Cover Story

The IPO League

June 2017
With over Rs.9,000 crore raised in the building and construction sector through IPOs and InvITs this year, now is the time for large companies to tap the equity market.

The IPO league is growing - and thriving. In the construction arena, whether it is companies involved in building products, building and infrastructure projects, or state-owned undertakings, the initial public offering (IPO) lane is clearly crowded.

While going public is not for every company with the pitfalls being numerous and stakes high, the concept is gaining currency - literally. As reports indicate, in FY2016-17, private-sector firms raised Rs 28,225 crore through IPOs, said to be among the best in six years. And this year - in fact, just in the past two to three months - several building and construction companies have made headlines for filing their draft red herring prospectus (DRHP) or announcing IPOs or InvITs. Companies that have recently announced their IPOs include HUDCO, PSP Projects and Shankara Building Products, and IRB and Sterlite Power Grid Ventures (IndiGrid) have announced InvITs.

This apart, companies such as Reliance Infrastructure, MEP Infrastructure, India Energy Exchange, GR Infraprojects, Capacit'e Infraprojects and Cochin Shipyard have filed or are in the process of filing their DRHP soon. Such is the traction just in the first half of the calendar year, and first quarter of the financial year!

A conducive market
Currently, the Indian capital markets are on a bull run, as evident from the Nifty touching an all-time high.

In this context, Dr Suresh Surana, Founder, RSM Astute Consulting Group, says, 'The response to the recent IPOs has been encouraging.' Referring to the success of the HUDCO IPO recently, Dr M Ravi Kanth, Chairman & Managing Director, HUDCO, adds, 'The environment looks conducive for IPOs in view of various government initiatives and schemes.' And Abhishek Lodhiya, Senior Equity Research Analyst-Infrastructure, Capital Goods and Real Estate, Angel Broking, says, 'There is high liquidity in the market. The IPOs of companies with a good financial track record are getting oversubscribed.'

The current market scenario remains upbeat in view of the expected good monsoon, soft interest rate regime, controlled inflation and various government initiatives such as implementation of the GST with effect from July 1, 2017; implementation of RERA; Pradhan Mantri Awas Yojna; Housing for All by 2022; smart city development; Skill India; Startup; Jan Dhan Yojana; and so on.

As Vikas Khemani, President & CEO, Edelweiss Securities, says, 'Increasing government spending across segments like roads, railways, metro rail and urban infra is leading to a substantial order book build-up for construction companies.' In fact, revenue visibility (in terms of book-to-bill) for major construction companies has improved to 4x (compared to 3x a year earlier). This has led to the expectation that revenue growth for construction companies, will improve significantly going ahead. 'Better revenue growth will aid these companies, owing to operating leverage, leading to margin improvement,' says Khemani. In addition, with interest rates being low, profitability is also expected to be better.

Capital markets are largely driven by investor sentiment and fundamentals. Bajrang Choudhary, Managing Director, Bharat Road Network (BRNL), says, 'After a moderate growth in the sensex in 2016, there's definitely a flurry of activities in the market, which is clearly visible from the series of IPOs lined up for listing over the next few months.' Also, the infrastructure sector in India is growing at an impressive rate, despite the country currently facing a massive funding gap to develop its infrastructure commensurate with its economic growth. And, while the outlook for the infrastructure sector is exciting, 'The scenario for real estate is mixed,' says Surana. 'The sector has been saddled with excessive inventory, lack of transparency, excessive regulations and debt, and stagnant prices.'

Also, investors are waiting for good IPOs - while the interest rate coming down is good for the corporate sector, it has an impact on the company's savings or the returns on its savings deposit. 'So, if ultimately it is a good robust market,' says a leading player in the construction sector, 'smaller investors will go in for mutual funds, following which assets under management (AUM) of mutual funds will be at record high; hence the need to look for and choose good companies.'

IPO or InvITs?
Raising resources either through InvITs or IPOs could be equally beneficial, as it would help finance the massive infrastructure asset creation needed for the country.

BRNL has filed its DRHP for an IPO. And, while Choudhary from BRNL views InvITs as a good yield generating instrument, best suited for infrastructure asset ownership companies to access capital, he says, 'We believe this platform is beneficial when the company raising capital is looking for marginal efficiency. It has limitations in the form of leveraging under construction assets and growth opportunities.' He emphasises that infrastructure is a highly capital-intensive business and, as such, if a company hits a roadblock in raising capital at the Holdco balance sheet, it makes a good case to raise capital through an InvIT by pushing operational assets to this platform for unlocking capital for growth. As return expectations on this platform are reasonably low, it helps increase return at the Holdco.

