Indian EPC 2011: Driving growth efficiently

V Sushi Shyamal analyses how the EPC sector has evolved into the most lucrative contracting activity in India.

As with all ideas that promise (relative) speed, simplicity and quality, Engineering, Procurement and Construction (EPC) has caught on quickly.The order books of the over 150 players in the arena are bulging, and there is increased interest in this sector from experienced foreign players who have made their India foray, new to the sector Indian conglomerates as well as pan-Indian infrastructure developers.

The sector is not without its bottlenecks.Contractors are feeling an increasing need to concentrate on core competencies, indeed, proper project selection is seen as key and being prudent with pretender risks; and tender offer risks is now seen as wise, not conservative. Also given a weakening global economy there is a growing focus on increasing margins and profitability and making most of the existing projects. Thirdly (and inherent to an EPC contract), there is the risk of executing projects on time and within the budget. And lastly, India is sadd­led with a resource crunch that grips this sector too. There are the obdurate, fundamental woes of scarcity of skilled labour, shortage of finance, unavailability of raw material and inadequate access to advanced technology and equipment. These challenges sometimes tend to pin­ch on quality, timely delivery and cost fronts.

Due to its many advantages, the EPC model today is well-defined, though multifariously structured. This som­ewhat simplistic structure provides a good idea:

Such a structure, however, makes clear allocation of responsibilities an imperative. As all the risks are borne by the contractor, blurred boundaries could have serious legal and project management repercussions. One such detailing of roles and responsibilities is in Table 1.

The Pie Is Meaty
The EPC market opportunity is still largely inter­dependent on the fortunes of the infrastructure sector. And this is where the going is smooth: as the graphic displays, huge investments are planned by the Planning Commission in the next plan alone. The investments are spread across the board: ports, railways, roads and bridges, irrigation, power, water supply and sanitation are all expected to see high inves­tments. With con­struction intensities of above 50 percent, this indicates a construction oppo­rtunity of Rs 16 trillion.

The Growth Engine Spurs On : Insights on New Trends And Techniques
The industry has managed to take the various chall­enges in its stride, for over the past years an evolution has occurred, both in the external shape and form of the companies as well as in their internal operations and structure. New, evolutionary, results focused, profits driven techniques in project management and strategic thinking have thus arisen. Some trends and techniques are discussed herein.

Project diversity gaining popularity: As globalisa­tion gain popularity, companies are embarking on geo­graphical diversification to mitigate political insta­bility and com­petitive pressures. Many large contractors have expanded their operations to the Middle East in a sign of broadening horizons. More interestingly, however, is the fact that major firms are increasingly being drawn to new sectors in a bid to broaden the revenue base. Almost 75 percent of contractors have ventured into the highway devel­op­ment business as means for forward integration. However, it must be borne in mind that new sectors must be entered only when there is sufficient sector expertise in the firm to bid and execute the projects.

The role of EPC contractor evolves: Construction companies have been adopting strategies ranging from inorganic growth through strategic tie-ups to in house startups in an effort to play a greater role within the construction space. They have also been forming JVs and alliances with project management companies to handle complex projects and enter the arena of EPCM (EPC and Management). The morphosis is driven by ris­ing competition, increasing complexities of projects, demand for technical expertise, stringent selection crit­erion for bidding including  tender offer eligibility norms, and cost and time constraints.

The pace of evolution can also be seen from the fact that Tecpro, TRF and McNally Bharat who used to execute only Coal handling plants (CHPs) and Ash han­dling plants (AHPs) have entered the EPC segment to gain scale and tap massive opportunities in Balance of plants (BoP) segment in power projects. Almost all cont­ractors have entered into the asset development business to generate in-house captive contracts. But with dynamic roles come the responsibility of arms length execution.

Increasing interest in India, Indian firms going global: While a number of Indian majors have struck international deals/ bid for projects around the globe, what is of great interest is also that many foreign comp­anies are beginning to take more than mere active inte­rest in the Indian market. Some of the key movements have been captured in the table below:

Rising M&A, JV and PE investments: opportunities abound: To achieve scale in recent past M&A activity is witnessed amongst EPC players and to accomplish fun­ding requirement, where the public sector has been reluctant to provide for, private players have stepped in. Many of them appear to have done so gleefully: in the PE sector alone, between FY 07 and FY 11, deals worth Rs 74 bn were announced, while an estimated equal amount being unannounced. The below tables act as a tab­leau to an increasingly rich scenery in the PE and M&A (JV) spaces respectively.

Technical Partnerships Gain Ground
In meeting tender qualification requirements and to develop the capability to bid and execute projects, con­tractors are entering into strategic partnership agree­me­nts with local/ international players who have the expertise. Recently, IL&FS Engineering Services has developed pre-engineered building technology in par­tnership with technology and service providers from Europe and Middle East. L&T- Rolls Royce, Thermax Limited-Amonix have also signed memorandums for technology knowledge power. Such partnerships assist Indian contractors to not only participate in high-end high value projects, but also provide access to superior technologies and project management skills.

Removing challenges in contracting: Realising that planned infrastructure creation cannot take place with­out private participation, the Government of India has also embarked on a number of policy reforms to simplify processes, ease credit availability, develop arbitrage reb­ate mechanisms and set up agencies to expedite growth. Some key steps are:
•As a consequence of pressure from the World Bank, India's road transport and highways ministry has developed new models to expedite current projects. India's planning commission also envisages a new EPC model where the contractor will accept the risk and responsibility for both the design and the construction.
•Introduction of various schemes for providing long-term funding to the infrastructure sector such as sett­ing up of Infrastructure Finance Company limited (IIFCL), viability gap funding (VGF) and funding project development expenses through the India infrastructure development fund (IIPDF) are being acted on.
•The government has permitted infrastructure com­panies to tap overseas market to raise funds. In infra­structure sector, external commercial borrowings (ECBs) have increased by over 65 percent to US$17.4 billion between September 2010 and August 2011. (Source: SEBI)
•In April 2011, the government decided to allow private equity (PE) players to jointly bid with deve­lopers for all infrastructure projects. This initiative will help meet private sector investment targets for the Twelfth Five Year Plan.
•Government's proposal of creation of Infrastructure Debt Funds (IDFs) in order to accelerate and enha­nce the flow of long term debt in infrastructure pro­jects for funding the government's programme of infrastructure development. While the proposal is still at policy stage it will facilitate funding of large gestation infrastructure financing.
•Announcement of the 'Takeout Financing' scheme under the Union Budget 2009-10 and set up of India Infrastructure Finance Company Limited (IIFCL) as a special purpose vehicle for providing long term fina­ncial assistance to infrastructure projects. Recently, IIFCL, LIC and IDFC entered into MoU to avail takeout of debt upto 50 percent of the total project cost in the ratio of 20:20:10 by the three institutions respectively. This mechanism is expected to help financing to the tune of Rs 30,000 crore.