Healthy Returns

Private equity (PE) investments in infrastructure have surged in the past three years. While roads and renewables continue to be the preferred sectors, other areas such as logistics, transmission lines, telecom and airports are also being explored by PE firms. Commitments are being made towards oper-

ating assets through various routes such as direct exposure, platform investments and infrastructure investment trusts. Investors have been able to clock double-digit returns on yield generating assets. Meanwhile, greenfield projects and stressed assets are not currently on the PE investor radar due to regulatory hurdles.

Current portfolio of select PE investors

Global Infrastructure Partners [GIP] India has been actively investing in the country since 2008 and manages two funds, which together have invested around $1.8 billion in the infrastructure sectors. The bulk of the investments of the firm’s second fund are in the energy and transportation sectors. Within the energy sector, there has been a lot of focus on investments in renewable energy assets. More recently, the company has started looking at the logistics sector as well.

Macquarie has been active in India for about a decade and has invested around $2.5 billion in the country so far. The firm has a large exposure of around $1.5 billion in the road sector. Apart from roads, the firm has a diversified portfolio across other sectors including power, telecom towers, airports and renewable energy.

Cube Highways, unlike GIP and Macquarie,  focuses primarily on the road sector. It owns and operates five highway projects across the country and has committed capital to another four operational projects. The firm is also evaluating other allied sectors such as logistics.

Investment strategy

When PE firms began looking at infrastructure assets, investors parked their funds in under-construction assets in partnership with developers/promoters. However, in the past few years, there has been a shift in strategy, with PE investors  investing in  operational/close-to-operational assets and prefer controlled investments (owning either a majority stake or 100 per cent stake) through which they can professionally manage these assets. Meanwhile, the holding period for infrastructure assets has increased and PE funds look to exit after six to eight years rather than the earlier three to five years.

There is substantial need for an increase in capital for infrastructure sectors and this in turn will drive the need for monetisation of operational assets. In terms of sectors, both roads and renewable energy are well understood by investors, as is evident from the level of investment. In the next three to five years, sectors such as airports, ports, water management, etc. are likely to see a surge in investments as well.

Stance on various asset classes

Stressed assets

Investors are more comfortable acquiring healthy assets of debt-laden promoters. While there is a huge potential in the stressed assets space, investor interest depends on a good track record of timely resolution of such assets. The key issue in the stressed assets space is that any delay in the resolution of such assets leads to a sharp deterioration in their value. Therefore, in order to bring PE firms on board for stressed assets, it is important for stakeholders (promoters, lenders and regulators) to take prompt and transparent decisions.

Greenfield assets

Renewable energy is one sector where PE players have made greenfield investments, largely on account of lower risk perceptions. For the infrastructure sector as a whole, uncontrollable risks such as delays in land acquisition and clearances bring a lot of uncertainty to greenfield projects. This, in turn, affects project timelines and thus financial returns, thereby diminishing the prospect of PE funding. Therefore, as a trade-off, PE players prefer to buy certainty at a premium. They are willing to invest higher amounts in projects with requisite approvals in place. Meanwhile, some projects such as liquefied natural gas (LNG) terminals are completely off the radar of investors due to the long gestation periods. On the other hand, brownfield investments could be explored in the future.

Yield generating assets

There are a number of yield generating infrastructure assets in private hands, particularly with PE investors. Financial investors invest in operating assets with the intention of generating periodic returns. Road assets have been able to give yields in the range of 12 to 16 per cent while renewable energy projects yield returns in the mid- to high teens. Meanwhile, some sectors have front-ended yield distribution while others have back-ended returns.

In the past couple of years, investors have started focusing on generating yields from operating assets, which was not the case a decade ago. The primary emphasis is on optimisation of the capital structure. The road sector, for instance, allows tolling on a daily basis, and this generates surplus cash to be distributed to the investors. In contrast, the power sector is cyclical in nature as it depends on receivables from distribution companies. Therefore, there is a skewed yield distribution.

A key factor taken into consideration by PE firms is that most of their investments as well as returns are dollar denominated. In addition, as cash flows are taxed, these firms calculate their returns, net of distribution taxes, on a dollar basis. Besides the timing of the investment, the timing of the exit is also a critical decision for PE players. PE funds are now making platform investments with the idea that even if the shareholders monetise their investment holdings, the business will continue. For instance, I Squared Capital sold a stake in Cube Highways to the Abu Dhabi Investment Authority and Japan’s Mitsubishi Corporation.

The winning of the first toll-operate-transfer (TOT) bundle by Macquarie has set an example for the monetisation of public assets. It is a precursor to more such offerings in sectors such as airports, ports, transmission lines, etc. There is substantial government capital locked in these assets. TOT is a good mechanism for bringing these assets under professional management and freeing up government capital. The government can take greenfield risks and later bid out the assets to PE players via the TOT model to recycle capital.

Role of pension and SWFs

Due to lower returns in developed economies such as the US and Europe, global investors have large sums of money to be invested. In this context, India has become a lucrative bet for foreign investors. More recently, pension funds and sovereign wealth funds (SWFs) have been showing greater interest in India’s infrastructure. However, how much opportunity exists for this investor class depends on the quantum of assets held privately. Sectors with limited government intervention have seen large infusion of funds from global investors. Renewable energy is one such example. The country’s renewable industry has expanded at a rapid pace in the past few years. Most of the projects have been privately funded and the bulk of this private funding has been routed through PE funds. However, this has not been the case with airports, a sector which has seen very limited private participation. Therefore, capital inflow from pension funds and SWFs depends on how much control the government is willing to relinquish.

The way forward

Co-investment could be explored as an investment strategy in the long term. Pension funds and SWFs in partnership with PE funds can take exposure to a larger slew of stable and mature infrastructure projects. In the short term (two to three years), passive investors will rely on the experiences of active fund managers such as GIP, Macquarie and Cube Highways who can de-risk assets and stabilise project cash flows. These passive investors can then pay a premium for investing in such assets. In the medium to long term, investors, after understanding the market dynamics, are likely to invest in the infrastructure sector via platforms or direct exposure.

Based on panel discussion among Mahendra Bisht, Principal, India Investment, Global Infrastructure Partners; Nirad Deshpande, Vice President, Macquarie Infrastructure and Real Assets (India); and Sandeep Lakhanpal, Head, M&A and Business Development, Cube Highways, at a recent India Infrastructure conference

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