An InvIT predominantly helps infrastructure companies deleverage their balance sheets in terms of the debt size on its books.

As Jayant Mhaiskar, Vice Chairman and Managing Director, MEP Infrastructure Developers, shares, 'InvIT regulations require 51 per cent minimum deleveraging on the total debt on the project, which is pulled under the InvIT structure and allows redeployment of fresh capital into newer projects. This enables companies to bid and work on more projects.'

The analyst take
The term IPO generally refers to equity or launch of equity shares while a typical InvIT is a kind of a hybrid product, more of debt with some sale of equity. Hence, it is called hybrid debt.

Viewing a conducive market for InvITs, K Ravichandran, Senior Vice President & Group Head, Corporate Ratings, ICRA, says, 'The yield level depends on how various operational assets function. Another important factor would be the price at which existing sponsors of SPVs are diluting their stake in those entities.' Highlighting one of the benefits of the InvIT, Ravichandran explains that it enables the sponsors to deleverage; they can raise capital by selling the stake to other prospective investors through InvIT, by diluting or raising equity and additional mobilisation. The price at which the seller transfers his stake to the InvIT investor is also important.

For his part, Khemani sees a conducive market for IPOs.
The broad-based capex recovery in the country should ensure that the prospects of these infrastructure companies remain robust going ahead,' he says. 'Improving investor sentiment and reducing the risk perception of companies leveraging the 'investment themes' will enable fund raising for unlisted companies.' As for InvITs, Khemani sees a twin benefit of lowering capital cost as well as better and faster asset churning for infrastructure companies. 'Infrastructure being capital-intensive, lower cost of capital can definitely allow infrastructure companies to improve profitability. In addition, faster asset churning keeps the balance sheet healthy and provides for a valuation benchmark for assets.'

Meanwhile, Dr Surana from RSM Astute Consulting Group points to the units of REITs as an innovative financial instrument for the Indian capital market and investors.

'REITs are similar to InvITs,' he says, 'which are meant for infrastructure projects in five broad sectors: Transport, energy, water sanitation, communication, and social and commercial infrastructure.'

In REITs, the developer can use the amount to repay the bank loan or create more assets, thereby increasing cash flow and giving it to the investors. As for InvITs, you basically discount your cash flow, reducing the debt from a company's book. Further, domestic and global investments are replacing bank loans, resulting in a huge return and cash flow available for distribution every six months. Companies also utilise this amount received to repay bank loans so that, going forward, banks can lend them to create new assets. And, with Rs 10 lakh being the minimum ticket size, an InvIT is more for established companies who have built assets.

There are companies who have generated 100-200 per cent returns in a year and there are also those whose share prices have fallen 99 per cent since the initial launch of the IPO. But an InvIT is more of a yield product, wherein the yield may not be that high compared to equity. As Ravichandran puts it, 'An InvIT is more of a long-term investment, where the companies involved with insurance and pension funds want a stable return. However, in an IPO, only equity-oriented investors who are willing to take a high risk would invest.'

Yield it!
If you want a stable yield, the underlying assets should be generating a stable revenue.

In this context, Lodhiya refers to the case of IndiGrid's InvIT. However, like in the case of the IRB InvIT, he adds, 'If your appetite for risk is higher, you can go for equity.'

Analysing the two InvITs, Lodhiya adds, 'In the IRB InvIT, for instance, the company will give 12.5 per cent yield; post tax, this will come down to 8.5 per cent (considering 33 per cent tax). This will further give a capital appreciation of around 4-5 per cent in three to four years, resulting in a yield of around 12 per cent in three years. The same is the case with IndiGrid. However, in IRB - where the revenue is a function of operational asset growth and traffic growth - the risk-reward ratio is much higher than that of IndiGrid, where the revenues come from stable tariff plans.'

Sharing its views on the PSP IPO, Reliance Securities views the company as one with a decent project execution track record and balance sheets properly managed over the years. The company's order book has grown almost 2.5 times in the past one to one-and-a-half years.

The company has shown an order book of Rs 929 crore on its prospectus, and has already secured around Rs 250 crore of orders in the first two months of the current fiscal and is targeting some big orders going ahead.

As the analyst firm sees it, the IPO is one way for the company to improve its financial strength, after which its fund-based and non-fund based limit will increase from Rs 200 crore to Rs 250 crore. This will give the company mileage to bid for more projects. Indeed, with the IPO pitch set for some big innings, the offering pipeline for 2017-18 looks promising - perhaps the best time for large companies to tap the equity market!


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