Table of Contents

Background..............................................................................................................................................2
Situation and PE’s Business Plan..............................................................................................................2
Process....................................................................................................................................................2
Analysis....................................................................................................................................................3
Analysis....................................................................................................................................................4
Reason for Selling below AVC..................................................................................................................5

Name – Saagar Chitkara

Roll Number - XC20200139

Graded By - Dhawal Goyal

Grade -
Background
A Private Equity (PE)1 firm, referred to as PE or simply The Firm in the document, with an established
track record of funding and collaborating with real estate and infrastructure developers in South East
Asia and The Middle East. The firm had already successfully completed and delivered close to 10 Mn. sq
units2 in area of real-estate and infrastructure space in Asia and was in early years of development in
India, until the year in discussion. The real-estate projects included commercial, residential, and mixed
and the infrastructure projects included mainly roads and highways. In the residential space the firm
catered to all segments – from luxury, mid-segment, and affordable housing.

Situation and PE’s Business Plan3

Boosted by Pradhan Mantri Awas Yojna (PMAY) or affordable housing for all by March 2022 4, the firm
decided to start a fund of INR 2,000 Cr.3 by inviting developers, with a proven track record and high
credit rating, to collaborate. The plan was to allocate 15%-20% of the total corpus towards affordable
housing in the 1st phase and remaining later towards infrastructure development and small to mid-
segment commercial real estate. The firm’s plan was to acquire 5%-10% of market share in India’s
affordable housing space and bid only for projects outside city limits (the further away from the city the
better), to have the potential of building connecting roads and highways. Additionally, the firm would
hold atleast 20% stake in the group and contribute by the following:

 Investing 20% stake or 400 Cr. in the initial fund

 Inculcating corporate governance at developer level
 Acquiring land and any other necessary approvals for constructions
 Conducting periodic audits and dealing with regulatory authorities

The firm would raise the remaining 1600 Cr. to be invested in the project from various developers. The
firm invited developers with a non-refundable one-time participation fee of 3% of the stake amount
along with strict pre-conditions of developer history etc. was outlined in the contract. For eg. If the
developer wanted to invest INR. 400 Cr. out of 1600 Cr. it would be entitled to a stake of 400/2000 =
10% in the group and the non-refundable participation fee would be INR 6 Cr. and similarly a developer
with an investment of 50 Cr. would be entitled to 2.5% of stake and would pay INR 1.5 Cr to participate.
The details of the individual developer stake and participation amount are outlined in the appendix.

The participation fee would be utilized for conducting financial, legal, and commercial due diligence on
the participating developer companies and their promoters.

Process
The 2000 Cr. would be utilized to fund the projects’ costs and additional funding may be raised through
debt. Each developer will develop part of the project equivalent to its stake (for the purpose of keeping
analysis simple in this document, it is safe to assume that the developmental units can be independent
units). The demand can be considered infinite and each developer would be able to produce as many
units (according to its stake) over a long-term horizon. To account for the order size, Central and State
government’s subsidies and investments; the costs, revenue and profit can be assumed time
independent and constant (though in the real world, real estate costs would be variable on account of
steel, cement, labour etc. costs). Though the cost or more specifically the Marginal Costs will change
according to the number of units delivered in a year as outlined below.

1
The company will be referred to as PE or the firm to protect the privacy of the client
2
Instead of actual area sq units are used
3
All figures in the document for revenue, expenses etc. have been scaled to protect the financials of the clients
4
https://www.businesstoday.in/current/economy-politics/housing-for-all-scheme-gets-govt-nod-all-you-need-to-
know/story/220739.html
For simplification ∆q, in the formula ∆VC/∆q, equal to 1 Economic Unit is assumed as 500,000 sq. unit of
area developed since it is a step function and cost within the interval is relatively constant. For eg. In the
table above the first 1 Mn. sq. units are developed at 2,200 Rs/ sq. unit and the next 500,000 sq. units at
2,100 Rs/sq. unit, so on and so forth.

These assumptions were provided by client based on COGS to develop area. The MC reduces till 4 Mn.
sq. units and marginally increases thereafter since there was upper limits on raw material quantity the
supplier would provide at discounted price. The contract terms between supplier and the group would
remain confidential.

