IRB currently has 18 BOT (build, operate and transfer) road projects counting up to 2,070 km with a total investment of 28,300 crore. Of these, 13 projects are operational, and five are under construction. The company’s InvIT will house six NHAI road projects and spread across six states, employing equity and sub-debt of 2,600 crore and debt of close to 3,300 crore (see: Road runner). These six projects generated close to 1,000 crore in revenues in FY16. IRB’s issue comprises a fresh issue of shares to raise 4,300 crore. A chunk of the proceeds is earmarked for issuing fresh debt to the project SPVs so that they can prepay entirely or make partial repayment of money to its lenders. This also includes repayment of loan taken by the SPVs from the parent (sponsor) IRB Infrastructure.
The debt of the six projects will get transferred to the books of IRB’s trust and thus bring down the overall debt at the parent level. The listed parent has a leverage of 14,000 crore with a debt-to-equity ratio of 2.8 times as on FY16. Post the float, the ratio is expected to shrink to 1.7 times, besides resulting in savings on interest. In FY16, the company incurred interest charges of around 1,063 crore. Even assuming an interest rate of 10%, a reduction of 4,500-5,000 crore in the overall debt will result in 500 crore interest savings for the company.
Yet another issue slated to hit the market soon is from Sterlite Power Grid Ventures, which is floating an InvIT named India Grid Trust to raise 2,650 crore. The company has got about 10 interstate power transmission projects having a capacity of 6,767 circuit km. As of FY16, the company had a debt of 44,500 crore on an equity of 16,328 crore in FY16. It is quite obvious that with the investment in assets that have a long gestation period, the initial years are difficult in terms of servicing the debt and interest cost. In FY16, the company incurred a finance cost of 3,830 crore on an operating profit of 4,467 crore. Thankfully, a large part of these concerns will be eased because of the issuance of InvIT. The trust will have two operational transmission lines and one substation transferred having an annual sales turnover of 450 crore. These assets employ close to 4,000 crore capital, including debt of 2,600 crore.
“The proceeds of the issue by IndiGrid will be utilised towards repayment or prepayment of external debt of up to 1,600 crore and sponsor sub-debt for the residual amount (net of issue expenses), incurred by the initial portfolio assets,” mentions Harsh Shah, chief financial officer, Sterlite Power. The balance 1,000 crore will be used for the repayment promoters loan or quasi-equity infused in these projects under the SPVs. Though the company is yet to receive the final approval from the regulator, a reduction of 2,600 crore debt will improve the liquidity and funding at the parent level, which can be further used for the future projects. ITNL, which has the largest road portfolio in the country with a total of 31 projects that include 13 operational projects, has seen its debt rising at a very rapid pace from 5,793 crore or 2.6 times equity in FY11 to 35,600 crore in FY16 or 5.3 times its equity. This also led to interest coverage ratio falling to as low as 1 time in FY16. The company is now looking to list its InvIT as with four projects or SPVs accounting for 2,000 kms. Under the scheme, projects will be transferred to a trust in which ITNL will hold 26% stake and the rest will be sold to other unit holders through the issue of InvITs. A part of the money to be raised will be used for issuing NCDs to the four SPVs, so that they can retire some of their high cost debt.
In the case of Reliance Infrastructure, the company’s InvIT aims to raise 3,000 crore, valuing the 10 road projects to be housed under the trust at 8,340 crore. The concession period for the highway projects varies from 18 to 30 years. As on FY17, the company’s consolidated debt stands at 16,500 crore. But given that the regulator has sought clarifications on certain issues, it’s not clear when the issue will hit the markets.
Given that the regulations mandate the regular payout of profits through dividends, the InvIT units are more likely to be valued on dividend yields. According to Kotak Securities, given the proposed enterprise value of 8,000 crore for IRB’s trust, the average yield over the entire duration of its portfolio of assets comes in the range of 11%, which is over 406 basis points above the 10-year gilt yield of 6.94% as on April 24th. Following the demonetisation move last November, surplus liquidity in the banking system has pulled down bond yields. The Kotak report goes on to the mention that IRB’s average yield is also 150-200 bps above the Masala bonds (rupee-denominated debt issued outside India). In the initial years, the report states that it is expected to be around 8.5-9.3% and would move up above 11% in the later years once the distributable cash flow increases.
