GVK Power & Infrastructure-Transaction premium: Kotak Sec

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GVK Power & Infrastructure (GVKP)
Infrastructure
Transaction implies significant premium—likely prices in development pipeline.
PE investment in power vertical implies a significant premium to our valuation (premoney
value of Rs45 bn versus our value of Rs32 bn) potentially including value from
development pipeline - 1,600 MW expansion at Jegurupadu and Gautami. However,
gas allocations for these expansions are not yet tied up. We would include value from
these projects only post some visible progress. Retain BUY and target price of Rs54.






Transaction implies significant premium to target price; potentially prices in development pipeline
GVK group divested 21% stake in GVK Energy to 3i India Infra. Fund for a consideration of Rs12
bn, implying pre-money value of Rs45 bn for its energy vertical - a significant premium to our
target valuation of Rs32 bn. We believe that the investment potentially prices in value from the
development pipeline of GVK viz. 800 MW expansion at Jegurupadu as well as Gautami and an
additional unit in Goindwal Sahib. The projects presently under construction (Alaknanda, Goindwal
Sahib and Tokisud mine) together require an additional equity investment of only Rs5.2 bn.

Gas availability, clearances may act as hindrances in progress of development projects

The development pipeline of GVK includes 1,600 MW of capacity expansion at Jegurupadu and
Gautami (800 MW each) and an additional unit at Goindwal Sahib. However, the gas allocation
for the 1,600 MW has not yet been tied up. The company may be cautious in its approach to its
projects given its past experience of significant delays and sub-optimal operations of GVK I, II and
Gautami due to gas shortage. Note that majority of incremental gas supply from KG-D6 basin has
already been allocated to various utilities. Furthermore, clearances and coal block availability are
yet to be worked out for the additional unit at Goindwal Sahib.'

Retain target price of Rs54/share; would include value for development projects on visible progress
We retain our SOTP-based target price of Rs54/share. We have included the Rs12 bn cash inflow
from the PE investment into our target price and have reduced the stake in the Energy vertical to
79%. However, we would include the value for the projects in the development pipeline only post
some visible progress. We have marginally reduced our value for the Mumbai airport real estate
development project owing to the expected delay in monetization.

Stock has underperformed, likely on delays in Mumbai real estate and regulatory uncertainties
Stock underperformance has been likely on account of (1) low visibility on monetization of
Mumbai real estate - contributes to about 28% of the total value of the company, (2) risks/
uncertainty related to regulatory environment in power (merchant sales) and airport (Single versus
Dual till model) sectors and (3) relatively slow progress on development of projects in the pipeline.


Transaction implies Rs13/share (24%) upside to current target of Rs54/share
GVK group divested 21% stake in its power vertical (GVK Energy) to 3i India Infrastructure
Fund for a consideration of Rs12 bn. This transaction values the GVK Power and
Infrastructure's energy vertical at Rs45 bn (on a pre-money basis) at a significant premium to
our ascribed valuation of Rs32 bn. This implies power portfolio valuation of Rs28/share
versus our ascribed valuation of Rs15/share. We believe this investment has come as straight
equity investment without any structure or downside protection being provided to the
investor unlike in case of Temasek’s investment in GMR’s energy vertical, which was a
structured transaction.

Our target price of Rs54/share is comprised of (1) Rs23/share for Mumbai airport, (2)
Rs7.6/share from road SPV, (3) Rs21/share from the power assets (including Rs6/share for
cash from PE investment), (4) Rs1.5/share from SEZ project and (5) Rs7/share for Bangalore
airport valued at 1X P/B. Further potential upside could arise from – (1) progress on Mumbai
real estate monetization, and (2) potential equity raising in airport vertical demonstrating
better-than-ascribed value.


