High Debt - A Concern - Unitech

The management of Unitech currently seems to be in distress and whatever has happened to the scrip since January 2008 it is apparent. Unitech, which rallied only one way during bull-run preceding the current slump to help its promoters become one of the richest families in India has lost 95 per cent of its market capitalization since its peak and the bigger issue is still here are no takers for the counter. While the displacement from the richest Indians list is a personal issue, on the professional front the management is facing two burring issues in the current scenario of liquidity crunch. First is to raise money to continue building houses and second is to find buyers for the homes they build. If the management gets this two things right, life could be smooth sailing. But the situation is so adverse that neither of the two seems to be moving in their direction. In the present adverse macro environment of high interest rates and tightening liquidity, developers are already witnessing lower sales of residential properties. With 77 per cent of its land bank dedicated to the residential properties the slowdown is expected to impact Unitech hard. Now we feel these factors along with high leveraged balance sheet and unsteady cash flows of the company are going to be the major worries for Unitech. In addition, it has a short-term liability amounting to Rs 2850 crore and with even the smaller projects getting delayed, slower volume growth, banks unwilling the restructure the loans and inability to list its planned RIETS, life is expected to be difficult for Unitech. Although the recent stake sale in telecom venture seems to be a silver lining and is expected to made up for some of the debt repayments, the execution of the project in longer term is still the concern.

The Company
Unitech is one of India's largest, probably most diversified real estate developers with a pan-India presence. As regards its land bank, Unitech has a land bank of 13,758 acres with total saleable area of around 696m sq ft spread over pan India. While residential projects account for about 77 per cent of land bank, commercial is around 8 per cent, IT Parks constitute 8 per cent and retail is 7 per cent. It is true that the company is having a huge land bank and NAV of the same will be on the higher side there are certain issues which we need to consider. First as there is a slowdown in the real estate sector there has been a dramatic shift regarding the valuation of the companies. With shortage of funds impacting the execution capabilities of real estate players analysts have started valuing the near term projects up to 2 years only. Now following are other issues bothering Unitech.[PAGE BREAK]

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Slowdown in residential segment - Hitting hard
Historically, residential development has been Unitech's mainstay. Its total planned development of 696 mn sq ft constitutes around 533mn sq ft of residential development. Now this asset light strategy helped the company in booming markets, but fails in current situation of liquidity crunch. Now what is the risk related to this? With slowdown in the residential segments, Unitech is expected to face difficulty in realising cash flow from future sale of residential properties. In addition, Unitech's ongoing projects portfolio caters to the luxury segment, having lower absorption rate leading to strain on volumes. This can be seen from the fact that Unitech has been able to sell only 340 apartments (5 per cent of overall planned apartments) in its recently launched project 'Unitech Grande'. Now the slower absorption rate has also forced the company to delay few of future launches. In addition as Unitech has been outsourcing construction it not only resulted in higher cost but also in lower check on timelines so the further delay is not ruled out. Now although the management has stated that it will focus on affordable housing it is too little and too long to generate cash which is the need of  the hour.

Strained Balance Sheet
As stated earlier, in the current scenario debt as well equity funding has become limited and with already high debt levels we feel higher risk is emerging for Unitech. We feel the liquidity crunch will intensify further with new projects requiring more funding and diminishing transaction volumes intensifying the difficulties. At present with total debt of Rs 10100 crore, Unitech is amongst the most highly leveraged property player with Debt/Equity ratio of 3.80x. Although Rs 2000 crore is related to its telecom subsidiary and the recent stake sale is expected to change the situation, we feel the short-term issues are yet to be solved .Now there are certain important factors which one should notice. We also feel that its interest cost will increase significantly as Rs2850 crore (Rs 2630 short-term debt + Rs 220 crore land repayment) of short-term funding is nearing refinancing. The rising interest cost is also seen from the fact that interest out go for H1FY09 is Rs 295 crore as compared to Rs 156 crore in H1FY08. Now, Unitech's present cost of debt is 12-14 per cent, we feel in the current scenario, incremental debt will be raised at a higher rate only.In addition the company is also unable to raise funds through other sources. Now as stated earlier the company has more of residential assets, but the company has also not managed to monetize its commercial properties. Post listing of Unitech Corporate Park (UCP) in December 2006, Unitech is facing challenges in monetising commercial assets. While the UCP is already down 50 per cent on AIM, the situation is worse as delay in listing of Unitech Office Trust (UOT) and planned QIP has weakened cash situation.

Sale of Telecom Stake- A Silver Lining
Unitech has recently entered into agreement with Telenor (One of Norway's largest telecom companies), for the sale of up to 60 per cent controlling stake in its telecom venture 'Unitech Wireless' for Rs 6120 crore. This values the telecom venture at equity value of Rs 10200. This equity will be injected in four tranches and will be completed by September 2009. Regarding the impact on Unitech balance sheet, till date Unitech has made an[PAGE BREAK]

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equity contribution of Rs138 crore and raised debt of Rs 2000 crore for its telecom venture. Post the stake acquisition by Telenor, the telecom venture will transfer Rs 300 crore to Unitech, which was earlier given as debt to the telecom venture. Rs 500 crore of debt will remain on Unitech's balance sheet as loan to the telecom subsidiary and the remaining Rs 1200 crore will be transferred to the subsidiary from Unitech's  consolidated balance sheet to telecom venture. We feel, with cash flow of Rs 300 crore from the first tranche of the stake sale (expected by end of December  '08), the stake sale seems to be positive for the stock giving it some breather. But again, any further capital commitment by Unitech to fund the telecom ventures, where it plans to invest Rs 15000 crore over next three years, would impact the stock. Unitech intends to launch services in H12009 but looking at the tough competition in the Industry it will be bit tough for the company to make its impact. The valuation of telecom subsidiary results in Rs 14 per share.

Financial Performance
On the financial front Unitech has not managed to impress with H1FY09 results as while the topline remained stagnant due to lower volumes and bottomline has got impacted by higher interest outgo. With lower sales volumes, the next few quarters are going to get affected. Now although the counter has corrected a sharply and valuation of telecom venture caps the down side, we feel even the upside is also capped pertaining to poor sentiments in the sector. Hence with many other blue chip counters available at cheaper valuations we recommend the investors to avoid the counter at current levels.