CHAPTER 6

Project Financing

Key Terms: Equity capital, Preference Capital, Reserves, Loan Fund, Bonds, Debentures, Securitization, Leasing, Short-term sources of Funds, Flexible Financing Scheme, NBFC, Zero Interest Bond

A project is, as stated in Vol. I, of long duration and so the fund requirement is normally for a long period; however, for working capital or for balancing purposes the funds are at times needed for a short period.

Sources of long-term funds could be

Further, short-term sources could be as follows:

It may be mentioned that a project manager is concerned with matching of fund requirements with the sources of funds as the project is normally of long duration.

Long-term Sources

Owners’ Funds

Owner’s funds are the sum total of capital “contributed and earned.” Capital contribution refers to owners’ investment in the project, while capital “earned” also called “reserves and surplus” is the profits earned and retained over the years. Capital is usually divided into shares of a certain denomination, say, Re. 1 or Rs. 2 or 5 or 10 or greater as decided by the management. Shares can be equity shares or preference shares. The total amount of preference shares is governed by the equity-preference ratio of 3:1.

Preference shares have preference on declaration of dividend and preference on repayment of capital. Preference shares, generally, carry a fixed rate of dividend and, normally, do not have a voting right to control or manage the company. Thus preference shares ensure the safety of capital and regularity of income to the investors. On the contrary, a study¹ has shown that from an investor’s point of view, preference shares do not assure any regularity of income, are not attractive among investors, and are not common source of funds for companies.

However, preference shareholders have a right to vote on matters relating to preference share capital and the voting right is in the same proportion as paid-up capital in respect of preference shares is to the total paid-up capital of the company.

Preference share may be cumulative or noncumulative preference share, where in case of cumulative preference share, dividend unpaid in any year is carried forward to the next year and the accumulated dividend arrears are to be paid before the company pays dividend on equity shares. In the absence of this feature, the preference share is noncumulative.

Equity shares, also known as ordinary shares, represent the risk capital and are the contribution by the promoters and owners of the project. They are entitled to all losses or profits after interest charges and dividend payment on preference share. Equity shareholders have voting rights and have the right to appoint directors; the votes are in proportion to the paid-up capital of the company. Since equity shares are the residual owners of the company, they are entitled, in case of liquidation, to the amount left after payment of all liabilities and preference share capital. In other words, the reserves, if available, belong to equity shareholders.

As per norms of capital mix, the promoters are required to contribute a certain percent of project cost. Debt-equity norm is prescribed, for industrial project; the ratio normally is 2:1; however, for infrastructure projects the ratio is 4:1. Most of the highway or infrastructure projects have debt–equity ratio of 70:30.

Share capital of a company is shown under the heads as

Reserves represent the profit earned and retained by the company. In other words, profit retained after distribution of dividend is a part of reserves. They also include profits on sale of fixed assets or a premium on issue of shares. Many a time reserves include revaluation reserve which is created on revaluation of fixed assets; it is only a book entry and not a free reserve and is to be shown separately. Reserves represent savings of the company, are normally indicative of financial soundness of the company, and are internal funds available for expansion and setting up of new projects. Free reserves are capitalized and bonus shares are issued to the existing shareholders. The bonus shares are generally issued with an objective of balancing capital mix and are a reward to the existing shareholders. Reserves also known as internal accruals don’t have explicit cost, and the notion that these are zero cost fund is unfounded and is not correct.

Loan Funds from Financial Institutions

Loan funds are in the form of term loans, debentures, and public deposits. Term loans are from banks, financial institutions, or others. These can be secured or unsecured. Assets financed from the proceeds of term loan provide prime security while other assets serve as collateral security. Term loans with the security of immovable property are first mortgage; in addition there can be second mortgage when loan is again taken on the security of the same property. Loans are less cumbersome source of borrowed funds as compared to debentures discussed later, as these (latter ones) are subject to the norms of regulatory bodies like SEBI in India or SEC in the United States.

