Road developers race towards annuity deals

It’s my way or the highway. That seems to be the attitude with which the highway developers are pitching for the national highway projects.

In four recent instances, highway developers have bagged projects quoting about 10% lower annuity than expected by the government, even if it means taking a hit in their returns.

As against a total annuity outgo of Rs328 crore expected by the public-private partnership appraisal committee of the finance ministry in five recent projects, with project cost totalling Rs3,168.37 crore, the annuity demand the government actually received was Rs266.75 crore for four projects. One project hasn’t yet been awarded (see table).

Such aggressive bidding in annuity projects exemplifies the appetite for highway infrastructure creation in the private sector.

“The kind of annuity quotes that the bidders have placed highlights the urgency with which they want to grab the projects. They do not even mind getting a lower rate of return from the project,” a senior National Highways Authority of India (NHAI) official said.

Indeed, the low annuity demand in case of the five projects is likely to bring down the internal rate of return for developers to 10-11% compared with a normal 16-17%.

In a project based on annuity model of highway development, the developer earns his returns from the project in the form of semi-annual payments, or annuity, from the government, and does not have tolling revenue rights. The government retains the tolling revenues. Annuity model is suitable for the rural/far-flung areas that lack traffic.

S Vaikunthanathan, director, finance, Madhucon Projects, said the bidding for annuity projects is not as aggressive as in the case of toll projects.

“In annuity, your topline is fixed. You can just look at utilising your resources better.”

He added that other than 2-3 projects in South India, annuity projects have not seen bids that are out of the ordinary. “The differences in annuity bids are marginal,” he said.

To bag the Barasat-Krishnagar project in West Bengal, the consortium consisting of Madhucon quoted a semi-annual annuity of Rs73.98 crore whereas the NHAI had estimated it to be Rs83.55 crore. That is an annual difference of Rs18.6 crore. The figure is much higher when taken for the entire concession period of the project. Madhucon has seven road assets.

Ranen Banerjee, executive director, PwC India, said the Planning Commission prescribes a rate of return for a project but the way it is financed can change that. “Usually, the debt-equity ratio is assumed to be 70:30 but if the developer goes for a higher debt say 90:10, the average cost of capital comes down,” he added.
Asked about other factors behind the varying bids, Banerjee said there could be various reasons like idle capacity and credential building.

Industry experts, however, feel the competitive bidding in toll and annuity forms of highway development is a short-term phenomenon. “The flurry of activities from the government side in the sector explains this. Also, there is less work going on in other sectors. However, once the builders have some projects with them, the trend may stop,” said M Murali, director general, National Highway Builders Federation.

Even for build, operate and transfer (toll) projects, where the risk is borne by developer as it earns returns through toll revenues, more and more regional players are coming up. Banking on their strengths as local players, like knowledge related to procurement, they are quoting relatively low.

For example, Keti constructions, a local player, offered Rs3.5 crore premium for the Rs550 crore Kota-Jhalawar project, in which NHAI expected a 43% viability gap funding demand.