PROJECT APPRAISAL AND FINANCE

Lavasa: Indias First Planned Hill City

(LAVASA CORPORATION HINDUSTAN CONSTRUCTION GROUP)

Report Submitted by: HARIKRISHNAN 10AC12

JAGADEESHKUMAR M 10AC13 SATHEESHKUMAR SIVARAMAN M VIGNESH N S 10AC31 10AC36 10AC42

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Table of Contents: (i) Introduction a. Company Background b. Project Concept c. Project Cost and Means of Finance d. Current Status of the Project (ii) (iii) (iv) (v) (vi) (vii) Question 1 Capital Structure Question 2 Financial Instruments Question 3 Sources of Finance Question 4 Internal Accruals Question 5 Internationalisation References

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Introduction:
Company Background: Lavasa Corporation Limited is jointly promoted by Hindustan Construction Company Ltd (HCC)- through its subsidiary company Hindustan Real Estate Limited (HREL), apart from Venkateshwara Hatcheries Pvt. Ltd. (VHPL), Janpath Investments Ltd (JIL an Avantha Group company), and Mr. Vinay Vithal Maniar (a trader and developer based in Pune). HCC, through its subsidiary and group companies, holds 65.01% stake in LCL. HCC is one of the largest private sector construction companies in India and specializes in construction of technologically complex and long gestation projects such as surface transport, hydel and nuclear power, marine works, and water supply. Project Concept: LCL is currently undertaking a project to create an integrated hill-station township Lavasaadmeasuring around 13500 acres, providing residential and business/leisure tourism and educational infrastructure close to Pune. LCL aims to offer all the necessary support facilities and infrastructure to become a self-contained township and tourism centre. LCL plans to develop the residential apartments and villas by itself and then sell it. For hotels and other institutions, it plans to develop it through different SPVs. The company is in the process of forming various SPVs (Special Purpose Vehicles) for implementing various commercial ventures in the project. The residential apartment and villas will be booked in advance and will take around two years from booking to be ready for possession. The exact number of residential structures constructed in a particular season will depend upon the bookings. The total project is envisaged to be taken up in various phases, the time period of which will span till 2021.The Phase I of the project, viz. development of Dasve village is proposed to be implemented by FY11. The project has been conceptualised with the help of the services of HOK, USA - a leading global provider of design and project delivery services across a network of offices in North America, Latin America, Europe and Asia. Project Cost and Means of Finance: The company has revised its execution plans and now intends to increase the development speed of Phase I (Dasve) and advance the development of Phase II (Mugaon). Phase II was originally planned to start the development in late FY11. Thus, due to advancement of Phase II and speedy completion of Phase I, the total developmental cost to be incurred till FY14 will be about Rs.6547 crore (till FY14) which is proposed to be funded through equity of Rs. 825 crore, internal accruals/developmental revenue of Rs.3820 crore, debt of Rs.1077 crore and DDCD of Rs.825 crore.

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Current Status of the Project: LCL has already acquired approximately 11410 acres of the planned 13500 acres. Out of the 2090 acres remaining to be acquired, only 94 acre pertains to the land to be developed under Phase I (Dasve village). The road network, civil works the water treatment and sewage treatment plants have been completed. The planned dam has been built and the water pipeline network has been laid down. The electricity distribution system and sub-stations are in place. LCL has already been able to tap electricity from the MSEB transmission line which passes through nearby area. The company has also entered into a power purchase agreement with Tata Power for the supply of electricity. LCL received most of the major approvals required for the development of Lavasa, viz. environmental, forest, pollution, quarrying and Irrigation dept. clearances. It has also been declared as special planning authority by the Government of Maharashtra. The company has already started bookings. As of now the company has sold around 829 villas / apartments. Total bookings already received by the company was recorded at Rs.941 crore with sales of Rs.212 crore. The company spent Rs.1801.78 crores on the project which was met through equity of Rs.431.47 crores, DDCD and bank loan of Rs.461.14 crore and Rs. 613.93 crore respectively, while the remaining amount was through creditors.

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1.

Is the capital structure appropriate for the project?

