After 10 years, four unsuccessful tenders, and a stressed developer, the Zojila tunnel project, aimed at providing all-weather connectivity between Srinagar, Kargil, and Leh, continues to hang fire. The crucial public infrastructure project — it was planned as Asia’s longest tunnel — received approval in 2007 but landed up with IL&FS Transportation Networks (ITNL) only late last year.
Is ITNL the right choice for such a project? All indications point to a big no.
Last month, Care Ratings downgraded ITNL’s credit rating to BB (with a negative outlook) from A minus, citing the company’s highly leveraged balance sheet and weak cash flow.
Even though the INR5,000 crore project is on an engineering, procurement, and construction (EPC) or cash-contract basis, ITNL will need a significant amount of working capital to fund its execution, which is expected to take seven years to complete due to the tough terrain and harsh weather conditions in the area.“Chances of completing it are at risk, given that it is a long-gestation project. IL&FS’s consolidated debt is rising and not enough revenue is being generated to support the principal or interest payments,” an analyst at a major brokerage says. If things go further south, the government can always retender the project, he adds.
Zojila isn’t an aberration. A bumpy ride is the norm for most infrastructure projects.
The Zojila tunnel mirrors the poor track record of infrastructure-project implementation in the country. The much-talked-about Mumbai Metro line 3, in planning phase since 2009, has taken nearly 10 years to reach the implementation stage. There have also been reports that execution of some sections of the Mumbai-Goa highway has been delayed by over six years due to the contractor’s financial troubles.
As of November 2017, 302 of the total 1,283 infrastructure projects, each worth INR150 crore or above, were running behind schedule, according to the Ministry of Statistics and Programme Implementation. The cost overruns for these projects are to the tune of INR1.45 lakh crore.
Given that the infrastructure sector is among the top five contributors to non-performing assets in the country, it’s about time that the government aligned its policies and gave greater weightage to the debt profile of bidders while awarding crucial public-infrastructure projects. Instead of automatically selecting the lowest bidder, evaluating bidders on a value-for-money basis might make better sense.
Focus on bidders’ financial profiles can help
While infrastructure analysts start raising eyebrows on companies with a debt-to-equity ratio of over 2.5 times, ITNL as of March 2017 has a leverage of 7.4 times, compared with 6.2 times a year ago.
Care Ratings in its July 2018 report says the management of ITNL in the past had given indications about a deleveraging plan either through a stake sale in its special-purpose vehicles or through adequate equity infusion. Either plan is yet to materialise. “Financial profile is very important and it should be the main criteria. For EPC contracts too, a lot of money is invested by the contractor in the form of working capital. Based on the bids, the government should also check if the company is in a position to execute the project and raise the required funding. You have to match the cash flows with the investment,” says an infrastructure-sector consultant with Asian Development Bank.
To be fair, for the Zojila project, the government did debar bidders who had applied for corporate-debt restructuring or strategic-debt restructuring in the last five years.
But it is more of a curative measure rather than a preventive one.
Other than debt, financial qualifications only include some net-worth limits and profitability parameters for bidders to be eligible.
According to the chief financial officer at a Mumbai-based metro-construction company, financial leverage of bidders is not a key requirement for being eligible to bid for and win contracts. He adds that the high leverage of infrastructure companies today is due to a mix of typical government-related issues such as delays owing to land acquisition and clearances and private-sector problems such as aggressive bidding.
“When you have stressed assets, you will never solve a problem by only addressing the numerator; the problem needs to be solved with the denominator as well. The non-performing asset is in the numerator, while the total asset is in the denominator. You need to fix the bad loan, but you also need to grow the denominator,” says Manish Sinha, managing director of commercial data analytics company Dun & Bradstreet.
But he is quick to add, “I am not advocating a ponzi scheme where you collect money today for yesterday’s project and today’s project is completed by collecting money tomorrow, which is what some real-estate and infrastructure companies have done.”
Follow the developed world’s model for fewer potholes
ITNL’s winning bid of INR4,899 crore for the Zojila tunnel project was almost half of the highest bidder’s, according to a news report. EPC projects usually see high competition as there is now requirement of long-term loans and the business is asset-light. The focus is almost always on winning a project by quoting the lowest price.
Manish Agarwal, capital projects and infrastructure leader at consultancy firm PwC India, is of the opinion that L1 — short for lowest bidder — alone should not be the criterion to decide grant of contracts.
“Technical competence, planning, thinking-through of the project, and the strength of the commercial bid should also be taken into account,” says Agarwal. “If a company bids 20% lower than others, the government needs to check if it is doable. Where is that discounted bid coming from? Is it coming from cost savings, efficiencies, or expectation of a lower return on equity?”
Most developing countries rely on the lowest cost technically acceptable (LCTA) model for procurement or contracting. On the other hand, developed countries have adopted other methods like a value-for-money system, which looks at the whole life-cycle cost of a project and at times may justify a higher initial purchase price of a good or service.
In developing countries, the lowest-bidder method works, as the process is simple and transparent and allows anti-corruption groups to keep a check on governments. However, a lowest-cost-based system can create problems such as aggressive bidding in a high-competition environment and also lead to cost pressures on companies, impacting a project’s outcome.
“You will find a lot of potholes on Indian roads. The technical mix used to build these roads is comparable to that in the US or Canada. But our roads develop potholes and theirs don’t. So, while contractors say they will use a certain quality, not many of them comply,” says the infrastructure consultant from Asian Development Bank quoted earlier. “One of the reasons companies cannot meet these technical parameters is because there is a lot of subcontracting involved.”
