BGR Energy Systems announced its decision to go public. Issue would be 1000 / 0 book built and the price would be in the bandofRs: 425Rs. 480 per share.
BGR Energy Systems announced its decision to go public. Issue would be 1000 / 0 book built and the price would be in the bandofRs: 425Rs. 480 per share.
BGR Energy Systems announced its decision to go public. Issue would be 1000 / 0 book built and the price would be in the bandofRs: 425Rs. 480 per share.
"= This case was prepared by Vishwanath S.R. of Institute of Management Technology, Nagpur.276 Cases in Corporate Finance
INTRODUCTION
In December 2007, BGR Energy Systems announced its decision to go public, Under the plan, the
company would offer 8,636,000 shares to the public and 500;000 shares to employees, The
maximum subscription amount for retail investors would be Rs. 100,000, The issue would be 100%
book built and the price would be in the band of Rs: 425-Rs. 480 per share. Upon completion of the
issue the company would get listed on the National Stock Exchange and’Bombay Stock Exchange, The
company appointed SBI Capital Markets, Kotak Mahindra Capital, UBS Securities India and CLSA
India as lead managets to the issue.
In book building, a syndicate of investment banks brings an issuer's equity to the market. One of
the investment banks acts as arranger with the rest of the members acting as underwriters, The
atranger gives notice of a possible price range. The underwriters sell equity on.a best efforts basis,
Orders for equity over the stated price range are collected by underwriters and returned to the
arranger. Thus, book building assesses not only price, but also volume at each price level. The
arranger has the final responsibility of setting the actual price at which equity will be issued and its
allocation to investors. The price, thus, reflects ‘market demand. The issue has two components—
placement portion and public portion. The placement portion is targeted at institutional investors
like Mutual funds. The book runner drafts the preliminary prospectus and files the prospectus with
the concerned authority (SEBI) for approval. The preliminary prospectus does not contain the issue
price. On obtaining the autliority’s approval, the book runner circulates'the preliminary prospectus
with intermediaries like merchant banks and brokers inviting them to join the syndicate. The revised
version of the prospectus indicates the price range. The intermediaries, in turn, circulate the
prospectus among their clients and place one order for the total quantity on behalf of all clients, The
book runner ‘builds the book’, records information like name of the intermediary, number and price
at which the buyer is willing to buy etc. The book is kept open till the issue gets enough orders, The
book runner then, in consultation with the issuer, prices, the issue, decides on the amount of
underwriting and allocation of securities. The final prospectus is filed with the concerned authority
(SEBI). The issuer advertises the prospectus announcement in the newspaper the next day. The issue
opens 10 days after the announcement and is kept open for three days. Syndicate members send their
completed application. Allotment is made partly on a firm basis and partly on the basis of public
subscription. If the public portion is undersubscribed, the syndicate members will receive allotment
in the public portion also, Likewise, if the issue is over subscribed, the syndicate member gets a
refund. Securities are allotted and listed on stock exchanges for trading purposes.
The issue of 91.36 lakh equity shares was aimed at raising Rs. 388.3-Rs, 438.5 crore (depending
on the price band of Rs. 425-480 per share). The energy equipment business is working capital
intensive and requires significant amount of working capital. The company availed a major portion of
working capital in the ordinary course of business from its banks as loans. At the time of the issue,
the company had received sanction of aggregate fund based limits of Rs. 5,590 million and non-fund
based limits of Rs. 8,020 million. As per the lending practice of banks, BGR was required to bring in
part of the working capital out of net owned funds. Net owned funds are required is to be provided
by shareholders by way of share capital, share premium and reserves and surplus.Case 16: BGR Energy Systems” Initial Public Offering 277
The objectives of the issue were to augment long-term working capital requirement, expand the
production capacity by establishing additional manufacturing facilities in the Mundra special
economic zone in Gujarat, China and Bahrain in the Middle East, and to fund corporate expenditure.
The plants to manufacture finned tubes in China and Bahrain were expected to offer proximity to
customers in that region. The details of the utilisation of issue proceeds are provided in Table: A.
eager err) ere)
amount to Petit?
