Gammon Infrastructure Projects IPO Analysis

Investors can stay away from the initial public offer of Gammon Infrastructure Projects Ltd. (GIPL). While the company’s unique positioning as a developer in the infrastructure space does provide long-term potential, the offer appears stiffly priced. At the price band of Rs 167-200, the offer values the company at 33-40 times the expected per share earnings for FY 2010. We, therefore, advocate revisiting the stock at a later date either when the secondary market offers better entry opportunities or when the company’s projects under development start contributing significantly to cash flows.

There is unlikely to be significant upside in GIPL’s earnings in FY 2009 as three of the seven projects under development are expected to become operational only by FY-10. The rest of the projects, mostly in the power segment, may have a longer gestation period before contributing to revenues. Besides, a number of other players in this business (not necessarily with the same business model) such as, IRB Developers and IVRCL, offer higher visibility for returns and have attractive valuations.
On the company and offer

GIPL is a holding company with subsidiaries and associates that are engaged in infrastructure project development. The company is a subsidiary of Gammon India. The parent will hold 73 per cent, post-issue. The company plans to raise Rs 270-330 crore through this offer, the proceeds of which would be invested in projects of subsidiaries and repayment of loan to the parent company. Post-issue, the market capitalisation of the company would be Rs 2,400-2,900 crore at the two ends of the price band.
Current projects

GIPL can be termed as one of the few pure infrastructure developers in the country as against a good number of players which remain part contractors. The company’s operations are clearly demarcated from its parent, as all infrastructure development projects are routed through GIPL.

The company also has a diversified basket of projects ranging from roads to power and ports with substantial holding in each of these. However, only four of the 11 projects are currently operational with the rest in the development phase (excluding the SEZs).

Of the operational projects, GIPL has two annuity road projects that provide a steady stream of revenues (by way of annuity and operation and maintenance) based on fixed long-term concession agreements. However, the fixed agreement rules out any scope for significant ramp up in revenues from these projects. Income from annuity constituted 70 per cent of revenues for the six months ended September 2007.

While the third subsidiary — Cochin Bridge Project — is toll-based, the project’s contribution to the revenue stream is minimal. Further, the Government has stipulated fixed toll rates, thus reducing the scope for any significant acceleration in revenues. The possibility of any surge in traffic also appears unlikely given the location of the bridge.

The fourth project — management of two berths in Visakhapatnam Port — now accounts for 12 per cent of revenues. While this subsidiary is yet to become profitable, we believe that the project holds high earnings visibility and lower risk, with favourable clauses such as take-or-pay. GIPL’s stake in this project is, however, restricted to 42 per cent at present as the project is in consortium with Portia Management Services of the UK. Of the four operational projects through subsidiaries, we expect the Vizag Sea Port to be the key revenue driver.

Revenue on a consolidated basis was Rs 147 crore for FY 2007 and Rs 77 crore for the half-year ended September 2007. Consolidated net profits for the above period stood at Rs 30 crore and Rs 11 crore respectively.
Future holds potential

GIPL’s more recently formed subsidiaries which have seven projects under development offer a diversified basket with toll and annuity road projects as well as hydro and bio-mass projects. Of these, the hydropower projects have longer gestation periods with operations expected to commence in FY 2011 and FY 2012. The renewable energy and container terminal projects are yet to witness financial closure and, therefore, not considered by us for valuation purposes.

The power projects could well hold potential what with a judicious mix of projects with power purchase agreements and those that can be sold as merchant power. For the biomass projects, while steady supply of raw materials such as rice straw or bagasse could be a constraint, the company is likely to be supported with good power tariffs in States such as Punjab and Haryana. Hydro and bio fuel projects hold the potential to improve the company’s profitability over the long term.

Similarly, the Mumbai Offshore Container Terminal Project in which the company has a 50 per cent stake holds favourable revenue sharing and exclusivity terms. The operation and maintenance clause is yet undecided with financial closure also pending. The business per se holds potential given the extreme congestion in the Mumbai harbour. Revenue flow from this stream has to be watched before assessing profitability.
Advantage of developer model

While the infrastructure space is generally known to offer low operating and net profit margins, infrastructure development lends potential for earning superior margins. Once the initial expenditure on building the asset is complete, such projects could provide a regular/accelerated stream of revenues.

As O&M cost of such assets are also paid for by the concessionaire, the profit margins are different from what are typically derived in a construction contract. GIPL’s operations currently earn margins of over 70 per cent on a consolidated basis. However, high interest costs (as each project involves significant debt-financing) can lead to more moderate net profit margins.

Though debt-free on a stand-alone basis, GIPL, on a consolidated basis, has a debt equity ratio of close to three. While the funds from the issue would strengthen the networth, the proceeds appear insignificant compared to the size of projects under implementation. Hence the subsidiaries would have to either tap debt avenues or look at further equity expansion at a later date. Such expansion over the medium term could dilute earnings, given that the payoff profiles for the company’s projects are fairly long.

The offer is open from March 10-13. Retail and non-institutional investors have the option of applying through a part-payment of Rs 50.

Via Businessline