The new, hybrid public-private partnership (PPP) model for developing roads will bring down the internal rate of return for road developers by as much as 400 basis points (bps) to 12-14% from 16-17% under the current model. That’s because the risks will be significantly lower given that the government will be responsible for all clearances, land acquisition, predicting the traffic and collecting the toll. The new model virtually resembles an EPC (engineering procurement construction) contract.
But not all companies are upset over the prospect of diminished returns. Mukund Sapre, executive director of IL&FS Transportation Networks, points out that while under the annuity model equity returns were in the range of 14%, the new model covers the developer’s risk.
“Since the quantum of debt will be smaller, interest costs will also be lower,” said W Vijaya Kumar, chief financial officer of the Hyderabad-based Ramky Infrastructure, adding that as of now, developers prefer lower returns and are not willing to take business risks.
The new model could attract a new class of investors such as sovereign wealth and pension funds that are looking for stable returns over a longer tenure, with limited risks. While some private equity players may participate in such projects, the relatively lower returns may keep them away.
Developers will now contribute 60% of the equity with the government bringing in the rest. The government will also be responsible for acquiring 90% of the land needed for the project, making it much easier for the developer to start construction. The developer will also be spared the law and order risks relating to toll collection. For constructing the road, the developer will get a biannual annuity from the government, in addition to a fee for operating and maintaining the asset.
The government has said 13 projects worth Rs 14,442 crore had been identified to be bid out under the new model. Close to 24 projects that have been stalled and need special clearance by the Cabinet, Nitin Gadkari, minister for roads and transportation, said recently.
The annuity-based model should be preferable to banks since their exposure will be to the government. Thanks to aggressive bidding by developers and projects getting stalled, several developers are not able to service their loans. Varun Mehta, DGM (finance) at Sadbhav Engineering, said the new model will prevent aggressive bidding since revenues will be fixed. Also, a phase of consolidation in the road projects sector that has already played out will diminish the competitive intensity in future bidding rounds, companies said.
Investment bankers like Pankaj Kalra, senior ED, Kotak Investment Banking, however, believe that given the lower risk profile of these projects, competitive intensity may prevail. “We believe bidders may settle for lower IRRs (internal rate of returns) to win projects as well. Besides, any upside in the form of higher traffic will also be forgone in such projects. Any subsequent investor in/buyer of these projects would thus give lower premiums (over invested capital) on these projects as compared to the ones with higher IRR and potential for traffic upside,” Kalra said.
Kalra said that an operating project under this pattern would be more like a debt instrument backed by annuity payments. Given the focus of sovereign wealth funds, pension and insurance funds on assured and predictable cash flows with minimum risk, select projects could find favour with them. However, traditional private equity funds that typically look for returns of 18% and above would not evince much interest in such projects, he added.
From a ratings perspective, Manish Gupta, director, Crisil Ratings, said that the level of aggression in the bidding process and hence the amount of annuity along with funding mix of the project would have to be closely monitored while rating of these projects.
* Hybrid PPP model for developing roads to bring down the internal rate of return for developers by 400 basis bps to 12-14% from 16-17% now
* The model could attract a new class of investors such as sovereign wealth and pension funds looking for stable returns over a longer tenure
* Developers will contribute 60% of the equity and the govt will be responsible for acquiring 90% of land needed for project