GMR's Shattered Dreams

Image: Mallikarjun Katakol for Forbes India

Safdarjung, India’s iconic British-era airfield that is now sadly defunct was the venue of a remarkable meeting one hot day in May. The crème de la crème of India’s passenger aviation business had assembled there to tell the sector’s new regulator how much they think travelers flying in and out of the city should be charged. The Airport Economic Regulatory Authority, or Aera, had a tough question to settle: Who should be made to bear the brunt of a 41 percent cost escalation in the construction of the Capital’s gleaming new international airport — the passengers, the government or the guy who built the airport?

The guy who built the airport — Grandhi Mallikarjun Rao, or GMR —   was chewing his nails off at his office in Bangalore 2,000 kilometres away. The veteran infrastructure entrepreneur was seeing his best-laid plans being blown to smithereens at a pace even he could not keep up with. In a matter of a few months, his world had turned topsy-turvy.

Rao was staring at a hole of Rs. 1,800 crore ($400 million) in his balance sheet for no fault of his. He had built a world-class airport terminal with a capacity of 34 million passengers in a record time of 37 months. Given that planning always lags behind demand growth for infrastructure in India, he had to widen the scope of the project along the way. An exclusive terminal for low-cost carriers, an underpass for easier access from the highway and a few other bells and whistles had made the airport future-proof. Yet, in place of the accolades he had expected, Rao was facing regulatory hurdles and policy flip-flops that could make his business unviable.

At the core of his problems is the shift in the power equation from the civil aviation ministry to the new regulator. Aera is pushing for a tight control on the returns of private airport operators (and consequently on airfare) through a new system of calculating revenues. This passenger-friendly move, however, could temper the rate of return and delay the breakeven at Delhi International Airport Ltd. (DIAL), a subsidiary of the listed GMR Infrastructure.

Even if Rao were to accept a slower journey to breakeven, he has a more urgent problem to solve. As per his calculations, the project cost had risen to Rs. 12,857 crore ($2.86 billion) of which all the equity, debt and government funding could not meet a gap of about 15 percent. He needs to recover that in some form and had proposed he be allowed to charge passengers a development fee for another three-and-a half-years. It is this question that the Safdarjung meeting debated. But no decision came through that day and it is still not clear whether the regulator will allow this unpopular move.

There is more bad news. Aviation is not the only business that is in jeopardy in GMR’s empire. Each of his other ventures — power, roads, special economic zones and even his recent international foray — has gotten into trouble. In most of these cases, the problems have largely to do with the changes in the environment, like regulatory U-turns, irrational competition and that fickle thing called stock market perception.

In the power sector, he is hemmed in by a shortage of gas and uncertainty over fuel linkages. Earlier, Rao lost out on the bids for ultra mega power projects that seriously undermined its plans to be a major player in power. As a way out, he paid a billion dollars for Dutch company Intergen with a capacity of 8,000 MW in five countries. But falling margins quickly turned that acquisition sour.

The roads business, while ostensibly more profitable than airports, has become a cutthroat pursuit. Taken in by the hype surrounding the infrastructure business, rookie entrepreneurs and road contractors are bidding aggressively. They are taking away the projects from more experienced hands. Last year, GMR bid for 24 projects and won only one.

While GMR demonstrated more hunger for new projects than their rivals like GVK, the pressure from investors grew by the day. “It is simply impossible to keep sustaining the hype,” says Vinayak Chatterjee, chairman of Feedback Infra. When short-term excitement ran out in this long-term business, shareholders became upset.

All this has led to a simple equation: Revenues are slow to come, profits uncertain, debt mounting and new investors hard to come by. This is not just the story of GMR but of much of the entire infrastructure sector in India, which after two decades of economic reforms, is still choked by bureaucratic and regulatory bottlenecks.

