Pipavav Shipyard Limited (PSL) is tapping the capital markets with a public issue. The company which is promoted by SKIL and co-promoted by Punj Lloyd is setting up a shipyard in Pipavav in Gujrat. This dockyard which would be complete in the next few months would be India’s largest shipyard. The company has begun commercial production and would deliver its first ship a ‘Panamax vessel in April 2010. The company is currently constructing the first batch of four Panamax vessels to be delivered to M/s Golden Ocean Group Limited.

Project

The project being constructed envisages the building of India’s largest dry dock and amongst the largest in the world. The dimensions of the same are 662 mts long and 65 mts wide. This dry dock can accommodate a VLCC (very large crude carrier) as well. The company has installed/is installing two large Goliath cranes each having a lifting capacity of 600 tons, including fit out berths. Alongside the dry dock, the company has a wet dock which could be used for ship repairing as well. The location of the shipyard is strategically located in Gujrat and ideally situated between Dubai and Singapore.

Ship building at PSL is done by building blocks, then mega blocks and then giga blocks. These blocks are very much similar to playing ‘lego’ when we were kids. Steel is cut, fabricated and then assembled. These blocks are then mounted and fabricated to form a mega block and then a giga block is made. On my visit to the shipyard we were explained that a Panamax vessel which has a 75000 ton DWT, weighs roughly 12000 tons. This ship is constructed in 12 giga blocks of roughly 1000-1200 tons each.

The building facility is effectively a modern state of the art assembling, manufacturing engineering unit having various capabilities. It is this capability that the co-promoter Punj Lloyd would like to exploit going forward. The company has the capability of making off-shore vessels which are used in oil exploration as well as defence related ships for the Indian Navy and coast guard. The company is in the process of completing its assessment of facilities for clearance of pre-requisites before it can bid for such enquiries. 

The shipyard site is an EOU (export oriented unit). The fabrication and block assembly facilities are set up in the company’s SEZ unit which is owned by its subsidiary E Complex with whom the company has a long term lease agreement. The entire shipyard other than the offshore yard would be ready in the next couple of months and the first vessel is to be delivered in April 2009. 

Order Book

The company has a healthy order book of roughly Rs 4500 crs which consists of 22 Panamax vessels from two overseas shipping companies valued at roughly Rs 3900 crs and a notification of award of contract from ONGC of 12 OSV’s for about Rs 550 crs.  Of the order for 22 Panamax vessels, the company is in discussion for 8 of such vessels and is engaged in arbitration for 4 such vessels which means that there is a firm order for 12 vessels and there is discussion/arbitration for 10 vessels. The ONGC order is a fixed price contract which does not allow for any escalation of contract price on any ground whatsoever. It is important to mention that the 22 Panamax vessels were all contracted before 14th August 2007 and are therefore eligible for a 30% subsidy from the government of India.

Ship building is a cyclical industry and is subject to wild fluctuations based on the economic cycle and the oil exploration industry based on the oil prices. There is widespread concern and almost every country wants to secure its energy security and has therefore increased the oil exploration efforts. In India also the success in finding oil in deep exploration blocks in the Krishna Godavari basin and in the Barmer oil fields in Rajasthan has increased the activity in these fields and also the need for more equipment.

The company having the potential and the capability to manufacture would be able to leverage on the expertise of its promoter and co-promoter in obtaining the necessary orders. The company has a technological tie up with M/s SembCorp Marine of Singapore.  

Valuation

The company has commenced commercial production from 1st April 2009 and as such there is no past performance to talk about. Revenue recognition is on completion method basis and there would be some revenue in the current year ending March 2010. With the first ship due for delivery only in April 2010, any meaningful revenue would only accrue in the financial year ending March 2011. With no revenue to talk about, EPS and therefore PE become redundant to talk about when one looks at valuation. The sheer size of the project makes any comparison with listed entities like ABG Shipyard and Bharti Shipyard unrealistic and improper. The government shipyards are un listed and therefore are again not comparable.

A correct and meaningful comparison can only be made once substantial revenue numbers are available and once clarity on a) the under negotiation orders and b) defence orders visibility becomes available. In the absence of any such clarity or visibility, there would always be risks associated with the revenue and also with the execution of the project.   

Promoters and their holding

The promoters of the company are the Gandhi brothers with a stake of 23.1% who have in the past promoted and sold Pipavav Port and the Mumbai SEZ project to the Mukesh Ambani group. Even in the case of PSL the promoters have sold to private equity investors and financial institutions a little over 54% of the pre-ipo equity. They inducted a co-promoter in the form of the Punj Lloyd group who has 22.3% shareholding. Post IPO this holding would get further diluted with the Gandhi brothers having 20.1% and Punj Lloyd having 19.4%.

The company has marquee investors in the form of Trinity Capital, 2iCapital, New York Life, Blackstone Asia Advisors amongst the FII’s and Indian investors in the form of IL&FS, UTI, IDBI and Exim bank amongst others.

The company’s ship building yard which is also a manufacturing, fabricating and assembling unit for various types of plant and machinery, is a state of the art facility and can be used for various end uses. No doubt the plant would be consistently operating and would be able to weather any cyclical downturns which would occur over time. However at the current moment of time the issue looks very expensive based on present conditions and the fact that the first full year of operation would be 2010-2011 and probably it would be only in 2011-2012 that the full potential of the plant/facility is realised

Risks

Expertise in ship-building is limited of the promoters. The company is yet to start delivery of the ships and the first one is expected only in April 2010. Of the total 22 Panamax vessels as many as 12 are under negotiation/arbitration and there could be delay in execution of the same orders. The limited experience in execution and cyclicality of the business could lead to delays. There is every possibility that there would be further issue of equity thus diluting the stake of those entering the company currently as shareholders. 

Conclusion

Considering all the above it appears that the book built price of band of Rs 55-60 is tilted against the investor, and even though there maybe some listing gains considering the small size of the issue of just about Rs 500 crs, I believe it makes sense to avoid the issue. It may make sense to buy the company post listing or when revenues and order book become more visible. Currently markets have also run up quite a bit with the benchmark indices having more than doubled over the last six months.

If however any investment is to be made with a minimum of three years horizon, the same may be done with a clear understanding that if markets correct 15 to 20% in the future this share could be available cheaper than the current price band