Private Equity: Telecom's infra-sharing model can be replicated in other sectors

IDFC was established in 1997 to channel the private capital into the infrastructure sector, and IDFC Private Equity was established in 2002-3 to provide equity support to infrastructure sector. Satish Mandhana, Managing Partner, IDFC PE, explains how infrastructure funds will be spent in the near future.

What did IDFC PE set out to do, and how has it been to find equity funding for the infra sectors?
When we started the private equity business people did not believe that there is money to be made in the infrastructure sector. Despite support from the Finance Minister at that time, for a private equity fund dedicated to the infrastructure sector, we had a tough time raising money for the nearly $200 million fund—our first. It took us more than a year to convince LIC, SBI and banks to contribute to that fund.

That fund has done extremely well. We have returned two and a half times of the money overall.

How does your fund define infrastructure?
We define infrastructure space in a broad manner, including not only the hard assets but the whole value chain that gets into the making of those assets. This includes manufacturing, personnel service providers, designers and consultants. If we identify a bottleneck in that value chain, we find an opportunity to fund it.

We also include social infrastructure as a part of our infrastructure definition, including education, healthcare and hospitality. Also, because the definition of infrastructure need not be just a hard asset rooted to the ground, and it can be soft infrastructure, we have the flexibility to include such soft infrastructure, perhaps value added services, and providing that service of transaction. So we can invest in that category, which is preferable to us in comparison to merely having a hard asset.

You said people needed convincing that money can be made in infrastructure. Did that thinking emerge from the concept that traditionally, infrastructure is essentially social-developmental in nature?
Right. In fact, the sceptical question in 1997, when the ideas were formed, was how an institution [such as ours] could survive when infrastructure is supposed to be provided by the government free of cost, and therefore there is no willingness to pay? CDC, where I then worked, was a initial shareholder of IDFC, so I had to convince my investment committee. I showed them the picture of Mumbai suburban rail with people hanging out of trains and sitting on their roofs. My clinching argument was that if we provide a better facility, I didn't see why they wouldn't pay for it.

So, in a way, within infrastructure, can we distinguish basic, developmental and free infrastructure like water up to a set upper limit of usage, from a premium portion of infrastructure for service over and above the basics?
In the infra value chain, we draw up a priority perspective, based on the amount of risk. There is an end which is riskier, where you don't have anything but just an idea. We are cognisant of the fact that if India is talking about a $1 trillion infra-spend over the next Plan (2012-17), we need to be aware of the big pipelines of projects in the picture, and the development of those pipelines may be through consulting organisations working with the government. We have seen the success of Ultra Mega Power Plants (UMPPs)—of how the Power Finance Corporation (PFC) took up the mandate to do the initial bids and roll it out.

On the other hand, the government interface to get a licence or get a concession or get something around it, and after all the clearances and construction, the project starts finding a revenue—either annuity or toll, or use-based revenue.

The risk return profile changes as the asset gets into operation: Generally, half the risk has been eliminated to a large extent. So we have various kinds of funds to be operational at various stages in the infra sector. Infrastructure asset class fund which looks at bullish monopolistic asset without any great risk around will come into the play in the asset as he is operational.

A PE fund whose focus is developmental will have a high-risk, high-return ratio. So we balance our portfolio out by investing in companies with cash throwing projects, a set of projects which are under construction, and set of ideas and concessions which are on the table. So we may take a risk and create a better return than what a normal cash throwing asset will throw up for a PE investor.

Our investment priorities have evolved with time and national requirements. Our first fund focused on hard infrastructure: India needed plenty of hard infra at that time. We saw a bottleneck there. As we moved forward to the second point, we realised that the bottlenecks are actually happening in the value chain and not at the end. So we started to focus on the value chain. We reached a stage of being able to support the developer and the manufacturing entity.

Do you ever base your funding on the assets themselves, or normally on the cash flow?
Our investment is almost always on cash flow. So we don't invest in the real estate since the real estate, underneath, has no capability to generate a cash flow for the intended infrastructure that is coming on it. That said, we are the first one in the country to propose the idea that for an asset to be productive, useful and remunerative for the owner and the user, it is desirable to have maximum uses. So we were the first ones in the country, for example, to fund a telecom tower company that was evolving a concept of a chain telecom towers. As you may be aware, this company, Quippo, was the first to innovate the concept of various telecom operators sharing common telecom towers on a rental basis (shared passive telecom infrastructure), which would be more cost-effective than what it would cost to put up individual towers. Initially, there was some scepticism since the towers were considered strategic assets that are important to an operating company. Soon, operators realised that was not the case. So the journey from 300 towers to 40,000 towers in three and a half years has been accomplished through an organic and inorganic growth. Now the company (since renamed Viom Networks) has become the world's biggest independently managed shared tower company and has the highest tenancy of 2.27 in the country.

Do you think that this infra-sharing model can be replicated in other sectors?
Yes, it is feasible, and is a generalisable concept. Take the case of a solar energy plant—currently under a lot of focus from the government. Like a thermal power plant, a solar thermal plant includes a boiler, a turbine, a balance-of-plant (BoP) and a solar field. In Indian context, these elements work six to seven hours in a typical day. The boiler, turbine, BoP, transformer and other assets will not be used for the remaining part of the day.

