ILFS Transportation Networks IPO Analysis

IL&FS Transportation Networks (ITNL), promoted by IL&FS (Infrastructure Leasing & Financial Services), is an established surface transportation infrastructure developer providing end-to-end solutions for BOT (build, operate and transfer) road projects.

The company, incorporated in 2000 to consolidate the existing road infrastructure projects of IL&FS and pursue various new project initiatives in the area of surface transportation infrastructure, currently has a total road portfolio of 9,397-lane km of BOT roads under development and management. Of which, about 35% is annuity projects and balance 65% are toll projects. Of the total road project portfolio, operational projects were eight with an aggregate distance of 4,081 lane km, and the projects under development number about 11 (including one overseas project in Spain), with an aggregate length of 5,316 lane km. In addition to the road sector projects, it is also developing the Gurgaon Metro Link Rail Project. Similarly, it operates the Nagpur City Bus Transportation Service on BOO basis. Moreover, the company is believed to be the preferred bidder for two projects, with an aggregate distance of 2,100-lane km.
All the BOT projects are implemented through special purpose vehicles (SUVs), and the company has controlling interest in a number of SPVs. Noida Toll bridge is the first BOT project of the company. It holds a 25.35% stake.

The company acquired a 100% stake in Spain-based Elsamex SA, which provides maintenance services primarily for highways and roads in Spain and other countries, in March 2008. Apart from o
operations and maintenance (O&M) of roads, Elsamex also offers O&M service for petrol stations and buildings. Elsamex has over 21,000-lane km of roads and over 3,100 petrol stations under maintenance worldwide. ITNL plans to diversify its operations into urban infrastructure, railways, and airports.

ITNL's major source of revenue are fees received on account of rendering 1) project development services; 2) advisory and project management services; 3) construction supervision services; 4) operation and maintenance service; 5) tolling; and 6) dividend and interest income on investments. O&M income, construction contract revenue, toll revenue and finance income accounted for about 63.2%, 13.3%, 6.9% and 6.2%, respectively, of the FY 2009 consolidated income of the company, excluding other income. However, the share of construction contract revenue has increased to 42.9% for the half-year ended September 2009, with that of O&M declining to 39.8%. Toll revenue and finance income stood at 7.2% and 4% for the same period.

The O&M revenue largely consists of income from 1) Elsamex's maintenance activities [beginning FY 2009]; and 2) operation and maintenance startup fees the company generate in India as well as recurring O&M fees to upkeep the road assets in India. The finance income consists of revenue from financial assets (roads or bridges for which ITNL entered into an annuity contract). The majority of the annuity received for these roads or bridges is not recognized as revenue but instead used to offset the cost of the original assets, which was capitalized.

Further, the company has also entered into a memorandum of understanding with Belbadi and Ascon Road Construction L.L.C (Ascon) to bid for new projects in the Gulf Cooperation Council Region and for setting up a contracting and project development strategic partnership to undertake major infrastructure, real estate development, and construction and maintenance projects. IL&FS has also entered into a memorandum of understanding with the AAI pursuant to which IL&FS has agreed to cooperate, identify, develop, implement, operate and maintain airports and associated projects outside India, and it intends to leverage IL&FS's arrangement with the AAI (Airport Authority of India) for identifying, securing and developing airport projects outside India. The company also entered into a memorandum of understanding with Middle East Coal Pte, Singapore, for financing, developing and implementing coal evacuation infrastructure facilities in Muara Wahau, Indonesia. The company intends to utilize Elsamex to bid for OMT (operate, maintain and transfer) projects outside India in the countries in which Elsamex operates.

Though the company is not get anything from the offer for sale (by Trinity Capital), at the offer price band of Rs 242-258, the fresh issue will result in proceeds of Rs 589.61 crore to Rs 596.45 crore. These funds will be used primarily for funding pre-payment and repayment of portion of the Rs 500-crore debt and balance for general corporate purposes.

