‘We don't like investments that are dependent on subsidies'

IDFC Project Equity, a fully-owned subsidiary of Infrastructure Development Finance Co, is a leading infrastructure equity investment manager. It manages the India Infrastructure Fund, a domestic venture capital fund with a corpus of about Rs 3,800 crore. It has picked up equity stakes in a few road and power projects, a gas distribution company and a municipal solid waste handling company. In this recent interview in his Mumbai office, Mr M.K. Sinha, President and CEO, IDFC Project Equity Co Ltd, with nearly two decades of international investment banking experience, discusses the infrastructure investment scenario in the country.

A B.Tech (Hons) from IIT-Kharagpur and an MBA from IIM-Ahmedabad, Mr Sinha spells out the company's investment strategy and says the pipeline for investment looks healthy. IDFC Project Equity, he says, would not like to invest in projects or sectors whose economics are dependent on Government subsidies. Excerpts:

Could you give us an update on the India Infrastructure Fund?

We are more than half-way through in committing our fund. We have a well diversified portfolio — three power assets, seven road assets, a gas distribution company, a municipal solid waste handling company and a port. In the past year-and-a-half, we have invested in a renewable company, Caparo. The pipeline looks pretty healthy in terms of the possibility of getting deals done. Until the early part of this year, the valuations were stretched; it wasn't attractive to do deals because the public markets served as competition for us.

The public market valued infrastructure companies way beyond what they should have been valued and, obviously, the sponsors love the highest valuation rather than settle with a private equity investor who values companies based on fundamentals and participates in the evolution of the company. We don't invest and then go passive. Public markets, once they invest the money, the sponsors are free to do what they want. I am not saying that in the negative sense. Obviously, getting money without strings attached is better than getting more expensive money with strings attached. The money that came from the public market without strings attached is no longer available. Which is why the investment climate for us is significantly better. Hopefully, we will do a few deals in the next six-eight months.

Infrastructure faces a tough climate right now and going forward. If you look at the power sector, there is shortage of coal. There are concerns about the payment capacity of the State electricity boards. We have had land acquisition and environment clearance issues. In the roads sector, there was a slowdown in awarding concessions. Land acquisition, shifting of utilities and environment clearances have caused execution delays in most of the greenfield road projects. I don't see that easing up going forward.

We would like to be selective in terms of investing alongside sponsors who have the ability to execute these projects in a time-efficient manner.

What kind of returns would you expect, because you invest in special purpose vehicles (SPVs) rather than the holding company?

Our focus is SPVs. We could invest at the holding company level too; make a structured investment so that our cash flows come from up-and-running SPVs. The vehicle that we invest in is not necessarily an SPV, but the risk that we take in our investments is SPV-focussed. At the SPV level, one of the issues that you have is exits. It is not easy to exit those investments. Our focus is SPV investment, which is lower risk, because the risks are contained within the SPV and can be analysed. For example, if you pick a power plant, whether all the land required is available or not, is there adequate coal for the power plant, is offtake tied up, at what price is the offtake tied up. It is much easier in one SPV situation.

If you have a power company with seven or eight power plants and five more under development, you cannot get a handle on all these risks at the holding company level. We would focus our investments on SPVs that we are comfortable with. We might invest in the SPV or we might end up investing at the holding company level. But at the holding company level our investments are so structured that the cash flows from the SPVs that we are comfortable with, service our investments.

But then your returns are also lower, because the exit options are fewer.

The returns are lower in the IRR sense. But that is the difference between an infrastructure fund and a private equity fund. Infrastructure funds are not meant to make huge returns. Because what we invest in are essential services which are public utilities, you are not expected to make 25-30 per cent returns. You are essentially serving a public cause. That doesn't mean you do not make profits. You make profits at a moderate level — 16-18 per cent return is acceptable. Infrastructure sector assets are long-term and so is our investment. It could be eight to 10 years. Our fund life is 12 years, extendable by another three years. While our IRRs are low, it is over a longer period of time. So our money on invested capital might not be very different from private equity. Except that we are more patient and it is over a longer term.

What kind of projects do you look at? Would you invest in a project whose promoter does not have a track record or do you go by the promoter's reputation?

Both are important. Because we are asset focussed, asset is more important. But that does not mean we completely ignore the promoter. Which is why we are selective, because a great asset can be messed up by a promoter who does not have the ability to execute.

The problems seem to be mounting in the power sector…

The power sector leaves a lot to be desired. While we have done a lot on generation, transmission and distribution, reforms have taken a back seat. Though some transmission concessions have been awarded, the progress has been tardy. I think the last distribution licences were awarded in Delhi. The licensees have improved the operating efficiencies of the distribution circles — the losses have come down from 51 per cent to the mid-teens, 14-16 per cent.

But, they have run up losses of Rs 1,900 crore because the regulator hasn't allowed tariff hikes. You cannot sustain this situation. The private sector will hesitate in getting into a situation where the regulator does not take into account the sustainability of the sector.

The regulator's job is to make sure the sector is viable rather than maintaining tariffs at the lowest possible rates. Everybody has to survive for this system to work — the generator, the transmission company and the distribution company — and not make super-normal profits so that the users are not harmed.

Cheap power is a good political give-away, that has been the problem with our power sector. Power is challenging because transmission and distribution reforms haven't happened; generation you are not sure about some of the parameters. Therefore, you have got to be selective about investing in the power sector. You can invest only if all the parameters are suitably tied up — offtake, fuel supply, land acquisition, environmental clearances. There is potential in the power sector. There is no question that power is an attractive investment opportunity because there is enough demand.

The road sector, on the other hand, faces challenges such as land acquisition, shifting of utilities and environmental clearances at the execution stage. But, once you have a road up and running, it is an annuity.

You have not been too active in the renewable space. Caparo is probably the first one.

Caparo is the first one. It is not that we haven't invested in the renewable space because we don't want to. We haven't found an attractive opportunity. Valuations were stretched. There is more to come. Likewise, we are looking at some other opportunities in the renewable sector. We are not very excited about the solar sector.

Why?

We don't like to invest where the economics of the investments are dependent on Government subsidies. Unless a sector is viable without subsidies, it doesn't make sense.

But then solar is a growing sector, isn't it?

Yes, but you have seen what happened in Spain, for example. The Government subsidies can fall away any time. Germany has been a little more measured. It will not offer further subsidies.

So, at least people who have invested, will not end up suffering. The way I look at it, the Government of India has to invest a lot more in healthcare and education. Power subsidies, I think, are not the most important agenda in the overall scheme of expenses.

Typically, what kind of stake will you pick up in these projects?

In road projects, it is what we like to call “partnership stakes”. It is never majority. We have picked up 49 per cent stake in most of the SPVs for road projects. Our typical size is 20-30 per cent. A significant minority is what we would like to call it.

How much of your fund is committed?

We are about 55 per cent committed. And we can launch our next fund as soon as we have invested 75 per cent.

When do you see that happening?

It is a lumpy business, difficult to forecast. But given the current climate, hopefully, in the next six to eight months. It is going to be a replica of the existing fund.

It will raise more money for the same proposition of investing in Indian infrastructure. We haven't gone to the market and started talking about raising the fund.

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