Some insights into the Unitech Telenor transaction

At a first glance when I looked at the transaction, I thought Unitech made a killing in the transaction, however taking a dip into the transaction reveals a different story. Below are a few reasons why I think that the transaction was a very desperate move by the real estate company to lower it debt in this tight market condition.
1. Comparable Valuation

Above is a list of transactions that have happened in the telecom sector recently with the valuation multiples. There are a few other transactions for which we do not have the valuation multiples, but the press notes say that all of these transactions in the telecom space attracted rich valuation multiples.
According to industry sources (Economic times), Unitech got a valuation of 7x of what it paid for acquiring the telecom business. However the valuation of 7x is superficial. It doesn’t factor in the un-accounted money Unitech must have paid to get the telecom license.
How can I say that there is an un-accounted component?

a. Companies were chosen on a first come first served basis to allocate spectrum. No auction process was held, even though Prime Minister Manmohan Singh publicly stated his preference for an auction process.
b. The cut off date for applications was preponed leaving a window of only few hours to receive fresh application.
c. The spectrum was given away at throw away prices.

Thus it is anybody’s guess that the actual valuation multiple that Unitech received for its telecom business was much below the 7x multiple quoted. To read more on this please refer to http://www.business-standard.com/india/storypage.php?autono=339837http://www.business-standard.com/india/storypage.php?autono=338815

The table above shows that mean valuation multiple for telecom business in India is 5x. With one of the lowest level of telecom penetration levels among the emerging countries, telecom sector attracts huge multiples.
Looking at the market multiples, It is evident that Telenor struck a good deal.

2. Statement by Unitech ManagementAt the time of acquisition of the telecom spectrum, the Unitech management had clearly mentioned that the wireless business would be an integral part of the company’s operation.

3. Debt scenarioPlease read my last post on Unitech’s sale of the telecom business.Thus the sale of wireless business by Unitech was a calculated and a desperate move.

Selling of non-core activities

a) Unitech

Unitech sold 60% stake in its telecom venture for Rs 6120crore to Norwegian telecom firm Telenor. The deal reduced Rs1200 crore of debt from Unitech's balance sheet and also reduced the interest burden. Following the transaction Unitech's share rose 7% when the share prices of its peers reduced by 3 -4%
Unitech is a highly leveraged company. Unitech's current debt (post the telenor transaction) amounts to Rs 6917cr, D/E ratio now stands at 3.2x
With PE investments drying up and marginal cost of debt being (15% - 30%)* for the real estate players it is anybodys’s guess what made Unitech offload a majority stake in telecom business.

b) Emami
Economic times on 26th October reported that Emami is in the process of exiting from the real estate business by selling 100% stake of its wholly-owned subsidiary, Emami Realty. It is in talks with other parties for selling the stake of the company in the realty firm.
Real estate accounted to Rs 463.2 crore to Emami's group topline and Rs 18.2 cr as PAT.
Companies whose core business is not real estate might look to exit from the real estate sector and Real estate companies who have a diversified portfolio might look at concentrating at one or two core businesses. This looks like a trend whenever there is a major shakeout.
This only follows the most basic theory of economics, that in the short term due to supernormal profits a lot of players might enter an industry/sector. However in the long term only a few survive.

Innovative ideas of raising funds

We see real estate companies adopting innovative strategies to sell existing stock and to raise funds. Lets dissect one such strategy adopted by Landmark group a construction company.
In a bid to raise funds in this tight market, the company has come up with a very innovative design of raising convertible debt (if I can put it that way) from retail investors.
Landmark group assures a 66% return to investors in 3 years. This would mean a 22% return per year on a simple interest basis and only 18.4 % on a compounded basis. Things still look good.
Now, the ways the transaction has been structure is such that an investor gets INR 72000 per year for 3 years, this works out to 12% interest rate (Compare this to a fixed deposit interest rate of 11% offered by banks), after the third year, the group promises to buyback the asset from the investor at a 30% higher price.
Factoring this additional return (30% mentioned immediately above), the investor gets an IRR = 15.57% from his investment. In other words, this is a neat way of raising money from the market at a cost of 15.5%.
Cost raising fund 15.5% at a time when real estate developers are finding it extremely difficult to raise funds. The marginal cost of debt for real estate players as reported by Economic times is between 15% - 60%. KP Singh, Promoter DLF in his statement mentioned that DLF’s marginal cost of debt is 15%.