Infrastructure firms have been caught in a quagmire for over a year now; they are faced with rising interest rates and spiralling costs amid lacklustre order inflows. Higher working capital needs and the inability to boost execution have put the profitability of these firms at risk.
Private sector infrastructure company IVRCL Ltd has seen a tailspin in profitability over the last four quarters due to similar reasons. To ease this short-term pain and release capital for funding future projects, the boards of IVRCL and IVRCL Assets and Holdings Ltd (IVRCL A&H) are seeking to merge the firms. Along with the September quarter results, the management announced a share-swap between the two listed firms—five shares of IVRCL for every six of IVRCL A&H held. Also, its tower manufacturing and real estate businesses will become wholly owned arms.
A report by IDFC Securities Ltd, while evaluating the decision, said, “At IVRCL’s current market price of Rs 37.50, the transaction implies a valuation of Rs 620 crore for IVRCL A&H, in line with its current market capitalization of Rs 610 crore...it implies a book value of price/book multiple of 0.56, which is favourable to IVRCL.”
Valuations apart, the restructuring is a step towards the sale of assets held in the holding company to unlock capital required for growth.
IVRCL is among the few mid-cap firms sitting pretty on an order book of Rs 25,600 crore— about four times its revenue.
To reduce its dependence on irrigation projects, largely in Andhra Pradesh, IVRCL had increased exposure to the road sector, where, after the commencement of tolling operations, the profit margins are higher than those in water and irrigation. From barely 5% of its order book in fiscal 2009, road projects now comprise around 21%. But these projects need equity infusion and high working capital during the gestation period.
Bharat Parekh, research analyst at DSP Merrill Lynch (India), said in a report: “Management’s renewed bullishness on roads was (the) driver of (the order) backlog in FY11; but intense competition and a lack of equity funding has led IVRCL step back to de-risk balance sheet.”
Ironically, the two firms’ businesses were de-merged in 2009, with all build-operate-transfer (BOT) assets being housed in IVRCL A&H, while IVRCL was only the execution company. What then prompted the remerger? With equity funding for mega projects being routed through IVRCL, the merger gives direct ownership of BOT assets and the huge land bank of the group to it, which could be monetized to raise funds for equity requirements and working capital.
In fact, IVRCL’s working capital has ballooned from Rs 2,600 crore at the end of March to Rs 3,200 crore in end-September. Of course, over the near term, IVRCL A&H’s debt burden will also add to IVRCL’s existing debt after the merger. However, the management is confident of lowering this through asset monetization and a scale-up in execution of projects in hand.
Needless to say, there will be pain in the near term with lower profits. For instance, higher interest and depreciation costs hit net profit in the September quarter. At Rs 7.4 crore, it was one-third of the year ago figure, though higher than that in the June quarter.
Shares of both firms have been range-bound and volatile since the announcement of the merger. It would make sense to now wait for asset sales, post-merger, to raise capital for growth and unlock value for the stock through faster revenue and profit growth.
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