Lavasa Corporation Limited has established an appropriate capital structure with proper balance of long term sources in accordance with their needs. This is evident from the following interpretations.  Total Capital: Total Shareholders Funds = Rs. 54,335.42 Lakhs Total Loans = Rs. 177,595.03 Lakhs Total Capital = Rs. 231930.45 Lakhs Interpretation: Lavasa Corporation Limited has used long term loans as a main source of finance than the equity and preference shares. This is due to the fact that the interest repaid on the loan is tax-deductible. This means that it shields part of the business income from taxes and lowers the tax liabilities every year. The interest is also based on the prime interest rate.  Debt-Equity Ratio:    

 = 3.268 Interpretation: Debt to Equity ratio of 3 implies that LCL has been aggressive in financing its growth with debt. If this were to increase earnings by a greater amount than the debt cost (interest), then the shareholders will get benefited. However, the cost of this debt financing may outweigh the return that the company generates on the debt through investment and business activities and become too much for the company to handle. This can lead to bankruptcy, which would leave shareholders with nothing.  Debt-Asset Ratio:    = 1.138 

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Interpretation: Slightly greater than 1.0 means the company has negative net worth and this implies that the company is exposed to certain risk factors. Some key risks are discussed below.  Degree of Operating Leverage:  



= 1.074 Interpretation: The contribution margin is nearly equal to the net operating income, since the project level is in the initial level of growth and sales.  Degree of Financial Leverage: 



= 1.866 Interpretation: The Company can expect a 1.866 change in EPS for every 1% change in EBIT. The fixed financing costs are met by debt rather by net operating income and hence the financial leverage is comparatively less. Key Risk Factors 1. Construction Risk: Construction work has already started as per the master-plan and the designs procured from various architects. The time-line of construction of various elements of the project would depend upon the demand generated by the project. 2. Market Risk: The project is in the initial stages of development and with sales tenure of 1520 years. LCL tested the market by opening bookings for a limited number of plots/villas, and received good response, as supply was highly limited. Also, the company has, so far, been successful in attracting various educational institutes and hotels to offer their services in Lavasa. However, as the company plans to develop the area as a township, its ability to create a market for permanent residents and commercial activity, apart from attracting tourists, will be one of the key factors dictating the viability of the project. The market risk is also augmented by the fact that, the project is situated at a fair distance from Pune -50 Km and Mumbai -150 Km, and thus,

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for people to reside in Lavasa, the town needs to develop sufficient commercial activity to sustain as a self-contained economy. As on June 30, 2009, Lavasa has leased out spaces for the retail outlets including food and beverage outlets. 3. Economic scenario: Indias GDP has been growing @ 8% for the past 3-4 years which has also led to a slew of activity in the tourism sector. Also, the past few years have seen a steep rise in the real estate prices and huge investments being attracted by the sector. Lavasa, as a project, relies heavily on the fate of the tourism and real estate market, which in turn is a function of the level of economic activity. Any slowdown in recovery of the countrys economy will have a substantial impact on the viability of the project, as tourism and buying of second homes would flourish only in a healthy economy. 4. Political Risk: Any intervention by political parties or social activists could hamper the development of the project. Now the company has been held up with environmental clearances 5. Real Estate Prices: Although the project is located away from any of the existing real estate markets, any downfall in real estate prices in the near-by markets will have an impact on the realizations of the project. The prices, of course, would also be governed by the demand that the city is able to generate. 6. Financial Risk: The ability of the project to meet its financial commitments depends largely on the success of the promoters in developing the township as a self contained area. Further, since the debt repayments are time bound, whereas the sales of the various elements of the project depend on the booking status, any delays in the project implementation schedule might affect the debt repayment ability of the project. To cushion against this uncertainty, the debt repayments have been guaranteed by the promoters by way of corporate/personal guarantee, put option on HCC apart from the revenue proceeds being generated by the project. (Word Count: 841)

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2. Were appropriate financial instruments used? Lavasa Corporation Limited being an infrastructure company has more of tangible assets and hence the source of financing is done more through debt. Sources of Finance Equity Shares Cumulative Redeemable Preference Share Capital Compulsory Convertible Preference Share Capital Reserves and Surplus Secured Loans y Term loans y Debentures Unsecured Loans y Short Term Loans from Financial Institutions Total Rs. Lakhs 4724.46 2725.00 2500.00 43573.56 68098.22 89496.81 20000.00 231117.95

1. 2. 3. 4. 5.

6.

