Ajay R 1311213|Rakesh Mondal 1311247|Darshak Savla 1311258|Soumya H 1311268|Vaikam 1311278

Group 11Section D

DLF IN THE REAL ESTATE BUSINESS

Competition & Strategy- Term 2- PGP 2013-15

ContentsINTRODUCTION.......................................................................................................................................2

DLF GROUP..............................................................................................................................................2

BUSINESS MODEL.................................................................................................................................2

DEVELOPMENT BUSINESS....................................................................................................................2

(a) Residential............................................................................................................................3

(b) Commercial Spaces..............................................................................................................3

RENTAL BUSINESS................................................................................................................................3

PROBLEM STATEMENT............................................................................................................................3

ANALYSIS OF THE FIRM...........................................................................................................................4

RESOURCE BASED VIEW.......................................................................................................................4

LAND BANKS.....................................................................................................................................4

CAPITAL............................................................................................................................................5

BRAND..............................................................................................................................................5

GOVERNMENT RELATION.................................................................................................................5

TECHNICAL EXPERTISE......................................................................................................................5

HUMAN RESOURCE..........................................................................................................................5

CAPABILITIES........................................................................................................................................5

PROCUREMENT................................................................................................................................6

CONSTRUCTION................................................................................................................................6

SALES AND MARKETING...................................................................................................................6

FINANCIALS..............................................................................................................................................8

CURRENT STRATEGY OF DLF...................................................................................................................8

STRATEGIC RECOMMENDATIONS..........................................................................................................9

Corporate Rebranding..........................................................................................................................9

Partnerships in core businesses...........................................................................................................9

Alternate Sources of funding – REITs and FDI...................................................................................10

Green Technology..............................................................................................................................10

Pre-fabricated construction materials...............................................................................................11

BUDGET AND FINANCIAL PROJECTIONS...............................................................................................11

TIME LINE...............................................................................................................................................12

CONTINGENCIES....................................................................................................................................12

ANNEXURES:..........................................................................................................................................13

INTRODUCTIONReal estate is one of the oldest and most critical sectors of the Indian economy, which contributes to about 5% to the country’s GDP. With a market size of USD 66.8 billion, it is the second largest employment generating industry in India.1 It is also the driver for many ancillary industries like cement, building material etc. Some of the major players in the real estate in India are DLF limited, Oberoi Realty, Godrej Properties, Sobha Developers and Jaypee Infratech.

This report deals with the performance of DLF in the real estate and construction business and the strategies it has currently considered. The culmination of the report is the recommendation for the strategies that can be implemented by DLF based on the understanding of Competition and Strategy as dealt in the Term 2 of the PGP 2013-2015 programme at IIM Bangalore

DLF GROUPDLF Group is the largest real estate company in India in terms of market capitalization and revenue.2 DLF exists in all four major segments of real estate namely: residential, office, commercial and retail. Historically, the firm has largely focussed in the regions of North India, with most projects and land holdings in the Delhi/ NCR region. It is in the recent past that DLF has started putting to use, its land bank which is sparsely distributed across India, in other metros, Tier 1 and Tier 2 cities.3 In terms of its product delivery, DLF has always differentiated itself with the premium segment, in all fields, such as residential, commercial, office or retail.

BUSINESS MODEL The core business of DLF is development of real estate, and leasing. DLF is also involved in other businesses such as hospitality, through food courts, restaurants, hotels, resorts etc.

Through the years, DLF had ventured into the wind turbine segment and the aluminium cladding segment through its venture Star Alu Build. Overall the entire business has revolved around the might of its land bank.

DEVELOPMENT BUSINESS DLF is primarily into the development business, focussing on the premium market in the NCR region in the following segments.

1 Real Estate Sector Report (September 2013) by Edelweiss Research 2 Refer Table 2: Annexure 3 Refer Table 1: Annexures

84%

16%

Area in msfDevelopment

Rental

(a) Residential The housing developmental business includes three categories: super luxury, luxury and premium homes. DLF has already established its presence by developing properties in all the metro cities. The next step in the expansion is ventures in smaller cities like Kochi and Indore. Despite these efforts, the stronghold remains cities and towns in North India including Delhi, Gurgaon, Lucknow, and Mullanpur (New Chandigarh). Most of the projects outside the NCR region are in the premium and mid-range segment.4

(b) Commercial Spaces Similar to the housing properties, most of DLF’s commercial complexes are primarily in the NCR region. In addition, DLF is starting to develop a small number of commercial properties in other regions especially in the other metro cities.