Many a time, financial institutions providing term loans lay down restrictive covenants which include the following:

Loan funds are proved either on “project basis” or on “balance sheet basis.” These are similar to direct market borrowings for a project or borrowing through financial intermediary route (normally called “vehicles” or special purpose vehicle (SPV)). In the former, it is the project that would be rated, while in the latter case, the intermediary would be rated and also the functioning and appraisal capabilities of the intermediary would be evaluated. When government generates user fees, such as toll facilities, water and sewer systems, and airports, to provide repayment for the infrastructure projects is an example of “balance sheet basis.”²

Lease Financing

Leasing as a source of finance for a project has acquired prominence over the years. In developing countries like Korea, Malaysia, Singapore, and Indonesia, one of the main reasons for the growth of leasing has been the emergence of the concept of the “right to use” over that of the “right to own.” In other words, the change from the concept of the “right to own” as a sign of popular social recognition has led to the popularity of leasing. Further, in developed countries like the United States, United Kingdom, and Australia, assets acquired on lease account for approximately 25 percent of the assets used and one out of every three capital expenditure decisions is in favor of leasing. In India also leasing as a source of finance is gaining importance. Various banks and financial institutions, like ICICI, IDBI, Housing Development Finance Corporation of India (HDFC), are involved in leasing; this is besides hundreds of the leasing companies.

Leasing-Meaning: Leasing normally is defined as a means by which a firm (lessee) acquires the economic use of an asset for a specified period of time at a specific charge. It means that the lease provides a right to use an asset without the right of ownership.

Leasing, hiring, and installment credit are similar terms and these have been so modified over the years that the distinction has become blurred. Leasing is not a novel concept to the world of finance, since there are a number of instances of leasing pertaining even to the middle ages and the 18th century. The giving of telephone on hire by M/s Bell Telephone Company, United States, in the 18th century is a well-known example. However, leasing acquired great importance particularly after the World War II in the United States, where a number of departmental stores like Sears Roebuck sold their buildings to financial and insurance companies and took back those buildings on lease as “sale and lease back.” Equipment leasing by manufacturing companies like IBM computers was another method of leasing purely for purposes of sales promotion either as a direct lease by the company or by setting up a computer leasing company.

Leasing types: Broadly, leasing can be of two types—operating lease and capital lease, the latter is also called financial lease.

Financial lease is an irrevocable contract that gives the lessee possession of capital assets and in turn binds him to make a series of payments to the lessor over a relatively long period of time. The long-term contract which is irrevocable, fully amortizes the lessor of the costs of the assets leased and thus normally intends to transfer ownership on payment of certain installments. Its main feature is to transfer most of the risks and rewards of ownership to the lessee. To be a financial lease, normally, following conditions should be fulfilled:

(For details, see International Accounting Standard (IAS) 17.)

Operating lease, on the other hand, is a short period contract usually cancelable by either the owner or the user of the asset (lessee) after giving a certain stipulated period notice. The objective of this type of lease is to provide to the lessee the use of the assets without any of the risks associated with the ownership. Rental of a car and equipment on a 2-year lease terminated on a 60-day notice are examples of the operating lease.

Financial lease discussed above is a device for acquiring capital equipment without paying cash and thus is an important source of fund for a project. It is called “wrap-around” financing, provides one hundred financing of equipment, and is an attractive mode of financing a project. It is preferable in situations where the opportunity cost of funds is high or where the finance amount required is too small to be of interest to major financial lenders or capital market. It is an important device in the expansion period for a small project and is convenient one for larger companies, particularly, when their needs are small and a specific asset is to be acquired.

For developing countries like India, financial lease is an attractive means of acquiring equipments or building infrastructure from overseas sources, as it would result in only the periodical lease charges being shown as external liabilities without any drain on the external reserves or buildup of external liability. Financing lease is an “off-balance sheet” item as the equipment owned by the lessor (owner) is not shown in the balance sheet of the lessee as an asset and a liability. Thus it helps the lessee in maintaining the balance sheet size and financial ratios to a reasonably low level. However, this advantage is superficial one, as the financial lease is included while analyzing the financial statements of the lessee. Further, International Accounting Standard 17 recommends capitalization of the financial lease; the asset to be disclosed and a corresponding liability for rentals are to be shown under the lease liability.

Institutional Finance

Commercial banks in India provide finance for infrastructure, though banks lending is not beyond 10 to 12 years. In fact, commercial banks are the second largest source of finance for infrastructure (about 24 percent), after government budgetary support (about 54 percent). According to Dr. K. C. Chakrabarty,³ the commercial, more particularly, the public sector, banks have supported the infrastructure requirements of a growing Indian economy, and the outstanding bank credit to the infrastructure sector, which stood at Rs. 72.43 billion in 1999 to 2000, has increased steadily to Rs. 7,860.45 billion in 2012 to 2013, a compounded annual growth rate (CAGR) of 43.41 percent over the last 13 years (see Tables 6.1 to 6.3) against an overall CAGR of bank finance to all industries at 20.38 percent during the same period. The share of bank finance to infrastructure in gross bank credit has increased from 1.63 percent in 2001 to 13.37 percent in 2013. Between March 2008 and 2013 alone, banks’ exposure to infrastructure has grown by more than three times. In addition, credit has also flown into infrastructure sector via NBFCs, mutual funds, and capital markets, the source of bulk of which is bank finance.

