KSK Energy Ventures IPO Analysis

Investors can stay away from the initial public offering of KSK Energy Ventures Ltd. (KSK). The offer appears expensively priced (PEM of 42-44 times on consolidated earnings) even as revenue and earning visibility is low in the medium to long-term.

The kind of earnings necessary to justify the asking price in the IPO is unlikely to come in before 2012-13. That the company has no experience in managing projects of the size that it now plans to implement is also a source of concern.
Outsourced power developer

KSK is an outsourced power developer that builds and operates small-sized captive power plants for either a single customer or a cluster of buyers. It now has three operational power plants adding up to a total capacity of 144 MW, but if its plans are executed without any glitches, it could achieve a capacity of over 9,000 MW in the next six years.

As with other power generating companies, KSK has structured each of its projects as a separate subsidiary. As per regulations, captive power buyers should own a minimum of 26 per cent equity in the company supplying the power and they should consume at least 51 per cent of the power generated. Thus, KSK shares equity ownership with its buyers in all its captive power supplying companies. For instance, cement manufacturer, Lafarge India, owns 49 per cent equity in the 43 MW Arasmeta project that supplies power to it.

The equity-sharing agreement is such that a majority of the economic benefits of equity ownership flows to KSK. In the case of Arasmeta, Lafarge has preferential dividend rights of just 0.1 per cent of the face value of the shares.

Where Lafarge gains is in lower tariff and in the assurance of uninterrupted supply of quality power. It pays just Rs 2.65 per unit for the power it buys from Arasmeta.

The tariff is so structured that increase in fuel costs are passed on to Lafarge but KSK has to bear increases in other expenses such as finance costs, taxes and duties, and maintenance.

Aiming high

From these modest beginnings, KSK now aims to become a large-sized power developer and the proceeds of this IPO will fuel a part of this ambition.

Under construction now are two projects aggregating 675 MW; the first, of 135 MW will be commissioned by the end of this calendar year, while the second and bigger one of 540 MW is slated for commissioning by the end of 2009.

Apart from this, there are three more projects under development adding up to 1973 MW. The IPO proceeds will be used to finance the biggest of the three — the 1,800 MW coal-fired project in Chattisgarh being implemented by Wardha Power Company Pvt. Ltd.

Besides these, there are projects, a mix of thermal and hydel, adding up to 6,345 MW in the planning stages now.
Fuel security

KSK’s strategy is to tie up with state mineral development corporations (SMDC) for coal supply.

Assuming that it is able to successfully tie-up agreements with such SMDCs and the latter follow those agreements in letter and spirit, KSK should not have a problem in fuel supply for its planned projects.

It has entered into an agreement with Gujarat Mineral Development Corporation (GMDC) for coal supply for the Chattisgarh project. GMDC will be acquiring 26 per cent equity in Wardha Power Company which will supply up to 1,010 MW to it at a fixed price of Rs 1.92 a unit. Importantly, there will be no increases in tariff during the term of the PPA, including for fuel cost increase.

Apart from this, KSK will also have to supply 540 MW to the Chattisgarh government as its share, leaving it with 250 MW to sell to other consumers at higher prices. The company is also negotiating with other state mineral development corporations such as in Madhya Pradesh and Puducherry for tying up coal supply for its other projects adding up to 3,600 MW capacity.
What troubles us

While there is a reasonable visibility in earnings in the near-term when the under-construction projects will be commissioned, the same cannot be said of the long-term.

There is not enough clarity on the pricing or on the quantum of free power available to KSK for sale to the market after accounting for the supplies to the host government and to the fuel supplier, as these are yet to be negotiated.

Besides, the company will have to raise almost Rs 22,000 crore in debt over the next five years to finance the projects that are in the planning stage.

How efficiently the company manages this exercise and how much of the interest cost it is able to build into the power tariff from each of those projects, will determine its earnings growth in the next five years.

Here, the lack of experience in managing large-sized projects is a definite cause for worry.

Besides, creating the management bandwidth required to simultaneously manage such large, diverse projects will be a major challenge, especially given the sharp ramp-up in the size of the overall business in a relatively short period of time.

The offer is priced aggressively with the company being valued at Rs 8,826 crore at the upper end of the price band. The PEM of 42-44 at the price band (based on consolidated 2007-08 EPS) is higher than what NTPC (18 times) and Tata Power (38 times) command. Given that there is clear visibility only to the extent of 992 MW of different projects that will be commissioned by 2011-12, the price being asked of investors does appear on the high side.

The prevailing market conditions anyway do not offer any comfort of gains either on listing or in the period immediately after that.

There are also a couple of other factors that trouble us. There appear to be too many companies in the group with complex holding patterns.

The holding company of KSK Energy Ventures is KSK Energy Ltd. which is registered in Mauritius.

This company is, in turn, a wholly-owned subsidiary of KSK Power Ventur Plc, registered in the Isle of Man. A few group companies with operating power plants and generating cash flows were transferred to another outfit owned by the promoters a few months ahead of the IPO.

Though power projects are typically housed in independent special purpose vehicles with a holding company, in KSK’s case, the presence of a wholly-promoter-owned company in the midst and the possible conflict of interests that could arise because of thi,s are a cause for concern.

Also worrying is a recent communication from GMDC that the fuel supply agreement that it signed with KSK for the 1,800 MW Chattisgarh project is subject to government approval (which is awaited).

What this communication means to the agreement for fuel supply and power offtake is not known at this point in time.

Offer details: KSK is offering 3.46 crore shares in the band of Rs 240-255 a share. The offer, lead-managed by Kotak Investment Banking and IDFC-SSKI, is open between June 23-25.