RENTAL BUSINESS DLF has firmly established its strength in the Office Leasing market with a number of projects across the country. Currently, a key focus area for DLF is development and leasing of retail malls, IT parks and spaces in IT parks. With quite a few projects and SEZs in cities like Chennai, Kolkata, Hyderabad and Pune, 5DLF has exhibited its ambition to move beyond the traditional NCR region where they have most of their rental projects.

PROBLEM STATEMENTFrom the annual report of DLF it has been observed that the revenue of the firm declined by 19.3% and the profit margin fell by 41.5% from between FY-12 to FY-13. Further the balance sheet of the firm shows a debt of INR195bn.6The largest of the problems is observed to be, deteriorating financial situation that requires to be improved.

Breaking the problem statement into a logic tree, provided insights and elicited various hypotheses for the problem faced by DLF as identified.

4 Refer Table 1 : Annexure5http://www.dlf.in/dlf/wcm/connect/Offices/Offices/Offices+on+Lease/Projects/IT+SEZs+and+Parks/DLF+IT+SEZ,+Chennai/6 DLF - Company Report by Edelweiss Research (October2013)

ANALYSIS OF THE FIRM

RESOURCE BASED VIEW In this section some of the key resources and capabilities of DLF are analysed to identify its relative strength with respect to its competitors. In the real estate industry some of the key resources that are essential for profitability and long term advantage of the firm are given below.

LAND BANKS Due to scarcity of available land in strategic locations it is one of the key resources contributing to the competitive advantage of a firm in real estate sector.

Improve financial situation

Deleverage Balance Sheet

Monetize Assets

Divest non-Core Assets

Expand into other segments to

generate economies

Address Project Delays - Inventory ↑

Relook at Regulations

Branding exercise to establish confidence

Marketing Efforts & Corporate

Governance

RESOURES

LAND

CAPITAL

BRAND

TEHNICAL EXPERTISE

HUMAN RESOURCE

GOVERMENT REALTIONS

DLF has a land bank of 314 msf, out of which 265 msf is held in development and 49 msf in lease business. Moreover the lands are held in strategic locations, which further strengthens DLF’s position. Most of its lands are concentrated in Gurgaon region, which constitutes about 46% of its entire land reserve. Apart from NCR region and metros, DLF also has land reserves of 45 msf in some of the Tier-2 and Tier-3 cities.7

CAPITAL DLF has the largest market capital among all the firms in the Real estate sector in India. The market cap of DLF is around INR 27,186 Crores, which is much higher than its nearest competitors.8 The FY13 balance sheet shows a working capital of INR 2,542 Crores, which shows the capital strength of the firm.

BRAND Being the market leader in the real estate sector, DLF has a reputed brand value. Moreover, DLF was the title sponsor of IPL till the year 2012, which increased its brand reach in the country. DLF has consistently striven to position itself as a premium brand in terms of the designs used, which are rich and embellished facades, to the high end architects and other service consultants it associates with. Each of their residential projects and malls boast of the state of the art amenities available in the country today.

GOVERNMENT RELATION DLF has been in the real estate sector for the last sixty years and has ensured good relationship with government agencies and regulatory departments.

TECHNICAL EXPERTISE DLF has contracts with many consultation firms in the industry like Hafeez Contractors, Arcop Consultants etc. Further the 60 years of experience in the sector gives DLF an edge over other rivals in terms of technological access.

HUMAN RESOURCE Much of the sales, marketing and legal activities are done in house by the employees. DLF has an internal mechanism to identify and groom talents within the organisation for critical roles which could not be outsourced. However many of the other activities like site survey, design and construction works have been outsourced to some of the best players in the respective industries. DLF has always exercised reason in out sourcing the activities that have not been their strengths and have worked in house on their core capabilities.

CAPABILITIES Some of the key capabilities of DLF are in activities like procurement, construction and sales and marketing.

