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IL&FS Transportation Networks IPO review and analysis by Angel Broking

Contributed by Angel Broking

By Angel Broking

Rationale for our 'Subscribe' view

IL&FS Transportation Network's (ITNL) IPO, we believe, is reasonably priced considering the emerging growth opportunities, its strong portfolio of assets and sound parentage. Further, on comparative valuations, ITNL (based on the limited information provided in the RHP, refer Exhibit1) scores over IRB Infra and would trade at 33% discount to IRB Infra on FY2010E P/BV. Hence, owing to attractive relative valuations, we recommend a Subscribe view on the IPO.

Strong Parentage and management at helm of affairs

On account of having strong backing from IL&FS, we believe that going ahead ITNL will enjoy an edge over competition while bidding for new projects or approaching lenders for financing its projects. ITNL is particularly well-placed due to its affiliation with IL&FS in light of the new National Highway Authority of India (NHAI) norms which specifies that a developer/asset owner cannot bid for new projects if 3 or more of its projects are awaiting financial closure. Thus, ITNL is set to garner increasing market share compared to its peers. Further, ITNL has on its Board an experienced and professional set of senior managers who have vast experience in the Surface Transportation Segment in the Infrastructure space.

An established player with a geographically diversified portfolio

ITNL is a surface transport player, with an established track record of successfully bidding, developing and operating Road BOT projects on a commercial basis. It is one of the India's largest players in the Road BOT Segment, with a geographically diversified Road BOT Asset portfolio, which insulates it from potential traffic related slowdowns in any particular region of India. The company boasts of a balanced portfolio of 19 projects (Toll-10, Annuity-9) of which eight are operational, while the balance are expected to be operational over the next 2-2.5 years. ITNL's Road BOT Asset portfolio is bi-furcated into Toll (65%) and Annuity projects (35%) on revenue basis, thereby reducing its dependence on traffic related revenue inflow.

Company Background

ITNL was set up by IL&FS in 2000 to consolidate its project portfolio in the Surface Transportation Sector and to pursue various new projects initiatives in surface transportation infrastructure. ITNL has a pan-India presence and is involved in the development, operation and maintenance of National and State highways, roads (including urban roads), flyovers and bridges in Andhra Pradesh, Delhi, Gujarat, Maharashtra, Karnataka, Uttar Pradesh, Kerala and Rajasthan. ITNL is currently among the largest operators in the Road BOT Segment with 10 Toll road projects and 9 Annuity projects. The Road BOT Asset portfolio is spilt into Annuity (35%) and Toll (65%) on a revenue basis. ITNL's current diverse project portfolio consists of 19 road projects - approximately 9,397 Lane km, which includes 4,086 Lane km under operation and maintenance and 5,311 Lane km under development.

ITNL's prowess in this business can be measured from the completed marque projects like Vadodara-Halol, North Karnataka expressway, Rajasthan Mega Highways, Thiruvananthapuram city roads and Ahmedabad Mehsana road project. Further, ITNL's associate company "Noida Toll Bridge Co. Ltd." was also the first toll bridge co. in India to be listed on the national and international stock exchanges.

ITNL is also developing capabilities in other transportation infrastructure sub-sectors such as mass rapid transport systems (MRTS) and Urban Transportation Infrastructure Segment. ITNL is developing 4.9 km track of elevated metro rail link project in Gurgaon (Haryana) as a partner of the consortium (DLF is the other partner). This project has a concession period of 99 years.

In March 2008, ITNL commenced its international operations through the acquisition of Elsamex S.A. (for a consideration of Euro52mn), a provider of maintenance services for highways and roads in Spain and other countries.

ITNL is also involved in mobilization, operation and maintenance of the Nagpur city bus services on BOO basis. The project, which commenced in February'07 and currently fully operational, enjoys a concession period of 10 years (renewable for another 5 years).

International Foray

ITNL acquired Elsamex S.A. to (i) complement its Road BOT operations utilising Elsamex's maintenance capabilities and (ii) to facilitate ITNL's entry into international markets such as Spain, Portugal and Latin America. Elsamex's primary business is the maintenance of roads, buildings and petrol stations, mainly in Spain, with additional operations in Portugal in Europe and Columbia and Mexico in South America. Elsamex also provides consulting services for roads and water supply projects in the areas of quality control, safety, health and environment. Additionally, Elsamex conducts research and development for road maintenance projects, with particular focus on bitumen technology.

