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GVK Power IPO: Our view - Views on News from Equitymaster
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GVK Power IPO: Our view
Feb 2, 2006

GVK Power and Infrastructure Limited (GVKPIL) is entering the capital markets with an issue of 8.3 m shares at a price band of Rs 260 to Rs 310 per share. The size of the issue is in the range of Rs 2.2 to Rs 2.6 bn. The issue opens on February 2, 2006 and will close on February 7, 2006. Here is a brief analysis of the issue. We shall be putting up a detailed analysis shortly.

Company background

GVK Power & Infrastructure Ltd (GVKPIL) is the holding company of the power businesses of GVK. GVKPIL currently owns:

  1. A 53.9% stake in GVK Industries Ltd (GIL), which operates two power plants in Andhra Pradesh

    • Operational 216 MW Jegurupadu Phase-I, and

    • 220 MW Jegurupadu Phase-II, which is likely to be commissioned in the current month.

  2. A 45.3% stake in GPL, which is developing a 464 MW combined-cycle power plant at Peddapuram in Andhra Pradesh (expected to be commissioned by September 2006). Using a part of the net proceeds from this public issue, GVKPIL will increase its stake in GPL to 51% by subscribing to the latter’s equity as part of the equity contribution in the project. The total cost of setting up the GPL project facility is Rs 14.5 bn, with the debt component (70% of project cost or Rs 10.2 bn) already been tied up with various banks and financial institutions. Out of the equity portion of Rs 4.3 bn, GVKPIL’s share stands at 45.3%, which it proposes to increase to 51% from the public issue proceeds.

Once the Jegurupadu Phase-II and 464 MW GPL power plants become operational by February and September 2006 respectively, GVKPIL’s total power generation capacity will reach 900 MW, almost equivalent to Reliance Energy’s 941 MW capacity. All the three plants of GVKPIL are independent power projects (IPPs) and will supply power to Andhra Pradesh power distribution companies (APDISCOMs) under long-term power purchase agreements (PPAs).

Objects of the issue
  Rs m
Equity investment in GPL (Gautami Power Limited) for setting up
a 464 MW power plant at Peddapuram in Andhra Pradesh
Repayment of bridge finance availed for funding the equity
of GPL power project
Repayment of short-term and long-term debt in GVKPIL 820
General corporate purposes & issue expenses 192
Net proceeds from the issue* 2,565
* At the upper price band of Rs 310 per share

Reasons to apply
Appetite for power yet to be addressed: India is largely a power deficient country and therefore, supply is a problem and not demand. During FY05, the peak shortage of power stood at 11.7% (i.e. demand exceeded supply) and The government has set an ambitious target to improve the current per capita consumption of power (561 units) to over 1,000 units by the end of eleventh five-year plan (2008-2012). GVKPIL, which is aspiring to be one of the larger private sector power generators in India, shall thus bear the fruits of growth of the Indian power sector going forward.

Once the Jegurupadu Phase II and GPL power projects are operation by February and September 2006 respectively, GVKPIL will reach a total generation capacity of 900 MW (almost 7% of total private sector power generation capacity in India). The company will also have over 2,000 MW of capacity under various stages of development. These expansions are a step in the right direction and will propel growth going forward.

Assured cash flows: All of GVKPIL’s generation projects have an assured source of revenue under a long term PPA with APDISCOMs, entered into in 1996 and valid for a period of 18 years (2014) and renewable by mutual consent for another 15 years. Under the terms of the PPA, APDISCOMs are under obligation to take-or-pay all the electricity generated by GVKPIL’s plants, provided that the latter operates its stations at minimum PLF of 68.5% (the Phase-I of the Jegurupadu plant’s PLF in FY05 stood at a healthy 75%, well above the stipulated norm) . The tariff payable by APDISCOMs is based on a two-part structure –

I. Fixed charge, which consists of:

  • Interest on debt and working capital

  • Return on equity at the rate of 16% on the approved equity component

  • Depreciation as per the rates under the Electricity Supply Act

  • Operations and maintenance expenses at the rate of 2% of the approved project cost, indexed to inflation

  • Foreign exchange variation for debt repayment

  • Insurance premium at the rate of 1% of the approved project cost, subject to actuals

II. Variable charge, which includes the cost of fuel, transportation, minimum fuel offtake charges, and all statutory duties, taxes, cess and levies applicable thereon.

