While the proposed integration of the DLF group’s commercial rental assets under one entity will no doubt ensure a steady revenue stream for DLF Ltd in the long term, the deal is skewed in favour of the promoters on many counts.

Post-merger, DLF’s subsidiary DLF Cyber City Developers Ltd (DCCDL) in a cash less transaction will be integrated with the promoter-held Caraf Builders and Constructions Pvt. Ltd, which in turn owns DLF Assets Pvt. Ltd (DAL).

The problem lies in the valuation. Analysts says the valuation of land in DCCDL is conservative compared with completed projects. In a 19 December report by IIFL (the institutional equities division of India Infoline Ltd), analysts point out, “This has led to lower valuation to the tune of Rs4.5 billion (Rs450 crore) for DCCDL land bank." This obviously implies lower valuations for the firm.

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Further, as the ownership of DAL shifts from the promoter (Caraf) to DLF, so will the debt. DLF’s debt, which is around Rs14,000 crore according to the management, will increase by Rs2,200 crore. The private equity investment which is housed in DAL in the form of compulsory cumulative preference shares also shifts to DLF. A major chunk of this investment is the Rs2,725 crore held by SC Asia.

In fact, post-merger, DLF will continue to carry DAL receivables on its books. The IIFL report states, “Since only 6.4 million sq. ft of DAL’s portfolio was valued, DLF’s receivables were not set off against DAL’s equity and will continue to be an overhang."

The group’s move to raise monies in DAL through a real estate investment trust (Reit) listing in Singapore around two years ago was to ease the situation. Unfortunately, due to bad market conditions, the plan was shelved. Market sources say that the merger paves the way for this listing going forward in the next six months. The presentation on the company website also states that potential investors investing in DAL preferred DLF as the sponsor for its listing. An analyst with a leading foreign investment research firm states that DAL would have to cough up at least $1 billion (Rs4,690 crore) in the next 12 months to set its house in order. But the Reit listing will certainly help.

The integration of assets will also strengthen DAL’s portfolio. DAL has a leased area of around 6.4 million sq. ft while Caraf holds around 3.3 million sq. ft. These assets, when combined with 6.7 million sq. ft of commercial building space held by DCCDL, will result in rental space of 16.4 million sq. ft. While this will increase the revenue stream for DLF by around Rs400-500 crore per annum through its 60% shareholding in the commercial arm, the profile of assets will add to DAL’s future potential. While DAL’s asset profile comprises of mainly the four special economic zones, DCCDL assets, which include commercial and retail space, besides an additional 11.83 million sq. ft of land, will add value to DAL’s asset profile.

The issue, though, is the valuation of the merger. Consequent to the 60:40 valuation, minority shareholders of DLF will have a 60% economic interest in the merged entity with promoter K.P. Singh’s family having the balance.

Several analysts have been critical of this ratio, stating that it goes against the interest of the minority shareholder. Most feel that a 70:30 ratio would have been a fairer valuation.

According to a report by Centrum Broking Pvt. Ltd, “our assumptions indicate that a fair merger ratio would be 68:32." Small wonder then that the share price has reacted negatively to the announcement. Over the week, the stock lost ground from Rs382 to close at around Rs355.

Graphics by Naveen Kumar Saini / Mint

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