Asset acquisitions in the infrastructure space have been on the rise in the past 15-20 months. While some companies are offloading assets to deleverage their balance sheets, others are doing so to shift their business strategies to increase market share. The trend has been witnessed in sectors such as roads, power, construction and cement, where a large number of players are looking to deleverage. In the road sector in particular, a number of companies have exited the build-operate-transfer (BOT) space by monetising operational BOT projects, in a bid to shift the focus back to the engineering, procurement and construction (EPC) mode of project execution.
A number of asset acquisitions in the road sector have been led by financial players such as private equity (PE) firms and pension funds. The highway sector is of great interest to such players as toll revenue generation is dependent on traffic volumes, unlike the power sector which depends on a number of factors including the financial health of state discoms.
The high growth of vehicular traffic in India, which forms the crux of toll road operations, is instrumental in attracting PE investment in the highway segment. Over the past 20 years, the number of car sales in the country has grown at a compound annual growth rate (CAGR) of 10.7 per cent while in the past 15 years, commercial vehicle sales have grown at a CAGR of 8.6 per cent. In comparison, the growth of car sales has been negligible or even negative in Western countries.
Another factor driving road asset acquisition is the stable regulatory framework that has been put in place by the government. Concession agreements and financing arrangements have undergone multiple rounds of changes giving rise to a fairly evolved regulatory structure. “This has provided a lot of comfort to investors in terms of how things are dealt with operationally,” says Sandeep Lakhanpal, head, M&A and business development, Cube Highways.
Many global investors and pension funds such as the Canada Pension Plan Investment Board (CPPIB) are eying the road segment which offers regulated brownfield operational assets. The sector does not depend on an external regulator for earning revenues on a day-to-day basis. “The experience in investing in under-construction assets has not been sweet to say the least,” says Ankur Srivastava, director, infrastructure, IDFC Alternatives. There are two classes of brownfield assets available for acquisition – one where the developer is stressed and the other where the asset itself is stressed. In the latter case, the total project cost exceeds that stated in the detailed project report (DPR), thereby leading to a valuation mismatch at the time of exiting the project. Therefore, it becomes difficult to get an investor on board for the stressed asset. However, a stressed developer with high debt on its books can resort to debt restructuring or get the asset rerated.
As far as the toll-operate-transfer (TOT) model is concerned, the assets being offered are of good quality and transaction sizes are large. This is well aligned with the interests of pension funds. “Asset acquisitions are important in order to jump start new projects,” says Parag Baduni, Partner, IL&FS Investment Managers.
Currently, there are around 200 operational road assets at both the centre and state levels. Of these, only 18-20 assets have changed hands. This could be partially attributed to the fact that many projects are unbankable due to a high level of unsustainable debt which deters potential investors. One of the most important challenges encountered by investors during acquisition is the long transaction time. It takes about a year to close a deal due to multiple regulatory approvals, matching promoter expectations, and issues in due diligence, negotiation and documentation. Another downside faced by the road sector is the small transaction size (barring TOT projects). Investors look at transactions valued at at least $150 million-$200 million which the sector fails to offer. Typically, a road project is valued at $30 million-$35 million. Therefore, such buyers use investment platforms to acquire operational assets rather than acquiring them directly. A case in point is the Rs 20 billion investment made by CPPIB in the infrastructure arm of Larsen & Toubro (L&T), L&T Infrastructure Development Projects Limited.
Compliance is another area that has continued to be a cause for investor concern. This includes labour, financing, toll road operation and concession compliances. As large financial investors follow strict compliance criteria, mitigating related issues further increases the time taken to close a deal. Despite the lucrative opportunity offered in the road sector, the number of transactions witnessed in a quarter has been no more than three, reflecting the intrinsic challenges which have slowed down asset uptake. Moreover, public sector banks are unwilling to take haircuts, an aspect that further exacerbates the situation. “Therefore, banking sector reforms could act as an enabler for speeding up asset acquisitions by global investors,” says Pushkar Kulkarni, principal, infrastructure and real assets, CPPIB India Advisors.
With regard to returns in the road sector, Parag Baduni says, “Annuities typically offer low-teen returns to investors while returns on toll-based projects are 100 basis points more than in annuities. The stressed asset situation has impacted return expectations of investors. In the renewable energy space, returns have been around the mid-teens but have compressed lately due to aggressive bidding.” Meanwhile, Sandeep Lakhanpal opines, “Our returns are calculated in dollars; therefore, there is a large hedging impact. Return expectations are pegged at mid- to high teens on a hold-to-maturity basis for toll roads. Intuitively, annuities are a riskier asset class than toll roads. In the case of toll roads, the toll indexation is going up, the consumer risk is spread over 10,000 people per day, and the earnings before interest, taxes, depreciation and amortisation (EBITDA) is increasing every year. On the contrary, in the case of an annuity project, the EBITDA is negative as the top line is constant but the expenses keep going up.”
Ankur Srivastava begs to differ on the risk component in annuities vis-à-vis toll roads. “On the pricing side, we believe that annuities are much less risky as demand risk is not there and pricing tends to be slightly lower than that of a typical BOT,” he says. Meanwhile, global pension funds weigh real returns on assets across geographies. In India, although the fiscal deficit has reduced, the country’s risk premium has not gone down, thereby impacting real returns.
Investors have shown a clear preference for acquiring operational assets with stable cash flows over under-construction assets. However, they are making efforts to develop capability and expertise to manage under-construction assets before testing the waters. Moreover, they are relatively more comfortable in taking federal government counterparty risk than state government risk. Industry experts believe that the pipeline of operational assets will remain robust for the next two years, which is likely to further drive the acquisition trend.
With regard to the deal size, investors are typically looking at a portfolio size of at least $100 million. Sector-wise, roads, renewable energy and transmission continue to attract investor interest for buyouts. In roads, there is a lot of optimism around the TOT model. Some pension funds such as CPPIB are looking for partnerships in these areas to invest in platforms.
Despite a surge in asset acquisitions, the appetite of developers for investing in new infrastructure projects has not gone up commensurately. This may affect the pipeline of projects being offered to financial investors four to five years hence, and in turn, may impede asset sale activity.
Based on a recent India Infrastructure conference on Asset Sales and Acquisitions in Infrastructure Sector