Tuesday 11 March 2008

IPO Review - Gammon Infrastructure

Gammon Infrastructure Projects (GIPL), a subsidiary of Gammon India (GIL), is the holding company of the infrastructure assets of the Gammon Group. It provides operations and maintenance services to the road subsidiaries. GIPL currently undertakes and develops roads, bridges, ports, and hydroelectric and biomass power projects in public-private partnership through its special purpose vehicle companies. Additionally, it has also identified urban infrastructure, airports, mass rapid transit systems, power transmission lines and special economic zones (SEZs) as focus areas.

Currently, GIPL has four operational build-operate-transfer (BOT) projects consisting of three road, a port project and seven development projects. It holds 49.0% equity and a further beneficial interest of 44.5% of the equity of Rajahmundry Expressway (REL) and Andhra Expressway (AEL), the companies that developed and own two of its operational annuity road projects: Rajahmundra-Dharmavaram and Dharmavaram-Tuni, respectively. The equity interest in Cochin Bridge Infrastructure Company (CBICL) that owns and operates the New Mattencherry bridge project in Cochin was 97.65%. The company holds 42.22% equity interest in Vizag Seport owning and operating two multi-purpose berths at Visakhapatnam Port.

Projects in development consist of the toll road stretch between Vadape-Gonde on the National Highway 3 connecting Nashik and Mumbai, the annuity Gorakhpur bypass project in Uttar Pradesh and the annuity Kosi River Bridge project in Bihar. The company is also developing a 66-MW Rangit II Hydro, a hydroelectric project of the Sikkim Hydro Power Ventures (SHPVL) in Sikkim and a 30-MW co-generation power project in Maharashtra. Other projects in development comprise special purpose vehicle (SPV) Indira Container Terminal’s (ICTPL)’s offshore container berths and container terminal at Mumbai Port including operation and maintenance of Ballard Pier Container Terminal, and development of two biomass power plants of 12 MW each in the Patiala district of Punjab.

In addition to the 11 projects that are already operational or under development, GIPL has three projects in pre-development: Adityapur Auto Components SEZ , eight biomass power projects of 10-12 MW each in Haryana, and the Tidong – II hydro electric power project with a capacity of 60-80 MW in Himachal Pradesh.

Proceeds from the issue will be deployed in the equity of the project’s SPVs executing the Kosi Bridge Project (Rs 24.15 crore), the Gorakhpur Bypass project (Rs 36.89 crore), the Rangit II Hydroelectric project (Rs 89.60 crore), the Mumbai-Nasik Road Project (Rs 51 crore), and repaying Rs 10-core loans to Gammon India , the parent company. The balance will be used to meet general corporate purposes and investment in strategic initiatives and acquisitions.

Strengths

Operational BOT projects are a balanced mix providing assured return projects (annuity projects) and capturing market upside, i.e., traffic (toll projects). Of the three operational road projects, two are annuity projects providing assured return. The New Mattencherry bridge project in Cochin is a toll-cum-annuity-based project with the toll fully linked to the wholesale price index. Of the three road projects under development, two are annuity projects and one is a toll project.

With GIL, a leading construction company, as parent, has strong project execution capability with a timeline that can be counted/ leveraged on bidding. Has completed two of its BOT projects in Andhra Pradesh well ahead of schedule and earned a bonus of around Rs 16 crore from the National Highway Authority of India for early completion.

Weaknesses

Two multipurpose berths developed by Vizag Seaport (VSPL) have long-term take or pay clause with Sail covering the entire concession period. However, as Vizag Port is a major port covered under the Major Port Act, there is only limited freedom for fixing tariff as the Tariff Authority for Major Ports (TAMP) caps the tariff for private operators. Similarly, the offshore container berth and terminal project and Ballard Pier Container Terminal will also come under TAMP, leaving little pricing freedom for port operations. VSPL is in the red, with a loss of Rs 5.84 crore in the half year ended September 2007 and Rs 15.06 crore in the fiscal ended March 2007.

Though has the backing of a strong parent with long operational experience in the construction sector, the group has little experience in development and operation of power projects. Also, the long gestation of hydel-power projects with attendant issues ranging from rehabilitation, acquisition of forest land, and other environment factors are also a concern. Further, due to intense competition, the ability to win bids in consortium in verticals such as Mass Rapid Transit System (MRTS) and airports remains to be seen.

The Securities and Exchange Board of India (Sebi) conducted an investigation into certain alleged irregularities in the rights issue of GIL in 2001. It was alleged funds of promoter GIL were used by Chairman and Managing Director Abhijit Rajan, the promoter of GIL, for subscription to the rights issue. Based on the findings, Sebi passed an order prohibiting GIL and Abhijit Rajan along with two other companies controlled by Rajan from accessing the capital markets directly or indirectly. As a result, this IPO has already suffered a delay of over a year. The Securities Appellate Tribunal has now granted an interim relief for the IPO. The next hearing in the matter is scheduled on 13 March 2008.

The Mumbai offshore container berth and terminal project and biomass project in Patiala and the cogeneration power project in Maharashtra are yet to achieve financial closure. Similarly, SHPVL has not achieved financial closure. The deadline for achieving financial closure has expired and this could land the project in rough weather as the government of Sikkim or any other nodal agency has the option to terminate the agreement.

As GIL is the parent company and the construction contracts of the SPVs are handled by GIL, the collapse of a flyover constructed by GIL in Hyderabad in September 2007 has the potential to damage credibility during future biding.

CBCIL has been assigned as concessionaire for the developing, operating and maintaining of the New Matterncherry bridge on BOT for 13 years and nine months under the agreement with the government of Kerala , Greater Cochin Development Authority and GIL on 27 October 1999. Subsequently, a supplementary concession agreement is being worked out, extending the concession by six years. However, this extension has been challenged in court. Nevertheless, CBICL continues to account the yearly annuity revenue as revenue even though it has not received the annuity from government of Kerala for the past 2 years.

Valuation

Consolidated revenue was Rs 147.70 crore in the fiscal ended March 2007 (FY 2007) as against Rs 76.78 crore in the 15 months ended March 2006, translating into a growth of 140% annualised. Net profit after minority interest was Rs 29.85 crore, a rise of 104% annualised. The spike in revenue and profit was partly due to getting controlling stake in AEL and REL from October 2005.

The EPS for FY 2007 works out to Rs 2.1. The P/E at the offer price band of Rs 167-Rs 200 is 79.5-95.2 times. Normally, such companies are valued based on sum-of-parts and net present value (NPV) of BOT projects. Thus, and EPS and P/E may not reflect the true picture