7http://www.dlf.in/dlf/wcm/connect/1179aa0049033cebabddaf5274424e45/APQ2FY14.pdf?MOD=AJPERES&CACHEID=1179aa0049033cebabddaf5274424e45Refer Annexures: Table 18 http://www.moneycontrol.com/stocks/top-companies-in-india/market-capitalisation-bse/construction-contracting-real-estate.html

PROCUREMENT Despite soaring inflation in the country, DLF has maintained a high Gross profit margin. One of the possible reasons is that, there is cost efficiency in material procurement and stability in overall cost.9

Year FY 13 FY 12 FY 10

Gross Profit Margin 58.02% 56.42% 56.58%

The immense scale of the projects as developed by DLF, and its long existence in the industry, has given suppliers the potential to delivery large quantities and lower prices achieving economies through scale.

CONSTRUCTION DLF has on its rolls a large battalion of designers, engineers, planners and experts in the services like Water Supply and Drainage, Fire, Electrical and Lighting etc. Though DLF has had people with strong technical skills, and also the latest plant and machinery, it has chosen the path of sub-contracting to avoid further dents to the financial situation that DLF is facing.

SALES AND MARKETING DLF has always enjoyed the benefit of having much lower costs of acquisition of customers through marketing, due to their brand’s reputation. This is generated through the economies of scale, (i.e. each of their projects have been large scale, thus addressing a huge potential customer base with a single campaign).Its corporate offices in different cities have their sales and marketing teams that can work in their specific regions.

9 http://www.moneycontrol.com/financials/dlf/ratios/D04

VRIO ANALYSISRESOURCE DATA VRIO Analysis COMMENTSLAND More than 314msf in development

and rental businessSustained Competitive advantage

Since land reserves are scares and not easily imitable by competitors. Also it is valuable in real estate industry.

CAPITAL Based on Market Cap DLF: $4333m & Competitor $994mn

Competitive parity Since capital can be raised through multiple avenues, it doesn't give competitive advantage.

BRAND Industry Market leader Sustained Competitive advantage

Brand value provides competitive edge over competitors.

HUMAN RESOURCE

In house training to develop employees, Well developed functional departments

Competitive Parity Other competitors also possesses talented human resource in their organisation. Hence it is not a rare resource

TECHNICAL EXPERTISE

Work with consultants of the likes of Hafeez Contractor and Jones Lang Lasalle

Competitive Parity Other competitors like Sobha constructors and Oberoi Realtors also possess technical expertise

Government Relations

No empirical data available Sustained competitive advantage

DLF has maintained good relationship with government agencies and regulatory departments.

FINANCIALS10

Sharp decline in DLF’s net sales figures is an area of concern.

The net sales for 2012-13 are 19.3% below 2011-12 levels. The drastic decline in sales can be seen from the decrease in area sold i.e 7.5 msf in 2013 as against 13.4 msf in 2012.

The EBITDA margin for the company has also gone down to 33.8% in the year 2013 from 40.5% in 2012. This can be explained by the increase in the ratio of operating expenses from 59.5% in 2012 to 66.2% in 2013.

The area under rent has increased from 23.7 msf to 31.4 msf which has led to an increase in rental income.

The ROAE is 3.4 and is very less as compared to its peers, as seen in Table 2, of annexures.

The most disturbing financial metric here is the interest expenditure, which is around 30% of the total revenues. The high interest expenditure has the highest contribution in bringing down the financial performance of DLF.

In the case of DLF, the Debt Equity Ratio (as at March 2013) of 1.0 is not substantially higher than industry aggregates (it is, of course, higher than certain competitors). However, the decline in ‘Net Cash Flow from Operations’ from over Rs. 2,500 Crores (2011-12) to around Rs. 2,000 Crores (2012-13) is an adverse signal for the company. DLF’s interest costs have undoubtedly increased as well. The Debt to EBITDA ratio has also gone up from 6.4 in 2011-12 to 9.4 in 2012-13.

A way of looking at this is – the core problem is with DLF’s operating cash flow; the insufficiency of operating cash flow creates a situation where the company has to (in net terms) take on additional debt, as in 2012-13. This effectively means growing interest costs. The unavoidable result is a vicious circle.