Source: Balance Sheet Those tangible assets can be easily liquidated to pay back the debt. Hence we claim the financial instruments used were appropriate. LCL has raised Rs.950 crore debts via issuance of DDCDs (Deep Discount Convertible Bonds) to various finance institutions. Key Features of DDCD The Investor shall have an option to convert the DDCDs into Equity Shares of the company within 5 years from the date of subscription or on the happening of an IPO. The conversion amount shall be calculated based on rate of return as agreed among the parties involved, compounded annually on the amount invested as DDCDs. The stake of investor shall depend upon the time of conversion, status of initial public offering and mutually accepted valuation of the company at that time. The investor and the parent company i.e Hindustan Construction Company Limited (HCC) shall have a put and call option respectively to sell/purchase the DDCDs at the end of 39th month, 48th month and 60th month of closing date. The redemption price will be based on the pre agreed (with investors) rate of return compounded annually, from the date of investment till exercise of option, on the amount invested as debenture. The redemption amount will be net of amount of coupon and upfront fees paid to the investor till the time of redemption. To reduce the coupon payment risk, LCL, for the DDCDs of Rs.950 crore to be issued has proposed the following arrangement for the repayment obligation of the coupon portion during the interval of the DDCDs being in force: (i) The company proposes to create Fixed Deposit for 1 year which will be created at the time of placement of the DDCDs and after receipt of subscription money within 2 working days

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and mark lien on the same in favor of the investor and to be rolled over till the exercise of put option date by the investor or conversion into equity shares whichever is earlier. (ii) The company would, create a FD to the extent of coupon payment for 1 year. Special Agreement: Axis Bank and Lavasa Corporation If Lavasa doesnt list any of its shares on any stock exchange within 5 years of the closing date or HCC fails to honor the put option given to the Axis Bank at the end of third, fourth and fifth years, Axis have the rights to convert the DDCDs. All the holders of DDCDs other than United bank, have either agreed to prepayment of DDCDs, or have given consent to convert the DDCDs held by them into equity shares or nonconvertible debentures of the company. Deep Discount Convertible Bonds: Name of the Bank Date of Issue Agreement Price Rs. (Mn) June 26, 2008 2250 Sept 23, 2008 1500 No. of Status DDCDs One One Equity Status 40% Equity conversion and 60% repayment NCD or any other debt instrument Equity Conversion Prepaid Either to be prepaid or NCDs (12.5%) Equity Conversion/NCDs 50% Equity and 50% NCDs Converted into NCDs

Axis Bank Bank of India

Allahabad Bank IndusInd Bank Andhra Bank United Bank of India Allahabad Bank ICICI

Dec 10, 2008 July 7, 2009 July 24, 2009 Aug 5, 2009 Oct 23, 2009 Dec 31, 2009

500 500 250 500 500 2500 1000 9500

One One One One One Ten One

Jammu & Kashmir Bank Mar 25, 2010 Total Source:RHP (Word Count: 633)

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3. Were the pros and cons of public and private sources of capital duly examined? Lavasa Corporation has raised much of the funds from private source of capital. Private equity funds operate in a market with a significantly lower degree of efficiency and liquidity. Since Lavasa Corporation is promoted by Hindustan Construction Company with a steady cash flow, private equity is ideal. Also it takes a long term to realize the benefits in Infrastructure Industry, so Lavasa has chosen private funds as a major source of finance. Because the investments often involve the acquisition of a controlling interest costing several millions of dollars, private source opportunities are generally more appropriate for large institutional investors with the time and resources to evaluate the potential risks and returns, and the patience to wait 10 years or longer to maximize. Lavasa has managed a balance between the public and private sources of funds. The Company has also raised equity shares. They have raised a sum of nearly Rs 10000 Lakhs. These funds can be helpful in managing the capital expenditure at a relatively low cost. Lavasas capital expenditure requirements exceed the available resources to an extent, and they are in the process of seeking additional debt or equity financing. Additional debt financing could increase the interest cost and it requires complying with additional restrictive covenants in the financing agreements. Additional equity financing could dilute the earnings per share and the value of investment in Equity Shares could be adversely affected. Lavasas ability to obtain additional financing on favourable commercial terms will depend on a number of factors, including:  Future financial condition, results of operations and cash flows;  The amount and terms of existing indebtedness;  General market conditions for financing activities by integrated city development companies; and  Economic, Political and other conditions in the markets in which they operate. (Word Count: 297)

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4. To what extent were internal accruals used as a source of finance? Historically, Lavasa Corporation has financed the project through (i) (ii) (iii) Cash from operations Sale of equity shares of Lavasa and its Subsidiaries or Associates Debt financing through bank loans and issuances of convertible debentures.

