Master Planning & Private Equity Case Summary

Summarize the case in points

Rahul Todi of Shrachi is considering the prospects of developing land near Bardhaman, West Bengal. Residential demand has been steadily increasing in India, with a trend toward urbanization reflected by a rising middle class that is settling in the cities where job and cultural opportunities are promising. The parcels of land that Todi is watching could potentially be developed through a partnership with the West Bengal Housing Board, a government entity that has as one of its goals the development of low income housing. On the flip side, Todi has entered the idea of partnering with Xander Funds, a private equity group that invests in real estate and other asset classes.

Should Rahul Todi and Shrachi leave their Kolkata base to develop in Bardhaman at all, in any form?

The vision that Todi has for the land assemblage project -- whereby small plots of land are aggregated and reorganized for real estate development -- is a an homogenized township, the units of which could command increasingly high prices as the development progressed.

What could go wrong?

A concern that Todi harbors is that relations between farmers, industrialists, and politicians in Bardhaman area was contentious in the recent past as a result of unscrupulous seizure of private land by the government in order to encourage industrialization by a car manufacturer. The local residents and farmers still resent the Tata Motors factory upset. Todi realizes that working with either financial partner could impose constraints and conditions of which he, as an independent developer, has not had to address. Certainly, the prospect of future deals with either of these two firms is also playing in Todi's head.

Homes Away From Home

What is your analysis of the potential for this city and for this site as plotted development built out by Shrachi as contemplated?

As Rahul Todi considers the land development opportunity, one factor dominates. The Bardhaman development is far away from the Kolkata base of the Shrachi enterprise and from Todi's network of business acquaintances, suppliers, and his home. The local Bardhaman residents and elected government contribute complexities that Todi would not encounter should he stick to real estate developments closer to his home base. The primary issue appears to be the degree to which a development can attract residents from the rural countryside and from the more urban areas, such as Kolkata, Katwa, and Kalna. The roads to the Bardhaman area are described as adequate to support a one to one and half hour commute. While this may be acceptable by Western standards, it may not be possible for a worker in a nearby urban area to commute to a residence in Bardhaman on a day-to-day basis. Regardless, projections for population growth in urban areas of India are upwards of 400 million people. The pressure to expand outward from city centers is likely to be profound. In addition to this pressure, there are growing environmental concerns that are likely to work against housing more people in overrun cities. The anticipated demand for housing units is 7.5 million units per year by 2013, across all housing sectors. What these figures indicate is that the demand for housing and environmental constraints are conditioning the rural and semi-rural areas, increasing the likelihood that development in these areas will be profitable in the near-term.

The potential for this township in Bardhaman presents as very positive with regard to ultimate outcome. Todi will need to proceed with great care, however, as the people in Bardhaman have been burned by their own government in the Tada Motors incident. For this reason, land assemblage may turn out to be one of the more difficult steps in the development process.

In Todi's favor, another developer from Kolkata has already progressed through the assemblage, reorganization, and selling of raw plots of land in a parcel nearby the area under consideration. A key decision is whether any of the homes should be constructed as affordable housing, or whether the development should contain a mix of low, mid, and luxury housing. This decision will be levered by the knowledge that approximately 85% of the total residential demand is affordable and mid-level segments. For this reason, these types of houses are make up the lion's share of development in the area.

Public or Private Partners?

India is in a unique position in her own history. The term "growth" means increases in the Indian economy, the Gross Domestic Product (GDP), and the real estate market -- which has become India's second-largest employer. With a growth rate of 30% year-over-year,...

And there was plenty of room to grow as only about 20% of India's land has been developed.
Todi faced a number of possible and promising configurations for funding. And he also had the option of just going it alone -- building the visionary township he desired or just selling the reorganized lots to self-builders. Todi viewed the township build out as a value-add for India -- he saw a positive contribution that he could help bring to fruition. The benefits of partnership in this venture would primarily be fiscal, although working with a government entity as an investor in a private-private partnership could smooth the skids with regulatory bodies and he like, as well as provide an infusion of cash. Shrachi is likely to view the government of West Bengal as one of the more stable of the constellation of possible co-investors, and this could be important for the long-term.

As Shrachi, would you allow the government of West Bengal to invest in your deal? Why or why not?

As a spokesperson for Shrachi, I contend that the West Bengal Housing Board would be a good co-investor, accruing benefit during the crucial early stage of development and would be a source of steady support in the future. Government-private relationships tend to ensure, whether by entropy or through a belief in economy of effort by sticking with tried-and-true vendors and partners.

How do you feel about the pricing and profit potential in the Public-Private Partnership?

With regard to the pricing and profit potential in the public-private partnership, the assumptions about the square footage and pricing of the group housing seems high. With the bungalows running about 900 Rs per square foot t build with a footprint of about 1,500, the group housing should be both smaller in size and cheaper in price. The modeling may not accurately reflect this differential. The WBHB asking price of Rs 290,000,000 seems fair and appears to gauge well the potential profit margins while keeping the price within a range that will result in good welfare outcomes.

What would be the appropriate ratios of investment and participation in cash flows, compared to the baseline?

Four financial measures are generally expected when a capital project is being valued on a projected cash flow basis. These measures are: (1) Net Present Value of Cash Flows (NPV); (2) Internal Rate of Return (IRR); (3) Profitability Index; and (4) Payback (PB). Appropriate ratios of investment and participation in cash flows for this capital projects build out would be as follows:

NPV = 0.00

IRR = > WCCC

PI = 1.00

PB = 1.68

Any project where the NVP is zero is considered a good candidate for investment. In other words, positive NVPs are desirable. The formula for calculating NVP is:

PV= Cash Flow / (1 + r)*n

Where r = discount rate, n = period (usually annual).

The rate and the period must use the same time measure.

The Internal Rate of Return (IRR) for each scenario seems optimistically high at 50.2%, 48.7%, 37.6%, and 46.0%. The IRR figures are immensely superior to comparables in the securities market, which tends to trigger some skepticism. Unlike net present value (NPV), IRR ignores the time value of money, which would be important in the 10-year prospectus for this build out. The rule of thumb is accept all investments where IRR is greater than the opportunity cost of capital (which is typically equal the weighted average cost of capital or WACC).

The rule of thumb for profitability is to accept all projects that have an index value equal or greater than one. Profitability Index is calculated in this manner:

Profitability Index = Present Value of Cash Flows / Cost of Project

The payback period is approximately six years for infrastructure costs. The realization multiple of the project is 1.68, as shown below.

Cumulative distribution returns / Paid-in capital= 4,116,420 / 2,447,848=1.68

How do you feel about the pricing and profit potential in the Private Equity component from the points-of-view of Shrachi, WBHB, and Xander?

The pricing and profit potential of including a private equity investment in the township project depend on several assumptions that may or may not hold true. Xander is inclined to invest in high end buildings, but the market for this expensive residences in a rural area of India is unlikely. That is, unless the infrastructure can support the build out as second homes for well-to-do professionals who live in urban areas during the work week,…