Hitting the road

India´s infrastructure story is drawing attention from global investors. With more than 70 per cent of the country´s infrastructure debt well-entrenched on the balance sheets of state-owned banks, it is pretty much going to be up to these investors to provide the much-needed funds in the future. India´s infrastructure market is already a compelling global story.

Investing in an infrastructure project isn´t really glamorous, more so if it happens to be a still developing economy like India that needs to first create some basic infrastructure. A new road project or a thermal power plant many not excite as much as investing in a cutting-edge technology start-up in India´s own Silicon Valley, Bengaluru. Although unexciting, investments in infrastructure are needed and are crucial for economic growth. Yet, financing such projects have fallen out of favour with banks. Who are the other investors who can plug this gap?

Scheduled commercial banks that have been the primary source for infrastructure financing, have to now look after their dented balance sheets. Consider the fact that bank credit to the infrastructure sector grew at a compound annual growth rate (CAGR) of 39.5 per cent in the last 14 years. Outstanding bank credit to the sector stood at Rs 10.07 trillion in March 2015 compared with Rs 95 billion in March 2001. According to the June 2015 Financial Stability Report of the Reserve Bank of India, infrastructure constituted 15 per cent of total advances of scheduled commercial banks. However, they had a much larger share of around 30 per cent in total stressed advances. After steel, roads account for the second largest amount of bad loans for the banking sector.

´Banks, ultimately, cannot take the whole burden of the infrastructure capital requirement in India. It is too large, plus there are asset liability issues that could emerge in the future,´ says Anshula Kant, Deputy Managing Director and Chief Financial Officer at India´s largest lender, the government-owned State Bank of India (SBI). About 14 per cent of SBI´s total loans are to infrastructure companies. Not surprisingly, Kant displays a wariness for long-term loans and a reluctance to take on as much risk as before, given a large chunk of the sector´s loans run the risk of being tagged as non-performing assets (NPA). Moreover, the new Basel 3 rules are guiding banks away from the long-term loans that are required to back infrastructure projects.

Perhaps, it´s just as well. The kind of security mechanisms required by the banking fraternity were something a developer always had a hard time providing. Rajat Seksaria, Vice President and Business Head, Punj Lloyd Infrastructure Ltd, says,´A specific banking clause is sometimes incorporated purely for the bankers´ requirement. This many not, per se, harm the commercials of the project but the authorities are inflexible in making those changes. This means many projects get screened out at an early financing stage, despite being fundamentally sound.´ Citing other onerous conditions, Seksaria is glad there is a new breed of investors that are now fast emerging.

With the banking finance tap now running dry combined with restricted public finances, there is a shortfall for the assets that need to be built. The Planning Commission estimates that the total infrastructure spending is estimated at around 10 per cent of India´s GDP in the 12th Five Year Plan, up from 7.6 per cent in the previous period. This means that the investment is likely to double to $1 trillion.

NEW INVESTORS
That has created a need and an opportunity for new entrants. Long-term investors such as insurers and pension funds are rumoured as being interested in ploughing money into infrastructure. In fact, the Canadian Pension Plan Investment Board (CPPIB) just opened an office in Mumbai in late October and said it would look at investing in infrastructure projects in India. So far, CPPIB has invested with L&T, Piramal Healthcare and with the Shapoorji Pallonji Group.

´The most natural buyer for an infrastructure asset, once it is operational and has a stream of very visible cash flows, is a pension fund,´ says Ashish Agarwal, Director-Infrastructure, Equirus Capital Private Ltd.

To be sure, a number of insurers, pension funds and sovereign wealth funds are reportedly exploring opportunities but it is still early days. Most such funds are investing for the first time in infrastructure assets in emerging markets where problems may still remain even after a project is operational. They may find in time that investing in a road project in India for 25-30 years is going to be very different from investing in a comparable project in the developed markets of Europe.

Hopefully, the experience will not be discouraging. A prudent approach will help.´I think they are two-three years away from making a real investment decision in India,´ says Agarwal.´I think that the private equity funds are the bridge between these operational assets being in the hand of a mid-cap Indian promoter to reaching their ultimate ideal buyer, which is a pension fund,´ he adds.

Kant concurs.´Interest in these assets will emerge when they de-leverage a little. Foreign funds are not going to come into very highly leveraged assets. The move from debt to equity has to happen for real interest to emerge. Even though the government is trying to push this along with friendlier rules and policies, the asset quality has to improve,´ she says.