As a measure to enable banks to provide funds to projects including infrastructure projects, the Reserve Bank of India (RBI) allowed banks in 2013 to issue bonds with a minimum maturity of 7 years to raise resources for lending to long-term projects in infrastructure subsectors and affordable housing. Further, such bonds were exempt from regulatory requirements such as the cash reserve ratio and the statutory liquidity ratio. Since then, quite a few banks, including ICICI Bank Ltd, have raised money through such long-term infrastructure bonds.

Table 6.1 Growth in bank credit to infrastructure sector

Table 6.2 Asset Quality of Infrastructure Loans by Scheduled Commercial Banks

Flexible financing scheme—5:25 scheme by commercial Banks: Flexible financing scheme popularly known as the 5:25 scheme was introduced by the Reserve Bank of India in July 2014.It allows banks to extend long-term loans of 20 to 25 years to match the cash flow of projects, while refinancing them every 5 or 7 years and the flexible financing scheme has been extended to existing projects where the total exposure of lenders is more than Rs.500 crore.

Table 6.3 Asset Quality of Infrastructure Loans by Scheduled Commercial Banks

The Flexible financing scheme would be a big relief for industry and banks, as on October 31, 2014, banks’ outstanding exposure to the infrastructure sector was at Rs.8.88 trillion and most of the infrastructure sector projects were more than Rs. 500 crores. Moreover, as per RBI data, the five sectors—infrastructure, iron and steel, textiles, aviation, and mining—together contributed 24 percent to total advances of commercial banks and accounted for around 53 percent of their total stressed advances. With the scheme so modified, the cash flows would match the repayment schedule, would provide a big relief for infrastructure companies, and would add to the viability of the long-term infrastructure projects.

In addition to commercial banks, NBFCs also provide funds for projects; the NBFCs include Infrastructure Development Finance Company and India Infrastructure Finance Company Limited.⁴

Bonds or Debentures

Bonds or debentures have similar features. Bonds are normally issued by governments or government departments, while debentures are issued by commercial enterprises. These are instruments for raising loan funds for long period. A bond is a long-term contract under which borrower agrees to make payments of principal and interest on specified dates to the holder of debenture/bond.

Parties to a bond include a trustee, a bank, or financial institution or insurance company, which are entrusted with the task of protecting the interest of the bond holders. Bonds are of different types depending upon their features. Some of the features include par value bond, coupon interest bond, zero interest bond, or deep discount bond. These can also be convertible, nonconvertible, or partly convertible; income bond or indexing bond. Bonds can also be original issue discount (OID) bonds as these are issued below par. Many a time, they carry features as call option and put option. In case of call-option bond, the issuing corporation has a right to call bond for redemption, while in put-option bond, the bond holder has the option to sell the bond to the company. In deferral call bond, the issuing corporation cannot call for a certain years.

For infrastructure projects, deep discount bonds or zero interest bonds with call option have been very popular as there is no commitment to pay periodical interest, while payment on maturity includes interest amount.

In western countries, bonds are an important source of funds for municipal corporations, that is, local bodies. In fact, municipal bond market was born in the United States in 1975, the New York City was the first one to issue bonds, and the municipal bond market in the United States is governed by the Securities Exchange Commission (SEC). A 15-member Municipal Securities Rule Making Board (MSRB) was established by SEC, an independent, self-regulatory agency, with the primary responsibility, to develop rules governing the activities of banks, brokers, and dealers in municipal securities.

Bond market earlier comprised mainly of ‘Plain Vanilla Bonds’ with simple cash flow structure having relatively straightforward valuation. The market has since progressed and investment banking firms have altered the cash flows of fixed income assets to attract wider range of investors. This enabled the borrowers to reduce their cost of raising funds. Government bond, on the basis of the stream of payments received by the holder, can either be a discount bond or a coupon bond. Coupon bonds pay interest periodically and also pay the principal at maturity, while deep discount bonds pay only a contractual fixed (which includes interest and principal) amount at maturity, there being no interest payment before maturity as such as they do not require cash outflows before maturity.