Long Term loans constitutes the integral part of finance which constitutes 77% of total funds raised, While the equity part and retained earnings forms just 4% and 19%. Further, a development of the scale of Lavasa requires large upfront investments and includes long periods of time before revenues are realized. Significant amount of capital expenditure incurred in the initial years, largely accounts for the purchase of land and infrastructure development. As there are gaps in time between our initial investments in projects and revenue recognition, funding requirements are substantial. Lavasa Corporation Limited has also used accumulated retained earnings as a source of finance. This is evident from the amount invested in infrastructure development of the hill city. Of the Rs. 43,573.46 lakhs available accumulated retained earnings, Rs. 10579.89 lakhs was invested in this project. This accounts for only one fourth of the accumulated Reserves and surplus. Lavasa has invested a little in the associate companies and long term investments (Pune Toll road), Shares and Mutual Funds. (Word Count: 204)

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5. How much should internationalization?

the firm depend

on

the domestic capital as against

Lavasa Corporation has engaged in a joint venture with Space Investment Co. Limited, Dubai to set up space world projects in lavasa. The JV Company will be engaged in providing entertainment, lodging, shopping and training to visitors through various modules under licensing agreement, support and business operations guidelines from the SIC and the United States Space and Rocket Center (USSRC). The parties have further agreed that for a period of three years from the commencement of operations in Lavasa. Lavasa Corporation and SIC holds 19% and 81% respectively in the JV Company. Also LCL has been in an agreement with SIC for setting up a Theme park (Space Theme Park India Limited). Lavasa Corporation holds 40% of the equity share capital of Space Theme Park India Limited and SIC holds the balance 60%. Lavasa Corporation and Bennett, Coleman & Co. Limited (BCCL) has entered into a share cum warrant agreement dated March 30, 2009. In accordance with the SW Agreement, BCCL agreed to subscribe to 10 shares of Rs. 10 each at a premium of Rs. 2,107 each and one warrant for a consideration of Rs. 81,250,000. Lavasa Corporation has entered tie-ups with some of the renowned organizations to internationalize their project. They are listed below. Hockey Academy: Lavasa Corporation Limited has partnered with Hockey Australia to develop a Hockey Academy in the hill city. This was intended to develop Lavasa as Indias most modern city with infrastructure facilities that will appeal to prospective residents and tourists. The setting up of a world class academy with Hockey Australia is to forge the best in class global tie ups to promote Lavasa. Football Academy: Lavasa Corporation has tied up with Manchester United to develop a football academy in the planned hill city. Sir Nick Faldo Golf Academy: Sir Nick Faldo (Legendary golfer) will be personally involved in setting up the Golf Academy and in the construction of the golf course. The Faldo Design Golf Academy will offer a specialised curriculum based on Sir Nick Faldo's core values as a player. A team of Faldo certified instructors would be stationed in the hill city to provide expert instructions. Faldo Design is a leading international golf course architectural practice dedicated to designing outstanding golf courses.

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Sir Steve Redgrave Rowing Academy: Lavasa Corporation has signed an MOU with Britains greatest Olympian and global sporting icon Steve Redgrave to launch the Sir Steve Redgrave Rowing Academy. The five-time Olympic champion and global sports management firm IMG will look into the key areas of organisation, planning, building and development of the academy structure. Other tie ups: Oase A leading water fountain design firm from Germany is designing a multi media fountain at Lavasa. This incorporates a laser and sound show along with a 60 meter central jet. When operational, this would be the world's highest fountain. Ecole Hoteliere Lavasa Lavasa Corporation hosts one of the world's oldest & most renowned names in hospitality training the Ecole Hoteliere de Lausanne. With its second batch of classes commencing on 1st July 2010, Ecole Hoteliere. Lavasa delivers international standard training and certifications. Its graduates can also acquire their international Master's degree internationally here. DoubleTree Hilton A 5 star boutique hotel from the well known Hilton group that would be operational by the end of 2011 with a capacity of 125 rooms. Lakeshore Water Sports The water presents you with an endless opportunity to indulge in a whole host of thrilling activities. This fullyequipped, stateoftheart, water sports facility Lakeshore, Operational since Dec 08. (Word Count: 590)

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References: y y y y y y y www.hccindia.com/lavasa_corporation.php www.sebi.gov.in/dp/lavasadraft.pdf www.lavasa.com/high/tie_ups.aspx www.lavasahillcity.com/ www.lavasa.com/high/reports/LAVASA%20Full%20AR%202010.pdf http://www.careratings.com/Current/1/9883.pdf CMIE Database

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