Friday 11 January 2008

Reliance Power IPO Analysis

Reliance Power (RPower), part of the Reliance Anil Dhirubhai Ambani Group, has embarked on setting up numerous power-generation plants. Reliance Energy (REL) is one of the promoters with a direct stake of 45% in the post-issue equity capital along with closely-held promoter group company AAA Projects, also with an equal 45% stake in RPower.

With currently no power project in operation, RPower is developing 13 power-generation projects with generation capacity of 28,200 MW. These 13 projects are to be executed over the next eight years. All power projects, except one (at Dadri in UP) are to be executed through various subsidiaries of the company and are currently under various stages of development.

The project portfolio also includes two of the first three Ultra Mega Power Projects (UMPP) finalised so far in the country: the pithead Sasan UMPP in Madhya Pradesh and import-coal-based Krishnapatnam UMPP in Andhra Pradesh.

RPower has identified six projects. Of these, Rosa Phase I (600 MW), Rosa Phase II (600 MW), ButiBori (300 MW), Shahapur TPS (1,200 MW), Sasan UMPP (3,960 MW) are coal fired. The 400-MW Urthing Sobla is a hydroelectric power project in Uttarakhand to be executed in the first phase. The aggregate generation capacity of all these projects is 7,060 MW. The seven other projects in the current project portfolio are the 7,480-MW gas-fired project at Dadri, the 2,800-MW Shahapur Gas project, the super-critical-based coal-fired 3,960-MW MP Power and three other hydroelectric projects: Siyom (1,000 MW), Tato II (700 MW), and Kalai II (1200 MW).

Reliance Natural Resources, a group company, is to supply imported coal to fire the Krishnapatnam UMPP and Shahapur coal-based power plant and gas to the Dadri and Shahapur gas power plants. Moreover, RPower, RNRL and North American Coal Corporation (NACC) have entered into a three-way MOU for coal mining in India. RNRL will be the mining operator and NACC will provide technical assistance including evaluation of geological data, mine planning and design, supervision of mining operations and training of personnel of RNRL and RPower with best mining practices. However, the company is yet to sign definitive contracts with all these collaborators.

The proceeds of the issue will be used to capitalise the subsidiaries that will execute the six identified projects.

Strengths

The Indian power sector has robust growth prospects with a large demand and supply deficit. With various proactive reforms in the power sector encouraging private-sector participation in all the three core segments of generation, transmission and distribution, players such as RPower, who will be the face of the group for power generation, will be able to capitalise on strong growth opportunities in the country.

Project portfolio and its customers are well diversified. The locations of all the 13 projects are either near the load centre or fuel source. Fuel required is also diversified. Seven are coal-based projects. Of these, two at Shahapur and Krishnapatnam will depend on imported coal, and two Sasan and MP Power are pithead projects. Their capacity aggregates 14,620 MW. Of the remaining six, two are gas based (aggregate capacity 1,0280 MW) and four are hydroelectric projects (aggregate capacity 3,300 MW), with three in Arunachal Pradesh and one in Uttarakahand. The potential customer base is also diversified with more than 25 procurers across state electricity boards (SEBs), state distribution companies, and private distribution licencees spread predominantly in power deficit northern and western parts of India.

The 300-MW Butibori project is a captive power project and is likely to get greater per unit realisation. With industrial tariff normally higher even if the company supplies power at a discount to the current industrial tariff, the margin will be greater. Further, the company intends to tie up only for 51% of the capacity of the unit with group captive players. The balance capacity could also act as a merchant power plant increasing per unit realisation.

Three out of the 13 projects employ efficient super critical technology. This three super-critical power projects account for about 11,920 MW t of the aggregate capacity addition of 28,200 MW. Moreover, implementation of the cost-efficient super-critical technology will also fetch carbon credits.

Weaknesses

Has no power project in operation and its first power generation unit, the Phase I of the 600-MW Rosa Power project, will go on stream only in December 2009. Unless there is any inorganic expansion, there will not be any operating revenue or cash flow from the core business of power generation.

Financial closure has been completed for only one project so far. Similarly, critical milestones such as power-purchasing agreement (PPA) for non-merchant power plants or finalising the engineering, procurement and constructirion (EPC) contractors or equipment suppliers are year to be executed. Except Rosa I and II ,core equipment suppliers or EPC players are yet to be finalised. Likewise, the PPA is not in place for most of the projects including Butibori, Rosa II, and Shahapur among the identified projects. Not crossing critical milestones is a major concern, particularly in view of the capacity constraint in power generation equipment resulting in long delivery schedules globally. Similar difficulties are likely in civil construction and for the balance of equipment, too, due to limited number of third-party contractors with huge backlog of orders. All these are expected to pose strong challenge in execution.

Coal for the Shahapur thermal power station (TPS) and Krishnapatnam UMPP and gas for the Shahapur and Dadri projects are to be procured through RNRL. But there is no definitive fuel supply agreement with RNRL for the coal and gas projects. Moreover, RNRL is in litigation on the gas reserves of Reliance Industries. This could impact the availability or the price of the fuel for the two gas-based projects of the company. Further, RNRL does not have any rights to coal resource either overseas or here right now. This is a cause of concern. Besides, the ministry of cola is yet to allocate coal for the Rosa II and Butibori projects.

Profitability largely depends on ability to maintain the actual operating cost within the budgeted limits, particularly for projects won through competitive bidding. The PPA for competitively bid projects based on imported coal provides for escalation linked to global coal prices. But the pithead power projects do not have this cushion. Any escalation in the mining and processing cost will not be insulated by the competitive tariff.

The current promoters, REL and AAA Project, have subscribed to the equity capital at par (Rs 10). They were allotted approximately 999.75 million shares each of face value of Rs 10 on 13 June 20’06. Subsequently, both REL and AAA Projects, were allotted 1,000 million shares of Rs 10 fully paid in the ratio of 1:1 when Reliance Public Power Utility (RPPUL) was merged with RPower from Sep 2007 by the order of the High Court of Mumbai. However. The current IPO is proposed at a premium based on the expected cash flows from the portfolio of projects to be executed.

Valuation

Ahead of the IPO, all the listed stocks in the power generation sector have been re-rated based on the expected price of RPower. The offer price band stands at Rs 405 to Rs 450. The discount of Rs 20 for retail investors and part payment of the issue price (Rs 115 on application and balance on call) is a sweetener. With no financial track record and no operational income expected to be generated till December 2009, when the first unit of Rosa I is expected to go on stream, the RPower scrip could end up with high volatility on news flow on the implementation of its various projects and winning of new projects.. At higher price band, RPower will have a market capitalisation of Rs 101700 crore compared with NTPC's current market capitalisation of Rs 221630 crore. While RPower has plans to implement 28,200-MW capacity with no assured returns in many projects and little experience in large project execution, NTPC already has 27,904-MW capacity with plans to set up additional 22,100 MW. Most of NTPC’s projects enjoy assured returns and it has one of the best track records of power-project execution. In the long run, RPower has many execution risks to contend with. But in the short term, the market seems willing to ignore all that.