Further, bonds issued by municipalities, can be put under two categories: generally obligation (GO) bonds and revenue bonds (RB). GO bonds are secured by the unlimited taxing power of the municipal corporation and are serviced out of the tax revenues and assets of the corporation. GO bonds generally provide facility of tax exemption to the investor and have a lower cost of borrowing. They are also referred to as “full faith” and create obligation due to diversity of security provided. Bonds issued by APIDC, KBJNL, and SSP, were GO bonds backed by state guarantees. On the other hand, revenue bonds (RB) are tied to the project, are issued for a specified project, and are to be serviced from the revenue proceeds of the project. As a result, feasibility analysis of the project is essential before the issue of RB. Net revenue from the project after meeting project operating expenses is pledged to bond holders. Thus RBs create local awareness regarding the project and its service and enhance the efficiency of the municipal corporation. RBs are not considered as public debt of the government and are not constrained or limited like deficit financing. In the United States, RBs have become popular among municipal corporations. It is viewed that they have a great potential in the Indian capital market considering the urgent need of urban infrastructure projects.

It may be mentioned that Bangalore Mahanagara Palike was the first ULB to have raised resources through private placement of municipal bonds in 1997 and Ahmedabad Municipal Corporation was the first to make a public offering in January 1998. Similarly, many other municipalities entered the capital market to raise funds including Nashik, Jalgaon, Aurangabad, Sholapur, Pune (Maharashtra); Hyderabad, Visakhapatnam (Andhra Pradesh); Vadodara (Gujarat), Chennai, Coimbatore, and Tirpur (Tamil Nadu); Hubli (Karnataka); Ludhiana, Jalandhar, Chandigarh, and Amritsar (Punjab). Corporations raising funds without government guarantee included Nashik, Nagaur, Ludhiana, and Madurai. Certain municipal corporations issued tax-free bonds, while many others raise finances by the issue of taxable bonds. Exhibit 6.1 presents the details of the amount raised by the issue of tax-free bonds by various corporations. In addition details of municipalities which raised funds through issue of taxable bonds are given in Exhibit 6.2.

Despite the above, bond market in India is not well developed and faces hurdles of low rating, reluctant investors, and unclear regulation. Most municipal corporations in India have a limited understanding of bond market.⁵

Having discussed various long-term sources of funds, their comparison in relation to ownership rights, repayment, claim on assets and on profits, and other aspects is presented in Exhibit 6.3.

Securitization as a Source of Infrastructure Finance⁶

Securitization has been one of the recent developments in the area of finance and has been used as a financial strategy by a number of organizations—commercial as well as noncommercial—to raise term finances and also as a step toward development of financial market. As a process to raise long-term funds, assets like receivables or expected receivables are sold which result in conversion of illiquid assets like receivables into marketable debt securities which are subsequently traded in the capital market. One well-known example of securitization has been that of Reliance India Limited (RIL) wherein the company raised Rs. 300 crores by securitization of its future expected flows of receivables from sale of oil and gas in future years.

In other words, a company sells its receivables, or expected receivables, or similar other assets, that are normally illiquid to a bank or a trust which in turn issues marketable debt securities. In this process the company converts its receivables into securities which are subsequently subscribed by investors, and thus finances are made available to the company. So securitization recycles funds, enabling the same funds to be available to support projects of higher growth.

Securitization thus can be defined as a process of conversion of assets into securities, securities into liquidity, liquidity into assets, and assets into securities on an ongoing basis.

Securitization of assets like receivables, as a source of funds, differs from bill rediscounting or factoring, as these alternate methods involve heavy paper work and are sources for a short period, as against securitization which is an arrangement normally for longer period.

Securitization: Process

Securitization starts with a company (originator) or a borrower approaching a financial institution or a bank for a loan or for financial assistance; assets portfolio like receivables are the basis of the loan and are offered for sale by the company.

Special Purpose Vehicle (SPV): SPV is created by the bank or the financial institution and receivables or other homogenous pool of assets are transferred by means of a transfer deed in favor of the SPV which acts as a trustee for investors. Once the assets are transferred, these are dropped from the asset portfolio of the originator. Such transfer deed is required to be stamped on ad valorem basis under the stamp laws of the concerned state and also needs to be registered under the Indian Registration Act 1908. As an alternative to the creation of SPV, the bank or financial institution may constitute itself as a trustee and that would not warrant stamp duty as there would be no transfer of assets.

Securitization Function: The assets so transferred to the SPV are structured and are converted into securities and necessary arrangements are made for the issue of the security instruments indicating expected maturity, interest rate, and so on.

Merchant Banker: Merchant banker is a key agency in the securitization process; it arranges to market the securities to investors, which are generally institutional investors like insurance companies, mutual funds, pension and provident funds, charitable and other trusts. The securities so issued by the SPV may be with or without “recourse” to the issuer. In “without recourse” issue, the investor bears the risk of default and does not enjoy any guarantee for repayment if cash collected falls short, that is, the issuer is under no obligation to pay the investor if the receivables do not realize.