Prien) Pies
Roun etsy
Ped
Es rr)
The issue. consisted of a fresh issue of 4,320,000 equity shares and an. offer of sale of 4,816,000
equity share by the promoters. The.company entered into an agreement with Citigroup. Venture
Capital, and Reliance Capital for subsctiption/purchase of 4,320,000. shares (placement of 2,880,000
shares and transfer by promoter of 1,440,000 shares), Pursuant to the above, the company, planned to
raise between Rs. 122.4-Rs, 129.6 crore. The shareholding pattern before and after the issue are
shown in Table B.
eo278 Cases in Corporate Finance
BGR ENERGY SYSTEMS!
The company was originally incorporated in 1985 as a joint venture between GEA Energietechnik
GmbH, Germany and the promotes, Raghupathy, co produce and sell on-line condenser tube cleaning
systems, debris filters, and rubber cleaning balls used in Thermal and nuclear power plants. In 1993
Raghupathy and his family members became the sole sharcholders of the company and began to
expand the range of product and services in the power and oil and gas industries. The company was
renamed BGR Energy Systems in 2007. Exhibits I chrough 4 present the financial statements and key
ratios for BGR. .
industry Background . .
Power The International Energy Agency estimates that more that $16 trillion or $550 b a year needs
to be invested in energy supply infrastructire worldwide over the three decades to 2030, ani amount
‘equal to 19% of projected gross domestic product. The average annual rate of investment is projected
to rise from $455 b in the decade 2001-10 to $632'b in the decade 2021-30,
According to CRIS INFAC, over the next five years, Indian investment in generation capacity is
expected to increase, with the central sector accounting for the largest share of such increase, Thus,
based on the above expansion, the construction investment is expected to be approximately Rs, 450
billion from 2005-06 to 2009-10. CRIS INFAC expects the impact of generation delicensing in the
Electricity Act will be felt largely in the period ftom 2002-12, given the minimum three year
construction period for Greenfield power projects.
‘The Indian government has an objective of achieving “Power for all by 2012”, The development of
the power sector traditionally has been the responsibility of the government through the central and
state utilities, with a relatively insignificant contribution by the private sector. In order to seduce the
gap between demand and supply, the Indian government formulated policies in 1991 for increasing
the role of the private sector in power sector.
On the other side, the dependence on captive power has been increasing, due to the continuing
shortage of power generation and India's economic growth. Currently, captive power capacity
accounts for 16% (19,103 MW), of total installed capacity in India in 2004-05. The Electricity Act
Provides imputes to captive generators by exempting them from license requirements, This results in
an increase in captive power capacity addition by industrial units. Reliability of power supply and
better economics are other factors pushitig industries to opt for captive generations,
On an average, the cost of setting up a 1 MW plant in the private sector is assumed to be Rs: 40-50 mh,
for coal-based plants, Rs. 25-40 mn. for gas/naphtha based plants and Rs. 45-60 mn, for
hydroelectric plants.
Oil and Gas Demand for engincering construction services in the oil and gas is dependent on the
level of exploration, production, storage, refining and transportation activity in the ofl and ges
1. This description is from the details available on the company’s website,Case 16: BGR Energy Systems’ Initial Public Offering 279
industry and the corresponding capital spending by energy industry conglomerates. ‘The oil and gas
sector has been one of the key industry focus areas of the engineering, procurement and construction
industry. The IEA has estimated that India will receive investments in the energy industry of
approximately US$ 900 bn. over the next 25 years. Further there will also be investment from the
private players like Reliance and Craine Industries.
BGR’S BUSINESSES AND COMPETITION
The company operates in two main segments:
The company carries out business in two segments: supply of systems and equipment and turnkey
engineering project gontractfhg. In the systems and equipment business, the company designs,
manufactures, sells and services a range of systems and equipment for power, oil and gas, refinery,
petrochemical and process industries. In the turnkey engineering project contracting business, the
company carties out engineering, manufacturing, procurement, construction and commissioning of
projects in power and oil and gas sector.
The company currently executes turnkey contracts to supply balance of plant (BOP) equipment,
services and civil work for power generation projects. It supplies all equipment barring boilers,
turbines and generators. Having completed various BOP contracts, the company has now changed its
focus to engineering, procurement and construction (EPC) contracting, in which BGR designs,
engineets and supplies all the equipment needed in the power plant. The company has also an
inftastructute business intended to provide construction services and technology.
