Gangavaram Port ProjectPMF Case Analysis

Group 1

Aritra Basuroy PGP/14/015Akhandal Mohanty PGP/14/063Nikhil Almalkar PGP/14/099Aravindh PGP/14/107Sandeep Tripathy PGP/14/114Ambica Prasad Patnaik PGP/14/192

The Gangavaram Port Project

On the east coast of India, in the state of Andhra Pradesh, about 15 kms. south of the Vishakhapatnam port, the Indian Government was planning to come up with an all weather and deep water port. The port will have good connectivity with the national railway system while a 4-lane road from the port will connect it to the National Highway-5, the Kolkata Chennai part of the Golden Quadrilateral.

After a global bid process, the contract for the port was awarded to a consortium led by Mr. DVS Raju in 2002. The port was supposed to be developed on a BOOT (Build-Own-Operate-Transfer) basis. The private sponsors were required to prepare a master plan, design the facility, arrange for finance, build and own the assets for the facility and operate the assets till the end of the concession period. The initial concession period was set at 30 years which was extendable by two further periods of 10 years each. Under the terms of the concession, the Government of AP provided the consortium the right to the waterfront and the concession to build, own, operate and transfer the project. Land for the project was also provided by the Government. While most of the terms of the concession agreement were in place, a major issue that nagged Mr. DVS Raju was the terms of the revenue sharing agreement – whether it will be set at terms favourable to the private sponsors as well as the Government.

Structure of ownership - Gangavaram Port Limited

An SPV (special purpose vehicle) named Gangavaram Port Limited (GPL) was formed with Mr. Raju and his associates owning a 51% equity stake, Warburg Pincus holding 28% equity and Andhra Pradesh Infrastructure Investment Company (APIIC) holding 11%. A portion of the land acquired was paid for by APIIC in lieu of its equity stake in the SPV while the rest was purchased by the SPV on direct payment.

The Private Sponsors

The consortium of private sponsors has a history of working for similar projects like the Dubai Ports, Malyasian West Port and Singapore Jurong Port. The consortium is being led by Mr. DVS Raju, the Chairman and Managing Director of the Hyderabad - based VisualSoft Technologies.

The Port Sector in India

India has a 7000 km long coastline which is serviced by 13 major ports and 187 minor or intermediate ports out of which around 140 are operable. The major ports, 12 of which are operated by the Port Trust of India handle the bulk of the port traffic (75%) with the minor ports handling the rest 25%. Dry and liquid bulk makes up about 80% of the port traffic in volume (See Exhibit – 1). Although most of the trade in India is carried by Indian sea routes, the existing infrastructure is insufficient to handle the flow of trade through sea routes seamlessly. The capacity of the major ports has increased to approx. 555.67

This case has been prepared by group 1, PMF as a part of the course curriculum and not to show any ineffective handling of any managerial situation

MTPA in 2008-09 while the traffic during the same period was 519.3 MTPA. Thus, the major ports were handling over 95% of the total capacity. See Exhibit – 2 for data on traffic handled by major ports. The major ports are under the jurisdiction of the Central Government whereas the non-major ones are under the State Governments. The Indian Ports Act, 1908 and the Major Port Trusts Act, 1963 provide the legal guidance for governing the sector. Policies are formulated by the Ministry of Shipping for governing the major ports while the minor ports are governed by the policies laid down by the respective State Government’s nodal departments.

Minor Ports

The traffic at non-major ports has grown at an average rate of 13% in the past but slackened to 6.5% in 2007-08 and 2% in 2008-09. The non-major ports can help in alleviating the problem of congestion at the major ports and therein lay their importance. Four states in India, Gujarat, Andhra Pradesh, Goa and Maharashtra together accounted for 96% of the total cargo traffic handled by the non-major ports in India in 2008-09.

Investments

Investments made into the port sector under the Tenth Plan are shown in Exhibit – 3a. During the tenth plan, about 4.86% of the allocated funds were utilized. The large shortfall has been mainly due to the failure of project formulation particularly in the case of the major ports. The projected investments as per the 11th plan have been shown in Exhibit – 3b. Private sector participation in this sector is also being actively encouraged. In the last 10 years, the Government has approved 25 private sector participations for major ports. Most of the current projects where private collaboration is being sought are being implemented on a BOT basis under PPP mode. The capacity addition through private sector participation has been 102.3 MTPA.