  Fighter-Survivor
Rao was born in a small town called Rajam in the Srikakulam district of Andhra Pradesh. Before him, the town was known for its jute mills and a temple for Navadurga Mata. The Goddess there has nine manifestations that represent creativity, energy, sacrifice, ambition, charm, radiance, nurturing, aggression and tenacity — qualities that Rao would go on to show in his entrepreneurial career.

The mechanical engineer started out in 1978 with a jute mill and was coasting along as a local satrap until the 1990s. When the economic reforms began, he sensed an opportunity in the infrastructure business. His first choice was power plants. He was one of the early independent power producers caught in the whirlpool of a badly handled reforms process that created more bottlenecks than it removed.

As someone who has launched 28 different businesses over the years, Rao knows a thing or two about tight corners. Very early in his power business, he had a taste of government indecision and learned to fight it. Lenders to his 220 MW barge-mounted power plant at Tanir Bavi near Mangalore held back their financing when the Karnataka government reneged on its commitment to open an escrow account (payment guarantee) for the electricity it would buy. He fought a lengthy court battle to win back the escrow. As a result, that project is the only one in the country to enjoy such a guarantee.

Not only was Rao willing to take on the government when his interests were at stake, he also excelled in his ability to build and nurture relationships. Senior colleagues who have worked with him closely say he is on excellent terms with the heads of banks and financial institutions.

He is often able to do this effortlessly, building relationships in small ways that matter. GMR once rented a house owned by a former governor of the Reserve Bank of India but lying unused. “Surely not illegal, but everyone knew why it was being done,” says an executive.

Rao’s generosity in lending his corporate jets to politicians is also well known. Now that his companies run Delhi and Hyderabad airports, there are even more avenues to keep in touch — special and discreet care at the airports for those who are important for him.

A bulk of Rao’s businesses is in regulated sectors. So being on the right side of the politicians and bureaucracy is also important for him. Over the years, Rao has earned a reputation for being what one rival calls “everybody’s man yet nobody’s man.”

His senior colleagues say he can build a rapport with the cook and remember him the next time even if it is two years later. He is in touch with hundreds of people and can make intelligent calls on politics, especially in his home state Andhra Pradesh.

“He never refuses a phone call,” says Subba Rao, chief financial officer of the GMR group. Over the years, it is this blend of street smartness combined with a lot of tenacity that helped him build assets worth $5 billion from total assets of a mere $11 million in 1999. With a personal net worth of $3.5 billion, G.M. Rao is 18th richest on the Forbes’ list of Indian billionaires.

Doing the Impossible
Many of his earliest businesses were started with friends and classmates — people who he trusted. But this did not always work. One of his most trusted lieutenants at Vysya Bank, Ramesh Gelli, was the cause of a serious crisis in 1994 when he quit and started a rival bank with 180 other staffers. A stunned Rao nevertheless turned his attention to rebuild the team. In due course, his investment in Vysya Bank proved extremely successful. He sold most of his 30 percent stake in it to Dutch Bank ING. (It is another matter that Gelli had an ignominious exit from his new venture, Global Trust Bank, on charges of fraud.)

“Over the years, he has been amazingly lucky about exiting businesses for a profit,” says CFO Subba Rao. GMR once started a brewery and sold it overnight at double the price. He also made a profitable exit from his software business, selling it to outsourcing company iGate.

All his ambition, energy and persistence were tested to the limit in the last four years when he spent most of his waking hours trying to get the Terminal 3 of the Delhi airport functional. When work started in 2007, he was given a target to finish it before the Commonwealth Games in late 2010. Just a little over three years to complete such a complex project? Even the best in the airport business baulked at the thought. Not just larger companies such as Changi Airport Group and Beijing Capital Airport but even the Delhi project’s consultant Mott MacDonald felt the deadline was unrealistic.

The stakes were simply too high for GMR. Winning the Delhi airport project had been a virtual coup for him and he couldn’t afford to fail.