Sapre from ITNL feels that most investors would be happy with a 9% yield, as they would be more interested in certainty, predictability and stability of the yield. “The profile of investors in the InvIT is completely different from the profile of investors in the main construction company. As a developer, a company can churn its equity and deploy in projects or assets that generate higher IRRs (internal rate of return), which could be as high as 14-16%,” says Sapre.
According to Shubham Jain, vice-president at Icra, InvIT is largely meant for investors such as HNIs and FIIs who are looking for long-term yield based products. “FIIs will be interested in these products because of the low interest rates in their home countries,” feels Jain.
Subramanian from Axis Capital says, “Dividend yield is one aspect of valuing such instruments, but in the market, investors would also factor in other aspects such as the nature of the projects, growth, quality of assets and other assumptions that impact cash flow.”
What is important is that the cash flow and assumption of cash flow will depend on the nature of assets. For example, cash flow generated by a transmission asset will be different from the cash generated by a road project in the form of toll or an annuity income.
“Post listing, prices of InvITs will closely track the dividend yield. There will be ups and down based on the assumptions and estimates of cash flow—for instance, an increase in traffic or toll rates—but that will be limited,” says Gaurav Karnik, partner and leader, real estate, EY India.
While the prices will closely track the cash flow and the dividend yield, there is a very important component to it relating to the risk and capital appreciation or component of growth. Issuers’ ability to obtain a premium valuation for their assets would depend upon a number of factors such as sponsor credibility and experience, quality and the ability of underlying assets to generate revenue and the presence of independent asset managers.
“InvITs will be rated only if they have to raise debt. But if they are raising equity, then there is no compulsion. To that extent, there is a risk if one is not able to understand or do a proper due diligence of the projects and the business,” points out Shubham Jain, head – infrastructure, ICRA
There are a number of cases when the operating assets have become subject to certain regulatory or public uncertainties. To put it in perspective, recently, after the case filed in the interest of the public, the Allahabad High Court had cancelled the rights of collecting the toll for Noida Toll Bridge Company’s only project in Noida, the Delhi-Noida Direct flyway, thus impacting its revenues and profits entirely. Post the court’s decision, the share price of the company had collapsed from about 22 a share in October last year to around 1.30 a share currently.
Similarly, in the year 2014, IRB Infrastructure projects in Kolhapur were disrupted when activists brought about a prohibition on collecting toll. IRB had already invested in the project and due to this disruption, the toll collection was delayed. Tata Power’s 4000 MW-capacity Mundra Ultra Mega Power Project (Mundra UMPP) was rendered to be completely unviable as it kept on producing power despite the escalation in fuel cost that was brought about as a result of the additional royalty levied by the Indonesian government on exports of coal. A similar issue was faced by Adani Power for its 4620 MW-capacity UMPP near the same location in Mundra, Gujarat. Tata Power had fuel linkages from its own mines in Indonesia. After four to five years of struggle, recently, in December 2016, both the companies were allowed to receive compensation for the increased cost of coal from the procurers of the power.
Against such a backdrop, analysts believe ITB’s enterprise valuation of 8,000 crore will be a big ask for IRB. For example, IRB valuations are based on highly aggressive assumptions of 7.5-7.8% traffic growth, with 5% hike in tariffs. However, 7.5%-7.8% traffic growth assumptions seem quite aggressive, even in the wake of an expected uptick in the country’s economy. “We would have been more comfortable with 5-6% traffic growth—which is the primary reason for the difference in our valuations and that of DRHP. The DRHP aggregates the equity value of these projects at 3,000 crore, which is higher than our valuation of 2,200 crore,” states a report from PhillipCapital.
A fall in traffic growth essentially means that the project IRR might come down and lead to erosion in equity valuations. Such reduction might impact the equity valuation in invested projects. For instance, if the market is willing to ascribe (based on the yield on units) the enterprise value of 5,000 crore instead of 5900 crore, the value of equity will reduce partly. In such a case, the major benefit to IRB would remain only in the form of improvement in the liquidity and reduction in debt.
Gaurav Karnik believes that given the state of flux existing among foreign investors, the InvIT model is still in a wait-and-watch mode. “If they manage to generate superior returns, it could emerge as the much needed breather for cash-starved infrastructure developers,” he says.
Whether that indeed would be the case could well be answered first by Mhaiskar.
This is the second of a two-part series. You can read part one here.