With the Ministry of Road Transport and Highways (MoRTH) estimating an investment requirement of about Rs 7 trillion for the development of national highways in the country during the next five years, the role of investors is more critical than ever. The key funding sources for the sector include gross budgetary support, the Central Road Fund, external borrowings by the National Highways Authority of India (NHAI), toll remittance, the monetisation of highways through toll-operate-transfer (TOT) projects, and private investment. Among these, the estimated share of asset monetisation and private investment is about 22 per cent. Meanwhile, the pace of financial closures in the sector has also been encouraging.
A sense of optimism
For the past few years, burdened with a number of stalled projects, the road sector has been going through difficult times. Most of the lenders have been worried about how the government plans to take the sector forward. But the past one year has seen positive signals from the government. Hand-holding of the financiers and developers by the government has undoubtedly gone a long way in re-establishing the confidence and enthusiasm of lenders in the road sector. The government is now more open to engaging in dialogue with industry stakeholders, and, in some cases, has also shown willingness to tweak policies.
Project size does not seem to be a major concern for investors any longer. While large-scale investments are preferred, lenders are also open to smaller transactions in the sector. However, most of the players are looking at acquiring operational assets which have lower risks associated with them. Valuations are being based on the current status of the asset and the future expectations from that particular asset. Amendments to tolling policies are also a major regulatory risk that lenders consider before evaluating an asset.
Further, from the banker’s side too, there has been an improvement in the due diligence process, which was an issue in the past. Lenders are being selective about the kind of exposures that contractors are taking. The capabilities of engineering, procurement and construction (EPC) contractors to execute multiple projects simultaneously are being carefully assessed. Meanwhile, from the project side, the complexity factor of a project, such as the kind of terrain, a rail overbridge or flyover requirement, etc., are also being understood and assessed beforehand.
HAM and TOT models garner investor interest
Lenders are particularly bullish on hybrid annuity model (HAM) projects, especially with the government changing the 20 per cent project completion clause (for the release of the first tranche of funding) to 10 per cent. Further, investors are also eagerly awaiting the auction of the first bundle of TOT projects. Key success factors for bidders include accurate toll estimates and assessments of the maintenance costs.
Meanwhile, in the case of TOT projects, investors are of the belief that funds from foreign pension funds should be used in combination with domestic funds. The government’s policy direction appears to be very clear with respect to bringing in substantial foreign capital into the country, in view of the huge bundle size of projects. It is only the big players that will be able to participate. Indian banks and other lenders are also willing to invest but this is likely to be only in the form of a consortium to begin with as at least Rs 50 billion-Rs 60 billion per package is required.
Financial closures, especially in the case of HAM projects, have seen an increase in recent times. As per India Infrastructure Research, between May 2014 and July 2017, 16 road projects achieved financial closure. About 60 per cent of these are being implemented under HAM. However, the average time lag between the date of award of a project and financial closure of eight months, and even 11 months in some cases, is a cause for concern.
The rise of InvITs and other sources of funding
The government’s decision to remove dividend distribution tax on infrastructure investment trusts (InvITs) has encouraged companies like IRB Infrastructure, IL&FS Transportation Networks Limited (ITNL), Larsen & Toubro, Reliance Infrastructure Limited and MEP Infrastructure Developers to list their assets under this instrument. InvITs are likely to provide funds for greenfield projects. However, it is important for investors to understand that InvITs cannot be treated as a short-term investment to make money in a few months’ time. These are in fact long-term infrastructure funds wherein money, profit, dividends, etc., are likely to come gradually over a period of time.
Apart from InvITs, there is a lot of appetite and interest from infrastructure debt funds. Together, these two products can go a long way in infusing additional liquidity into the market.
Further, the MoRTH’s masala bond issuance has also received an overwhelming response. The Rs 30 billion issue, which was listed on the London Stock Exchange, was welcomed by investors from across the globe with Asia contributing 60 per cent of the subscription and the balance 40 per cent coming from Europe. Besides, NHAI garnered a sum of Rs 5.02 billion through the issuance of debt securities on the Bombay Stock Exchange’s electronic book mechanism platform. The issue was oversubscribed by over 10 times.
