book may be artificially inflated , and in india pledge of demat and listed security is a only good security worth mentioning. If u take any other security , the debtor may drag u into the courts for ages. So who gives a damn to the security of physical assets.

  7. Our company does project funding for real estate developers. The reason it makes sense to pay 36% (or more) is because the developers have used short term funds (customer advances, progress payments etc) to buy long term illiquid assets (land banks). No further money is forthcoming from customers or banks as they have not made enough progress on current projects. The only way out is to execute current projects fast, faster and then even faster with the funds they raise at the exhorbitant rates so that they can get the customer and bank funds flowing again (velocity/multiplier effect).

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