So the Ponzi scheme will end

Ultimately, all Ponzi schemes come to an end.The fourth-quarter results of DLF, the country's largest real estate company, prove just that.

The company's net profit fell 93% to Rs 159 crore from Rs 2,177 crore in the same period last year. This was primarily on account of sales falling 69% to Rs 1,351 crore from Rs 4,372 crore in the same period last year.

And why did sales fall? Primarily because the company's main "business model" has come undone.

Since it got re-listed on the exchanges in July 2007, DLF had been essentially boosting sales and profits by making a substantial portion of its sales to DLF Assets (DAL).
This would have been a good business strategy if DAL paid for the sales, which it did not.

For the quarter ended September 2008, the company reported total sales of Rs 3,744 crore, of which nearly 39%, or Rs 1,470 crore, were to DAL. At the same time, the receivables from DAL increased by Rs 1,446 crore, almost equal to the sales.

For the quarter ended June 30, 2008, as much as Rs 1,560 crore, or 40% of its sales were again to DAL. Interestingly, the quarter-on-quarter increase in receivables from DAL was Rs 1,450 crore, a number very close to the sales to DAL during the quarter.

Evidently, even though sales were being made to DAL, hardly any sales were actually being paid for by DAL.

In other words, the company was using aggressive accounting to boost its sales as well as profit numbers. As long as these "paper" sales to DAL kept going, the net sales and profit numbers of DLF kept growing quarter on quarter. But profit is not always cash, as any accountant will tell you.

The "business model" was akin to a Ponzi scheme, where an illusion of a successful investment scheme is created by using money being brought in by new investors to pay off the older investors.

In this instance, as long as sales to DAL kept going up, DLF kept showing increasing profits and sales. But at the same time, receivables kept going up as well.

For a Ponzi scheme to keep going, the money new investors get into the scheme should be more than the money being paid to the older investors. Similarly, for DLF revenues and profits to keep growing, the company needed to book more and more sales to DAL, which couldn't have gone on forever.

Sales to DAL fell to Rs 655 crore for the quarter ended December 31, 2008, down from Rs 2,057 crore for the quarter ended December 31, 2007. This dramatic fall led to the total income of DLF falling 59% to Rs 1,503 crore. Profit fell even more dramatically by 68% to Rs 682 crore.

And for the quarter ended March 31, 2009, sales to DAL have fallen even more dramatically to Rs 322 crore, as against Rs 1,845 crore in quarter ended March 31, 2008. This has pulled down sales and profits of DLF big time.

Clearly, accounting gimmickry to boost sales cannot continue forever.

In the March quarter, DAL paid around Rs 800 crore of the nearly Rs 5,400 crore it owed DLF as on December 31, 2008. But even after this, DAL owes around Rs 4,900 crore (Rs 5,400 crore outstanding in the last quarter - Rs 800 crore paid by DAL + Rs 323 crore of sales made to DAL during the quarter) to DLF, which is not a good sign.
DLF has suspended further sales to DAL.

The stock has rallied 66.5% since March 9, 2009, despite there being no fundamental improvement in the company's situation. Further complicating the scenario is the fact that for the first six months of this financial year, DLF has outstanding land bank payments of Rs 5,000 crore and debt refinancing needs of Rs 4,500 crore, say analysts.
In order to reduce debt, the company is trying to sell its non-core assets like its wind power business. The non-core businesses --- DLF Pramerica Life Insurance, Hotels and Power, etc --- posted a loss of Rs 163 crore for the quarter.

The downtrend in real estate prices only makes the situation even more difficult. The company, which like most real estate companies, had been holding on to prices, recently sold its Capital Greens project located at Shivaji Marg, Delhi, at Rs 4,500-5,500 per sq ft, 30-40% lower than prices of existing projects. Even though the booking amount paid by the customers will help the company improve its cash position, it may not be good enough to solve the funding problems of DLF.

Analysts say the company may also see cancellations of bookings made previously, given the state of the economy. Other than this, in the March quarter, the company gave price reset and other benefits to customers, which led to Rs 688 crore of lower revenue and a profit-before-tax impact of Rs 302 crore.

The company's situation sure does not look good.

For those who still have the stock, it might be a good time to sell before the bears come in.

by Vivek Kaul, DNA