BOP is the weakest link in Indian Power Equipment space as there are very few companies in the
field. Typically, the BOP package accounts for 40% of the power plant cost and power producer
manufactures about 40% of the BOP equipment in-house, giving BOP suppliers an edge, Order
inflow for the industry continues to be strong as the power sector continues to attract investment as
well as due to no let down in capacity building in the manufacturing sector.
BGR’s business is divided into seven key areas.
Power Plant Business
BGR boasts itself to be one of the first companies to develop the BOP concept in India. It provides
services for both gas and coal-fired plants. The company manufactures approximately 40-50% of the
materials included in BOP, in-house, while the rest of the materials are sourced from outside. After
successfully executing a number of BOP contracts, the company has started taking up EPC contracts
now. Till date, the power plant division has completed three projects and is currently executing four
other.
Key competitors in this segment include Bharat Heavy Electricals Ltd (BHEL), Larsen and Toubro
(L&T), Tata Projects, Punj Lloyd Ltd and Reliance Energy.280. Cases in Corporate Finance
Captive Power Business
Established in 2006, the captive power business provides services to standalone power plants and
Public utility projects in India. The division executes projects ranging from 25-150 megawatt (MW)
and is currently working on two projects,
Key competitors in this segment include Cethar Vessels Pvt Ltd (CVL), Tata Projects, Indure Ltd,
L&T and Greenesol Power System Pyt Ltd for projects under 50 MW and L&T. BHEL, Thermax,
and Tata Projects for projects over 50 MW.
Oil and Gas Equipment Business
Started?in 2001, the oil and gas equipment business provides Fange of services mainly those needed to
unspent oil or gas between well-head and end users. Manufacturing activities for this businces are
carried out by the subsidiary Progen. Customers include industries focused on oil snd gas fields,
cross country pipelines, refineries, petrochemicals and power plants
Key domestic compertors include Gastech Process Enginceting India Led and Multter Filtration
Engineering Led. And foreign competitors include Equinox Hydrocarbon Processing Facilities
(Canada), Kar group, Kurdistan and Petral Resources from Fran
Air Fin Cooler Business
The Air Fin Cooler business designs, manufactures and markets air-cooled heat exchangers, air-
cooled radiators and finned tubes used in oil and gas, power, process and petrochemical industries.
The manufacturing facility is located in Panjetty near Chennai. For 18 months ended March 31,
2007, the Air Fin Cooler division clocked a revenue of Rs. 96.9 crore.
Key domestic competicors in this segment include Paharput Cooling ‘Towers and GEI Industrial
Systems and international competitors include Samyoung Science sed Technology, Korea Heat
Exchangers Industries Ltd, FBM Hudson and GEA Battignolles Techniques Termiques
Environmental Engineering Business
The environmental engineering business supplies a range of products and services to customers
across India and abroad. Originally started to provide de-aerators domestically, the company has now
diversified into water treatment, demineralisation plants for power projects, effluent treatment and
recycling and reverse osmosis-based desalination plants. The company claims to have manufactured
the largest de-aerator in India for Nuclear Power Corporation facility at Tarapur with a capacity of
3.103 tonne per hour.
Key competitors in this segment include BHEL, L8T, Thetmax, Allied Energy Systems Pvt Ltd,
VATech Wabag, Ion Exchange LedCase 16: BGR Energy Systems’ Initial Public Offering 281
Electrical Power Business
Started in 2003, the Electrical power business works in conjunction with other businesses of the
company by supplying electrical systems and equipment for power stations, refineries and
petrochemical operations. This line of business undertakes turnkey contracts to set up transmission
and distribution networks, gas insulated substations, switchgears and other electrical projects.
Key competitors in this segment include ABB Ltd, L&T, Crompton Greaves, Areva T&D,
Siemens and IVRCL.
Infrastructure Business
‘The Infrastructure business was set up to address growing demand for products and services for the
construction of roads, ports and airports. The company claims to be capable of providing advanced
technology for complex infrastructure ‘projects. The focus here is on built-operate-transfer (BOT)
projects in India, tunneling, BOT and specialised construction projects related to airports and
seaports, and multi-level parking in metro cities.
Key competitors in this segment include L&T, IVRCL, Gammon India and Reliance.
‘To strengthen its position among competitors, BGR has entered into alliances for its different
business segments. For instance, ic has formed global marketing agreements with Samsung (for air-fin
coolers); Termomeccanica Ecologia, Italy, for environmental engineering; SK Engineering and
Construction, Korea, to jointly explore opportunities in the domestic market for infrastructure
projects; and Ariel Corporation for oi! and gas equipment.