Thus the SPV is only a pass-through vehicle and manager of the assets and the cash flow pool.

Credit Rating: Issue of securities, as per the prescribed rules, is required to be rated by a credit rating agency which considers cash flows and various other parameters to assess the certainty of collections of receivables and redemption of the securities on maturity along with the payment of interest.

Payment on Maturity: Proceeds collected from the outstanding receivables are utilized by the SPV to service the securities, that is, to pay interest and the principal on maturity.

Securitization: Illustration

The process of securitization is illustrated by the following project relating to laying down of a water pipeline to improve the water distribution system. The expected revenue from the project could be securitized to raise funds to finance the project. Details regarding project cost, project revenue, and commercial viability at 12 percent discount rate are given below:

Water Supply: Pipeline Project Cost (Rs. in million)

Year	Cost
1	0.02
2	0.69
3	12.44
4	2.91
5	0.71
6	0.26
Total cost	17.03

Water Supply Pipeline Project: Operating Details and Estimated Annual Income Statement (Rs. in million)

Water Supply Pipeline Project: Commercial Viability

Net Present Value at 12 percent Discount Rate

For the above project, securitization process would be as under:

Securitization: Characteristic

The securitization process has the following characteristics:

Securitization: Prerequisites

For securitization to be meaningful, following are the requirements:

Securitization: Origins and Position in India

Securitization first developed in the United States during 1975 starting with housing mortgage and has diversified to credit card, home loans, student loans, and small business loans. United Kingdom is the second largest market for securitization and the Bank of England played a leading role in evolving guidelines for banking and other authorized institutions whereas countries like France, Germany, and Japan have been relatively slow starters.

In India, Citibank was the first to securitize auto loans and placed a paper with GIC mutual fund in 1991. Since then there have been variety of deals relating to housing loans, auto deal, credit card, and future flows of receivables, and financial institutions like ICICI, IDBI, and IFCI have been instrumental in various securitization deals. Some of the recent instances of securitization are

Securitization: Feasible Areas

Securitization is feasible in areas where a reasonably certain sum of money is expected to be received over the years, not a very short period. “Limited access projects,” where services are provided on the levy of user charges and also having a certainty of expected receipts for the coming years, are suitable for the securitization process. These would include real-estate finance, auto finance, car rentals, credit cards, hoteliers and real-estate rentals; insurance companies expecting insurance premiums; educational institutions expecting regular fees; organizations expecting regular collections from their services or goods; and public authorities expecting regular toll revenues, property tax collections, or collections for the water and sewerage services, or electricity supplies dues.

Housing loans is another potential area of securitization and approximately 70 percent of housing loans in the United States are securitized. Company like Housing Development Finance Corporation (HDFC) having a housing loan portfolio of Rs. 10,000 crores can securitize its future revenues, that is, instalment payments made by borrowers, as collateral to raise cash; route this income through SPV to convince investors that their collection is safe; and sell tradable debt payer.

For urban development projects, in particular those of “limited access” nature, where demand is more or less certain, securitization of expected receivables could be a source of funds. For example, municipality like Ahmadabad Municipal Corporation (AMC) could securitize expected revenues from property tax; similarly a public utility having annual revenue collection say of Rs. 100 crores could securitize these expected receipts and raise hundreds of crores of rupees to finance its new project.

Short-term Funds

Public Deposits: Deposits accepted by a company are unsecured loans for a specific period and at a specific rate of interest. Public deposits have been an important source of funds because of convenience and low formalities required. However, it has been subjected to more regulatory provisions to safeguard the interest of depositors.

Norms for accepting deposits from public are as follows:

Various companies which have accepted deposits from the public include Bharat Heavy Electricals Limited (BHEL), Oil & Natural Gas Commission (ONGC), Indian Oil Corporation (IOC), Steel Authority of India Ltd (SAIL), Ashok Leyland, and Larsen & Toubro.

Financing Facilities by Banks

Banks are an important source of finances for business enterprises, and they provide financial services in various forms as

Cash Credits/Overdrafts: There is an arrangement with a bank under which a predetermined limit of borrowings is specified by the bank. However, the borrower has the facility of repaying any amount earlier.

Loans from Banks: Banks also advance a fixed amount of loan at an agreed rate of interest; the whole amount of advance is at the disposal of the borrower and interest is charged on entire amount of the loan outstanding.