Gangavaram Port – Bidding, Construction and Phased Development

The first Phase of Bidding

The Gangavaram port was first conceived by the Government of Andhra Pradesh in 1994 with potential demand slated to come from the Visakhapatnam Steel Plant, Parawada Industrial Estate and many other proposed SEZs in the nearby region. The first round of bidding was conducted emphatically but the Government of AP failed to select a bidder in 1996. The bids were invited on the basis of a Build, Operate, Scale-up and Transfer (BOST) model with commitments on minimum guaranteed revenue per annum, percentage of revenue share per annum and the quantum of investment required for the first phase of the Gangavaram port. Two bids were submitted on the basis of the criteria laid down by the government. However upon evaluation of the bids, concerns regarding the practicality of the market assumptions including the traffic projections and the tariff structure began to emerge. The GoAP (Government of Andhra Pradesh) came to the conclusion that both the bids were speculative in nature and presented an untenable proposition. Thus it rejected both the bids and took a decision to review the BOST policy and the entire tender selection process to permit a more tenable and non-speculative

bidding methodology. Hence the weak bid preparation from the government on account of euphoria resulted in cancellation of the first phase of the bid.

The Second Round of Bidding

After the GoAP realised its fault on account of weak bid preparation which resulted in highly speculative bids in the first phase, it appointed a reputed consultant to carry out the feasibility and procurement studies. The comprehensive feasibility study was prepared and this time around GoAP decided to take the bid international. The project development costs were initially borne by APIIC (Andhra Pradesh Industrial Infrastructure Competition). Thus the second round of international competitive bidding and developer was awarded the project and concession by GoAP in 2002. Even though the second round of bidding was completed and the project was awarded to the consortium led by DVS Raju it took two years from 2002 – 2004 to iron out various developmental issues continued to come up and were resolved. Even this more elaborate bidding process in the second phase, major agreement issues were not exhaustively deliberated during the pre-bid phase which resulted in long negotiations with the bidder after awarding the project. Almost 82 issues came out from the 390 clauses of draft concession agreement and all of them had to be resolved before achieving financial closure. Even after finalization of the concession agreement, various issues continued to plague the Gangavaram Port project. Several protests by the villagers turned violent as they were not happy with the R&R settlement package. Financial closure was achieved finally in 2005 and soon after the deal was awarded Asia-Pacific region’s “Infrastructure Deal of the Year” by Thomson’s Project Finance International.

The process details have been provided in Exhibit 3c.

Construction Phase and Current Status

The construction of the port was completed in April 2008.The port has been operational since August, 2008 and has handled more than 8 MT of cargo as at August 2009, including cargo such as Coking Coal, Steam Coal, Iron Ore, Limestone, Bauxite, Urea, Slag, Steel, Raw Sugar, Scrap and Project Cargo.

The port has handled the largest coal vessel to call at Indian Ports, Capesize vessel MV Ocean Dragon (151,049 DWT) and has achieved high cargo discharge rates (71,808 tonnes per day).

Further Expansion Plans

Keeping the future requirements of industry in mind, Gangavaram Port Master Plan has been designed with facilities to handle up to 300,000 DWT vessels, flexibility for phased development and room for expansion for a plan period of 50 years. The salient features of further expansion plans include:

Plan for entire spectrum of cargos, with berths for handling dry bulk, other dry bulk, break bulk and container cargo with dedicated cargo centric zones

Breakwaters to provide complete protection to berths from waves and swell to facilitate all weather, round the year port operations

Navigation channel and harbour area providing adequate manoeuvring room for ships Total land area of 2800 acres for port facilities development

Extensive ancillary facilities and state-of-the-art utilities/services Adequate backup area for developing stack yards, covered storage sheds, tankages, container

freight station etc. Rail and road access up to the stack yards, storage sheds and container yard Provision to provide value added services like Coal Blending Provision for Ship building and repair facilities Marine Oil Terminal consisting of Single Point Mooring system for handling VLCCs, sub-sea

pipeline and Tank farm

In order to reinforce the expansion and development plans of the Gangavaram Port Limited, the state government has announced plans to construct Rs. 21 crore four lane flyover to the Gangavaram port.