The break-up of revenues from different businesses is given in Exhibit 5. At the time of the issue,
BGR had an order book of Rs, 3321.2 crore from all its businesses, Exhibit 6 provides a summary of
financial information for some of the major peet companies and BGR.
PREPARING TO GO PUBLIC
The process of preparing the company to go public is time consuming, BGR had hoped to take the
company public in order to build the brand and raise additional capital. The senior management at
BGR was aware that the IPO would be the first day of its public life and believed that it was very
important to meet the company’s responsibilities to its new shareholders and for life in the public
spot light. The company’s executives spent several months preparing the company to take it public,
developing the infrastructure and systems that would enable it to meet the demands placed on public
companies. While the IPO brought additional capital, a stock market listing entailed costs like
investment bankers fees, stock exchange listing fees, IPO grading fee” and so on. The issue expenses
could be as high as 6% of net proceeds. In addition to the explicit cost of going public, there is also
an implicit cost in going public- public issues often list at a price much higher than the issue price, a
2. In 2007, the Securities Exchange Board of India made it mandatory that all IPOs must get a grading from
‘one of the eredie rating agencies like Crisil, ICRA, CARE and Fitch. The grading is on a 5 point scale with 1
idicating poor fundamentals and 5 indicating strong fundamentals. The cost of grading works out to
Rs, 500,000 and takes about 3-4 weeks.282 Cases in Corporate Finance
Phenomenon called IPO underpricing. In the eatly 90s an average IPO produced 35.3% returns upon
listing?
Market Conditions
Apart from the costs of going public, other issues included possibility of poor response from
investors and the issue getting listed below the issue price. Companies like Wockhardt and Emaar
MGEF had to cancel their IPO due to poor market conditions and companies like Reliance Power had
seen their issue open at a discount of 35% in the recent past.
After a big initial public offering season in 2006, some 150 companies were expected to raise up
fo $10 billion in new listings in 2007. A combination of near double-digit economic growth, a
roaring bull market, and expansion-minded executives had set the stage for another year of high-
volume initial public offering activity in India. And this year could be a record-buster, felt the market
watchers.
One reason was the Bombay Stock Exchange’ benchmark Sensex Index, which delivered neatly
50% return in 2006, was up about 2.2% by January 2007. More than 30 companies had already filed
ot received approval from the Securities and Exchange Board of India to raise $6.3 billion in early
2007.
About 80 companies raised $5.4-billion in 2006. And some investors were rewarded handsomely,
Particularly with companies in high-growth sectors. Energy transportation company, Gujarat State
Petronet, which operates the second-largest pipeline in India, raised $84 million in its ICO in
February 2006 and shares jumped 75% during its first day of trading, IT Service firm Tech Mahindra
was another winner. Its shares more than doubled to 743 rupees ($16.84) since its IPO in August
2006.
Even so, investing in India IPOs overall has been a risky affait. About 50% of the Class of 2006
initial offerings was trading at break-even or below their listed price in 2007. One of the real
disappointments in 2006 was Jet Airways, India’s biggest domestic airliner. It launched trading a year
back just as oil prices started their ascent to record levels by mid-year and budget carriers started to
pressure margins. Jer’s share price is off 30% to 763.95 rupees ($17.32) from its initial trading price
back in February, 2005. No-frlls cartier Air Deccan, which also debuted a year back, has fared
better and now trades at $3.40 per share vs. a listing price of $2.20.
Exhibit 7 presents a list of IPOs in 2007.
Preparing the Prospectus
Having selected lead managers, the company’s officials turned their attention to the preparation of
the prospectus. The Securities Exchange Board of India (Act) requires all companies to prepare a
Prospectus for distribution of securities to investors. The contents of the prospectus and
3+ Loughran, Tim, Jay Ritter and Kristian Rydqvist, “Initial Public Offerings: International Insights", Pacifi
Basin Journal, Vol 2, June 1994.Case 16: BGR Energy Systems’ Initial Public Offering 283
supplemental financial information are governed by the SEBI regulations. The prospectus is an
important document. The company and its management team are liable for information provided in
the prospectus and for omission of any material information. The company’s investment banker
drafts the prospectus after conducting due diligence investigation of the firm in consultation with the
accountant and the legal counsel. The prospectus gives the details of the company’s business and
management, names of principal shareholders and their level of ownership, audited financial
statements, underwriting agreement, information on the use of proceeds, dividend policy and
capitalisation, A discussion of management's perception of all risk factors and competitive position is
also included, The company has'to file the draft prospectus with SEBI through a merchant banker.