CURRENT STRATEGY OF DLF

DLF’s current strategy can be better analysed by considering its vision and mission statements. The stated vision is “to contribute significantly to building the new India and becoming the world’s most valuable real estate company” and their mission is “to build world-class real estate concepts across all business lines, with higher standards of quality, professionalism and customer service”. But in the past few months DLF has faced numerous setbacks due to delayed launches, delayed or uncertainty of receipt of proceeds from asset monetization and the stay order on its luxury residential projects.

10 http://www.dlf.in/dlf/wcm/connect/1179aa0049033cebabddaf5274424e45/APQ2FY14.pdf?MOD=AJPERES&CACHEID=1179aa0049033cebabddaf5274424e45

In order to overcome the various obstacles, DLF has adopted a number of complementary strategies which include:

• The continued focus on debt reduction which is a key positive.• Expansion of land reserves in strategic locations in addition to the NCR region, its

stronghold in terms of land reserves.• Stronger entry into Tier-2 and Tier-3 cities, with the increasing disposable

income, as given the core business of DLF a national presence. It includes development of SEZ in these cities to keep pace with the government’s plan for more SEZs.

• Management strategy to optimize the workforce in terms of number and skill to enhance execution capabilities and customer relationship management.

STRATEGIC RECOMMENDATIONS

Corporate Rebranding

RecommendationDLF should take up the exercise of corporate rebranding on an urgent basis by practicing the best corporate governance practices, ensuring transparency in all its deals.

ReasonsDLF has been in news for the wrong reasons and has found itself in the middle of a political storm with activists like Mr. Arvind Kejriwal accusing it of carrying out dubious deals with Skylight Realty (owned by Mr. Robert Vadra) since 2008. The publicly released statement by the Canadian investment-research firm Veritas alleging DLF to have inflated its sales figures by Rs. 11,236 crores and its profit after tax (PAT) by Rs. 7,233 crores via its dealings with DLF Assets Ltd has also contributed to the negative publicity of DLF. Also, the Competition Commission of India had imposed a huge penalty of Rs. 630 crores for abusing its dominant position and indulging in promotion of monopolistic conditions in the market.Therefore, to improve its repute and image in the market, we have suggested DLF to take up the exercise of corporate rebranding through better corporate governance.

Partnerships in core businesses

RecommendationDLF should outsource the construction work to quality players, who can develop a cost effective product, due to the economies of scale at the supplier end. For example, it can assign construction contracts to well-known contractors like L&T, HCC etc

ReasonsAcquiring land and identifying core development projects are the strengths of DLF. Combining these strengths with the expertise of contractors like L&T, HCC etc would enable DLF to create positive synergies for its projects. With their help, DLF can bring down the delay in the launch of projects which would help it to bring down its current inventory holding period of 1839 days.11

Contracting will also help DLF in deleveraging its balance sheet as it would reduce the need to incur capital expenditure to execute the projects.

Alternate Sources of funding – REITs and FDI

RecommendationDLF should focus on deleveraging its Balance Sheet and simultaneously look for alternate sources of finances in the form of REITs and FDI.

ReasonsDLF had more than INR 24,800 Crores of debt on its Balance Sheet and a consequent interest expense of more than INR 2,300 Crores for the financial year 2012-13. The high interest expenditure impacts its profitability with the expected ROAE for Financial Year 14 as 3.4% as against the industry average of 13.1%. The alternatives available for DLF are raising equity through REITs and FDI. The advantage of raising funds through equity is that it does not carry a periodic fixed cost and thereby does not prevent the company from making reinvestments in new projects.12

The introduction of REITs by SEBI would give an opportunity to the small retail investors to earn higher returns by mobilising their savings into the real estate industry. Also, with the relaxation of norms of FDI in the real estate industry, the foreign investors, desiring to tap the attractive valuations and returns of the Indian real estate industry, could be a significant source of equity finance for the company.

Green Technology

RecommendationDLF should explore the field of building green buildings by using cleaner and more environmental friendly technologies.

ReasonsWith greater emphasis on clean and green construction, the concept of green buildings has the potential to be the next big thing in the real estate industry. Since the technology is in its

11 DLF - Company Report by Edelweiss Research (October2013)12 DLF - Company Report by Edelweiss Research (October2013)-Balance sheet.

nascent stage, the cost of such construction techniques can be slightly on a higher side. However, since DLF’s properties are majorly for premium customers, marketing and selling such properties should not be a problem for DLF.

