Why would a media baron used to glamour and glitterati turn to something as mundane as infrastructure? Anything for the next billion? Wrong. That may be a very welcome by-product but the correct answer is, to deploy the already earned billions such that they give steady returns over long periods of time.

In 2004, the Essel Group’s flagship Zee Entertainment — which is also the company Subhash Chandra is best known for — had settled into a comfortable steady-state. But Chandra was looking for the next big leap. The stock market frenzy during the dotcom boom had taken Zee to dizzy valuations — at the peak, it was counted among India’s largest companies by market-cap. Chandra was also smart enough to cash in on that frenzy, so perhaps he was looking for a suitable play to deploy his large kitty. “Since we are largely into service-oriented businesses, you have to work hard every day to make money. We wanted to get into something that will be on auto-pilot — an annuity business,” says Chandra. “Sure, returns may be lower, but they are regular.”

At the same time as other companies like GMR and GVK — which were still small and dreaming big, thanks to opportunities opening up in public-private partnership (PPP) projects — Chandra also wrote his script to ride the infrastructure wave. He partnered with Turkey’s TAV Investment Corporation to bid for modernisation of the Delhi and Mumbai airports — but didn’t make the cut. The period between 2004 and 2008, which also marked the biggest boom in the Indian infrastructure sector, were lost years for Chandra. 

But that was probably a blessing in disguise: by the time Chandra finally made his debut into the infrastructure sector, everyone else was fatigued. In 2008, when companies were hit by the credit crunch and players were struggling for cash, Chandra kick-started his business again and, in fact, went ahead full throttle. He roped in C Venkataramana, a mechanical engineer from GVK, to give wing to his infra plans and Essel Infraprojects was born. “We took the amusement parks business out of the company and started bidding for infrastructure projects — aggressively,” says Venkataramana. 

Essel’s first project was through a joint venture to execute a small road project (a 75-km portion on the two-lane Malegaon-Murbad road in Maharashtra). “The project was won by one Mr Lakhani from Nagpur, but he did not have the money to execute it. We funded 50% of the project and did it,” says Chandra. “And then, we went on to do another 12 on our own.” 

Currently, Essel Infraprojects has an order book of ₹24,000 crore. Its main assets are its build-operate-transfer (BOT) road projects. Chandra has already deployed around ₹1,800 crore of equity into the business. “We had decided we will invest up to ₹2,000 crore and then the business has to run itself,” says Chandra. But then, Essel Infraprojects is still not profitable, although it clocked revenues of ₹1,350 crore in FY12. 

Now, Chandra isn’t thinking about how much more cash he needs to pump into the business but how to make it big enough so it will continue to expand on its own steam. On March 28, the Essel group acquired a 10.19% stake in IVRCL from the open market using two group investment vehicles, Asian Satellite Broadcast and Jay Properties. The financial details were not disclosed but, based on the Hyderabad-based infrastructure company’s current market capitalisation of ₹1,612 crore, the deal should have cost about ₹164 crore. Since then, the company has steadily increased its stake to 12.27%, fuelling speculation that Chandra will mount a hostile bid on IVRCL. 

Not surprisingly, Chandra does not want to get into details of how he plans to acquire IVRCL, but it seems unlikely he will give up the fight easily. “Yes, we are in the process of increasing our stake in IVRCL,” he says. Already, the Essel group’s stake in the company is more than that of IVRCL’s promoters, led by CMD E Sudhir Reddy. Indeed, the grapevine says Essel has hiked its stake to nearly 18%, but Chandra declines to comment. 

IVRCL’s promoters collectively hold 11.8% but that may not be the only part of the shareholding they have influence over — ‘other corporate bodies’ hold about 20.71%. Meanwhile, Chandra has made an offer to the promoters to buy them out at ₹90 a share. Reddy hasn’t accepted — yet. “No one can hope to control the company with a mere 11% holding,” says Anil Singhvi, founder, Ican Investment Advisors. Both parties are in talks with financial institutions for support and stake sales, but no one will comment. Understandably so. Three institutions — Norges Bank, HSBC and Prudential ICICI Life Insurance — together hold 25.34% stake in the company and will be key to determining which way this battle heads.

