There was much euphoria when Sydney-based infrastructure asset management group Macquarie Group Ltd bagged the first toll-operate-transfer (TOT) road project. It sets the ball rolling on the government’s plans to monetize existing highways and raise funds for future road projects. It also marks the entry of one of the world’s topmost infrastructure funds into the country.
Yet, the deal has flummoxed all in the industry for the hefty premium at which Macquarie bid to bag the contract. At Rs9,681.5 crore, the company pays an outlandish 55% premium over the reserve (concession) price of Rs6,285 crore set by the National Highways Authority of India (NHAI) for nine highways for a period of 30 years. The price is also 30% higher than that of the second highest bidder.
The worry is, this auction of the first bundle of TOT projects will set a trend of premium bidding in government auctions, a trend that historically has led to undesirable outcomes.
Take the case of build-operate-transfer (BOT) projects that ran into trouble about a decade ago. Initially, road developers like IVRCL Ltd, IL&FS Transportation Networks Ltd and Madhucon Projects Ltd were loved by investors. But all it took was lower-than-estimated traffic and consequently lower toll collections on some highways for these companies to sink under their own weight.
As competition picked up, companies fell prey to their own aggressive bidding. A similar euphoria in power projects also ended in tears.
In view of several such debacles in the infrastructure sector, where premium bids have led to financial trauma, Macquarie’s bid price raises concerns. The price is determined on the basis of interest rates and estimated traffic on these routes to arrive at future cash flows. All of these are dynamic over the concession period of 30 years and can affect cash flows, and therefore the rate of return for the developer.
Sceptics point out that some of the new projects planned under the grand Bharatmala programme may cannibalize traffic flows on existing routes. Such factors may alter traffic flow, revenues and consequently the internal rate of return. Back in 2011-12, returns from projects went haywire when traffic flow fell 30-40% below estimates in many cases.
With several road projects coming up for auction under the TOT model and with scores of new developers waiting in the wings, competition may see premia rising in future too. Bidders will need to be cautious.
In the TOT model, developers put money on the table upfront, with a mix of debt and equity. In all earlier BOT cases, the huge debt burden is what pulled the developer into a quagmire. In fact, several developers of stuck infrastructure projects had sought government intervention to exit their projects in order to prevent financial insolvency.
Further, TOT model auctions are for a period of 30 years, which will be subject to the vagaries of business cycles. In other words, the bids must ensure that the upsides make up for the downsides to deliver the average rate of return that will ensure viability of the project.
That said, a positive factor in the model is that NHAI is likely to auction commercially viable roads, where traffic has been plying for some time, unlike in BOT projects, where new road construction itself entails risks.