Rs6 bn incremental equity required for projects under construction vs Rs12 bn PE
Projects currently under construction of GVK have a total equity requirement to the tune of
about Rs11.5 bn comprised of (1) Rs5.4 bn equity for Alaknanda Hydro power project (330
MW), (2) Rs5.4 nm equity for Goindwal Sahib thermal power project (540 MW) and (3)
Rs750 mn for Tokisud coal mine project (52 mn tons reserves). Of this total equity
requirement, the company has already invested Rs6.4 bn of equity (Rs3 bn in Alaknanda,
Rs3.1 bn in Goindwal Sahib and Rs327 mn in Tokisud). Hence the company requires about
Rs5.2 bn of incremental equity investments for projects under construction


Implies positive view on incremental project pipeline
The excess of the PE investments (Rs12 bn) over the actual equity requirement for ongoing
projects (Rs5.2 bn) implies that the PE investor is investing the equity with a positive view on
incremental development pipeline beyond Alaknanda and Goindwal Sahib as well. The
incremental development pipeline potentially explains most of the difference between our
valuation and the PE deal valuation. The other projects under development/ in the pipeline
for development by GVK include (1) 370 MW Goriganga hydro power project, (2) expansion
projects for GVK Industries and Gautami gas-based power projects by 800 MW each, and (3)
690 MW GVK Ratle hydroelectric project.



About 900 MW operational and 870 MW under construction
GVK has an operational capacity of about 900 MW (440 MW at GVK Industries and 464
MW at Gautami). The two projects under construction have a cumulative capacity of about
870 MW viz. Alaknanda (330 MW run of the river hydro project) and Goindwal Sahib (540
MW coal based project). GVK Energy has development projects of Tokisud as well as
Saregraha coal mine with a likely production capacity of 3 mn tons per annum. Tokisud
project has received requisite clearances with a development cost of Rs 3 bn and has been
financially closed.

Pipeline of 1,600 MW expansion hinging on gas and another unit at Goindwal
Beyond the existing projects under development GVK also plans to develop 800 MW of
incremental gas based capacity at both Jegurupadu (GVK Industries) as well as Gautami.
However, gas availability for these expansion projects has not been tied up and considering
past experience GVK may approach the expansion projects with more caution. GVK is also
thinking of putting up an additional unit at Goindwal Sahib. In this case, clearances and coal
block availability are yet to be worked out. Incremental hydro power projects Ratle and
Goriganga are not a part of this transaction.

Majority of incremental gas supply likely to be already tied up till FY2013E
Kotak’s Oil & Gas team expects the supply in natural gas to go up by about 77 mcm/day
over FY2010-13E from 160 mcm/day to 237 mcm/day. A majority of this additional supply is
from Reliance’s KG-D6 basin contributing to about 63% (49 mcm/day) of the increase. We
note that about 43 mcm/day of the expected 88-90 mcm/day supply from KG-D6 basin has
already allocated to the power sector with about 30-35 mcm/day supply already tied up.



Evaluating similar transaction in airports; but real estate, regulatory issues may
put off investors
GVK is also evaluating the option of inducting private equity investors in the airport vertical
holding company (which would holds stakes in Bangalore and Mumbai international airport).
However uncertainty about value unlocking in real estate transaction in Mumbai as well as
regulatory uncertainty on tariffs in Bangalore airport may keep investors away in that
transaction. GVK, through GVK Airport Developers, has borrowed about Rs6.85 bn from
banks for buying a stake in Bangalore International Airport and this loan is likely to be
refinanced to gain more time.

MIAL real estate monetization remains slow; unlikely to realize in FY2011E
Mumbai airport real estate monetization is yet to make progress as the company is awaiting
MMRDA approvals. The approval process, which would involve advertisements by MMRDA
followed by finalization of plans based on the quantum of objections, could take up as long
as until three four months. Bid process following that may imply that actual realization of
sale takes place by the end of FY2011E and may potentially slip into FY2012E. The
management has also cited that they are not aggressively pushing for the approvals as they
believe that Mumbai real estate prices are headed for an increase in FY2012E and the
company does not have any great need for cash either.

Reiterate BUY with target price of Rs54/share
We retain our SOTP-based target price of Rs54/share. We have included the Rs12 bn cash
inflow from the PE investment into our target price and have reduced the stake in the
Energy vertical to 79%. We have also marginally reduced the value for Mumbai airport real
estate development project led by expected delay in monetization.

GVK would need gas supply of about 8-9 mcm/day for the planned expansion of 1,600 MW
at Jegurupadu and Gautami.