However, Sanjeev Kaushik, Deputy Managing Director, Indian Infrastructure Company Ltd (IIFCL), believes that by dint of being a government-owned company, IIFCL is better placed to attract such investors. In fact, he is hoping they invest in new projects.´The need is to make sure they get into greenfield investment options,´ he says. He adds,´Some of this can be routed through organisations like IIFCL which are specialised vehicles. There is no explicit government guarantee but we are hundred percent government owned. There is a degree of comfort for overseas funds to channelise funds through us.´

DEAL FLOW
Speaking of private equity, deal flows have picked up of late and sellers are lining up as they look to exit stressed assets and free up cash to invest in other projects under execution. This is emerging as the best way to raise cash. Recent regulatory changes in this regard have helped. However, whereas earlier, private equity funds would more often than not buy stake in a holding company, they have also started focussing on taking ownership positions in the infrastructure assets themselves.´As a minority partner at the holding company level where you have several assets, even if one or two of those turn bad, it can kill the returns of the entire portfolio. The smart investors realised that this may not be the most prudent way of making money in infrastructure in India. They realised they have to be in control of the assets they are funding,´ says Agarwal.

Hence, the deals in September and October this year where Canada´s Brookfield Asset Management picked up nine projects from Gammon India while PE firm I Squared Capital picked up the Agra-Jaipur express-way project from Madhucon Projects. Equirus Capital were exclusive advisers in the latter and expects to announce a bigger deal shortly.

In fact, the last two deals may well mark a period of accelerated deal-making in infrastructure, particularly in roads projects.

Seksaria reveals that the development arm of Punj Lloyd Group is also looking to divest stake in its sole road asset, its annuity roads project, the Khagaria Purnea highway project in Bihar.´We are not actively looking at divesting but looking to bring in someone at a holding company level to fuel our growth for more projects in the future. We are in discussions with both private equity and strategic investors,´ says Seksaria.

Companies such as Lanco Infratech, IVRCL, Reliance Infrastructure, Soma Enterprise and IL&FS Transportation Networks, among a number of others, are reportedly looking to divest their operational road projects. Over the last three years, there have been about seven-eight such strategic deals with PE firms like IDFC, SBI Macquarie and I Squared all picking up infrastructure assets.

OLD WINE IN A NEW BOTTLE?
To be sure, developers have mixed views on the government´s new hybrid annuity model for roads development. While some developers don´t see many takers, Seksaria says´there are some early signs that banks may want to lend for the new hybrid annuity projects that the National Highways Authority of India (NHAI) has come out with. Although there are no real projects in the market right now, but the new concept pretty much has what banks and developers had always asked for. It de-risks completely a lot of things.´

OTHER INFRASTRUCTURE
Other than roads, the only other sector within the infrastructure domain attracting interest on a large scale from financiers and investors is renewable energy. And niche I-bankers Greenstone Investment Banking want to set the pace with respect to deal-making and introducing more and newer investors to India´s renewable energy sector. Having just advised Aditya Birla Nuvo in a transaction with private equity firm Abraaj Group, Rahul Goswami, Managing Director, Greenstone Investment Banking, is clear about the firm´s objectives.´I wanted to be ahead of the curve and position ourselves as the number one financial advisor in this space in India,´ he says. Having already brought in international PE firm Abraaj Group to India in a transaction with the Aditya Birla Group, Goswami reveals he is working on two big-ticket deals and at least, a few smaller-sized ones. He expects to announce these in the next six months. To be sure, the buzz in this space is palpable. Banks are also keen on financing renewable energy projects as much as a host of private investors, both domestic and foreign.

Seksaria reveals Punj Lloyd is looking to carve out its renewable energy division into a separate company.´We are in discussions with potential investors and partners,´ he says.

CONCLUSION
The action hasn´t all been with respect to only strategic or private equity deals. Since the announce¡ment of Narendra Modi as the new Prime Minister last year, the stock markets have rallied and sentiment has improved. Consider the fact that infrastructure companies raised about $11 billion in FY11 followed by almost zero capital raising activity in the next three years. However, there has been a pick-up in initial public offerings (IPO) and qualified institutional placements (QIP) over the last sixteen months. Infrastructure companies have raised close to $8 billion already. With a pro-development Prime Minister at the helm of the country´s affairs, the feel-good factor will remain for the next few years, barring something drastic. Going beyond sentiment, the government has shown its intention in cleaning up the mess. For overseas investors evaluating different countries, what´s certain is that India´s infrastructure story is no doubt proving to be an interesting draw. With more than 70 per cent of the country´s infrastructure debt well-entrenched on the balance sheets of state-owned banks, it is pretty much going to be up to these investors to provide the much-needed funds in the future. India´s infrastructure market is already a compelling global story.