The Hindu Business Line : Maytas Infra: Invest at cut-off

Though projects are routed through several special purpose vehicles, they have the potential to add value to core operations and may emerge as primary businesses later.

Mr Teja Raju, Vice-Chairman… Diversification, well timed.

Vidya Bala

Investors with a long-term perspective can consider subscribing to the initial public offer of Maytas Infra. A well-diversified business portfolio, timely moves to capitalise on the emerging business opportunities and the ability to achieve superior profit margins are positives for this mid-sized infrastructure company. As the company appears set to aggressively foray into new segments in infrastructure, investors should be willing to accept lower return on equity over the next couple of years.

At the offer price band of Rs 320-370, the price-earnings ratio, based on the FY-07 earnings (and on the pre-IPO equity base), is 29-33. On an expanded equity base, the PE is at 17-19 times its likely FY-09 earnings. We have not factored in any income flow from the company’s investments in special purpose vehicles (SPVs). The valuation appears justified compared to similar-sized peers in the light of the more diversified business profile of the company.

Business

Maytas Infra is a construction company deriving revenues from segments such as irrigation, roads, bridges and buildings infrastructure. The company is transitioning into an infrastructure company with participation in power generation projects and public-private partnerships in infrastructure. A major portion of the IPO proceeds (Rs 280-330 crore) would be invested in special purpose vehicles that would operate in infrastructure development and the rest to acquire construction equipment. Post-offer, the market cap of the company in the offer price band would be Rs 1,800-2,200 crore.

Strong foundation

Maytas Infra started out as a construction contractor and graduated steadily to offering turnkey services. The orders in hand, at Rs 3,589 crore as of June 2007, amount to 4.5 times the total revenues for FY-07.

While the company has in the past derived much of its revenues from irrigation, roads and bridges, other segments such as power transmission and distribution, oil and gas pipelines and railway infrastructure have now become conspicuous in the standalone order-book. These new segments now account for close to 20 per cent of the present order-book. Electrification projects in Madhya Pradesh, pipeline project from Gujarat State Petronet and railway siding and the linkage for Vedanta Alumina are few of the projects in these segments. The entry appears well-timed given that government spending in these segments has increased significantly and not too many players now possess the capabilities to foray into all the above segments.

Even in its core business segments, the company has moved from the traditional areas of canals and bridges to the more lucrative lift irrigation and dams.

We expect this increasing presence in high-end projects to improve profit margins. The diversification is also likely to shield the company from any slowdown in one segment.

Interestingly, the company has adopted the joint-venture routes in a number of the above new projects. While joint ventures may mean profit-sharing, they are likely to result in providing technical experience and qualification to bid for future projects. JV partners such as Nagarjuna Construction and Navayuga Engineering are likely to provide sound support on the technology front.

Maytas Infra has also demonstrated strong growth in its financials over the past three years. The company’s sales and profits grew by 58 per cent and 105 per cent respectively, on a compounded annual basis. The current operating profit margin of 16 per cent is superior to most infrastructure companies, which mostly operate within a band of 8-12 per cent. That the company has significantly added to its own skilled personnel to depend less on sub-contracting, may also help profit margins over the medium-term.

The SPV route

Maytas Infra intends to deploy about 57 per cent of the IPO proceeds towards investment in three special purpose vehicles (termed as associate companies) created to fund the company’s expansion into the infrastructure development segment. In other words, IPO funds would not be deployed in the company directly but used to invest in these SPVs. The company would only receive dividends (from the distributable surplus, if any, of such SPVs) that could add to its net profits.

While this strategy does not on the face of it appear investor-friendly, the SPV route is increasingly sought-after by infrastructure companies, as it protects the parent company from the higher risks involved in new business forays. It also reduces the burden on the balance-sheet as the SPV operates as an independent company for raising funds. The equity contribution required in an SPV is also relatively less as infrastructure SPVs are generally highly leveraged.

The SPV mode adopted by Maytas for 11 projects (in roads, power and port) is a good move for the following reasons:

One, Maytas does not have the experience of executing hardcore infrastructure projects. The fact that these SPVs are in consortium with bigger players provides it the necessary support in terms of finance and technical qualification.

Two, the company has been cautious in taking stakes of less than 50 per cent in these SPVs; it however, has the option of increasing the stake at a later date.

Three, the partners in these SPVs are established players such as Nagarjuna Construction and GVK Power and Infrastructure, thus reducing execution risks.

Four, most of the SPV projects being annuity or toll projects are likely to yield steady cash flow, thus suggesting that Maytas may receive regular dividends from the SPV. The non-core businesses have the potential to emerge as primary businesses that may add substantially to revenues at a later stage.
Risks

Of Maytas’ SPVs in the power business, the planned projects have tied-up for fuel requirements, but the existing Gautami Power project is facing rough weather, as it is yet to receive natural gas supply from GAIL. The company is hoping to come up with an amicable solution with the State government on this issue. There could be a risk of cost overruns denting the SPV’s profits. Another planned hydropower project does not have any offtake agreement as it is proposed to be a merchant power facility. While this results in risks on the demand and price front, given the power shortage in India, the company may be able to sell its power at competitive price. One of the SPVs has faced setbacks in financial closure on a road project due to delay by NHAI in providing right over land.

The IPO is open from September 27 to October 04. DSP Merrill Lynch and JM Financial are the lead managers.

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