Battle it will be, whether short and swift or prolonged and convoluted. But even as that plays out, what headway has Essel Infraprojects made in the infrastructure space? And what does it hope to achieve by acquiring IVRCL?

Sky to the ground

Entering the business full swing only in 2008, Essel undeniably lost the lead in infrastructure. But it seems to be making up for lost time. The business has moved from a small office in south Mumbai’s Prabhadevi to a 30,000 sq ft office in Kohinoor City, an upcoming commercial property in the central suburbs. Then, the company has been aggressive in road projects, one of the most active segments in the infrastructure space where the government is still handing out projects. In contrast, the other infrastructure segment that was touted to be the biggest opportunity ever — power generation — is in the doldrums as companies struggle with the lack of fuel linkages. 

Of the 12 road projects Essel has bagged so far, four are national highway projects while the rest are state projects; five are already complete and seven are under construction. (See: Road to riches) Currently, the company has a portfolio worth ₹7,500 crore. Additionally, it has qualified for 40 road projects across Maharashtra, MP, Gujarat and Punjab, collectively worth ₹25,000 crore, where it is yet to bid. “We are aggressive players in the road sector, but we bid sensibly. In most projects, if not the L1 bidder, we are at least L2 or L3,” says Venkataramana. “All the projects we have executed, we have been able to complete at least six months ahead of schedule.” 

Road to riches

Essel has an order book dominated by road projects, with ₹7,500 crore under execution; it has qualified for another ₹25,000 crore worth of orders

The fast-paced action in roads apart, Essel has been exploring a new business every year. In 2009, the company jumped into urban infrastructure — it’s building an international school on 500,000 sq ft in Mumbai’s Bandra Kurla Complex for the Essel Group, which will be ready in 2013. There’s also a 50-acre sports city in Bhopal for the MP government. The projects are worth roughly ₹2,000 crore.

In 2010, Essel Infra ventured into the power business, trying its hand at various projects from hydel to solar. It’s bagged an 82 MW hydel project in Nepal and has signed up for a thermal power project with the MP government. “We haven’t closed this project yet; we will go ahead only after there is clarity on coal linkages,” says Venkataramana. There’s also a 20 MW solar project at Osmanabad, Maharashtra, under the National Solar Mission. “We are bidding for various projects across transmission, solar and hydel power,” he says.

Last year, the company got into what is potentially the big business of the future — water and environment management. It has tied up with foreign companies for this: Arrow Ecology of Israel for Municipal Solid Waste (MSW) and with Tahal of Israel/ Hyflux of Singapore for sewage treatment plant (STP); GE/ Hyflux of Singapore for de-salination; and GE Jenbacher for landfill gas. 

And Essel already has some projects in hand in these areas. There’s a 24x7 water project in Aurangabad, which essentially involves bringing water from the irrigation source and supplying it across the city to both homes and commercial establishments. Then, the company is executing an MSW project at Deonar along with joint venture partner United Phosphorus, where some 2,000 tonnes of solid waste is treated every day. Currently, the company gets a fee to manage the waste, but it is also in the process of putting up plants to generate both power and compost out of this waste. 

Essel is now aggressively pushing to bag STP and MSW projects and has already qualified for some eight or 10 projects across the country. “We have about ₹7,500 crore in the kitty and have qualified for other projects for roughly a similar amount,” says Venkataramana. 

Essel Infraprojects’ ₹24,000-crore order book has to be executed over the next four years, for which the company will require equity funding of close to ₹4,000 crore. Chandra has already ploughed in nearly all his committed amount, which means the additional capital needs to come from outside, probably private placements. “We have a phased capital raising plan,” says Venkataramana, although he refuses to divulge any details. 

