Sunday 3 February 2008

IRB Infrastructure Developers IPO Review

Investors with a long-term outlook can subscribe to the initial public offer of IRB Infrastructure Developers. A good track record in the build-operate-transfer (BOT) space, early-mover advantage in running toll roads and in-house capabilities in construction, road maintenance and toll collection suggest strong growth potential for this infrastructure company.

The offer price of Rs 180-220 appears stiff and the current market correction has provided an opportunity to enter a number of blue chips at reasonable valuations. We would, therefore, be comfortable recommending an ‘invest’ at the lower end of the price band. Our conservative estimate of the consolidated per share earnings for FY 2009 on the post offer equity base works out to Rs 3.1.

This is, however, without factoring in any increase in toll charges and traffic for the toll roads operated by the company, or revenues likely to flow from the company’s real-estate venture.
Background

IRB Infrastructure Developers is primarily a holding company with wholly-owned subsidiaries, which are engaged in road and highway construction and maintenance. The group is at present involved in 12 BOT projects out of which 11 are in the operational phase (with maintenance and toll collection being done by the group). The company also plans to foray into real-estate . IRB plans to raise about Rs 100 crore to invest in one of the subsidiaries and also repay its own loans and that of its subsidiaries. Post-listing, the market capitalisation of the stock would be Rs 6,000-7,000 crore.
Early bird

The toll model is normally considered risky, although the revenue potential is high if the project attracts high traffic. Being one of the early private players in the space, IRB has managed to negotiate lucrative business terms that have compensated for risks associated with the toll model.

For one, IRB’s existing BOT projects do not have any toll-sharing arrangement with the Government. With high-traffic segments such as the Mumbai-Pune Expressway, part of NH-4 and Pune-Nashik road in its portfolio, IRB is likely to enjoy a high internal rate of return on its projects compared to peers who have more recently entered the segment and have thus settled for less attractive terms.

While the current basket of 12 BOT projects would enjoy superior profitability, new bids may see relatively muted returns with the Government now actively looking at toll-sharing models. .

Two, the company has non-compete clauses in some projects, which would restrict the Government from building or operating any competing BOT projects that could possibly reduce the toll inflows for the company. Similarly, control over projects such as the Mumbai-Pune Expressway as well as the Mumbai-Pune portion of the NH-4 corridor (both under IRB’s purview) ensures that the company does not face any competition from adjoining corridors.

Three, the company may benefit from periodic hikes in toll rates, some of which may be significant if traffic numbers are encouraging. For instance, the Mumbai-Pune Expressway is likely to command 18 per cent increase in toll rates the coming year.

The above factors suggest that the timing and locational advantages of the existing portfolio may endow IRB with a clear edge in the toll road segment.
Pre-qualification and integration

While IRB’s operations have been concentrated in Maharashtra and Gujarat, its experience in BOT has earned it pre-qualification by NHAI in NHDP Phase V projects in other States such as Tamil Nadu, New Delhi and Uttar Pradesh. Additionally, IRB’s operations appear well integrated, with capability to build and maintain roads as well as manage toll collection. This integration reduces the need to outsource work, which, in turn, results in higher profit margins.

IRB’s order book as of October 2007 stood at Rs 2,325 crore. While this would convert to revenues over 2008-2010, we expect toll revenues (not included in the order book) to be the most significant revenue driver. Income from BOT projects (predominantly toll revenues) accounted for the largest chunk of the recent consolidated revenues of the company .

IRB posted consolidated sales of Rs 262 crore for the five months ended August 2007 and net profits after minority interest of Rs 24 crore. The reported numbers may not be indicative of the company’s future revenues for two reasons. Revenues of fully controlled subsidiaries have been only partly captured in the August 2007 financials, because of recent consolidation.

Two, a few other subsidiaries have also been consolidated post August 2007; and these have not been accounted. The recent consolidation is positive because earnings that would have otherwise accrued to special purpose vehicles (SPVs) will now directly accrue to the fully-owned subsidiaries.

As most of the projects under the subsidiaries are operational, risk of funding also appears minimal.

IRB and its subsidiaries carry high levels of debt. While repayment from the offer proceeds would reduce the debt, newer projects and a foray into real-estate could require further raising of funds.

IRB plans to venture into real-estate and has acquired 925 acres of land for building a township in Pune district. With its hands full in the infrastructure space, we are cautious about its capability as a real-estate developer. The offer closes on February 5.