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PPP projects seen as risky and not safe in current market conditions

With poor market conditions to raise equities, infrastructure players may find it difficult to stay afloat. A brief primer shows how debt can be dangerous

Public-Private Partnerships (PPP), an innovative method of roping in the private sector to engage in judicious government and infrastructural projects is currently seen as risky and dangerous, as more and more companies endanger themselves by borrowing recklessly to keep projects afloat. While potential returns can prove to be huge, there’s one catch. If private infrastructure players fail to finish the project on time, they will be penalised, usually at high rates, and this damages their prospects for bidding in future projects. Given the current market situation, infrastructure players are frantically trying to keep projects alive, albeit in a very unhealthy way—by loading up their balance sheets with debt.

According to a recent ICRA report, it is learnt that private infrastructural companies could be gearing up as much 20 times to keep their projects afloat. In other words, the holding/infrastructure company, if it is listed, will see a project decimated if its share price goes down by just 5%.

With so much gearing and little likelihood of generating cash flows, these companies will find it difficult to service their debt obligations in future and will soon go belly-up, which will lead to disastrous consequences across the economy, especially banks that are increasingly writing off loans, much the same way as Lehman Brothers went kaput.

The current challenging market conditions make it difficult to raise equity. Further, government policy inaction and vague tax laws have made private equities leery of investing in government projects, even attractive ones. This leaves infrastructure companies with no choice but to raise debt.  

Typically, an infrastructure company, or holding company, will have several smaller subsidiaries or “special purpose vehicles” (SPVs), which are project entities unto themselves, merely owned by the holding company. The idea is assign a governmental project to each SPV, so as to keep management efficient. Each SPV has its own balance sheet. When you add all the SPV balance sheets, you will get the main holding company’s balance sheet. It is a neat thing to do. But the problem comes when there’s debt involved. Let us see how.

Sometimes, government projects require huge amounts of money to be raised by the parent company to fund the project. The private infrastructure players can raise money through bank loans, initial public offers (IPOs), from private equity firms and sometimes from its own coffers (either using parent company’s cash, or cross-subsidising from profitable SPVs and such).

The ICRA report explains, in detail, how infrastructure companies saddle SPVs with debt, which translates into a much higher debt for the holding company. In the report, it explains how companies can raise debt in three different ways and how they can affect its balance sheet. Since parts of the report are very technical, we will not be going through them in detail, instead give a brief overview of the methods of madness in raising debt.

a)    Funding of equity in projects SPVs by raising debt at holding company level resulting in high overall leverage

This is the most basic form of funding an SPV. Basically the holding company or the infrastructure company raises initial debt. By creating a SPV, it invests part of this initial debt in form of part-equity ownership in the SPV. Within the SPV, it uses the equity ownership to raise further debt, to finance the remainder of the project cost. Thus the leverage found here is seven times. So, if the holding company is listed and its market price moves down 14%, it will see the equity in a particular SPV wiped out.

b)    Part funding of equity contribution through EPC profits; availability of mobilisation advances further reduces the initial fund requirement for equity infusion

This is slightly more complicated. In the previous example, we had one part equity and one part debt. In this case, the equity part of the SPV is funded through cash flows from the project. Thus, there is less debt involved, but also less equity as well. Thus, at SPV level, the gearing for the holding company is now much greater, due to less equity. Here, the gearing is found to be roughly 12 times. It takes only 8% downside in market movement to put a project at a risk.

c)    Loan re-financing/securitisation as a means to upfront profits

This is the most complex of the three. Basically, it involves in ‘securitising’ of cash flows to secure even more debt. In other words, debt is being raised in the lieu of cash flows, which flows into the holding company as debt and not equity. Here, the gearing is found to be 20 times. In the most difficult of market conditions, securitising is usually followed, as it involves raising debt in small dosages, which over time becomes too big to handle. All it takes is just a 5% market downside to wipe off an SPV.

The ICRA report does not mention what is the status of infrastructure companies and hence it is not known to what extent these companies have raised debt or how bad the situation is. We do know that PPP isn’t all that safe we thought out to be, especially in challenging market conditions.


Tata Steel Q4 net profit tumbles 90% to Rs433 crore

Despite a marginal increase in total revenues, the seventh largest steel producer in the world, reported 90% fall in fourth quarter net profit

Mumbai: Tata Steel on Friday posted a nearly 90% fall in its consolidated net profit at Rs433 crore for the fourth quarter ended March 31, 2012, despite a marginal increase in total income, reports PTI.

The company, which is currently the seventh largest steel producer in the world, had clocked Rs4,176 crore net profit in the corresponding quarter previous fiscal, it said in a statement.

Total income of the company during the January-March quarter, however, rose to Rs33,999 crore against Rs33,824 crore in the year-ago period.

On standalone basis, Tata Steel's net profit in Q4 FY12 stood at Rs 1,560 crore compared to Rs 1,708 crore.

Shares of the company closed Friday at Rs399.85 apiece at the BSE, down 1.5% over the previous close.


Kakodkar concerned over rise in import of electronic products

Import bill for oil itself is a serious issue in the context of not just balance of payment, but also in terms of energy security and large import of electronics surpassing even oil imports, is a serious issue in terms of balance of payments

Hyderabad: Voicing concern over the growing import bill of electronic products, Atomic Energy Commission (AEC) member Anil Kakodkar on Friday said such massive import is not good from the strategic point of view, reports PTI.

"While we have benefitted from the open door policy that we have followed for imported products, we should also realise that we have become that much more vulnerable. It is now well-known that India's import bill for electronic products would exceed that for oil and hydrocarbons," Kakodkar said, after launching a 'Programmable Logic Controller' (PLC) developed by the Electronics Corp of India Ltd (ECIL).

"This does not speak well. Because, import bill for oil itself is a serious issue in the context of not just balance of payment, but also in terms of energy security. Such large import of electronics surpassing even oil imports, is a serious issue in terms of balance of payments. But I think it is a huge issue in terms of security of Indian cyber space," he said.

He said dependence of individuals, as well as of the nation, had increased upon imports. An awareness needs to be brought about on these issues.

Talking to reporters later, Kakodkar favoured certain degree of protectionism to indigenous development. "Because you ask somebody to come out with a new product and compete with something which is already in the market. That itself is a market barrier for new devleopment. It is very clear also that creates a lot of vulnerability."

"In some countries abroad, there are rules saying in the strategic area, everything you source has to be of local origin. They go through lot of audits to make sure whether there has been a breach on that policy. According to me, this is perfectly logical," he said.

Asked where does the problem lie for the import bill in electronics being so high even after so many years of independence, he said there is no point in blaming the government and a "cultural correction" is needed amongst all.

Saying that it applied to several other sectors like power and steel and not just electronics, he felt that a feeling of Indianness and strong linkages among R and D, commercialisation and human resource development to develop the required capabilities.

Appreciating the ECIL, a PSU company, for bringing out security products in IT area, he said the journey should eventually lead to national capability of total solutions in terms of ICT requirements at least in strategically important domains.

Maintaining that the awareness to convert laboratory development into a commercial product "has not sunk in" in the scientific community in the country, he felt that it is one of the reasons for not being "so successful in translating all our R and D into commercially robust products".

YS Mayya, CMD, ECIL stated that the corporation will be targeting the PLCs at strategic sectors of atomic energy, defence, aerospace and homeland security where safety and security cannot be compromised.

Currently Indian market is dominated by foreign brands which, due to commercial reasons, does not expose their designs and software for full verification. There have been problems of denials and end-user restrictions in past, he added


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