Strengths

Parent IL&FS has reputation in infrastructure development, with advisory relationship with various agencies/arms of governments, both Central and state, implementing infrastructure projects. This differentiates ITNL from other infra developers who transformed themselves from being construction companies to project developers. On strong parent, the company is well positioned to generate value in the pre-construction phase, with its advisory role. IL&FS also brings in strong management team with vast experience in infrastructure development and financing of infra projects.

Has strong execution capability, with a track record of operational projects.

The government of India is strongly committed to road sector development, with construction of 20 km of road a day, expressways etc. This is all set to bring enormous opportunities for road sector developers.

Weakness

Though the GoI is committed to highway construction of 20 km a day, the last couple of years, especially 2008 and 2009, has not seen major finalization of orders from NHAI (National Highways Authority of India), the nodal agency for highway development in the country at the national level.

Though the company, off late, took up design, engineering and project management for SPVs, it still outsources civil works unlike its competitors, who are integrated players. Thus, it is unable to capture the complete value chain.

IL&FS and certain other group companies have equity interests or other investments in other companies that offer services that are similar to the business of ITNL, such as Maytas Infrastructure, Chhattisgarh Highway Development Company, Jharkhand Accelerated Road Development Company, MP Toll Roads, Road Infrastructure Development Company of Rajasthan and IL&FS Nepal Infrastructure Development Company Private. This may result in conflict of interest in addressing business opportunities and strategies in circumstances where ITNL's interests differ from other companies in which IL&FS or group companies have an interest. Additionally, as per the model concession agreement, an applicant will be considered to have conflict of interest and will be disqualified if such applicant and any other applicant have common shareholders or other ownership interest direct or indirect of more than 25% of the paid-up and subscribed capital. As neither IL&FS nor any group company has undertaken to refrain from competing with ITNL's business, future bidding of the company may be affected in such conflict of interest cases.

As on September 30, 2009, approximately about 40% of the loans were repayable with a period of the next 12 months. The total indebtedness of the company as on September 30, 2009, was Rs 2417.13 crore. Moreover, about 21.40% of the total debt availed by ITNL as on January 21, 2010, is repayable on demand, with the unsecured debt from promoter/ group companies such as IL&FS, IL&FS Securities Services and IL&FS Financial Services aggregating to Rs 340 crore.

The company's plans of integration of Elsamex with the company might (i) take longer than expected; or (ii) cost more than expected. Any failure to effectively implement the Elsamex integration strategy would have an adverse bearing on the financials of the ITNL.

Promoter of the company, i.e. IL&FS, has been involved in SEBI proceedings. SEBI had restrained IL&FS depositary participant from opening fresh demat accounts in relation to the investigations relating to IPO scam. However, the show cause notice of the enquiry officer was disposed of, accepting the response of IL&FS.

Though GOI is committed and removed some irritants relating to concession agreement and RFQ/RFP (Request for Qualification/ Request for Proposal), land acquisition remains a roadblock, affecting the timely completion of projects. Moreover, some external factors not in the control of the developers such as insufficient/quality traffic assessment could affect the successful implementation and viability of the project.

Valuation

The financials of FY 2008 and FY 2009 are not comparable on acquisition of Elsamex SA in March 2008. The revenue for FY 2009 was up by 246% to Rs 1252.59 crore. However, the net profit (after minority interest) was lower by 70% to Rs 27.88 crore, with OPM crashing to 17.6% in FY 2009 compared to 50.6% in FY 2008 on account of thin margin business of Elsamex. But the revenue for the half-year ended September 2009 was at Rs 958.34 crore. With OPM improving to 35.2% on the back of change in revenue mix in favour of construction services business, net profit stood at Rs 118.23 crore. On post-issue equity (based on price band of Rs 242-258), the annualized EPS works out to Rs 12.2 -12.3. This is discounted 19.8 times at the lower price band and 21 times at the upper price band. In comparison, IRB Infrastructure quotes at a PE of 26.3 times its nine months ended December 2009 annualized consolidated EPS.