Budget and FinancingThe total project cost is estimated at Rs. 1,696 crores. No VGF has been provided to the project. A consortium of 13 Banks led by SBI Capital Markets arranged term senior & subordinate loans of Rs. 1,170 crores for the phase I development. The transaction won the award of being the largest transaction in India of a merchant Greenfield port financing on non-recourse basis at a leveraging of 69:31.

The future receivables of port usage will be used by Gangavaram Port Limited to repay the loans which have been raised at an attractive rate of under 9% p.a. for the 14 year facility. An independent analyst’s estimates of the financial ratios of the feasibility study have been provided in Exhibit 3d.

ProblemDVS Raju and his partners find the project attractive, but the one thing that is making them wary about the prospects of the project: revenue-sharing with state government. For projects in which land is not bought from govt, revenue sharing is a common practice. But if they have to share revenues in loss-making years, it increases the risk of the project substantially. Hence revenue-sharing agreement has to be carefully negotiated and if the profitability is at risk due to this agreement, a mechanism has to be thought out to make the project viable.

The following questions crossed their minds.

a) What kind of revenue-sharing agreement should they enter?b) How to negotiate with the govt. for the best terms?c) Are there any additional concessions they can ask for?

This project is very crucial for the sponsors as this was their first green-field port project and a success in this project would provide them access to future projects as well. However, the success of any large infrastructure project hinges on the structure of the project that addresses the concerns of all associated parties: govt., partners and sponsors.

PossibilitiesThe port project is critical for all the parties involved. The sponsors are aware of the risks they are taking and the risk analysis shows the revenue sharing agreement to be one of the important issues. While project finance redistributes and allocates the risks to the parties that are best equipped to bear them, the revenue sharing exposes the partners to a potentially lower rate of return. The sponsors were thinking about all the social benefits the project is going to bring around in the region and the importance of the port to the prosperity. The revenues were exposed to uncertainties of the shipping business and the volatility of the global economic environment complicated the matters.

The impact of sharing the revenues with government on the projects internal rate of return worried the sponsors. For the projects of this type the returns need to be commensurate with the risks, which tend to be on the higher side. The sensitivity of the rate of return to the revenues is tabled in Exhibit 9. Moreover the consultants employed by the consortium had an interesting real option POV take on the whole issue. They felt that the Govt., by scrapping the 1 st bidding process and initiating a comprehensive feasibility analysis, was buying itself a call option on the real asset that the port was. Taking this analogy further, the option premium was considered to be the extra cost undertaken for this analysis and the revenue foregone owing to postponement of bid allotment; the time to expiry was the stipulated time before which results of 2nd bidding procedure needed to be announced; Strike price was the NPV predicted from the best alternative (say, calling for another round of bidding and then awarding the contract). So the Govt. by exercising this option would be giving the go-ahead nod to the project right after this 2nd bidding procedure. The contention of the consultants was that the Govt. had a lot to lose if they did not exercise this option. They had done significant number crunching to support their case. They felt that this insightful information was an important trump card that was held by the consortium and could be used cleverly while on the negotiating platform.

The sponsors wondered whether the government will be willing to share the revenue uncertainty. One way to do that was to make the receipts contingent on profitability rather than revenues. The variability in the profits could be factored in the projections. The viability of the project hinged on its potential to meet the return requirements for the sponsors and the government. A suggestion was to share the revenues only in the years of profit. Exhibit 8 explains the outcomes of such an arrangement. The impact on the government’s return from the revenues is tabled. Along with the social returns, the sponsors hoped these will be convincing enough for the government. The negotiations needed to highlight this aspect.

Exhibits

Exhibit 1: Share of Cargo (Major & minor ports)

Source: Position Paper on the Ports Sector in India; Dept. of Economic Affairs, Ministry of Finance, GoI

Exhibit 2: Traffic handled at major ports

Exhibit 3a: Investments under the tenth plan

Source: Position Paper on the Ports Sector in India; Dept. of Economic Affairs, Ministry of Finance, GoI

Exhibit 3b: Projected Investments under the eleventh plan

Source: Position Paper on the Ports Sector in India; Dept. of Economic Affairs, Ministry of Finance, GoI

