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Indian Infra Developers : Foregoing Valuable Options

January 16, 2013

In the last 2 weeks, two big infrastructure players- GMR and GVK issued project cancellation notices to the National Highway Authority.  The ostensible reason was the delay in obtaining environmental clearances.  The real reason, of course, was the developers, facing severe balance sheet pressures, were looking for a way out of cash guzzling projects which in the near term were likely to see only net cash out flows.

However, we opine, this strategy was a mistake.  A delay in the commencement of a road project is actually good for a developer.  A developer in entitled to collect toll during the concession period (say 20 years).  “Zero day ” starts only after a project has secured all clearances.  In a growing economy such as India, road traffic can only go up, for the forseeable future.  So, having a zero date two years later, when traffic would be much higher, is better than having a zero date today.  In effect, the environmental ministry, by delaying the clearance, had given an option to the developers for FREE.  By cancelling the project, the developers have killed the value of the option, even if it conserves short-term cash.  The developers would have been better off if they sold the project, so that the value  of the option could have been captured.  Of course, thanks to the pessimism in the sector, a sale would have been hard.

Since the benefits of this option accrues only to the shareholders, creditors to GMR and GVK should be fine with the project cancellation.

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From → Credit Analysis

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