If at all, a public listing may not be a feasible option in the near-term, considering the current stock market climate and the lack of investor appetite for infrastructure developers. Besides, although Essel has completed execution of projects worth nearly ₹10,000 crore so far, managing execution across so many verticals may be a challenge and that’s where picking up an ongoing set-up probably makes immense sense for the group. 

Going for the kill

For the longest time now, IVRCL has been the low-hanging fruit no one wanted to pluck. Most companies in the infra space are overleveraged and are struggling to manage their finances, but IVRCL has been particularly vulnerable for many years because of the dangerously-low promoter shareholding in the company — the promoter holding has been at the same level for more than eight years. But now, as the company’s market value has crashed to ₹1,600 crore (it had a market-cap of ₹730 crore at the nadir in December 2011), it’s also going extremely cheap.

But is it really a bargain? The low valuation is not without reason. IVRCL’s balance sheet is one of the worst among infrastructure companies. In the past four years, the company relied heavily on debt funding, which resulted in a high interest outgo. Last fiscal, the consolidated debt stood at ₹4,300 crore and annual interest outgo was nearly ₹500 crore. This year is not radically different. The company has been borrowing to meet its working capital needs and investment requirements of its subsidiaries. “Last fiscal, IVRCL had 35 bankers, which indicates the lack of trust of lenders,” says Jaishankar Krishnamoorthy, an independent analyst who specialises in forensic accounting. Advances to subsidiaries was up at ₹850 crore in Q3FY12 from ₹540 crore in Q3FY11. 

Granted, the company has been making all the right noises for several quarters now about reducing its debt by monetising assets — essentially, sell real estate and dilute its stake in some projects. But none of this has fructified. Subsidiary company IVRCL Assets & Holdings has around 1,200 acres of land across areas like Noida, Pune, Chennai, Visakhapatnam and Bengaluru, collectively valued at ₹1,500 crore. In the December quarter, the company sold three land parcels in Noida for ₹225 crore — that’s just a drop compared with its ocean of debt. Selling more land may not help much, either. It may be enough to fund IVRCL’s four under-construction road projects, but not to cut debt substantially. “The company needs about #1,800 crore for equity infusion in BOT projects, of which ₹300 crore is needed in FY13,” says Abhinav Bhandari, an analyst with Elara Capital.

The financial mess has obviously affected execution, too. The company’s revenue growth has been on a downward trajectory for many quarters. The order book is shrinking, too, but at a slower pace because the existing pipeline is still not getting knocked off fast enough because of execution delays (see: One way). For the nine months of FY12, IVRCL’s revenue remained flat at ₹3,363 crore, while profit slumped 80% to ₹19 crore y-o-y. 

One way

IVRCL’s revenues and order book have been falling continuously

That’s not all. There are also concerns that IVRCL’s books may not be as clean as an acquirer would like. Krishnamoorthy draws attention to some worrying facts in the company’s FY11 annual report. The auditors had qualified that the company’s subsidiary with financial assets of ₹800 crore had not been audited; it was only certified by the management. The qualifications also said the group had invested ₹1,200 crore on three toll roads whose collections are far lower than projections — “therefore, the auditors can’t ascertain the carrying value of the asset”.

Besides, says Krishnamoorthy, some of the company’s accounting practices are aggressive, which means profits are overstated to that extent: for instance, its debenture issue expenses of 1% are taken to the balance-sheet rather than expenses in the P&L every year. Then again, subsidiary Hindustan Dorr Oliver has suffered losses that wiped out its entire net worth, but the management has made no provisions for the goodwill, stating that it is recoverable. 

What's fair

Chandra has already offered to buy-out Reddy at ₹90, higher than its estimated fair value

With so much going against it, what makes IVRCL even appear on the radar of a buyer? As it turns out, the company does hold sufficient promise. It has an order book of ₹26,000 crore; 11 BOT projects of which four are operational; an extensive land bank; a 50% stake in listed subsidiary Hindustan Dorr Oliver; and even an oil block in Egypt (see: What’s fair).