Letter of Credit: Another facility extended by a bank is to issue a letter of credit. This is an arrangement whereby bank undertakes the responsibility to honor obligation of its customer, if he fails to pay. It is an indirect form of financing where bank assumes risk but does not provide financing.

Bank while extending short-term funds normally requires security which may be a movable property, like inventory. Such arrangement of advancing loan on the security of inventory is called hypothecation, wherein the borrower does not part with the goods. As against the above, loan advanced by the bank on the security of goods deposited is called pledge.

Discount of Bills: There is an arrangement with bank and a discount house under which the banker purchases the trade bills. It is financing of the trade bills and is similar to factoring.

Factoring are funds arising by discounting of accounts receivables with banks or other financial institutions. This source is not well developed in India, like that of in developed countries.

Commercial paper is another method of raising shorter funds. It is a short-term unsecured promissory note issued by firms enjoying high credit rating and having current ratio of 1.33 for a period having maturity of 90 days to 360 days. It is of high denomination value as Rs. 1,00,000 or so.

Trade credit reflects credit provided by suppliers of goods and services; these include payments of dues to employees and others and are termed accruals or outstanding payments. These normally vary with level of activity, nature of business, and terms of payments and accounts for approximately 20 to 50 percent of total short-term funds. Apparently, these are zero cost source of fund. However, suppliers give different credit terms which have different cost of credit. For example, credit term of say 2/10, net 30 means 2% discount if payment within 10 days otherwise net payment due within 30 days. This term of credit involves a cost of 36.73 percent ((2/98) (360/20) = 36.73%). Various terms of credit and the cost associated are illustrated in Exhibit 6.4.

Project Financing: Issues Concerning Project Manager

A project has long life and has long gestation period and a project manager has to tap various sources of finances matching the project life and its return. Equity though better is costly and is generally suitable for commercial projects. Bonds or debt is convenient but has to be serviced by payment of interest and repayment on maturity of about 15 years. In that case infrastructure bonds of long duration and that too zero interest bonds or deep discount bonds are most suited. Financial lease is convenient when the capital market situation is not conducive. Pension and other retirement funds are important sources for projects, but are not prevalent in India. Lastly, the short-term funds are suitable to meet project operating fund requirements and should not be used for long-term requirements.

Brief Case Examples

Hotel Leelaventure Sells Biz Park to RIL

Hotel Leelaventure Ltd has decided to sell its information technology business park in Chennai to Reliance Industries Ltd for Rs. 170.17 crores. Hotel Leelaventure plans to turn around by rising around Rs. 3,500 crores through sale of noncore assets and stakes in individual luxury hotel projects and by forging joint ventures with hotel developers and other ways to pay off debt.

Trent to Buy TVS Shriram stake

Board of Directors of Trent Ltd, a Tata group retail company, decided to buy back the entire stake of private equity firm TVS Shriram Growth Fund in bookstore chain Landmark Ltd for Rs. 84 crores. As such the entire holding of 1.82 million shares in Landmark would be acquired by Trent Ltd.

Trent had piked up a 74 percent stake in the Chennai-based retailer for Rs. 103.6 crores. In November 2009, TVS Shriram Growth Fund picked up a 25 percent stake in Landmark from Trent for Rs. 65 crores.

2 × 800 KV Kishenpur–Moga Transmission Line Project

Power Grid Corporation (PGC), a state enterprise approved 2 × 800 KV Kishenpur–Moga Transmission Line Project. Korba-Spain was selected out of six firms shortlisted for the project. The major components of the project included towers, conductors, and insulators.

Conductors are power carrying components; insulator strings insulate the live conductors from the tower on which conductors are supported.

The project approved cost was Rs. 417.17 crores with the completion date as March 1998.

The project was delayed by 3 years due to repeated failures of tower during testing, nonavailability of test beds in India, and also contractual disputes.

Cost estimates of the project got escalated to Rs. 938.48 crores due to factors which included

Plizer Plc.: Combination of Pfizer Inc. and Allergan Plc. Combine

Pfizer Inc. New York and Allergan Plc. Ireland combined in November 2015 to form a new company named Plizer Plc. This was a biggest deal in a record $160 million ever in the healthcare sector and would allow Pfizer Inc. to shift its legal base to Ireland to reduce its tax rate.

Pfizer Inc. based in New York made medications including Viagra, pain drug Lyrica, and the Prevnar pneumococcal vaccine, while Allergan based in Dublin produced Botox and Alzheimer’s drug Namenda. This deal would be unprecedented on many levels. It was the biggest pharmaceutical acquisition having a total sales of about $60 billion. It was the largest ever in the pharmaceutical world, eclipsing Pfizer’s purchase of Warner–Lambert Co. in 2000 for $116 billion.