Elsamex has experience of providing O&M services to over 21,000 lane km of roads across 10 countries in Latin America and European region. It is also involved in maintenance of 3,100 petrol stations in Europe. Elsamex mainly provides O&M services coupled with consulting services for road and water projects as well as conducts R&D for road maintenance projects using the bitumen technology. Elsamex is currently involved in the development of 2 road projects (255 lane km in Spain and 152 lane km in Hyderabad) through joint venture agreements.

ITNL generates revenues primarily from Elsamex's maintenance business and from annuity receipts, toll collection, operation and maintenance activities and advisory and project management fees from Road BOT projects.

Thus, Elsamex not only provides direct leeway into the international market, but also imparts its expertise and niche technology in the emerging high-Margin O&M Segment, which will be utilised by ITNL in India.

IPO details

ITNL plans to raise upto Rs700cr via its Initial Public offer (IPO) in a price band of Rs242-258 implying a fresh issue of 2.5cr and 2.3cr at the lower and upper price band, respectively. The lot size is of 25shares. Besides the fresh issue Trinity Capital (Two) Limited, would offload its stake of 0.43cr shares via secondary market sale transaction. The IPO proceeds are intended to be used for pre-payment and re-payment of portion of debt availed by ITNL.

Investment Positives

Strong Parentage

Parent Infrastructure Leasing & Financial Services (IL&FS) is a strong brand. Post listing of the stock on the bourses, IL&FS will hold 75.1% stake in ITNL. On account of having such strong backing from IL&FS, we believe that going ahead ITNL will enjoy an edge over competition while bidding for new projects or approaching lenders for financing its projects. ITNL is particularly well-placed due to its affiliation with IL&FS in light of the new National Highway Authority of India (NHAI) norms which specifies that a developer/asset owner cannot bid for new projects if 3 or more of its projects are awaiting financial closure. Thus, ITNL is set to garner increasing market share compared to peers.

Strong management bandwidth

ITNL has on its Board an experienced and professional set of senior managers who have vast experience in the Surface Transportation Segment in the Infrastructure space. Management also comprises personnel who have been associated with NHAI in the past, and their operational expertise would prove to be of immense benefit for the company while bidding for the upcoming projects as road infrastructure development gathers momentum. Moreover, ITNL has plans to diversify its business model by making in-ways into other transport businesses like railways, airports and others. Although benefits will accrue over the long term, it depicts management's vision to transform ITNL into an infrastructure major.

An established player with a geographically diversified portfolio

ITNL is a surface transport player, with an established track record of having successfully bid, developed and operating Road BOT projects on a commercial basis. It is one of the India's largest players in the Road BOT Segment, with a geographically diversified Road BOT Asset portfolio, which insulates it from potential traffic related slowdowns in any particular region of India. The company boasts of a balanced portfolio of 19 projects (Toll-10, Annuity-9) of which eight are operational, while the balance are expected to be operational over the next 2-2.5years. ITNL's Road BOT Asset portfolio is bi-furcated into Toll (65%) and Annuity projects (35%) on revenue basis, thereby reducing its dependence on traffic related revenue inflow.

Favourable industry dynamics

Currently, infrastructure development has assumed focal interest primarily because of the cascading effect it has on overall economic progress. Past studies reveal that every Rupee spent on creating road infrastructure creates seven rupees in terms of economic benefits. In this backdrop, the Minister of Road, Transport and Highways, Kamal Nath has set forth an aggressive target of constructing 20km of roads a day as against 5- 6km/day achieved till date over the past five years. Even though the target seems to be aggressive (ramping up road development activity four-folds), the recent schedule of award activity suggests that this target seems achievable. In the past, it was the award activity that served as a major bottleneck.

Therefore, to achieve the set target of building 20km/day, the NHAI is required to award at least 21,000km over the next three years to achieve its objective of constructing 7,000km per year. Construction relating to about 37,000km of NH needs to be completed by 2017, which would depend on the award activity getting completed by 2014. The recently amended Work plan by the B K Chaturvedi Committee highlights the awarding activity schedule to achieve the set target. All these factors highlight the increasing attention that Road development is fetching, which directly benefits leaders in the Road development sector like ITNL and IRB Infrastructure.

