Tuesday, October 4, 2016

This time is no different

Livemint reports that the EPC bids for the National highway projects have been following the same script of aggressive and over-optimistic bidding,
A total of 52 EPC road projects worth about Rs.26,700 crore have been awarded between January and June, according to data compiled by brokerage Equirus Securities Pvt. Ltd. Of these, close to 40 projects were won below the National Highways Authority of India’s estimated cost and each of the projects attracted three to 14 bidders. The government’s push for a new low-risk hybrid-annuity model (HAM), in which the state commits up to 40% of the project’s total cost to kick-start private sector investments, and the emergence of a number of smaller, regional companies have added to the competitive intensity, according to road developers and analysts.
And to get a sense of the scale of froth,
Larsen and Toubro Ltd (L&T) has... won five awards in the six months ended 30 June, all of them below estimated costs. It won two EPC projects in Tamil Nadu in February by bidding 27% and 13% lower than the project cost... In March, L&T won a road project in Kerala at a bid that was 38% below the estimated project cost. Similarly, Bhopal-based Dilip Buildcon Ltd has won six contracts, which were between 13% and 31% below the estimated cost.
It is inconceivable that these projects can be completed at such optimistic cost estimations. Given the transaction costs and inevitable delays (even with full site acquired), it would be a near miracle to make reasonable returns at such cost estimates. The public agency which is allocating the bids and the bankers who are lending to such developers are clearly living in a world with a different set of economic rules. 

Clearly developers are bidding aggressively to bag the contract, with the expectation that they can renegotiate. Further, for cash strapped infrastructure contractors, the 40% upfront cash payment holds great attraction. Cash flow considerations, therefore, trumps commercial viability. 

In the real world of infrastructure financing, there is nothing unusual about such reckless bidding. In fact, it is a truism that finance loses its disciplining powers and developers their prudence, when the market is on the upswing, as is the case with roads EPC projects. The only surprise is that the latest cycle has been initiated even as the damages from the previous bout still remains large on the balance sheets of both developers and lenders.  

2 comments:

KP said...

Dear Gulzar,

You have been flagging off this issue in the past so many years that I have been visiting your blog. How is it that the government(s) and banks have not devised any heuristic to identify the upper bound of risk in the bids / estimates ?

If the attraction is the upfront cash flow - can the monitoring of the cash flow limit its use to the project under consideration ??

Or is the whole deliverable hedged on future cash flows accruing from other projects ?

I am trying to understand the basis for the confidence with which companies have bid - or do they effectively shut off future opportunities for competitors allowing for a near monopoly in future extensions to current projects that they have captured ???

regards, KP.

Gulzar Natarajan said...

Thanks KP for the comments. There is nothing surprising about this trend. It gets repeated everywhere. Latin America is the best example of such recurrent booms. Also the GFC was all about such lending and borrowing decisions, which would not have passed even basic due diligence. When the credit cycle is on the upswing everybody's incentive is aligned to getting money out of the doors or deals done, or you risk falling back... Even today, businesses in the US are borrowing crazy to finance buybacks and mergers and advisory firms are egging them on. The low rates cannot stay like that for long and when the tide turns, there will be pain...

For companies bidding, there is entrenched moral hazard now that gives them the absolute confidence that there will be renegotiations... After all the lenders to these companies are PSU banks and any forced losses will only be one part of government (say, Ministry of Transport or NHAI) inflicting losses on the other (banks)...