Image: Amit Verma

NO LIGHT AT THE END OF THE TUNNEL The cost of DIAL's T2 Terminal project went up due to facilities such as this underpass

During the bidding in 2005, it had actually been the pair of Anil Ambani group and ASA of Mexico that emerged as the highest financial bidder. GMR with Fraport had been only the second.

However, some in the group of ministers examining the bids weren’t keen on giving Ambani either of the two largest airports in the country that together account for half of the national traffic. Ambani was then perceived as loose cannon of sorts. His political connections with Samajwadi Party chief, Mulayam Singh Yadav, and his spat with his elder brother, Mukesh Ambani, also weighed in.

It is still not clear what transpired but the group of ministers decided to give higher weight to the technical part of the bids where GMR was strong given his partnerships with Malaysian and Frankfurt airports. Rao was allowed to match Ambani’s financial bid. He was also allowed to choose between Delhi and Mumbai airports. He chose Delhi, given its larger size and fewer land problems. (Ambani’s court battle against this award proved futile.)

GMR’s challenge really wasn’t the construction of the 520,000-sq.m. terminal, but getting relevant permissions from countless government departments. “When we got into the project, I did not fully know what I was in for,” recalls Rao. He had a tough time convincing the government of the need for the low-cost terminal and the underpass. Each of these mini projects needed clearances from over 40 departments. In fact, to convince the Cabinet Secretary K.M. Chandrasekhar of the need for the underpass, Rao drove him through the traffic and showed how a jam on the highway could lead to thousands of people missing their flights. He didn’t even hesitate to knock on the doors of Delhi Chief Minister Sheila Dikshit and Prime Minister Manmohan Singh when big decisions needed to be pushed through. All this effort proved fruitful in the end and the terminal was completed in record time.

A Man Cornered
But as the applause dies down, GMR Infrastructure is left with a debt of about Rs. 22,000 crore ($5 billion). A large portion of this was incurred for the Delhi airport project. Ironically, the total cost of this one project is slightly more than the entire net worth of the company at Rs. 12,000 crore ($2.7 billion).

GMR could live with it only if the promised revenue sources from the Delhi airport were not under threat. But the advent of Aera has changed the dynamics of the aviation business almost overnight. Aera Chairman Yashwant Bhave marked out boundaries with advice from the law ministry to make sure his rulings on airport revenues would overrule any agreement signed in the past — even if they were with the government. This simply meant that the government’s promises and GMR’s assumptions in the Delhi airport project were invalid if Aera didn’t agree with them.

Airports get two types of revenues — the air side revenue for services rendered to airlines and the land side revenues from restaurants, shops, parking lots and so on. If both revenue streams are considered together, it will dramatically reduce the airport charges for the passengers but also reduce revenue potential for the airport operator. But if only the airside revenues are considered for determining the charges, the passengers will have to shell out more to compensate the operator for all his investment. The government had promised GMR to keep a large part of landside revenues out of the calculation, meaning he could hope to recover his investment reasonably quickly.

But Aera is now considering putting all revenues in one pot and keeping the charges low for the passenger. Rao says the logic of all his investment has gone for a toss with this volte-face.

Meanwhile, a separate effort to recoup the cost escalation due to extra projects such as the underpass is being actively opposed by the Air Passengers Association of India. In the Safdarjung meeting, the association’s president, D. Sudharkara Reddy, argued that it would be unfair to burden the passengers for the cost overrun. Aera is yet to decide on the matter.

The stock market has sensed the uncertainty and hammered the stock down. GMR Infrastructure’s shares have lost 50 percent of their value in the last one year alone to trade as low as Rs. 34 apiece (a face value of Re. 1). This is a two-thirds loss from the peak of Rs. 1,005 (a face value of Rs. 10) the shares saw in August 2007, at the peak of the market bubble and infrastructure hype.

“The market doesn’t like infra stocks because the companies raised money at very high valuations and now don’t seem to be delivering fast enough,” says analyst Rahul Agarwal of Anand Rathi group. GMR, in particular, is perceived as having high debt and struggling to charge enough user fees from passengers. There is no problem with execution of projects but with the cash flow, he says. “Why on earth should I put my money on these projects when I have hundreds of other options with faster returns?” asks Agarwal.

