Investors can consider subscribing to the initial public offering (IPO) of Lanco Infratech (LITL) at the cut-off price with a medium/-long-term holding perspective. LITL is in the growth phase and earnings from the investments being made now will begin to kick in gradually from 2008-09.
The various power projects that LITL is now investing in appear well sewn-up and the company's construction business is likely to bring in revenues till the power projects go on stream.
Our recommendation factors in the positives; the risks associated with this offer are elaborated in the accompanying box.
The challenge, however, arises from the lack of experience in simultaneously managing projects of such a scale based on different fuels, but the comforting factor is that the finances and power purchase agreements have been tied up for a major part of the expansion.
Simultaneously, LITL will also be investing in the business of property development where it has no experience. The positive here is that the company owns valuable land in Hyderabad, which has appreciated significantly and where it proposes to implement an integrated information technology park and residential campus.
Holding SPVs
LITL is a holding company that invests in the equity of subsidiaries created for specific projects. It owns 34 per cent of Lanco Kondapalli Power, which owns and operates the group's biggest power asset to date — the 360 MW gas-based combined cycle power plant in Andhra Pradesh.
LITL's stake in this company will rise to 59 per cent once it completes the acquisition of 25 per cent equity from one of the existing partners.
The company will also be buying 15 per cent equity from the Aban group, taking its total stake to 51 per cent in Aban Power Company, which operates a 120 MW gas-based plant in Tamil Nadu.
The planned investment for the two purchases accounts for a little more than 15 per cent of the IPO proceeds of Rs 1,067 crore at the upper end of the price band.
The rest of the funds will be invested in the various power projects being implemented by different subsidiary companies and in the property development project in Hyderabad.
The company is now implementing a 600 MW project based on coal at Amarkantak, Chattisgarh, the first phase of which (300 MW) is scheduled to go on stream 16 months from now, followed by the second phase in October 2008.
LITL recently tied up the finances for its 1,015 MW imported coal-based power plant in association with the Nagarjuna group in Mangalore where it plans to hold 74-per cent equity.
Apart from this, the company is on the verge of reaching financial closure for a 500 MW hydro power plant in Sikkim. It has also been shortlisted as the successful bidder for the 1,000 MW coal-based project in Anpara, Uttar Pradesh. In addition to these, LITL is investing in some small hydro power plants in Himachal Pradesh and Uttaranchal.
While these smaller hydro plants will go on stream by April 08, the Nagarjuna and Sikkim projects are scheduled to start operations only by December 09 with Anpara to follow after that.
In short, the full benefit of the investments planned now will not be felt in LITL's financials before 2010-11.
Revenue streams
LITL's revenues will flow in from three streams — dividends from equity investment in the various subsidiaries implementing projects; engineering, procurement and construction (EPC) of these projects (power and property) and property development.
The construction business of the company now derives 90 per cent of its revenues from contracts with group outfits. While the use of its own construction division to implement group company projects helps in capturing value across the chain, it could also be a disadvantage if any of these projects land in distress.
The dividend income stream will depend on the policy of the various subsidiaries.
The property development income is probably subject to the highest risk among the three streams, given the company's lack of experience in this field and also the inherent volatile nature of the property market.
The key risks
The principal risk to our recommendation stems from the implementation aspect; LITL will grow from a company managing 509 MW of primarily gas-based power plants to one managing more than 3,700 MW of gas, coal, hydro and bio-mass based power plants in the next three years.
The two operating projects — Lanco Kondapalli and Aban Power — are supplied gas by Gail India. Gas supply in the Andhra Pradesh region is significantly short of demand.
While the Kondapalli project has a firm allocation, Gail's supplies in the last three years have shown a marginal declining trend.
A significant shortfall in gas supply could lead to some uncertainty as the company will have to decide between switching to liquid fuel, which is more expensive, or generating at lower capacities and take cover under the standby charges payable by the buyer.
Significantly, the gas supply agreement with Gail will come up for renewal in 2010 when some hard bargaining can be expected for both price and quantum of gas.
Any delay in the implementation of the various projects could set back the expected earnings stream of LITL; not only will the earnings and cash flows from the new projects be delayed, the revenues from construction activity would also be affected.
A steady generation of cash flows is crucial for LITL as it will be on the investment mode for the next three-four years.
The Anpara project has just been bagged by the company and the PPA is yet to be signed for offtake of power from the project.
Offer details: LITL is offering 4.44 crore shares in the price band of Rs 200-240.
The issue, which will open on November 6 and close on November 10, is lead-managed by JM Morgan Stanley, Enam Financial, ICICI Securties and Kotak Mahindra.