Pre-fabricated construction materials

RecommendationsDLF should explore the idea of using pre-fabricated materials in its constructions.ReasonsUsage of pre-fabricated construction materials reduces the construction cycle time drastically.Eg. L&T Construction has successfully achieved close to completion of a prefabricated construction project in Mumbai. In the case of this project, a slum rehabilitation project for the Omkar group, the time consumed for constructing 6 towers of G+23 floors was taken as 22months, including the initial set up time and the manufacturing of the precast unit.13 The caveat here is that, efficiency in prefabricated construction can be achieved only if the entire design, plans and elevations are be conceived in a modular way to achieve efficiency, in terms of cost and ease of production in the process of prefabrication/ mass production. High inventory cycle time shoots up the cost of construction. Hence, significant cost reduction can be achieved by using pre-fabricated construction material.

BUDGET AND FINANCIAL PROJECTIONSBuilders DLF Godrej Oberoi SobhaAdvertisement % 2.5 0.85 1.6 2.5

14

In terms of absolute cost, DLF spends close to 4x the advertisement expenditure by Sobha. Thus a rebranding effort is expected to give better yields on the amounts invested in advertising.

13 http://www.business-standard.com/article/companies/l-t-set-to-build-india-s-first-pre-cast-residential-high-rise-111092500028_1.html14 Oberoi:http://www.capitaline.com/user/subdiv.asp?mainopt=CPLC&StringVal=sac&DType=MAN&cocode=38025&Dispfld=Selling+and+Administration+Expenses++&noofyrs=10&Id=CPLC&seldet=&selpltype=, Godrej:http://www.capitaline.com/user/subdiv.asp?mainopt=CPLC&StringVal=sac&DType=MAN&cocode=15613&Dispfld=Selling+and+Administration+Expenses++&noofyrs=10&Id=CPLC&seldet=&selpltype=, Sobha:http://www.capitaline.com/user/subdiv.asp?mainopt=CPLC&StringVal=sac&DType=MAN&cocode=27443&Dispfld=Selling+and+Administration+Expenses++&noofyrs=10&Id=CPLC&seldet=&selpltype=

In terms of the expected returns on the divesting of non-core assets, the below mentioned table indicates the amount of money DLF stands to gain on considering divesting as a strategy to deleverage.

TIME LINE

We recommend the following timeline for implementation of the above recommendation.

Recommendation TimePartnerships with contractors Immediate

Rebranding 6 months

Exploring green technology For new projects

Usage of pre-fabricated construction materials

For new projects

Divestment of non-core assets 18 months

Monetize assets 36 months

Raise funds through REITs Within 6 months of enactment of the Bill

Raise funds through FDI For new projects satisfying the eligibility criteria

CONTINGENCIES

Delay in launches due to lack of approvals/adverse macro environment Any delay in launch due to approvals/adverse macro-environment will result in continued pressure on operating cash flows.

Inability to monetise non-core assets and deleverage will keep balance sheet stressed DLF has in the past attempted to deleverage its balance sheet without much success – due to a combination of weak market conditions and high price expectations. While the management is hopeful of delivering on its deleveraging plans, any delays in doing the same can strain the cash flows of the company and lead to erosion of NAV and cause underperformance of the stock.

ANNEXURES:i. Table 1: The land bank reserve distribution across the country.

15

ii. Peer Comparison of Financial Ratios.

Company Market Capital (USD Mn)

EV/EBITDA Multiple

ROAE (%)

Debt/Equity Ratio

Inventory Days

DLF 4,333 14 3.4 1.0 1839Brigade Enterprises

104 7 4.4 0.9 684

Godrej Properties 599 9.4 12.6 1.2 1576Jaypee Infratech 396 3.6 22 1.2 1127Oberoi Realty 994 5.2 18.1 0 1112Sobha Developers 518 5.3 18.2 0.6 71716

15 DLF - Company Report by Edelweiss Research (October2013)16 Source – Edelweiss Research Reports for DLF (October 2013), Brigade Enterprises (October 2013), Jaypee Infratech (November 2013), Oberoi Realty (October 2013), Sobha Developers (November 2013); Annual Report 2012-13 of Godrej Properties