What’s the agenda?

For Chandra especially, IVRCL is not just a valuable asset available cheap — it can be of considerable strategic advantage. Analysts reckon that IVRCL could be the media baron’s vehicle to bring Essel Infraprojects to the bourses. Infrastructure is a capital-intensive business and sooner than later Chandra will need to take the company public. Essel needs capital to execute its projects and although it’s not as if Chandra can’t cough up that cash, attracting private investors will also require him to chart out a public listing plan soon enough.

That will be a challenge, given how the company is built currently: Essel’s portfolio is currently dominated by BOT projects rather than engineering, procurement and construction (EPC) contracts. Unlike a few years ago, investors no longer fancy the developer model because of the long-trail nature of profits. What compounds the waning faith in developers is that companies are bidding aggressively for projects, which means there’s no guarantee about how profitable the ventures will ultimately turn out to be. Indeed, there’s no visibility on the profitability of even road projects as many are falling short of traffic expectations. And investors are no longer willing to participate in a profit-less prosperity story.

Companies are trying to work around that. For instance, they’re engaging in construction EPC activity themselves rather than sub-contracting it to other companies so they keep the profits ringing in their own EPC companies. The idea then, for Chandra, would be to acquire IVRCL and reverse merge the company into Essel Infraprojects to create an integrated infrastructure player and derive the best value for his consolidated company. That is what most analysts and fund managers are already anticipating. “If Essel were successful in a takeover, its finances could help IVRCL to complete its BOOT pipeline and place orders for Essel Infra’s assets on IVRCL E&C, apart from potentially reverse merging its large infra assets,” said Bharat Parekh, analyst at Bank of America-Merrill Lynch, in his
recent note. 

Neither Chandra nor Venkataramana will comment on anything related to the acquisition of IVRCL, but this is clear: Chandra is unlikely to keep his company as a pure developer. “Ultimately, our objective is to become an integrated player with a presence across the spectrum, including EPC, because doing your own EPC does bring in some tangible benefits,” says Venkataramana. “It really helps if you have complete control over all your projects.”

But there are several hurdles to cross before that final outcome. First, IVRCL’s business itself is not easy. Nearly half of its revenues come from the state and it’s no secret that government contracts require you to manage the local environment and bureaucracy. That is also one of the reasons the company’s chairman and managing director, Reddy, has managed to keep himself at the helm for over seven years, despite his minuscule holding. Chandra is prepared. “As a businessman and as an Indian, these are not things that should deter me from looking at a business opportunity,” he says.

Second, taking over an infrastructure company and running it is not easy as it is a very people-oriented business, points out Lagadapati Rajagopal, founder chairman of Lanco Infratech. “Although on the face of it, Subhash Chandra’s interest in road projects coupled with IVRCL’s order book and potential is a good match, both come from different mindsets and do business differently. That’s tricky,” says the CFO of a rival infrastructure company. But then, Chandra has Venkataramana leading his team. He was with GVK based out of Hyderabad for 13 years and understands the local environment well. “GVK Reddy gave me the muscle in infrastructure and Subhash Chandra has helped tone it,” says Venkataramana.

Whatever the challenges, Chandra is not naïve enough to underestimate the risks involved. IVRCL has completely lost trust among its lenders, which Chandra may be able to reinstate with his credentials and personal guarantees — a step that will also considerably reduce the company’s lending costs and improve its margins. He may also do a better job of monetising the company’s real estate assets than it has so far, one reason for which may be Reddy’s own expectations — the slump in the real estate market has clearly discouraged IVRCL from selling at a lesser value. 

Says Bajaj Allianz CIO Sampath Reddy, “By nature, promoters of infrastructure in our country have demonstrated very high risk appetite. And they do not fancy selling down assets, especially land, and keeping the cash.” Allianz holds 2.45% in the company and Reddy says he has not been approached by either of the parties yet. “We are open to both parties. We will try and understand from each one what they have in mind and how and what they will deliver for the shareholders,” he adds. 

