STREET VIEW: DLF is looking to take a stake in DAL

We present to you the views of different analysts across brokerage houses.

CSFB
The story so far …
DLF Assets Ltd (DAL), a promoter company, entered into an agreement to buy 13 mn sq ft of commercial assets from DLF at a 9% cap rate. Against this, DLF recognised revenues of Rs101.7 bn between FY07 and FY09E at an average rental of Rs58/sf/m and PBT of Rs68.2 bn (~Rs40/share). Of the 13 mn sq ft, 9 mn sq ft is to be completed and ~6 mn sq ft leased by March 2009. The purchase was financed by about Rs1 bn in promoter equity, Rs43.5 bn in private equity (PE) from D.E. Shaw (US$400 mn) and Symphony (US$675 mn). The total outstanding from DAL to DLF is expected to be about Rs57.2 bn (US$1.1 bn) as of March 2009.
Valuation loss due to adverse cap rate movement
Cap rates and valuations have moved adversely since DAL contracted to buy at a 9% cap rate from DLF. Yields for listed Indian commercial assets currently range from 13% to 20%. We believe the fair valuation for DAL today could be somewhere between 11% and 13% cap rate resulting in a Rs19-32 bn erosion in DAL’s asset value.
Loss on private equity transaction
Media reports suggest D.E. Shaw wants to exit from DAL and that it has been promised a USD-protected return. We estimate the potential loss on an assumed 12.5% return to be about US$172 mn on the D.E. Shaw investment. While we do not know Symphony’s terms, we estimate a further potential loss of about US$209 mn if it were on similar terms as D.E. Shaw’s.

Reliance Equities
Merger likely to result in a dilution of 10–15% in DLF. The DLF-DAL merger is likely to result in dilution of 10–15% in DLF (assuming DAL’s are valued at the sale price). DLF had sales of Rs 106.2 billion in FY08–9M FY09 (out of a total transaction value of Rs 150 billion) to DAL. DAL paid Rs 51.6 billion (entirely through private equity funding), while the rest Rs 54.6 billion is yet to be paid (receivables). The merger would bring DAL assets on DLF’s books, while DLF shares would be issued after netting the receivables.

Morgan Stanley
What may happen – OPTION 1: DLF could take a partial equity stake in DAL in lieu of receivables. OPTION 2: DLF could buy the entire equity of DAL and merge the company. In option 2, the valuation at which DLF would acquire DAL and who would pay for the difference will be the key. It appears that DLF could buy back the assets at a meaningfully higher cap rate (12% or so), implying 30% or so lower value.
What would this mean for DLF – In option 1, not much would change for DLF except that receivables would get promoted to investments. In option 2, P/L impact – DLF would get rental flow of Rs 6 bln pa (available to securitise), B/S impact – assumes $1.05 bln debt (DE Shaw/Symphony) and assets sold to DAL. Valuation difference would either result in book writedown (DLF bears the cost) or new receivable/cash (promoters bear the cost).
Our thoughts - We think that DLF should transition its business model to ‘third party’ sales and mark down its historical DAL sales to market value. Intrinsic value of 9.5 msf of now completed DAL assets is roughly Rs60 bln at 11% yield vs Rs110 bln booked by DLF. Stay U/W