Positive changes on the Roads front…

- Change in guard: There has been a structural change in the dynamics/functioning of the industry with Kamal Nath taking over as Minister of this crucial sector. This is evident from the immediate implementation of the B K Chaturvedi Committee report as well as the recent change in the NHAI norms.

- Opportunities abound: We believe that the Road Sector offers abundant opportunities on account of the following:
1) Emerging Political will: Huge capex lined up the government. We expect orders to the tune of around 12,000km to be awarded in the next 12-15 months translating into an opportunity of nearly 1lakh crore.
2) Adequate Road infrastructure need of the hour: The country's vehicular fleet has increased at 9.4% CAGR over 2001-09, while the country's NH network posted an abysmal 2.4% CAGR. Going ahead, the country's vehicular traffic is set to post a CAGR of 8-10% over the next five years, which once again highlights the urgent need to focus on setting up an adequate Road infrastructure in the country.

Moreover, with the sanctioning of the B K Chaturvedi Committee recommendations relating to structural and procedural issues of Road development bring to the fore the fact that things are on fast track.

Investment Concerns

Project risks

Considering the company's nature of business, which is highly capital intensive and is plagued with long gestation period, timely completion of projects and controlling cost over-runs becomes necessary to manage the company's Profitability. Also, such projects are dogged by land acquisitions matters, environmental clearance issues, operational inefficiencies and others, which result in inordinate delays in project completion as well as increase costs in turn impacting Profitability.

Heavy Sub-contracting could affect project timelines

ITNL outsources its construction work to third party contractors. Consequently, timely completion of projects and quality assurances are dependent on third party players and contractors owing to which it does not have direct control over operations. Thus, project delays could increase project costs and hurt project IRRs.

Conflict of Interest

IL&FS has investments in certain companies (read Maytas Infra), which are in similar line of business as ITNL, which may result in conflict of interests with respect to business strategies. However, management has categorically stated that henceforth ITNL would be the only group company bidding for assets in the surface transportation business.

International Venture

ITNL ventured into the international markets by acquiring Elsamex, which is a leading player in Spain involved in highway construction and maintenance along with O&M experience of 8,000km in 10 countries. However, the company works on very low EBITDA Margins while having a high working capital cycle. We have not analysed the financials of Elsamex due to lack of information. Nonetheless, Elsamex contributes significantly to ITNL's Revenues on consolidated basis. Hence, any negative surprises on this front could impact our recommendation.

Change in MAT Rate

ITNL BOT assets avail tax benefits under Section 80IA and pays tax at the MAT rate. Hence, Profitability would be impacted if there are changes in the MAT rate (the recent Budget increased the MAT rate from 15% to 18%). Further, the high rate of MAT in the Direct Tax Code (DTC) ie. 2% of gross assets, we believe is highly unlikely to get implemented.

Pending stake transfer

ITNL has economic interest through call option agreements or covered warrants in some of its BOT assets, which we have factored to get transferred to ITNL. Any variation in this would impact our recommendation.

Outlook and Valuation

The UPA government is focusing on infrastructure development as one of its key action areas. In line with this, investments to the tune of Rs3lakh crore have been allocated for the Roads Sector in the Eleventh Five-Year Plan. Such sectoral allocation coupled with Kamal Nath's ambitious target of constructing 20km/a day highlight the government's serious intent of achieving its set targets. Moreover, the recently announced capex plans by global Auto majors along with robust Auto sales numbers neccessitate development of the road infrastructure in the country. Against this backdrop of such political and corporate actions shaping up, we believe that the infrastructure players  involved in Road development, ownership and operation and maintenance would emerge major beneficiaries.

ITNL's IPO, we believe is reasonably priced considering the emerging growth opportunities, its strong portfolio of assets and sound parentage. Further, on comparative valuations, ITNL (based on the limited information provided in the RHP) scores over IRB Infra. Hence, owing to relative attractive valuations, we recommend a Subscribe view on the IPO.

IL&FS has investments in certain companies (read Maytas Infra), which are in similar line of business as ITNL, which may result in conflict of interests with respect to business strategies. However, management has categorically stated that henceforth ITNL would be the only group company bidding for assets in the surface transportation business.