Aftei the preparation of prospectus, the merchant banker along with the due diligence certificates
and other compliances sends the same to SEBI for vetting. On receiving the same, the Board
scrutinises it and may,suggest changes *ithin 21 days of receipt of prospectus. A company can come
our with a public issue any time within 365 days from the date of the letter from SEBI, or if no letter
is received from SEBI, within 365 days from the dace of expiry of 21 days of submission of
prospectus with SEBI. If the issue size is up to Rs. 20 crores, then the merchant bankers are required
to file prospectus with the regional office of SEBI falling under the jurisdiction in which registered
office of the company is situated. If the issue size is more than Rs. 20 crore, merchant bankers are
required to file prospectus at SEBI, Mumbai office. A prospectus is also filed with the concerned
stock exchanges along wich the application for listing its securities. After making changes, if any,
made by SEBI/Stock Exchanges, the final Prospectus duly signed by all the Directors (or by
Authorised Representatives’ through its Power of Attorney) must be filed with the Registrar of
Companies (ROC) along with the copy of all material documents. The ROC may suggest changes
which should also be reported to SEBI / Stock Exchanges. The date on which ROC Card is obtained.
is the date of the prospectus. The draft offer document filed with the SEBI shall be made public for a
period of 21 days from the date of filing the offer document with the SEBI. Once the registration
statement is approved by the SEBI, the marketing of the offering begins.
After the preparation of the prospectus, the company sets out on a road show to address potential
investors, A typical road show lasts 3-4 weeks. A timeline diagram of the IPO process is given in
Exhibit 8. Once the stock is listed, the underwriter has the obligation to stabilise the price and
provide analyst recommendations.
Pricing and Valuation
Finally, the company had to make sure the issue price was right. If the price were to be low, the issue
would be hopelessly oversubscribed whereas if the price were to be high there was a possibility that
the stock would list at below the issue price.
In determining the initial public offering price, the factors that would be considered are the
prevailing market and general economic condition, the history of and prospects for the company and
industry, an assessment of the company’s management and its operating results and the market prices
of securities and certain financial and operating information as they relate to market valuations of
companies engaged in activities similar to those of the company. The company could either perform
a discounted cash flow valuation or compare the valuation multiples with those of the peer group
companies. The DCF approach involved forecasting of cash flows to equity and estimation of
appropriate discount rate to discount cash flows. The value of equity thus arrived, is divided by the284 Cases in Corporate Finance
umber of shares outstanding to atrive at the intrinsic value, Exhibit 9 presents the free cash flow to
equity in 2007.
Under the relacive valuation, the objective was to find out if BGR was under or over valued relative
12 beer companies. Credit Rating agency, ICRA assigned a grading of 3 to the BGR IPO suggesting
javerage fundamentals” and four brokerage houses- Asic C Mehta Investments, Sharekhan, Manele
Investments, and Jaypee Capital Services gave a “subscribe” recommendation,
ighteen months “Three monthsCase 16: BGR Energy Systems’ initial Public Offering 285
| Bhibit? EAC)
Particulars —
Source: Analyst reports,286 Cases in Corporate Finance
Source: Company, analyst reports.
1 = Power Projects Business
2 = Captive Power Business
3 = Oil and Gas equipment
4 = Air fin coolers business
ee
ource: Analyst reports,
-Case 16: BGR Energy Systems’ Initial Public Offering 287
id Industry P/E Multiple
Ti een ena eeuses288. Cases in Corporate Finance
(Exhibit 8 Contd.)
y No. No.of Days
Fling Fm 2 ih OGCase 16: BGR Energy Systems’ Initial Public Offering 289
) Kee ceed Reo med
References
1, Mehta, Chintan, “BGR Energy Systems IPO Note”, Asit C. Mehta Investment Intermediates Ltd.,
December 4, 2007
2. BGR Energy Systems IPO Flash, Sharekhan, December 3, 2007
3. BGR Energy Systems Lid.: Power play, Mansulth Investment and Trading Solutions
4, BGR Energy Systems, Jaypee Capital Services