APDISCOMs’ payment obligations to GVKPIL under the PPA are secured by letters of credit, escrow arrangement and state government guarantee. Also, the fact that the former has never defaulted on its payment obligations and is recognised as the number one off-taker (by CRISIL and ICRA) among all power distribution companies in India raises our confidence in GVKPIL’s ‘assured’ growth prospects.

Reasons not to apply
Fuel constraints: Like most of the other power generating companies in the country GVKPIL’s existing capacity and proposed capacities are constrained for lack of sufficient fuel for operations. Considering that the natural gas availability in Andhra Pradesh is lower than the actual demand, the company’s new projects (220 MW Jegurupadu Phase II and 464 MW GPL) are likely to be affected by the shortage of natural gas from their respective commercial operation dates, until December 31 2006. Post this, if the non-availability of gas persists, these projects will be entitled to deemed generation, provided the company is in a position to prove that the projects are available to generate electricity using alternative fuels. And if the company is unable to make any alternate arrangements in a timely manner or if any such alternate arrangement is relatively costlier than gas-based generation (like naphtha), GVKPIL’s performance might be impacted.

Government intervention: One of the biggest risks for power generation players like GVKPIL is that the government regulator (in this case the Andhra Pradesh Electricity regulatory Commission) decides the returns (tariffs) on power sold. Recently, the post tax return on the equity of central power generating units was reduced from 16% to 14%. If it were to reduce further, it will have a negative impact on earnings for power generating companies. Besides, policy decisions (say, free power as had been promised by the incumbent Andhra Pradesh government) may affect the financial health of even the best of SEBs (like APDISCOMs), which in turn could impact GVKPIL’s profitability in the future.

Comparative Valuations & Comments
Based on the above analysis, we are pretty confident and clear about GVKPIL’s growth prospects. Given the GVK Group’s track record with respect to other businesses under its fold, we do not foresee any major execution risk as far as the expansion projects are concerned (of course, government intervention and natural gas availability are areas of concern). In this context, GVKPIL can be a part of portfolio with a long-term investment perspective.

(FY05) GVKPIL* Tata Power Rel. Energy NTPC
Generation capacity (MW) 900 2,320 941 23,749
Revenues (Rs m) 73 39,270 41,307 232,996
Current market price (Rs)** 310 469 615 116
Price to book value *** (x) 1.5 2.0 2.0 2.3
Net asset value (Rs) **** 530 474 344 123
Premium/(Discount) to NAV (%) (41.5) (1.1) 78.6 (5.4)
* Considering the ongoing expansion of 220 MW - Jegurupadu Phase II and 464 MW for GPL;
** Higher price band; *** Adjusted for FY06 expected book value for GVKPIL
**** Based on the expected capacity of 900 MW for GVKPIL and includes only power business of Reliance Energy

The company, by utilizing a part of the issue proceeds, will consolidate its position in the power generating subsidiaries and thus, we have valued the stock on a net asset value basis, capturing the company’s share in the power assets of GVK Industries Ltd (436 MW) and Gautami Power Ltd (464 MW). On the NAV basis, we have arrived at Rs 530 as the potential value of GVKPIL, which is at a large 42% discount to the higher issue price level of 310 per share. Even on a price to book value, the issue looks attractive when compared to the larger listed companies – Tata Power, Reliance Energy and NTPC. Considering this factor, and also factoring in the negatives as we have mentioned above, investors with long-term horizon can ‘APPLY’ to the issue of GVKPIL. However, they need to keep in mind the company’s ability to execute projects on time without cost overruns and manage administration-related issues that typically mire the power sector players.

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