Highway to Hyderabad

Under the new Takeover Code, Essel Group will have to make an open offer to the public once it increases its stake in IVRCL to 24.99%, which is higher than the earlier threshold of 15%. That, in a sense, is helpful, because Chandra then has enough time to gradually acquire the additional stake in the company without any pressure to make a public offer. The flip side is that, with the intent clear, it may allow the current management time to strip the company of its key assets, making the deal less lucrative for Essel. 

The battle for control of the company could go either way. In any case, Chandra has already built a substantial stake in the company, and now has put money on the table to buy out Reddy. Either Reddy takes that offer and steps aside or musters enough support for himself. Because the next move for Chandra would be to negotiate and buy additional stake from the institutions. And once he reaches the 25% mark, he could make an open offer to take control of the company. He may even choose to go for a voluntary open-offer. 

It will be imperative for Chandra to have a majority 51% stake before he can push for a merger with Essel Infraprojects, especially if Reddy does not sell his shares. If Chandra does not get the magic figure from the open offer, he can always take control of the company and then re-capitalise it to hike his stake further to 51%, marginalising other shareholders. “No one can raise questions about re-capitalising a company that is over-leveraged,” says Ican’s Singhvi. 

Notably, Chandra has to spend roughly ₹930 crore if he were to offer ₹90 — the price he has now offered to Sudhir Reddy — to shareholders across the board, and take majority control with 51% (assuming 12.27% has been acquired, Chandra has to purchase an additional 38.73% equity or 1.03 million shares). Every additional ₹10 per share will mean an additional ₹103 crore outgo.  

In the end, it will all come down to which side the financial institutions take, because a bulk of the shares of the company — about 38.4% — is with FIIs as of December 2011 (see: Triple ace). Analysts say IVRCL is in talks with its existing investors to convince them to back the company in a hostile takeover. But then, so is Essel. 

Triple ace

Top three institutions hold 25% in IVRCL and will be instrumental in determining who will control the company

Although none of the financial institutions would air their views publicly, sources suggest that for most institutions it’s the price that will be the determining element — it may be difficult to choose between Reddy and Chandra. Reddy has not walked the talk so far and continues to run the company with hardly any skin in the game. 

Chandra may be on a better footing to get the company out of its financial mess, but that alone may not be the best thing for shareholders because of the inherent business risks of a change in control. “Institutions will largely be opportunistic. Promoter preferences do not matter here. After all, the fund manager’s mandate is to maximise return on his funds, so he will try and extract the best price possible from whoever is willing to pay.” 

Yet, they may not settle for anything cheap now that it is a question of strategic stake sale. “Generally, when such transaction happens, companies pay a high premium and that ultimately benefits the residual shareholders. This global trend leads investors to expect a good price irrespective of the present business circumstances or stock market sentiment,” says S Naren, chief investment officer, Prudential ICICI Mutual Fund. 

Also, none of the institutions have built their positions in IVRCL recently, which means their acquisition costs are higher. “If not a premium, these investors would want to at least recover their costs,” says Elara Capital’s Bhandari.  

Already, shares of IVRCL have gained over 15% from the time news of Essel’s acquisition became public. “This sort of move is good — how else would the shareholder benefit? Otherwise, promoters could sit on a company with very low holdings and not care for the shareholders,” says Allianz’s
Sampath Reddy. 

Sampath’s country cousin hardly seems in the mood to cede control and Chandra has probably thought it through to the end game far too well to backtrack now. From the Essel group chief’s point of view, the sooner the deal goes through, the better it is, for both IVRCL and Essel Infraprojects. But Chandra hardly seems anxious. “I practise vipassana,” he says. “Whether the deal happens or not, I know how to keep my composure and stay happy.”