Moreover, players in the sector are also taking the initial public offering (IPO) route to raise funds. Since 2015, six key IPOs have been launched. The most recent ones include the offers by Dilip Buildcon and the IRB InvIT Fund. Besides, PNC Infratech, MEP, and Sadbhav Infrastructure Project Limited (SIPL) have also successfully launched their IPOs. However, Bharat Road Network Limited’s IPO launch in September 2017 is an exception to this. Owing to the company’s young assets and weak financial performance in the past, the response to its IPO was not as good as expected. Meanwhile, the MoRTH is also planning an IPO for NHAI in 2018.
Meanwhile, lenders feel that there is potential for another product – credit enhancement – in which guarantees are given to developers so that they can upgrade their rating and become eligible for a bond issue. According to lenders, the product has done well in the power sector and can be useful in the case of roads as well.
Further, new sources of multilateral funding have emerged, providing a thrust to sector growth. For instance, the Asian Infrastructure Investment Bank (AIIB) approved its first equity investment of $150 million to the India Infrastructure Fund to support infrastructure projects in India, including those in the road sector. Recently, AIIB approved funds worth $329 million for the Gujarat Rural Roads Project. Besides, the New Development Bank has also granted a loan of Rs 23.95 billion for the Madhya Pradesh District Roads II Sector Project.
Activity in the asset acquisition market
In recent times, the sector has seen increased involvement of both domestic and foreign players in picking up stakes in road assets. Since 2016, about 15 equity dilution deals have been inked by players like GMR Infrastructure Limited, HCC Limited, SIPL, and PNC Infratech Limited. Meanwhile, on the buyers’ side, several global investors are eyeing operational and revenue-generating assets in India.
Key financial hiccups
The creditworthiness of developers has taken a hit due to their overleveraged balance sheets and stressed profitability. Hence, the need for long-term financing from foreign pension and wealth funds, as well as regulatory and contracting policies for the same is more pronounced than ever. From the lenders’ side, the problem of non-performing assets needs to be dealt with. Several big players have either opted for debt restructuring or for a hiving off of road assets to maintain their fund balance.
Pessimism in the sector is a result of the issues which various developers are facing with respect to financing, which in turn have been created by the existing policy framework and aggressive bidding in the past. Further, especially in the case of TOT projects, factors such as financial default, contract termination payment, state-level policy changes, etc. could likely challenge the success of the TOT model. After five years, there will need to be a conscious effort to understand whether a TOT project is bleeding or not and accordingly adopt a corrective measure immediately, rather than procrastinate and thus discourage investors.
As a result of these challenges, banks have faced difficulties in loan recovery and corporate debt restructuring cases have been on the rise. Companies like Shapoorji Pallonji, ITNL, SIPL and Ashoka Buildcon Limited have refinanced debt. Recently, Supreme Infrastructure received the nod to restructure its Rs 24.1 billion debt raised from a State Bank of India-led consortium under the Scheme for Sustainable Structuring of Stressed Assets. Unless these gaps are bridged effectively, the sector will continue to face financial capacity constraints.
Conclusion
Financially, things seem to be moving in the right direction for the sector. Bank funding in the previous financial year was lower than alternative sources of funding, for the first time in the recent history of the sector and this trend is likely to continue. The entry of foreign pension funds in the market is likely to at least partially ease the problem of non-availability of long-term funds. The excess rupee liquidity in the market will aid faster turnaround of TOT projects, leading to alternative sources of funding which were not available earlier, thus making the sector financially attractive. Although the ground is yet to be tested, this is a huge opportunity and lenders will have to find a way to mitigate risks and participate in TOT project auctions. Nonetheless, in view of the large quantum of funds required for sector development, it is important to tap all possible sources of funding and evolve new ones.