The transaction was structured so that Dublin-based Allergan was technically buying its much larger partner, a move that made it easier for the new company to locate its tax address in Ireland for tax purposes, though the drugmaker’s operational headquarters would be in New York. Pfizer’s chief executive officer Ian Read would be chairman and the CEO of the new company, with Allergan’s CEO Brent Saunders as president and chief operating officer overseeing sales, manufacturing, and strategy. Pfizer’s 11 board members would join 4 from Allergan including Saunders and executive chairman Paul Bisaro.

Pfizer would exchange 11.3 shares for each Allergan share valuing the smaller drug maker at $363.63 a share.

The new company established abroad in Ireland for a lower tax rate, a controversial process called an “inversion,” would be the largest such move in history. Pfizer and Allergan’s deal appeared structured to avoid the tax inversion rules.

As per the tax laws, the United States had the highest tax rate for business in the world, at 35 percent, and was one of the only countries to tax corporate profits wherever they were earned. Earlier moves by the US treasury derailed other proposed inversions, including AbbVie Inc.’s plan to buy Ireland’s Shire Plc. for an estimated $52 billion.

It was estimated that the deal would help the companies to invest in more innovative drugs and that Pfizer Plc. would have 4,000 US employees. The deal was expected to facilitate Pfizer to reconfigure itself by splitting the newly enlarged company into two: one focused on new drug development and the other on selling older medications.

The industry experts would mark a peaking point for the Irish firm Allergan’s history of tens of acquisitions and selloffs. Last year Allergan had fended off a hostile and determined acquisition bid from Canadian drug maker Valeant before getting acquired by Actavis in a $70.5 billion transaction. For history of Allergan’s deals over the years see Box A.

Case Studies

Case Study 6.1

Tata Chemicals Limited (TCL)

Established in 1939, Tata Chemicals (TCL) owns and operates the largest and most integrated inorganic chemicals complex in the country at Mithapur, Gujarat. The company is among the largest producers of synthetic soda ash in the world and has the largest share of the domestic market. TCL is also among the nation’s leading manufacturers of urea and phosphoric fertilizers. Its urea plant, located in Babrala, Uttar Pradesh, is the country’s most efficient fertilizer unit and produces 12 percent of the country’s urea output in the private sector. In June 2004, the company completed its acquisition of Hindustan Lever Chemicals (HLCL), a manufacturer of bulk chemicals and phosphatic fertilizers. HLCL’s plant at Haldia, West Bengal, was India’s largest producer of sodium tripolyphosphate.

Following the acquisition of HLCL, the TCL also acquired a stake in 2005 as an equal partner in Indo MarocPhosphore, by acquisition of shares from the two existing joint venture (JV) partners, for a total consideration of Rs.166crores. Further, in 2006, TCL acquired the UK-based Brunner Mond Group for Rs. 508 crores for a 63.3 percent stake and became the world’s third largest soda ash manufacturer. TCL was ISO-9001/14001 certified and had an export presence in South and Southeast Asia, the Middle East, and Africa; was in the process of expanding its operations globally; and had set itself the objective of becoming the lowest-cost producer of soda ash in the world. The acquisition of an equal partnership in Indo MarocPhosphore SA (IMACID) along with Chambal fertilizers and global phosphate major, OCP of Morocco, was the step toward globalization.

Summarized income statement and balance sheet of TCL are given in Tables 6.4 and 6.5, respectively.

TCL had finalized the acquisition of US-based natural soda ash produce General Chemical Industrial Products (GCIP) for $1 billion. That would increase the capacity of TCL from 3 million tonnes a year to 5.5 million tonnes a year and TCL would become the second largest soda ash player globally.

Apart from the scale, the acquisition would benefit TCL in terms of access to cheap raw material and improvement in margins as GC1P has access to natural soda ash mines in the United States, which were expected to last for 100 years. This would be advantageous for TCL as the production cost of natural soda ash was cheaper by 40 to 45 percent compared with synthetic soda ash, which was power intensive. After the acquisition, natural soda ash would contribute more than 50 percent of the total combined capacity. According to a research study, natural soda ash had an operating margin of about 30 percent compared with 17 to 18 percent in case of synthetic soda ash.

