Bidders with access to low cost debt likely gainers in TOT auctions

Long-term traffic forecasting and absorption of up to 20 per cent variation in toll collections likely major challenges in TOT model   The first bundle of highway projects to be awarded through the toll-operate-transfer (TOT) route involving 10 stretches – six highways along the East Coast in Andhra Pradesh and part of the Golden Quadrilateral (GQ) – the busy Kolkata-Chennai route and the remaining four located in Gujarat, are estimated to be valued at Rs 6,000 crore, as per ICRA.   According to an ICRA note, the initial estimated concession value (IECV) of authority, which is discounted value (at the rate of three percent above bank rate, equivalent to 9.25 per cent) of the free cash flow expected to be generated by the project highway, from the valuation date till the end of the concession period of 30 years is the base price for the bid. A single concessionaire will be selected for all the projects in the bundle on the basis of the highest total upfront concession fee, which is the sum of the ‘bid concession fee’ for each project in the bundle.   Throwing more light, Shubham Jain, Vice President & Sector Head, Corporate Ratings, ICRA, said: “Given that IECV is estimated with a discounting rate of bank rate plus 300 bps – currently at 9.25 per cent, players with access to low cost debt will be at an advantage. The ability of the participants to generate high equity IRR would critically hinge on the cost of debt. Assuming that the cash flows are in line with NHAI’s estimates, for a project with D/E of 70:30, at 8 per cent cost of debt the equity return would be around 12 per cent while the ones with 9 per cent cost of debt would earn a single digit return on their investments.”   The total length of the first bundle is 646 km. Almost 60 per cent of the projects have greater than 10 years of toll collection track record with maximum vintage being 12.40 years. All ten projects have more than five years of vintage. For the six stretches along the GQ with high traffic density, the average toll collection per day is at Rs 0.15 crore, whereas for the non-GQ stretches it is Rs 0.06 crore per day.   The operational nature of these assets eliminates execution risk and the traffic risk is relatively lower when compared to greenfield projects as the base traffic and growth trends are established for a majority of the stretches. Nonetheless, projecting traffic growth for a 30-year period will be challenging. Given the long concession period, there could be a requirement for capacity augmentation (lane up-gradation). While there is no obligation on the TOT concessionaire to take up augmentation – the NHAI can employ a third party contractor for lane up gradation. However, the O&M and tolling obligation rests with the TOT concessionaire.    Adds Jain, “In the absence of long tenure debt, equivalent to 75-80 per cent of the concession fee, the TOT projects would require refinancing at a later stage. Further, forecasting traffic for a 30-year period is extremely challenging, given the dynamic nature of the road network with many state highways getting upgraded to national highways on a regular basis. For many non-BOT stretches which were irregularly maintained in the past, the major maintenance requirement could be significantly higher once the TOT concessionaire takes over the project. Hence, there is a possibility of dispute on quality-related issues.”   Also, given that the TOT concessionaires are expected to absorb at least 20 per cent loss in toll collections without compensation, the bidders may factor this in their bid concession fee. This, along with the discounting rate of 9.25 per cent for arriving at the IECV may result in bidders quoting cautiously to start with, says ICRA.   Overall, the government expects to mop up about Rs 34,000 crore through TOT route over the medium term, which would be utilised to part fund the recently announced Bharatmala Pariyojana (24,800 km) involving total expenditure of Rs 6,92,324 crore.