Infographic: Sameer Pawar

One of GMR’s most scathing critics is stocks commentator S.P. Tulsian. He says the company has been too slow to exploit the assets around the Delhi airport for income. It has got partners for only 45 acres out of the 250 acres available there, he says. “Investors, including PSU banks that invested in the company three years ago, have not been able to make money.”

One could argue that it was the unrealistic expectation of the stock markets that was the problem and not the way GMR or others run their airport projects. Four years ago, when the private sector signed up for such projects, investors typically assigned value to the land parcels that came with the contracts. So these projects were valued largely as real estate developments.

Even though passenger numbers are growing now and the aviation sector is back on its feet, the markets are spooked by the delay in converting the land parcels into revenue streams.

The same irrational exuberance had gripped the power and road sectors too. In power, companies had been valued on the basis of merchant power tariffs. In 2006-07, two years before elections, state electricity boards had been keen to avoid power cuts and had bought power at Rs. 7-Rs. 10 per unit. Industrial users too kept up the demand. The markets gave power companies equity value of Rs. 4 crore per MW of generation capacity. Even projects on paper got astronomical valuations.

Today, merchant tariffs are down to Rs. 3-Rs. 4 per unit. State boards are in a financial mess. As a result, valuations too have fallen. It has become extremely difficult for power companies to raise money.

In roads, profit margins have fallen due to stiff competition. GMR’s first two road projects earned returns of as much as 65 percent but the latest projects yield returns in single digits. “There is likely to be a big shakeout here” that will eliminate inexperienced players spoiling the market with their abysmally low bids, Subba Rao says.

Too Foreign for Comfort
Meanwhile, GMR has had a close shave in his globalisation plans. His power business abroad has not gone as well as its airport contracts in Istanbul and Male. His billion-dollar acquisition of Intergen was supposed to help in expansion but ended up bleeding the group’s finances.

Rao had lost out to the Tatas and Anil Ambani’s group in the bids for the ultra mega power projects.

“We had to build up scale and since there were no more big projects up for bidding in India, we had to look abroad,” Madhu Terdal, GMR group’s president for new and emerging businesses, explains. “The plan was to use it to set up projects in emerging markets as well as India.”

The hard landing for Intergen came within six months of buying the company. The economic slowdown pushed down the so-called spark spreads (the margins that power producers make) and the company’s core profits began to drop. But there was a bigger problem. GMR’s plans to expand Intergen were being blocked by the Ontario Teacher’s Pension Plan fund, which owned the other half of the company. “By early 2010, we had decided to exit,” says Rao. His only caveat to his officials was that the sale should not be a loss. Terdal’s team started scouting for a strategic buyer.

GMR finally sold its 50 percent stake in Intergen this April to the Huaneng group for $1.2 billion making the buyer the second largest power utility in the world. The transaction was at the level of GMR’s group holding company. But the listed GMR Infrastructure had stood guarantee for the borrowings. The sale has freed up cash.

Rao says the Intergen experience had taught him lessons. A 50 percent stake doesn’t make sense. “We will now only get into deals where we have a clear majority or are the operators.”

The group has become more measured in its globalisation effort. “We have set clear hurdle rates to evaluate all opportunities and are much more process-oriented on risk. What I did in the past was largely intuitive but the business is much larger and more complex now and gut feel cannot work,” says Rao.

The experience has also made GMR avoid some of the other big moves that rivals like GVK and Adani are making to secure resources. They are the billion-dollar coal mine-development deals in Australia and elsewhere.

That doesn’t mean Rao has ceased to be a risk-taker. Take his keenness to enter nuclear power, for instance. “We would like to be the first to enter once the government allows it,” he says. It is just that he will now count every rupee he invests in a new project.