If we employ the same concept to be using it for the whole time, the solar thermal plant could be a hybrid with gas. So when solar is not working, it is possible to use the same assets using gas. Now the equation changes in terms of the cost of production of energy.

Through a basic concept of capacity utilisation, you can have a whole efficiency gain coming into the picture.
Yes, and the project can become more viable and attractive. The government does not need to provide heavy subsidies any more.

Do investments in soft infrastructure normally rake in higher returns?
They should. For us, a project needs to be sustainable, ie, produce a reasonable profit. Depending on what the model of using hardware—owning, leasing, renting—it will be a little less capital intensive in comparison to a power plant or a port.

Now, about capex vs opex: We are still building infrastructure, and often have to start from scratch rather than having the luxury of funding an operating venture. Is the funding opportunity different in India from what it is elsewhere in the world in terms of how financing takes place?
I believe there is certainly a limitation under the types and nature of instruments which are available for financing the infra projects. Many infra projects require a longer tenure funding.

Take the case of Delhi Metro. If this 30-year loan from the Japanese government had not been available, the Delhi Metro would not have been a viable proposition. Infrastructure projects require a 25-year funding, but banks in our country don't provide loans beyond the 12-15 year schedule. Similarly, many of the hedging instruments that are used internationally are missing in the Indian context. So, in case you intend to do a foreign exposure of the loans, etc, there is a gap which exists largely in terms of long-tenure bonds to support the infrastructure.

The government's move to attract personal funds of Rs 20,000 is a good one. Now it can take advantage of the database thus created, and create more debt funds geared towards them specifically.

Do you stand to gain from that?
As a private equity investor we look forward to strong debt support available for the infra sector to be able to do a business. If the banking sector ever says it is full up on, say, power exposure, then we cannot fund power either.

IDFC is a vertically integrated funding structure. How has that worked for you?
We have completely integrated. Uniquely, IDFC as a PE operator, we bring to the table not only the funding support, but also institutional support, providing debt finance, and advisory. IDFC also has the capacity to advise an entrepreneur on a bid on a particular asset or an opportunity. There is a capital market advisory, for which IDFC Capital can provide the loans. No other private equity fund has the depths of this nature and associate product features that can come on the table alongside the private equity.

What are the main sectors or segments you are looking forward to, this year?
We look forward to urban infrastructure, which is a kind of emerging need, especially relating to waste management, including wastewater. We have an Ahmedabad based company that collects and treats the sewage from the municipality and sells
it to the industries, thus creating a value chain.

What kind of investment do you see in the next year in water and wastewater?
One of the challenges has been that the major constituent of water has been the municipalities, and interfacing with them has been a challenge for many entrepreneurs.

Why is the challenge even there?
It is a fragmented market, not very consolidated. The skills required to manage it and to face the municipalities is very different from the skills required to manage and interface with an industry: attending to documentation, bidding process and really work along the permission, rights of way, and various other issues which a municipality has in control all the time.

True, but does IDFC align with those city level governances so that you can ease the bottlenecks. Do you see that as a bottleneck?
Yes, through our advocacy division. We have various advisory groups within IDFC, which interface with various government bodies at the state and central level. The advisory is a fee base sustainable income, provided on bid. IDFC has formed joint ventures with some of the state governments such Delhi and Karnataka, acting as an advisor to the government on various issues of infrastructure in that particular government.

Apart from urban infrastructure, in which other segments do you see action?
Social infrastructure, including health care and education, will remain as a focused need for the country. Climate change and conservation, through energy efficiency or RE, will be a focus area. Traditional sectors such as transport will remain in favour. Railways will come up as a newer sector to emerge. A big constraint has been the mindset of the Railways, but with some of the announcements of the current projects and with elections in West Bengal this year, we hope things should work better
in 2011.

One of the things we are talking about is PPP in the rail sector, the railways stands to gain even as a landlord as one of the biggest land-holders in the country.
Yes, a big asset. They have taken the right step in terms of creating an entity which holds the land. They need to monetise it to gain a big impetus.

Road has been gaining traffic in India over rail, which is not right from a carbon footprint point of view, neither is it from any other perspective.

What happens when something goes wrong with your invested project—maybe when a promoter makes a decision against what you would advise?
First of all we have a very strong relationship with the promoter all the time, irrespective of the amount of our stake in the company.

Let me state an example of what we do if something goes wrong. We invested in a Chennai-based shipping and shipyard company called Good Earth Maritime (GML). Soon after putting in the money, the Baltic Index crashed drastically from 20,000 to 200. So in an ensuing situation with existing ships in the shipyards not finding orders, the question of a new shipyard getting orders didn't even arise. If you don't get orders in the beginning, you start incurring cash loss. So we stopped spending money on the shipyard. Despite having put in the money for the shipyard purposes, we advised the company to look into changing the business model.

Meanwhile, we realised that the company had coal mines in Indonesia and realised that the power sector in this country requires huge supply of coal from Indonesia. So we advised them to just focus on moving coal from Indonesia to India for power projects and acquire coal mines. Instead of using the money to build a shipyard, we diverted the funds and advised them to use it to purchase the coal mines, changing up the nature of the business. It is working out fine.