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Brigade Enterprises - IPO Our view
Dec 11, 2007

Brigade Enterprises Limited (BEL), a Bangalore-based real estate developer, is issuing 16.6 m shares as part of its initial public offering, which began yesterday and will be remain open for subscription till December 13 2007. The company has priced its offering at Rs 351 to Rs 390 per share. At the higher price band, it expects to raise Rs 6.5 bn from the issue, which will be towards funding its land acquisition and construction initiatives. Here is a brief snapshot of the issue. Company background
Brigade Enterprises was formed as a partnership firm in 1990 and was converted into a public limited company in 2007. It is a real estate development company based in Bangalore (Karnataka), primarily focused on the development of residential, commercial and hospitality properties in South India. Its residential properties include integrated lifestyle enclaves and apartment buildings targeted towards middle income and high income customers. Its integrated lifestyle enclaves include a combination of apartment complexes, commercial and retail space, recreational clubs, parks, schools, convention centres and car parking and which have ranged from 1.6 msqft (m square feet) to 7.2 msqft of developable area. Its commercial properties include office space, software and IT parks, schools, hospitals and retail malls with entertainment facilities, such as multiplexes. The company’s properties in the hospitality sector include serviced residences, hotels, resorts, spas, recreational clubs and convention centres in Bangalore and other parts of South India.

Reasons to apply
Strong presence in Bangalore: Brigade Enterprises has a strong presence in Bangalore. It is primarily focused on the development of residential, commercial and hospitality properties in the city and other locations in South India (Mysore, Mangalore and Hyderabad). The company has built several properties, which have been among the first of their kind in the real estate industry in Bangalore. Also the company is one of the early developers of integrated lifestyle enclaves in Bangalore, which are conceptualised as self-contained, gated communities, generally including a combination of apartment complexes, commercial and retail space, recreational clubs, parks, schools, convention centres and car parking. The company plans to focus on the construction of integrated lifestyle enclaves, as these have been successful as a result of the changing lifestyles and consumer trends in the real estate market. Also majority of the land bank is located in premium localities of Bangalore like Whitefield, which gives the company higher realisations compared to its peers. This we believe is a big advantage, which the company has over its peers.

Focus on hospitality segment: Brigade is also active in hospitality segment with 115 service residences in Bangalore and is also developing three hotels and resorts in South India. The company intends to operate these serviced residences, hotels and resorts themselves and through arrangements with international hotel operators, such as Starwood, Inter-Continental, Banyan Tree and Accor. We believe that this experience will help it in ensuring effective administration and operations of its future serviced residence properties, as well and hotels and resorts.

Presence in multiple real estate domains: The company has presence in development of properties in multiple real estate business domains. It has developed residential, commercial and hospitality properties and intends to capitalise on this experience by continuing to focus on these business domains. Till date, it has developed 41 residential properties including two integrated lifestyle enclaves and is currently developing 14 residential properties, including two integrated lifestyle enclaves, across Bangalore and Mysore. In the commercial segment, it has developed 21 commercial properties, including offices and software parks, and is currently developing 6 commercial properties, including those within integrated enclaves, in Bangalore and Mysore. In the hospitality sector, it has completed the development of two serviced residence properties under the brand ‘Brigade Homestead’, two recreational clubs and one convention centre within its integrated lifestyle enclaves and is currently managing all these properties. The company is currently developing 5 hospitality properties including those within integrated enclaves. We believe that this ability gives the company the edge over the peers in the South Indian region.

Reasons not to apply
Alarm bells from the financiers: The Reserve Bank of India has regularly made clear reference to the strongly expanding market for property loans (housing and industrial property) as part of the reason for raising its key policy rates recently. Since September 2004 the refinancing rate (repo rate) has been lifted by a total of 325 basis points to 7.75% at present. The reverse repo rate, to which many variable interest rates are pegged, has also been hiked to 6%. And since July 2005, property loans have had to be backed by slightly more equity. The risk weight on mortgages has also been raised from 100 basis points to 125 basis points. On the whole, lending terms for banks have thus been tightened up. Any further build up on these rates might lead to a dampening impact on real estate credit, which might especially be seen in second and third tier cities. This is a concern with respect to sustenance of strong performance for company in the future.

The flip side of ‘land banks’: Land banks, like order backlogs for engineering and construction companies, provides visibility for future growth. However, these also contain execution risks. Land, for instance, is a highly illiquid asset. And in times of economic downturns, when land demand and prices move downhill, companies that have built up large land banks at higher prices might have to take huge hits on their balance sheets. This situation is currently witnessed in the US housing market, where several real estate companies have gone bankrupt or are near bankruptcy due to depreciated values of the land banks that they had created during ‘good’ times and the consequent impact on their books.

Investors also need to understand that there is a lag between the time companies acquire land or development rights (build up land banks) and the time that they can construct and develop such project and sell their inventories. Further, the actual timing of the completion of a project may be different from its forecasted schedules for a number of reasons, including obtaining governmental approvals and building permits. In addition, the real estate investments, both in land and constructed inventories, are relatively illiquid, which may limit companies’ ability to vary their exposure in the real estate business promptly in response to changes in economic or other conditions.

Valuations and Recommendation:

NAV Calculation
Particulars Rs m
Net Present Value 39,023
Add: Excess of cash over net debt 3,465
Less: Present value of Land acquisition cost -1,794
Less: Customer advances -2,205
Add: Tax shield on land acquisition 610
Market value 39,099
Number of shares (post issue) 111
Market value/share 353

We have arrived at a value of Rs 353 per share, which is almost equal to the lower end of the price band (Rs 351). The property prices we have assumed are lower than the prevailing market rates as we expect property prices to soften in the near future. Secondly, most of the land bank is in Bangalore, so the company is prone to downturn in the Bangalore real estate market. However, one year forward NAV comes at Rs 389 giving a return of 11% on the lower end of the price band. As such, investors who have high appetite for risk can APPLY to the issue at the lower end of the price band.

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