Analysis
A total of 25 developers bid for a stake in the group, with a contribution ranging between 50 Cr. and 200
Cr. Each of them paid a participation fee of 3% of the potential stake amount. Out of 25 only 12
developers’ bids were accepted. The marginal cost for additional 500k sq. units in a specific time period
is mentioned above and the Average Total Cost (ATC), Average Variable Cost (AVC), Fixed Cost (Fixed
Cost), and Price (P) are highlighted in the table and graph below.
INR Cr. per sq/Units
Q Revenue Contribution to PE Contribution to Group Fixed Cost TVC P AVC MC ATC
1,000,000 200 40 10 400 220 2,000 2,200 2,200 6,200
1,500,000 300 60 15 400 325 2,000 2,167 2,100 4,833
2,500,000 500 100 25 400 503 2,000 2,010 1,775 3,610
3,500,000 700 140 35 400 658 2,000 1,879 1,550 3,021
4,000,000 800 160 40 400 735 2,000 1,838 1,550 2,838
6,000,000 1,200 240 60 400 1,065 2,000 1,775 1,650 2,442

The fixed Cost of 400 Cr. initially infused and ATC are represented on the secondary vertical axis while
MC, P and AVC on primary vertical axis for better graphical representation.
 7,000

2,400

6,000

2,200
5,000

2,000
PER SQ. UNITS

4,000

1,800
3,000

1,600
2,000

1,400 1,000

1,200 -
1,000,000 1,500,000 2,500,000 3,500,000 4,000,000 6,000,000
Q

AVC MC P Fixed Cost ATC

Analysis
The Group had decided to price at Rs. 2000 5/ sq unit area delivered, which was in lower 20% of the
market circle6.

1. Sunk Cost – The non-refundable one time participation fee of 3% potential stake can be considered
as sunk cost. Either party could choose to forgo further participation after diligence.
2. Marginal Cost – Already covered above was the cost of developing additional 500k sq units over and
above 100k sq. units in a particular time period.
3. AVC – The cost was calculated by taking the first Mn. sq/units * 2200 + Sumproduct of additional
(500k sq/units and corresponding MC) and diving the total by Q. For eq. for calculating 2.5 Mn. sq
units – (1 Mn.* 2200 + 500k*2100 + 500k*1800 + 500k*1750)/(2.5 Mn sq units) = 2010 Rs/ sq unit.
The table for below outlines various Q’s developed, TVC, AVC and MC.

INR. Cr. Per sq. Units

Q TVC AVC MC
1,000,000 220 2,200 2,200
1,500,000 325 2,167 2,100
2,500,000 503 2,010 1,775
3,500,000 658 1,879 1,550
4,000,000 735 1,838 1,550
6,000,000 1,065 1,775 1,650
4. ATC – Calculated by (VC+ Fixed Cost, 400 Cr.)/Q

5
The average price has adjusted for the purpose of the document to protect the financial strategy of the group. In
reality it was still below the circle price and AVC
6
The average price per sq units can be found on various property listing websites and ranged between 1500 Rs/sq.
units and 6000 Rs/sq. units depending upon state and proximity to a major city.
5. Other Calculations – In addition to operating costs, 25% of revenue directly went to the group. The
breakdown of 25% is below:
a. 20% - Went to the group for auditing and management costs
b. 5% - Were withheld in RE for the group and mentions the increase in Equity for all
stakeholders.

For analysis only operating costs have been considered.

Reason for Selling below AVC

As outlined above, the Price was fixed at 2000 Rs./Sq. units, while AVC ranged from 2200 to 1775 Rs./Sq.
units. The reasons for operating at below AVC are outlined below:

1. The objective of the firm was to bid for and develop affordable housing projects only outside major
city limits. Even though the bidding price was below the AVC, the firm saw great potential in
establishing credibility with local bodies for infrastructure development as well. The expected
returns from such infrastructure projects, that would require almost 50% of the corpus or 1,000 Cr.,
were 30% or above. The absolute and equity return would more than offset loses incurred from
affordable housing. Furthermore, the firm believed that necessary approvals in the area would give
them priority in infrastructure projects in such areas in the bidding process.
2. The PE firm was relatively new to Indian market with only overseas track record. The firm planned to
deal exclusively with credible developers, conduct regular audits and instill corporate governance.
The long-term objective was to get themselves rated by a domestic agency and gain access to
cheaper credit domestically. The primary debt could cost anywhere between 8% and 12% depending
upon the credit rating of the company. The chances of receiving a higher rating are greatly enhanced
by credit history, cash flow, regular audits etc. Moreover, even a .5% lower interest rate would lead
to massive savings. Eg. On a loan amount of 500 Cr. a .5% Interest Rate would cost 2.5 Cr. in interest
alone.
3. The firm had limited connects with distributors and suppliers of raw materials in India. By placing
huge orders, the firm wanted to attain competitive advantage by establishing relationships with
other stakeholders in the supply chain. These relationships would be critical in getting favorable
terms for high value projects. Some of the favourable terms identified were following:
a. Higher Accounts Payable cycle – instead of 1 month in the beginning the suppliers would be
open to negotiating a longer interest free payback time.
b. Mitigate some of the losses against volatility in steel and cement prices by establishing
contracts at high volume orders.
c. Gaining priority delivery in case of supply shortage of raw materials.

As evident from analysis above, each of the points mentioned above would support the decision of the
Firm to bid for and sell at lower than AVC under the affordable housing scheme to gain a higher ROE
overall.
Appendix