Financial Re-Engineering with Respect to Funding of New Projects of Al Masaken - Essay Example

Financial Re-Engineering with Respect to Funding of New Projects of Al Masaken: A Case Study Executive Summary: Being a subsidiary and a group company of Aerated Concrete Industries Company K S C C (ACICO), Al Masaken Real Estate Company has created for itself a remarkable position in the booming real estate sector in the Gulf region. The company has so far executed various prestigious construction projects worth close to $ 300 million with a construction area extending up to 291,143 Square meters. Backed up by a good design and engineering team the company has crossed over the initial struggles and has reached the position to take up construction projects of high rise buildings on its own financial strength. As a strategic financial initiative, it was suggested that Al Masaken be promoted as an independent business entity and raise the additional funds required for its proposed high rise construction projects following the IPO route supported by the group image of ACICO. This case study details the circumstances which led to such a decision of providing the individual status to Al Masaken and the various other factors which contributed to the proposal. Al Masaken- A Background: Specialized in Housing/Villa projects, Al Masaken was established in 1998 as a part of ACICO group with a 25% ownership from ACICO. Having sailed through the initial hiccups the company specialized in the new wave construction of vertical housing by the year 2003. Being one of the subsidiaries of the ACICO, the financial strategy was to obtain short term loans to finance the purchase of the real estate properties and for the process of construction activity and repay the loan within a maximum period of one and a half years. Financing Strategy at the Holding company: ACICO adopted a financial policy of long-term borrowing for its other manufacturing activities and short-term borrowing for the construction activity. This overall financing structure of long and short term borrowings went well with the company until the year 2003 when the company invested large sums of money in acquiring real estate property for the proposed construction projects of two high rise buildings involving the construction of 58 and 48 storied buildings respectively as a business growth strategy. Why Spin-off? (The Need for Financial Re-engineering): The new business line of high rise building construction was capital intensive and required huge sums of money on a long term basis as the construction process would take a longer time than what was being done hitherto by Al Masaken. This huge requirement of sum for a longer time period had upset the financial borrowing mix, the company was following. These additional requirements of funds could not be managed through bank borrowings since the company has already exceeded the borrowing limits sanctioned by the bank on the basis of the company’s debt equity ratio. With the additional investments in the real estate the company could not substantially raise the equity portion to request additional funds from the banks. In order to sustain in the business the CFO of Al masaken suggested a spin-off proposal which would enable the company to raise additional capital financing required for the new projects. Other Attributes for the spin-off decision: During the year 2003, with the government’s decision to stop issuing building permits for the undeveloped areas, the land cost spiraled by more than 80 percent in the case of available plots of land. Coupled with this the increase in the interest cost deteriorated the gross margins of the business. With higher risks the margin which was at 22 percent came down and spin-off was the only way forward to get the additional funds as well as to replace the bank borrowings by funds from the investors. Another factor to be considered is the time of the top management needed for the execution of the new projects. While the current top management people are busy, with the spin-off entity it would be possible for the new management to devote more time and attention to the new projects. Rationale of Conversion of Fixed Assets into Liquid Assets: Another rationale behind the decision to spin-off Al Masaken was to get the potential advantage of converting fixed assets into liquid assets. The strategy is worked out on the premise of selling the real estate properties to the new spin-off company by Al Masaken and with the proceeds Al masaken will buy up to 35 percent of the shares in the new company. This way the fixed assets will be converted into liquid assets of stocks in the new company which will go to improve the financial standing of the new company from the point of view of external borrowings from banks and other financial institutions. The point to note here is that the fixed assets are those which the company acquired for its vertical building projects in 2004 where the investment is heavy; it also freezed almost 70 percent of the borrowing limits of Al masaken. The spin-off proposal is a welcome decision in the light of the fact that the payback period for such investments in the land for the high rise building is not less than seven years and the return on these assets would no way even match the funding cost and the revenue loss because of losing alternative opportunities. The Proposal and the Organisation Structure: A pictorial representation of the proposed spin-off of Al Masaken is appended below: The organisation would follow a normal structure with a Chairman assisted by an Executive Committee and an Audit Committee from the Board of Directors. The other members of the organization structure are the Managing Director reporting to the Chairman assisted by Managers of Support Services, Operations, Business Development and Sales and Marketing Divisions. The Human Relations, Information Technology and Finance and Administration department would come under Support-services division. All the divisions will be manned by able and experienced engineers and other staff. What is the Standing of Al Masaken in the Gulf Real Estae Sector? Before the spin-off strategy is evaluated it is imperative that a study into the market standing vis-à-vis the industry position of the Gulf Real Estate sector is undertaken. An Overview of the Gulf Real Estate Sector: Rapid developments with multi-billion dollar projects characterize the Gulf Cooperation Council Countries (GCC) real estate sector. The real estate sector occupies a major position in the economy of the GCC countries with Dubai having 25 percent of its GDP accounted by the construction industry. It is not meager in respect of the rest of the regions and countries. While the geographical location and the presence of the natural resource of Oil have made the real estate sector flourishing, the following factors contributed for furthering the resultant advantages: Rapid population growth in the region Soaring oil prices resulted in increased liquidity Easing GCC