Exhibit 3c: Projected Investments under the eleventh plan

Source: PPP website of GoI, Ministry of Finance

Exhibit 3d: Projected Investments under the eleventh plan

Source: PPP website of GoI, Ministry of Finance

Exhibit 4: Risk Allocation Framework

Source: PPP website of GoI, Ministry of Finance

Exhibit 5: Traffic and tariff projections

YearCargo (in MTPA)

Revenue per unit cargo (Rs. Millions per MTPA)

2010 8.00 251.252011 10.40 276.382012 13.52 304.012013 17.58 334.412014 19.07 367.862015 20.69 404.642016 22.45 437.012017 24.36 471.972018 26.43 509.732019 28.67 550.512020 31.11 594.552021 33.76 642.112022 36.63 693.482023 39.74 748.962024 43.12 808.882025 46.78 873.592026 50.76 943.482027 55.07 1018.952028 59.75 1100.472029 64.83 1188.512030 70.34 1283.592031 76.32 1386.282032 82.81 1497.182033 89.85 1616.952034 97.49 1746.312035 105.77 1886.01

Exhibit 6: Capital Expenditure plan

YearCap-Ex in Rs Millions

2005 0.82006 11.52007 554.42008 11.82009 8.82010 15,322.002011 3064.42012 3064.42013 260002014 26002015 2602016 522017 522018 522019 522020 522021 522022 522023 522024 522025 522026 522027 522028 522029 522030 522031 522032 522033 522034 522035 52

Exhibit 7: Operational Expense forecasts

Year

Raw materials, stores & spares

Power, fuel & water charges

Compensation to employees

Indirect taxes

Selling & distribution expenses

Other operational exp. of non-fin. servicesent.

2010 386.00 108.00 130.10 0.80 33.20 720.702011 551.98 154.44 175.64 1.14 47.48 828.812012 789.33 220.85 237.11 1.64 67.89 953.132013 1128.74 315.81 320.09 2.34 97.08 1096.092014 1347.16 376.92 432.13 2.79 115.87 1260.512015 1607.83 449.86 583.37 3.33 138.29 1449.592016 1884.06 527.15 758.38 3.90 162.05 1667.022017 2207.74 617.71 985.90 4.58 189.89 1917.082018 2587.03 723.83 1281.67 5.36 222.51 2204.642019 3031.48 848.19 1666.17 6.28 260.74 2535.332020 3552.28 993.90 2166.02 7.36 305.53 2915.632021 4162.57 1164.66 2815.83 8.63 358.02 3352.982022 4877.70 1364.74 3660.58 10.11 419.53 3855.932023 5715.68 1599.21 4758.75 11.85 491.61 4434.312024 6697.64 1873.95 6186.38 13.88 576.07 5099.462025 7848.29 2195.90 8042.29 16.27 675.03 5864.382026 9196.63 2573.15 10454.98 19.06 791.01 6744.042027 10776.61 3015.22 13591.47 22.33 926.90 7755.642028 12628.03 3533.23 17668.91 26.17 1086.14 8918.992029 14797.53 4140.24 22969.58 30.67 1272.74 10256.842030 17339.74 4851.53 29860.46 35.94 1491.40 11795.362031 20318.71 5685.03 38818.59 42.11 1747.62 13564.672032 23809.47 6661.72 50464.17 49.35 2047.86 15599.372033 27899.93 7806.20 65603.42 57.82 2399.68 17939.272034 32693.14 9147.30 85284.45 67.76 2811.95 20630.162035 38309.82 10718.81 110869.78 79.40 3295.04 23724.69

Additional Expenses:

a) Depreciation : 10% of net blockb) Interest rate : 9% ( leverage 69% )

Exhibit 8: The revenue sharingRevenue Share Project Equity IRR

5% 23.51%6% 23.29%7% 23.08%8% 22.86%9% 22.63%

10% 22.41%11% 22.18%12% 21.95%13% 21.72%14% 21.48%15% 21.24%

Exhibit 9: Sensitivity of government returns

Revenue Share Govt IRR

Govt IRR with no Revenue in loss making years

5% 32.47% 31.23%6% 33.88% 32.36%7% 35.24% 33.44%8% 36.57% 34.48%9% 37.86% 34.42%

10% 39.12% 35.26%11% 40.35% 36.06%12% 41.56% 36.83%13% 42.74% 37.57%14% 43.89% 38.30%15% 45.02% 38.99%