Decent earning is likely only from FY 2008

GVK Power & Infrastructure (GVKPIL) is the holding company of the power businesses of GVK and also provides operations and maintenance services to its power assets. G V Krishna Reddy controlled GVK is a diversified business group with interests in power, roads, urban infrastructure, bioscience, hotels and manufacturing. The group has identified power and infrastructure as focus areas.

GVKPIL presently owns a 53.96% stake in GVK Industries (GIL), which has two power plants: (i) the operational 216-MW Jegurupadu Phase I, and (ii) the 220-MW Jegurupadu Phase II project, to be commissioned by mid February 2006.

In addition, GVKPIL currently owns a 47.47% equity stake in Gautami Power (GPL), which is developing a 464-MW combined cycle power plant that is expected to be commissioned by September 2006. GVKPIL will increase its ownership in GPL to 51% by subscribing to the equity of GPL. Once all the three plants become operational, the total capacity of the three plants will be 900 MW. All the three plants are independent power plants (IPP) and supply, or will supply, their output to Andhra Pradesh power distribution companies (APDISCOMs) under their respective long-term power purchase agreements

GVKPIL proposes to utilise the funds raised through this issue to contribute part of the equity required by GPL to establish a 464-MW duel fuel combined cycle plant located in Andhra Pradesh and repay the bridge finance availed for funding the equity of GPL. The equity investment in GPL is estimated at Rs. 95.3 crore and the repayment of loan is estimated at Rs 60 crore.

The initial public offer (IPO) is of 8,275,556 equity shares of Rs 10 each through 100% book-building process. The price band has been fixed at Rs 260 to Rs 310 per equity share of Rs 10 each. The issue opens on 2 February and closes on 7 February 2006. It will constitute 35% of the fully diluted post-issue paid-up capital of the GVKPIL.

• Each of GVKPIL’s generation facilities has an assured source of revenue under a take- or- pay power purchase agreement(PPA) with APDISCOMs. The power distribution companies are required to pay for the plant's output at an agreed plant load factor (PLF), regardless of whether or not APDISCOMs actually takes delivery of the power generated. APDISCOMs’ payment obligations to GVKPIL, as per PPAs, are secured by letters of credit, escrow arrangement and the state government’s guarantee covering all of APDISCOMs’ payment obligations. According to GVKPIL’s management APDISCOMs has never defaulted on their monthly payment obligations even by a signal day.

• It is expected that GVKPIL will benefit from economies of scale through the use of shared facilities between Jegurupadu Phase I and Jegurupadu Phase II. These shared facilities include using the approach roads to the projects, sharing the use of the demineralised plant capacity, raw water storage reservoir and potable water, staff quarters, and the administrative building and the compound walls.

Weaknesses

• Currently there is shortage in the availability of gas in Andhra Pradesh. The shortage is likely to persist at least in FY 2007. As a result, operations of the existing Jegurupadu phase I as well as proposed phase II and GPL will be adversely affected.

Valuation

The FY 2005 EPS of GVKPIL (standalone) stands at Rs 0.7 on post-issue equity. The company’s net profit in the first half of FY 2006 has been inflated by Rs 2 crore by the one-time technical services fees received from subsidiary and interim dividend of Rs 5 crore received form the subsidiary. Thus, the net profit of Rs 4.23 crore in the first half of FY 2006 cannot be annualised. Here it will be more appropriate to consider the consolidated results, which shows a net profit of only Rs 48 lakh. On annualising it, the consolidated EPS is just Rs 0.4. Th offer price band is Rs 260-310. Naturally, the price band factors in the company’s expected full earnings from the two proposed new power projects. However, considering the state of natural gas availability, these projects are likely to fully reflect earning only from FY 2008.