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GIPL IPO: Our view - Views on News from Equitymaster
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GIPL IPO: Our view
Mar 11, 2008

Issue Summary:
Gammon Infrastructure Projects Limited (GIPL), a Mumbai-based construction company, is issuing 16.55 m shares as part of its initial public offering, which began yesterday and will remain open for subscription till March 13, 2008. The company has priced its offering at Rs 167 to Rs 200 per share. At the higher price band, it expects to raise Rs 3.3 bn from the issue, which will be towards funding the investments in its subsidiaries that are involved in construction and maintenance of roads. Here is a brief snapshot of the issue.

Company background
GIPL is an infrastructure project development company incorporated in 2001 to participate in the development of infrastructure projects in India. GIPL currently undertakes and develops projects such as roads, bridges, ports, hydroelectric power and biomass power projects on a PPP (Public Private Partnership) basis. In addition, GIPL has also identified urban infrastructure, airports, mass rapid transit systems, power transmission lines and SEZs as areas of focus for project development. The company also offers services in other areas of project development, such as project advisory services, project funding and operations and maintenance activities.

Reasons to apply
Project portfolio with assured revenues: In case of GIPL, all of its operational projects have assured sources of revenue under either an annuity or take-or-pay type arrangement with various governmental or quasi-governmental entities, under which such entities are required to pay for the projectís output or availability at predetermined levels. The annuities receivable by REL and AEL (SPVs of the company) from NHAI are structured to cover the fixed costs of operating the projects, interest and depreciation. Under these concession agreements, NHAIís payment obligations are secured by letters of credit, which provide further assurance that the SPVs will receive revenues in a timely manner. Contracts of this nature have reduced the revenue risk associated with the project, thereby balancing market risk with assured returns. We believe that this annuity based projects gives GIPL an upper hand over its listed counterparts.

Strong operating experience: GIPL is among the first companies in India incorporated exclusively to participate in infrastructure development through the PPP model. Also, the company has a track record in meeting project completion targets. This expertise gives GIPL significant competitive advantages to deal with any construction or implementation risk in an industry.

Reasons not to apply
Management concerns: In case of GIPL the CMD was previously prohibited by SEBI from accessing the capital markets. In addition to these, the CMD and the two others companies are also prohibited from selling their shareholding in GIPL for three years from the date of allotment of the IPO. Based on these issues and also on the perceived poor quality of corporate governance, investors have to be extremely wary of investing in construction companies.

Poor return ratios: Apart from management quality, the returns from the business are also important to make a good investment. GIPL has net margins of around 14% and ROCE of only 8%. Such low returns necessitate equity dilution and higher leverage, as evident from the D/E ratio of the company, which stands at a steep 1.3x even after factoring in proceeds from the IPO.

Valuations and Recommendation:
Profit & Loss Data (Rs m) FY06 FY07 1HFY08
Total sales 768 1,477 777
% Growth 92.4% NA
Total expenditure 186 315 201
EBIDTA 582 1,162 577
EBIDTA margin (%) 75.7% 78.6% 74.2%
Other income 17 112 60
Depreciation 193 384 199
Financial expenses 231 450 255
Profit before tax 174 440 182
Share in associates 102 (7) (4)
Minority Interest 23 21 11
Tax 70 114 58
Effective tax rate 40.3% 25.8% 31.8%
Profit after tax 183 299 110
% Growth 63.4% NA
Net profit margins (%) 23.8% 20.2% 14.1%
Annualised EPS (Rs) 1.3 2.1 1.5
Balance Sheet Data (Rs m)
Equity 2,516 2,803 2,891
Debt 5,118 6,678 8,135
Capital Employed 7,634 9,482 11,026
Debt to equity 2.0 2.4 2.8
Return on equity 7.3% 10.6% 7.6%
Return on capital employed 5.3% 9.4% 7.9%
Debtor days 289 183 146
Current ratio 6.4 4.1 2.6
Sales/GFA 0.1 0.2 0.2
* Calculated on post issue diluted capital;
Note: Sales and earnings are annualised for 1HFY08 for calculation of ratios

Recommendation
The company currently has 2 annuity projects, 1 toll and annuity project and 1 toll based project. While the annuity-based projects provide a steady stream of revenues, we believe that the revenues growth till FY10 will be sluggish. This is largely because out of the 7 projects, which are under construction, 3 are coming after FY10 and 2 would come in the second half of FY10. Add to it declining net margins, poor return ratios and a high debt to equity ratio. We have valued the company on a DCF basis and have arrived at a fair value per share of Rs 111, which is a good 34% discount to the lower end of the price band. As such we recommend investors to "AVOID" the issue.

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