In the past five to six years, private equity (PE) investor appetite has been largely absent from the road sector. However, more recently, the government’s asset recycling plans have attracted substantial interest from long-term PE players. In a much-awaited development, the first project bundle under the toll-operate-transfer (TOT) model was awarded to the Macquarie Group in March 2018. While the award is in itself a big step, oversubscription of the project bundle has increased the government’s confidence in the potential for asset monetisation. The deal is being lauded as one of the largest foreign direct investments in the country’s infrastructure sector.
The deal
A joint venture (JV) of Sydney-based infrastructure asset management company the Macquarie Group and Ashoka Buildcon Limited has secured the rights to manage 648 km of national highways under the first bundle bid out on a TOT basis. Ashoka Buildcon will be responsible for the operations and maintenance (O&M) of the stretches. The equity component will be financed from the $3 billion raised by the Macquarie Asia Infrastructure Fund II. “We are positive about the TOT model and are pleased to have been awarded this concession by the National Highways Authority of India (NHAI) for the O&M of a diversified portfolio of nine roads,” says Suresh Goyal, head, Macquarie Infrastructure and Real Assets (MIRA).
MIRA-managed funds have been investing in Indian toll roads since 2012. Terming it a unique proposition, Goyal further asserts, “This is an opportunity to invest in a high quality diversified portfolio of roads over a long concession period of 30 years located in the two high-growth states of Andhra Pradesh and Gujarat.”
The maiden TOT bundle was bagged with a bid which was 1.5 times higher than NHAI’s estimates of about Rs 62 billion. During the development of these projects, the government had invested about Rs 8 billion. The bid is also 30 per cent higher than the second highest quote. The overvaluation bodes well for the government’s asset recycling plans. Such a valuation by long-term capital providers also reflects that there is a great appetite for well-structured deals in India. Applauding the development, Jaijit Bhattacharya, partner and head, economics, regulatory and policy advisory, KPMG India, says, “This is a very encouraging development. It has taken some time for the government to develop a robust policy foundation to enable TOT on roads so that the model stands the scrutiny of time.”
MIRA had quoted a bid price of Rs 96.81 billion. The other bidders in the fray were Brookfield Asset Management, a JV of IRB Infrastructure Developers and Autostrade, and a JV of Holland’s Roadis and the National Infrastructure and Investment Fund, which quoted Rs 75.11 billion, Rs 69.3 billion and Rs 66.11 billion respectively. The auction is a part of the government’s plan to monetise publicly funded operational national highways through the TOT model.
However, investors were seen to be exercising a lot of caution while bidding for these projects. Having burnt their fingers several times in the past, the investors posted a long list of pre-bid queries for clarification from NHAI. The initial bid submission date, which was in early January 2018, was first revised to February 8 and further pushed to February 22.
Rewind two years
Back in 2016, the Cabinet Committee on Economic Affairs had authorised NHAI to monetise publicly funded national highway projects. Projects which are operational and have been generating toll revenues for at least two years after the commercial operation date are eligible for monetisation under the TOT model. In a preliminary step, around 75 operational national highway projects completed with public funding have been identified for potential monetisation using the TOT model. Under this model, the right of collection of user fee (toll) on selected operational national highway stretches constructed through public funding is proposed to be assigned for a specific time period to developers/investors against upfront payment of a lump sum amount to the government.
Further, during the contract period, the responsibility for O&M will remain with the assigned developer/investor. The move is expected to provide an efficient framework requiring reduced involvement of NHAI in projects after completion of construction. It will also create business opportunities for a new vertical of developers who specialise in O&M of highways and a category of investors (institutional investors including pension and insurance funds, sovereign funds, etc.) which are averse to taking construction risks but are adequately equipped to make long-term investments in road infrastructure.
Next steps: Tackling toll woes
The funds generated from the monetisation of highways will be used for new infrastructure programmes such as the Bharatmala Pariyojana, the government’s ambitious Rs 7 trillion road development initiative. “The successful round of TOT bidding not only opens up an investment route into India’s infrastructure story that has significantly reduced risks, but also signals the entry of serious Australian investments into this sector. It would be worthwhile to extend this concept to other government and public sector unit-owned infrastructure,” says Bhattacharya.
The need for securitising cash flows for undertaking investments in network expansion has set the ball rolling for the introduction of the TOT model. The model will facilitate the raising of upfront capital for project development under the engineering, procurement and construction model as well as the hybrid annuity model.
Three tranches of projects will be bid out during 2018-19 and NHAI expects to award a length of about 2,500 km under TOT and raise around $3 billion. Work, in fact, has reportedly started on monetising the next three bundles and NHAI is expected to invite bids for the second bundle of about 10 projects by April 2018. Meanwhile, the government is also in the process of formulating a strategy to rope in small investors. The success of the first tranche will establish a sound framework for future bids.
Nonetheless, the model like several others is not free from issues. In the TOT model too, returns could be erratic if the toll traffic intensity reduces due to unforeseen factors. The equity internal rate of return is expected to be in the range of 12-13 per cent. As far as the first bundle is concerned, highway stretches in Gujarat are more lucrative as compared to those in Andhra Pradesh, mainly due to the presence of industrial clusters in and around stretches in the former. However, the impact of the goods and services tax on freight movement and the presence of alternative routes may impede the expected growth in toll revenues. Besides, unforeseen factors such as latent defects and other macroeconomic anomalies could also slow down revenue growth. Nonetheless, as a bundle, the nine highway sections have a good mix of inbuilt hedges against potential risks.
A few stakeholders have also recommended a reduction in the concession period from 30 years. Besides, the cost of borrowing could also be an issue. In the near future, this is expected to keep the private sector away from bidding for TOT bundles. Securing funds from Indian banks will continue to be a challenge. While the private sector is still reluctant to invest in new highways, it is considering tapping into the TOT opportunity. Players such as MEP Infrastructure Developers are planning tie-ups with overseas funds to jointly bid for projects.
Net, net, TOT looks like one of the most well-charted initiatives of the government. As the Ministry of Road Transport and Highways’ ambitious road development plans require massive investments, TOT could certainly provide a fillip to meeting financing needs. “We believe that this is a very good strategy adopted by the government to monetise brownfield assets and should be replicated across other asset classes also like transmission, gas pipelines, etc.,” says Goyal. While the next few rounds could see moderation in the deal sizes, the market competition is certainly set to increase.