regulations regarding freehold land ownership Slow down in investment opportunities in the other developed countries GCC nations’ policies to attract more foreign investments in mega projects The route of privatization adopted by some of the GCC governments Rapid emergence of financial institutions Market Summary: Followed by Dubai, UAE has a highest demand for housing due to the influx of expatriates and the demand is further accentuated by the high profile national youth. Moreover with the increase in the number of large scale projects, this market will witness an industry boom in the near future. The price and rents of real estates are already on the increasing trend. Other Gulf regions also contribute to the growth of the industry which stands at $ 120 billion as at the end of the year 2005. Target Market: Kuwait and the rest of the GCC nations will be the target markets for Al Masaken with special emphasis to Dubai having larger expatriates. Competition: The competition is stiff due to: Kuwait government’s support in giving interest free loan up to $ 240,000 for purchase of houses by Kuwaiti nationals who are looking for real value for their investments Significant rise in the prices of land, labour and construction materials due to increase in the oil prices Product Offering: Al Masaken is in a position to offer the following products to its prospective customers: Readymade Houses or villas which will be ready for occupation on buying Custom made Houses where the land and design selection will be done by the customers. This segment represents 35 percent of the total customers. Al Masaken is better placed in this segment due to its flexible construction policies. Land and Loan Houses represent 15 percent of the total market, where the government is providing a land and a loan of $ 200,000 to construct a house. This is another niche market for Al Masaken. Apartments for higher middle income group who would like to own their apartments instead of renting and this represent 5 percent of the market. Critical Factors: The industry is not left without some critical issues to tackle. Some of the issues are: The potential threat that the government of Kuwait may stop the housing loan to the citizens Delay in payment of construction costs by the customers which ultimately delay the construction process More demand for construction materials which affect the availability Market Strategy: Having established a reputation for quality construction, Al Masaken can look for opening up of new markets and customer segments projecting its image of good products, appealing designs and excellent services. To reach the customers with these unique selling points Al Masaken will make use of Exhibitions, Advertising in different media; Direct marketing and Public relations for the promotion of its projects and the cost of these strategic measures have already been included in the marketing budget of the company. Position of Al Masaken: Having studied the relative position of the industry, before the proposal for spin-off could be evaluated, an in-depth study of the position of the company’s standing in the industry is to be analysed. For this purpose, the best evaluation method would be to make a SWOT analysis which will give the standing of the company with respect to its strategic planning vis-à-vis the strength of the company in the product and market in which the company deals in. Strengths: Backed by established and financially sound group as promoter Rich experience in construction management Successful track record since the inception of the company Financial and operational assistance from the other group companies Weaknesses: Employee retention and attrition leading to loss of key employees Reliance on few experienced individuals for the execution of construction projects Opportunities: High growth rate of Kuwait and GCC countries population Enhanced buying power of the Kuwaiti and GCC nationals All round increase in the demand for housing Threats: Growing competition Mounting finance and material costs Escalation in the prices of land Potential danger of the government stopping the housing loans to the citizens Changes in governmental regulations affecting the industry Introduction of new and efficient building systems by the competitors Target Customers: Al Masaken will adopt a marketing strategy to approach the following target customers who are considered to be the potential growth segments for the company’s construction activity. Common or individual customers Land and Loan customers Expatriates Building contractors Property developers What is the methodology for raising funds after spin-off? Al Masaken when spun off will become an independent company and will go in for an Initial Public Offering (IPO) of its shares to raise the additional capital financing. These shares will be offered for the public subscription. Based on the industry/market analysis and the respective financial and market standing of the company the public is expected to subscribe to these shares. The decision of the potential investors to invest their funds in the proposed IPO will be supported by the group image of ACICO. What is the amount required? The expected funds from this offering net of all third party fees and commissions payable and how such funds are proposed to be utilized is given in the following table: PARTICULARS KD CASH OUTFLOW Acquisition of Ea'maar and Estithmar Fund 2,737,322 Acquisition of Land and Working Capital Requirement, including Jabriya Project 12,272,000 Acquisition of an Investment Property 3,000,000 TOTAL – A 18,009,322 Cash to cover contingency 1,800,932 TOTAL FUNDS REQUIRED 19,810,254 TOTAL FUNDS REQUIRED - Rounded 20,000,000 What is the exit strategy for the Al Masaken Management? The management of Al-Masaken will formulate a primary market exit strategy in order to assist investors who invest with the express goal of ensuring liquidity of their investments. The management in order to expedite the liquidity event has formulated an early exit strategy achieved upon a probable listing of Al-Masaken, in the Kuwait Stock Exchange (KSE). Upon listing of Al-Masaken in the KSE, investors would be able to exit from this investment by trading their shares in the exchange. Conclusion: The overall plan for the spin-off of Al Masaken along with its relative marketing strength and an overview of the construction industry is provided in this case study paper to enable the reader to from an idea about the spin-off proposal of Al Masaken Real Estate Development Company. References: In order to construct this case study the following sources were referred, although no mention of the individual sources has been provided in the body of the text: Al Masaken Article of Association Kuwait International Company for Financial & Management consulting. Property World Middle East. Pricewaterhouse Coopers – Global Real estate Now July 2006 Feature. National Bank of Dubai. Public Authority for Housing Welfare, Kuwait Planning Council, Qatar Read More