Financing a Sea Link

Introduction

The rapid urbanization and increased commercial and industrial activities in metropolitan cities in India has led to increased demand for infrastructure that can cater to growing transportation demand.  Mumbai, being the financial capital of the country, has observed this trend. The approximate population of 18.5 million, along with increase in migrated population in the last decade, which according to census report constitutes 15.1% of the total population of Mumbai has further contributed to the growing demand for transportation infrastructure.

The recently finished Bandra-Worli Sea Link was constructed with the intention of satisfying some of the demand for alternative routes in densely populated region of Mumbai with high commercial activity. A similar project that connects the traffic from Versova to Bandra through the sea is estimated yield similar benefits as the existing sea link. The starting point for the sea link will be Versova Road and the ending point will be Naushad Ali Road.

The infrastructure project like Bandra-Worli Sea Link that provides alternative routes for road transportation can significantly save travel time with increased speed and reduced possibility of road congestion. With estimated annual traffic estimated to exceed 3.4 crore, such projects can help minimize economic losses in terms of productivity time and vehicle operating cost. Other benefits of such projects can be that they help minimize accidents and road rage incidents and air and noise pollution.

The proposed Versova-Bandra sea link project may raise some environmental and social concerns like in the case of Bandra-Worli Sea Link. Some of these concerns include the destruction of flora and fauna in the vicinity of the area covered by the project and compromising the livelihood of the fisherman working in the area. These concerns can be adequately addressed by taking special measures in the design phase of the project and providing alternative avenues of livelihood to the population which has been affected by the project.

The design and construction activities of the project is planned to be carried out by a Special Purpose Vehicle (SPV) created by the major construction companies like Larsen and Toubro, Reliance Infrastructure, Hindustan Construction Company and the government body responsible for infrastructure, namely, MMRDA. All the parent entities will contribute to the capital of the SPV in the form of equity. This equity along with the debt will finance all the activities undertaken in the project. The construction cost of the Versova-Bandra Sea Link has been estimated to be 7500 crores and the operating cost comes out to be 1% of the construction cost.

The project is planned to utilize the state of the art technology for construction activities, traffic monitoring system and toll collection system. The final structure will create value for the consumers, that is, the general population, in terms of convenience and time savings in commuting.

Estimation of Beta

For calculating β of the project, we break it down to its components:-

βAsset = βsales + βOperating Leverage + βFinancing Leverage

Consistent with the nature of the project :-

• βsales = 0. The reason for this is that we do not foresee any unexpected changes in revenues due to traffic scenarios (steady traffic increase over the years, with composition of traffic largely remaining constant). Furthermore, we do not anticipate any parallel project which can share the traffic over this route, in near future.
• βOperating Leverage = 0. Although operating leverage should be very high, due to the nature of operating and construction costs, largely being Fixed Costs (not varying with traffic), but due to βsales being negligible.
• βFinancing Leverage = High (D/E ratio = 3 to 5). Due to high capital expenditure involved in initial years, coupled with steady long term revenues, the nature of project makes it conductive for a high debt laden capital structure.

Asset Beta is estimated from AMP Capital Global’s research report (Exhibit 1), wherein βAsset from toll roads is given as 0.45 (low) to 0.55(high). Taking an average, we get a figure of 0.50.

Estimation of WACC (Weighted Average cost of capital) – Exhibit 2

From this we calculate βUnlevered and βLevered, and then the Cost of Equity (ke) = 19.76%

Then from Cash flows, we calculate NPV, IRR, and Payback for the project.

Debt%-NPV data (Exhibit 4)

Market value of the levered project

Market value of the levered project has the following components: -

1. Value of unlevered project

Market value of unlevered firm = NPV of Cash Flows (including a perpetuity of PV/ke)

1. PV of Tax shield

Present value of tax shield = (Tc x D); where Tc = Corporate tax rate = 35%; D = Amount borrowed

1. PV of cost of Financial Distress

This includes the PV of expenses that may be incurred in the future scenario of a bankruptcy, and includes legal fee, financial distress in the form of customer loss, supplier loss, brand equity and credibility loss. Since the financial leverage of the project is substantial (D/E=3.37), ‘the intention for filing bankruptcy at the end of creditors would be quite less, as they would like to overlook defaults in the hope of nursing the project in a difficult period.’^[1] However the project involves a tangible asset, in the form of a motorable road, costs of bankruptcy are limited to legal expenses borne during the process. As a ballpark estimate, we take it as 0.5% of the NPV of unlevered project.