Tata Chemical Limited

Table 6.4 Income Statement

(Rs. Crore)
	March ‘07	March ‘06	March ‘05
Total revenues	4,089	3,602	3,110
PBT	634	511	453
PAT	444	353	340
Dividends	172	150	140

Table 6.5 Balance Sheet

(Rs. Crores)
	March ‘07	March ‘06	March ‘05
Owners’ funds
Share capital	215	215	215
Reserve and surplus	2,178	1,953	1,783
Loan funds	1,042	1,454	1,324
Total funds	3,435	3,622	3,322
Uses of funds
Fixed assets (net)	1,515	1,550	1,562
Investments	1,354	722	941
Net current assets
Current assets	1,917	2,484	1,983
Less current liabilities	1,351	1,134	1,164
Net current assets	566	1,350	819

Soda ash had a range of applications from glass to detergent to toothpaste. Soda ash could be manufactured either the synthetic way or naturally. While the synthetic way involves extracting soda ash from common salt, soda ash was also mined from deposits in the earth called “Trona.” GCIP had huge mines in the Green River Basin in Wyoming, United States, and the cost of producing soda ash from the Trona ore deposits were among the lowest in the world. In the words of Homi Khusrokhan, Managing Director of TCL, “While globally 60% of the soda ash produced was used for glass, 30% for detergent and 10% for other purposes, in India it was exactly the opposite with 60% being used for detergent, and 30% for glass, this will change.”

Earlier, purchase of UK-based Brunner Mond by TCL in 2005 had strengthened its reach in Europe and West Asia, while GCIP acquisition would this time provide access to the Americas. The acquisition seemed to be well timed as soda ash prices had moved up over the past 3 years and was 30 percent higher y-o-y at present. This was due to higher demand from Asia for glass and detergents—its biggest applications.

While the operational benefits of the acquisition were clearly visible, at about 2.5 times revenues, as per one estimate, the price appeared on the higher side. Also, how TCL would finance this purchase would be crucial. TCL was weighing the alternatives of financing, that is, debt:equity ratios of 50:50 or 75: 25 or 100 percent debt.

To its advantage, its cash balance and investments were estimated at Rs. 2,000 crores. At Rs. 292, the stock trades at 10 times for the FY09 estimated consolidated earnings without accounting for this recent GCIP acquisition. This looked attractive considering the future benefits of the acquisition and the strong soda ash cycle.

Issues for discussion

Case Study 6.2

Zee Entertainment: Bonus Issue of Redeemable Preference Shares

Zee Entertainment, one of India’s largest media entertainment companies, announced distribution of Rs. 2,000 crores to shareholders through a bonus issue on completion of 20 years in the business. The bonus issue was 21 redeemable preference shares of Re.1 each for every equity share of Re.1 each held in the company. The redeemable preference shares carry an interest rate of 6 percent payable annually.

The shareholders would realize the value only when the redeemable shares get listed on stock exchanges. However, the redeemable preference shares will not be eligible for any dividend announced by the company or any voting rights.

The major beneficiary on the issue of the bonus share would be the promoters as they hold 43.36 percent equity stakes in the company. Thus out of Rs. 2,000 crores, the promoters will garner Rs. 860 crores through this process.

This kind of complex financial structure was earlier adopted by India’s largest FCMG company, Hindustan Unilever (HUL), way back in October 2001. The HUL had announced an issue of bonus debentures to shareholders in the ratio of one fully paid debenture of Rs. 6 each, for every Re. 1 equity share held in the company. The debentures carried an interest rate of 9 percent payable annually.

Such issue of bonus redeemable preference shares by Zee Entertainment or bonus debentures issued by HUL, besides being an attractive financial proposal for the existing shareholders, also enabled the company to preserve cash for some time before distributing to its shareholders.

 

¹ Gupta LC, Preference Shares and Company Finance, Madras Institute of Financial Management & Research, Madras, (Vohra Distributors, 1975).

² US Department of Treasury Office of Economic Policy, Expanding our Nations’ Infrastructure through Innovative Financing (September, 2014).

³ KC Chakrabarty, Keynote address delivered by Dr. K.C. Chakrabarty, Deputy Governor, Reserve Bank of India at the Annual Infrastructure Finance Conclave organized by SBI Capital Markets Limited at Agra on August 9, 2013.

⁴ For details of NBFCs see Infrastructure Development and Financing by Nand Dhameja and Sarika Dhameja, Viva Publication 2015.

⁵ Manas Chakrabarti Municipal Bond Market in India (Indian Journal of Applied Research Volume : 4 | Issue : 3 | Mar 2014).

⁶ This section is adopted from Infrastructure Development and Financing by Nand Dhameja and Sarika Dhameja, Viva Publication 2015.