Infrastructure players need to attain scalability to be accepted by the capital market investor

As one of India's larger infrastructure funds, the company has believed in investing in the high-growth sectors. Varun Bajpai, Chief Executive Officer, SBI Macquarie Infrastructure Management Pvt Ltd, tells Shashidhar Nanjundaiah which sectors will attract the most private equity and what exit options are open.

What is the single biggest post-investment risk an infrastructure finance company faces in India?
One of the biggest challenges in investing in infrastructure today is project execution risk. While some people imagine execution just in terms of construction or land acquisition, it goes beyond that. What's critical is whether you can manage manpower or have that much skilled labour. There are also environmental challenges. It's not that the intention is not there, or the regulation is not there—the experience of doing it is not there. The people who are looking to execute these projects may not be people who have run 20 roads or built power plants before.
The challenge therefore, when investing into Indian infrastructure assets, is selecting projects with promoters that are best placed not only to manage the project execution risks of the project but also to operate the business in the most efficient way once it has been commissioned.

Infrastructure would pass off for the social sector or essential services, because the government willed its development, which means a business plan follows, not initiates, a project. Does that come in the way of viability?
Let's look at an example to answer this question. Road projects are typically of three types: Build, Operate, Transfer (BOT), Annuity and EPC. The classifications are often an indication of the project's viability. Previously, during road bids, projects were initially classified as BOT. The ones that were not successfully bid out as BOT projects due to lack of clarity over their viability were then bid out by the government as Annuity projects. If this, too, did not enable the successful bidding of the projects, then they were offered as EPC contracts (typically for highway projects in the North-East, etc). This may differentiate an infrastructure project from some other essential or social service, for instance, Education or Microfinance. 
That said, because of the nature of this sector and its importance to the nation's development, the government does offer assistance through various instruments to alter its viability framework; for example, grants offered for road projects, capital subsidies offered for power projects in the areas such as the North-East, and Renewable Energy Certificates (RECs) for renewable power.

Do you believe Macquarie has entered the Indian market at an opportune time? Does this nation now have enough experience in infrastructure to be called stable and low-risk?
Macquarie is the largest infrastructure fund manager globally, with over 30 funds managing 97 infrastructure assets across 23 countries as of 31 March 2011. With $92 billion of infrastructure assets under management globally, including emerging markets such as China, India, Mexico, Russia and African countries. Indian infrastructure is at an inflection point and is poised for significant growth. While some of the above issues are important, the growth prospects cannot be ignored. Moreover, there have been favourable amendments in recent times across the regulatory framework as India employs its empirical evidence to understand how to better develop the infrastructure space. Clearly, there has been a lot of improvement, and clearly, there is still a lot of catching up to do.

What are the emerging opportunities for private equity (PE) players in infrastructure in India?
A vast majority of India's infrastructure is yet to be built; therefore they are significant opportunities for PE players in infrastructure in India.

The more underdeveloped the sector is, the more it needs investments. The Indian power sector, for example, is a key focus because of the strength of the economic returns that it stands to generate. This is driven by the large power supply deficit that is already well known and publicised across the country and globally.

Apart from the traditional infrastructure sectors such as power, roads, ports, airports and telecommunications, which continue to offer significant opportunities for private equity player's, there are a number of emerging sectors that are also drawing significant interest recently: Logistics, Waste and Water Management, Renewable Power. The cold chain logistics space has drawn significant number of PE investments in recent years. The same can be said for Renewable Power projects ex-Wind/Hydel Power.

Coal prices are a concern for the power generation business. Do you see that cloud on the investors' horizon?
Coal pricing is one of the most significant factors related to the cost structure for a thermal power plant. However, facts suggest that domestic coal may not be entirely unreasonably priced.

Coal from Coal India (CIL) is considered as a proxy for domestic coal, bearing in mind that over 82 per cent of indigenous coal is produced by CIL. A majority of CIL's non-coking output is either E or F grade coal which has low calorific value. However, Indian coal is also significantly cheaper. The sales mix helps us to better understand the pricing structure of Indian coal: More than 80 per cent of Indian coal is sold through Fuel Supply Agreements at rates which are over 60 per cent discounted to international rates. Even the higher grade coal (A/B/C) in India is at least 15 per cent discounted to international rates.

On the back of a price revision in February 2011, CIL's net blended sales realisation stood at Rs 1,187 per tonne as of FY2011. This implies that on average, Indian coal is discounted at well over 70 per cent compared to global prices, though as mentioned before, international coal is of higher grade.

A recent study by research analysts of the mining sector concluded that the delivered cost of power-grade domestic coal is significantly lower than the cost of imported coal at port when delivered to consumers within a range of 1,000 km. Moreover, Indian coal remains a cheaper option when the imported coal has to cover more than 500 km and domestic coal has to cover less than 1,400 km.

That said, a significant chunk of imported coal for India comes from Indonesia and Australia and recent developments there have not been favourable. The Indonesian government's recent legislation to mark up Indonesian coal prices to enable greater parity with international prices may adversely affect several Indian players who have acquired coal mines there. In some cases, there have been concerns regarding the export licence review for Australian coal. These are undeniable and very real concerns for the thermal developers.

A PE fund typically is usually high-risk, high-return, but by the nature of infrastructure operations, the risk is considerably lower. How good is that trade-off?
Any investor must face some risk from factors such as regulatory uncertainties, implementation issues, political issues, the macroeconomic scenario and the creditworthiness or track record of the developer. Longer gestation periods (thereby implying longer horizons for the investor) and the quantum of investment mark infrastructure projects. By their nature, these projects demand higher ticket size investments, thereby augmenting the concentration risk. Our view is that, the risk profile for the infrastructure space is well complemented by the stable returns on offer from the real assets, which essentially makes it a worthwhile trade-off.

It's said the exit route for the private equity in infrastructure is limited (especially since big-ticket projects often entail Special Purpose Vehicles [SPVs]). What are your ways to address that issue?
Infrastructure players need to attain a certain scalability to be accepted by the capital market investor. As you can imagine, attaining this needs a fair amount of investment and time. Moreover, as you mentioned, most projects are housed under SPVs for financing or structuring.

Again, these need to be aggregated or restructured to facilitate exit for the investor. So, in recent times, several infrastructure investors have employed structured instruments instead of straight equity. Common instruments include Compulsorily Convertible Preferential Shares (CCPS), Compulsorily Convertible Debentures (CCDs), and so on. PE players in this space may seek to operate with a variety of exit options that offer some hedging against implementation delays, typical to this space.

So exits may be facilitated through capital markets, or Waterfall Mechanism, which enables swapping into the shares of the holding company from the SPV level, and / or regular Put-Call options.