AFLOAT GMR's baare-mounted power plant has faced fuel shortage

The Fight-Back
India’s infrastructure dream hasn’t exactly gone sour, but it is clear by now that it is a terribly difficult business to make money especially because the government doesn’t seem to be ready yet. Chatterjee of Feedback points to the lumpy nature of the business. He says GMR is like a boa constrictor that has just swallowed a large animal. It will take a while before the meal is digested and the hunter becomes nimble again.

Rao, on the other hand, is clear about what he needs to do.

First of all, he is not too worried about the stock market’s daily judgement of his business. “Infrastructure is a long-term game and I am not in a hurry,” he says. He and his family own 70 percent of the company and are ready to wait for the market to figure out the nature of its operations.

Neither is Rao in a hurry to sell the land near the Delhi airport. He is waiting for Aera to rule how the proceeds of such a sale would be treated.

With public equity markets turning their back on infrastructure, he has turned to private equity investors. The company has raised $200 million from Macquarie and the State Bank of India in April for the airport business and $300 million from Temasek and Infrastructure Development Finance Corporation for the power business.

Subba Rao says domestic capital available in India is not enough to fund infrastructure. The group is considering an overseas listing for GMR Power, most probably in London.

Secondly, Rao is making sure his company is in fighting form. For a family-run company, one way to do this is to get an independent appraisal of the business. He has set up a five member general performance advisory council, to evaluate the company every year and rate it on a scale of 1 to 10. Planning commission member Arun Maira set up the framework for the council and its scope. Management guru Ram Charan, Rao’s mentor, says he has never seen anything like this elsewhere in the world.

Private equity investors have a much better understanding of the business and have a long-term horizon.  Vikram Limaye, IDFC’s executive director says, “GMR has demonstrated the capability of executing projects. Cash flows for the company will improve once projects that are under development come online.”

One of the priorities is to improve revenues by bagging more airports. With four airports, GMR is already the fifth largest private airport developer in the world. Now it is looking for mid-sized airports for possible acquisitions. Facilities in Indonesia, Cambodia, North Africa and Eastern Europe are being evaluated.

In new projects, GMR seeks to be the hands-on operator and will go without partners even for retail, fuel and cargo operations. “If you leave everything to the partners, you are simply a landlord,” says P. Sripahty, CEO for international airports at GMR.

The other major priority is to maximise cash flow. Rao says he will achieve this by keeping projects at various stages of implementation and operation in his portfolio so that not all are in the same phase.

Apart from airports, Rao is making serious moves towards ports where he sees a big potential. He also has three large special economic zones, each exceeding 2,000 acres. He has been steadily acquiring land over the past four years. The government has rolled back many concessions for such zones and GMR must quickly come up with ways to make money off them.

With Rs. 2,000 crore of cash reserves, the company isn’t in any kind of a financial problem. The Intergen sale has also released funds. This means the company will be able to meet its investment needs.

Rao is also hedging against the worst-case scenario of Aera’s ruling on land side revenues going against its interests. (Aera has roped in PriceWaterhouseCoopers to evaluate the strategy in such an event.) He is also closely looking at the model at the UK’s Heathrow and Gatwick airports that already follow the so-called ‘single-till’ model that he wants to avoid.

Even as he fights these nerve-racking battles, the 61-year-old entrepreneur is giving shape to his legacy. He has passed on the operational responsibility of the airports and international businesses to his sons, Kiran and Raju, respectively. His son-in-law Srinivas Bommidala serves as the chairman of GMR’s urban infrastructure and highways business.

GMR doesn’t think of any of the current problems as threatening his business. This intense investment phase may make the balance sheet look stretched, but there is no other way to build the infrastructure business. And expectations have to match that reality. “We are being seen like real estate or construction companies, not as infrastructure developers,” he complains. “We have a much larger view — 30, 40 years. We can’t run the business on a quarter-to-quarter basis.”  

(Edited by S. Srinivasan)