The bottom line
A value-for-money model will allow awarding agencies to take a holistic view of the project, its contractors, financiers, and end-users, thereby nipping in the bud the factors that delay or make projects unviable.
But until these changes are made, timely execution and quality in public infrastructure will remain a distant dream.
Is ITNL the right choice for such a project? All indications point to a big no.
Last month, Care Ratings downgraded ITNL’s credit rating to BB (with a negative outlook) from A minus, citing the company’s highly leveraged balance sheet and weak cash flow.
Even though the INR5,000 crore project is on an engineering, procurement, and construction (EPC) or cash-contract basis, ITNL will need a significant amount of working capital to fund its execution, which is expected to take seven years to complete due to the tough terrain and harsh weather conditions in the area.“Chances of completing it are at risk, given that it is a long-gestation project. IL&FS’s consolidated debt is rising and not enough revenue is being generated to support the principal or interest payments,” an analyst at a major brokerage says. If things go further south, the government can always retender the project, he adds.
Zojila isn’t an aberration. A bumpy ride is the norm for most infrastructure projects.
The Zojila tunnel mirrors the poor track record of infrastructure-project implementation in the country. The much-talked-about Mumbai Metro line 3, in planning phase since 2009, has taken nearly 10 years to reach the implementation stage. There have also been reports that execution of some sections of the Mumbai-Goa highway has been delayed by over six years due to the contractor’s financial troubles.
As of November 2017, 302 of the total 1,283 infrastructure projects, each worth INR150 crore or above, were running behind schedule, according to the Ministry of Statistics and Programme Implementation. The cost overruns for these projects are to the tune of INR1.45 lakh crore.
Given that the infrastructure sector is among the top five contributors to non-performing assets in the country, it’s about time that the government aligned its policies and gave greater weightage to the debt profile of bidders while awarding crucial public-infrastructure projects. Instead of automatically selecting the lowest bidder, evaluating bidders on a value-for-money basis might make better sense.
Focus on bidders’ financial profiles can help
While infrastructure analysts start raising eyebrows on companies with a debt-to-equity ratio of over 2.5 times, ITNL as of March 2017 has a leverage of 7.4 times, compared with 6.2 times a year ago.
Care Ratings in its July 2018 report says the management of ITNL in the past had given indications about a deleveraging plan either through a stake sale in its special-purpose vehicles or through adequate equity infusion. Either plan is yet to materialise. “Financial profile is very important and it should be the main criteria. For EPC contracts too, a lot of money is invested by the contractor in the form of working capital. Based on the bids, the government should also check if the company is in a position to execute the project and raise the required funding. You have to match the cash flows with the investment,” says an infrastructure-sector consultant with Asian Development Bank.
To be fair, for the Zojila project, the government did debar bidders who had applied for corporate-debt restructuring or strategic-debt restructuring in the last five years.
But it is more of a curative measure rather than a preventive one.
Other than debt, financial qualifications only include some net-worth limits and profitability parameters for bidders to be eligible.
According to the chief financial officer at a Mumbai-based metro-construction company, financial leverage of bidders is not a key requirement for being eligible to bid for and win contracts. He adds that the high leverage of infrastructure companies today is due to a mix of typical government-related issues such as delays owing to land acquisition and clearances and private-sector problems such as aggressive bidding.
“When you have stressed assets, you will never solve a problem by only addressing the numerator; the problem needs to be solved with the denominator as well. The non-performing asset is in the numerator, while the total asset is in the denominator. You need to fix the bad loan, but you also need to grow the denominator,” says Manish Sinha, managing director of commercial data analytics company Dun & Bradstreet.
But he is quick to add, “I am not advocating a ponzi scheme where you collect money today for yesterday’s project and today’s project is completed by collecting money tomorrow, which is what some real-estate and infrastructure companies have done.”
Follow the developed world’s model for fewer potholes
ITNL’s winning bid of INR4,899 crore for the Zojila tunnel project was almost half of the highest bidder’s, according to a news report. EPC projects usually see high competition as there is now requirement of long-term loans and the business is asset-light. The focus is almost always on winning a project by quoting the lowest price.
Manish Agarwal, capital projects and infrastructure leader at consultancy firm PwC India, is of the opinion that L1 — short for lowest bidder — alone should not be the criterion to decide grant of contracts.
“Technical competence, planning, thinking-through of the project, and the strength of the commercial bid should also be taken into account,” says Agarwal. “If a company bids 20% lower than others, the government needs to check if it is doable. Where is that discounted bid coming from? Is it coming from cost savings, efficiencies, or expectation of a lower return on equity?”
Most developing countries rely on the lowest cost technically acceptable (LCTA) model for procurement or contracting. On the other hand, developed countries have adopted other methods like a value-for-money system, which looks at the whole life-cycle cost of a project and at times may justify a higher initial purchase price of a good or service.
In developing countries, the lowest-bidder method works, as the process is simple and transparent and allows anti-corruption groups to keep a check on governments. However, a lowest-cost-based system can create problems such as aggressive bidding in a high-competition environment and also lead to cost pressures on companies, impacting a project’s outcome.
“You will find a lot of potholes on Indian roads. The technical mix used to build these roads is comparable to that in the US or Canada. But our roads develop potholes and theirs don’t. So, while contractors say they will use a certain quality, not many of them comply,” says the infrastructure consultant from Asian Development Bank quoted earlier. “One of the reasons companies cannot meet these technical parameters is because there is a lot of subcontracting involved.”
The bottom line
A value-for-money model will allow awarding agencies to take a holistic view of the project, its contractors, financiers, and end-users, thereby nipping in the bud the factors that delay or make projects unviable.
But until these changes are made, timely execution and quality in public infrastructure will remain a distant dream.
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