InvIT or UnfIT? - Part 2

The whole concept is a khichdi of four layers (Parent company, InvIT, SPV and finally assets) with five different parties involved in a complicated structure (Parent company also called sponsor, InvIT fund unit holders also called investors, project manager, investment manager and trustees.) All these layers camouflage the overall level of indebtedness (leverage taken at all levels viz. Sponsor/Parent level, InvIT level and SPV/Asset level). In terms of control, all these entities are for all practical purposes, influenced by the promoter.

• The purpose it serves is to deleverage the parent company’s balance sheet while passing on the toll-risk to the unit holders.
• It was marketed as a debt-product, but the attributes resemble equity. The quantum of return to the unit holders is not ascertainable, and the timing is even more uncertain.
• The unit holders (akin to shareholders) don’t have many real rights in the structure – they are at the mercy of the sponsors or trustees (who in turn are appointed by promoters/sponsors).
• The unit holders also don’t have a say in determining the price at which the assets move to the InvIT from the parent company (that shall be determined once the issue is over.) This implies these assets may be transferred at a price higher than the cost at which the parent holds them currently. In other words, the InvIT may be buying these assets at gold plated prices; and there are only Ttrustees to stop this from happening, but we all know who butters the trustee’s bread. (Caveat: The management and lead manager say this is not happening, but the risks in the prospectus say this is possible)
• Even the quantum of debt in the InvIT does not seem to have been capped. What this means is that in the future, InvIT can raise debt to buy gold-plated assets from the parent company (to book profit in its books and also ease its own debt burden) at the expense of InvIT unit holders.
• The amount of external (not InvIT unit holders) debt outstanding on the SPV’s balance sheets after this issue (proceeds of which shall be mostly used to pay down existing debt) is unknown, though from projected cash flows, this amount may be Rs.500-600 cr. If that be so, this is not a big number to worry about. However, the prospectus allows additional external borrowing at the SPV level, which could be a cause for worry in the future.
• As per my understanding by reading the prospectus, each unit shall represent 40% equity interest (Rs.2,000 crore) in the InvIT, and 60% (Rs.3,000 crore) debt interest in the InvIT.
  
• We can assume the future cash flows that would accrue to unit holders on two different bases with their respective consequences as follows:

1. As per the concession agreement with the NHAI, the increase in toll (in price terms, without any increase in traffic) would be 3.5%. This amount shall not suffice for the principal on the unit holders to be repaid. But of course, it’s unrealistic to assume that traffic won’t grow in the future. So let’s go to the next scenario.

2. If we go by the guidance of the management of a total increase in revenue of 9.5% annually for the remaining life of the respective assets, they claim to generate a 12% return for the unit holder. However, if we assume that the O&M expenses grow at a pace as their consultant suggests, and that over time when the debt is paid-down, the InvIT shall become a taxable entity, then the return to unit holder turns out to be in single-digit. It’s just simple mathematics – adding all revenues from all toll roads over their life with a 9.5% annual growth assumption (the current revenue from each of them are available in the prospectus).

• It seems that the principal servicing of entire debt and equity component is contingent upon a very aggressive assumption of 9-11% growth in toll revenues year after year for 15-20 years. The explanation of the management is that it shall get more assets subsequently without stating that those additional assets shall come with its own share of incremental liabilities. The other argument of the management maybe that this (InvIT) is a perpetual structure and so the capital need not ever be redeemed/repaid by them; the investor can trade it in the market if he needs to redeem his capital.

 Conclusion

• Sebi has done well to keep out retail investors from this new product. It deserves credit for the same.
• The project execution risk is not there anymore, but the toll risk remains very much intact. And especially after the DND Flyway (Noida toll bridge) fiasco, this risk is real. Presumably the commuters on these highways far outnumber the ones on DND and therefore are a large vote bank for any agitation to go unnoticed.
• In effect, the debt of the sponsor is being refinanced at a lower rate without any debt covenants or restrictions or collaterals or guarantees. This is on the basis that toll risk is lower than execution risk; it may be, on paper. Wah Aladdin ke Chirag! Maybe it's time we revisit the theory on modern finance.
• The structure of the product, in effect, takes the cost of equity below cost of debt. Of course the magicians (product designers) would have been compensated handsomely for this. Job well-done!
• To recoup his capital, the investor would have to rely on, to a large extent, increased traffic and increased toll every year till the concession period is over. That seems a tall order.
• Even if we take the management’s guidance of annual growth in revenues of 9.5% over the life of the respective projects, and assume the expenses grow as per the consultant and use the principles of liquidation to repay liabilities to various parties (first service interest, then use balance surplus to repay debt principal, then give dividends and then finally redeem capital of equityholders), and apply MAT rate of income-tax to the income of the InvIT over the life of these assets, the debt portion of the InvIT unit shall return 13% (taxable) while the equity portion shall return 5% (tax-free) over 15-20 years. That’s a single-digit weighted average pre-tax return for the investor. This does not reconcile with the management’s guided return range of 12%. Perhaps the reason for this is that their increase in expense assumptions are more aggressive than the consultant, and they may have assumed a permanent tax-holiday on all the projects.
• The fact that the issue was over-subscribed a little less than 10x suggests that in this yield-hungry world, the philosophy seems to be to buy anything at any price (BAAP).

In this BAAP world, it doesn’t matter if what you are buying is ‘UnfIT’, though it’s called InvIT even though a more apt name would have been InfIT. I reckon that in a few years, if we get a liquid market in these units, they could trade at a discount to the issue price. And if they don’t, it implies that so long as investors get a decent initial yield on their unit, they are happy holding it forever even if the principal repayment is quite uncertain and subject to a not-so-short list of conditions and assumptions. BAAP re BAAP!

As for me, I would much rather invest in shares of banks who would be repaid by infrastructure borrowers who shall in turn be bailed-out by the investors in InvIT. Or just stay invested in pure vanilla debt-products. To me, the pricing of the risk doesn’t seem right in this ‘UnfIT’ offering.

Disclaimer: Maybe some of the deductions that we have arrived at by corroborating different figures in the prospectus are erroneous. I am happy to stand corrected by whoever has a better understanding. Some figures are rounded-off to the nearest Rs.50/100 crore.  

Credit: Thanks to Deepak Mishra (chartered accountant) for helping me solve the puzzle.

PS: The ‘conversation’ is (only) a bit exaggerated to add a little humour, and to illustrate that even people in the know don’t seem to have all the answers on this new product. Nothing more.

This is the second of a two-part series, you can read part one here. The writer is CIO, Renaissance Group