Many construction firms, working on infrastructure projects on a Build-Operate-Transfer (BOT) basis, may reboot their business model to raise capital to fund future business growth.

Staggered cash flows coupled with sudden spike in interest rates and cost of raw materials have dimmed the lure these projects had in earlier years.

"Construction firms are looking at hiving off these projects into holding units and sell stakes in them to recycle blocked capital," said Manikkan Sangameswaram, managing director (India), Babcock & Brown, an investment bank.

Gayatri Projects Ltd, with five BOT projects on its books, transferred those investments to a unit, in which it sold about 30 per cent stake to Australia's AMP

Madhucon Projects transferred its infrastructure projects, along with four BOT road projects, to a separate unit.

Last year, Nagarjuna Construction issued equity shares and warrants to units of Blackstone Group, raising about $150 million to funds its BOT and other projects.

This trend could gather momentum if more contracts are awarded in the next six months as construction firms cannot raise equity capital at current valuations, he said.

"Equity dilution is a permanent damage that you do," said Ashutosh Maheshvari, chief executive officer of, Motilal Oswal Investment Advisors.

UNVIABLE IRRs

Firms, which bid for BOT projects from 2003 onwards, gained from low interest rates and a nine per cent GDP expansion. There was often a six points spread between the cost of funds and the internal rate of return (IRR) they had bid at.

"Firms started falling over themselves to win such projects and had cut down the IRR. By 2007, it had become messy, as firms were quoting off-the-cuff rates," said Hindustan Construction Co's (HCC) Chief Financial Officer Praveen Sood.

On a 8-9 per cent interest rate, firms were quoting IRRs of 11-12 per cent, leading to wafer-thin margins. However, with rising interest rates and higher raw material prices, these companies have been caught in a bind.

"There is no point in borrowing and investing to get return of 12 per cent when your own cost is 13 per cent," Sood said.

"Whatever BOT projects we are bidding for, will be keeping in mind the interest rates and inflation," said Gayatri's Vice-President (finance), K.G. Naidu.

With the prevailing interest rate regime, companies are looking at IRRs of 16-20 per cent on their equity, Naidu said. HCC, which is working on two BOT projects, is looking at an IRR of about 17 per cent, Sood said.

These firms are also including price escalation clauses into engineering, procurement and construction contracts. Gayatri would take a hit of about 50-100 basis points on its operating margins on BOT projects due to cost pressures, Naidu said.