Six years doesn’t seem like a long time. Yet, 2010 was a time of hope when businesses fuelled by debt and optimism went on an expansion spree, confident the economy had indeed rebounded from the pits of a global financial crisis.
How it all unravelled is now well-documented. The economy stalled and factories idled, and companies unable to repay debt put up their assets for sale. And those who remained prudent during the go-go years emerged from the sidelines, snapping up assets and setting their eyes on the long term.
One of them was JSW Energy Ltd, which found the time was ripe to make its move. Within a span of two years, the company snapped up three power plants with a combined capacity of 2,891 megawatts (MW) for nearly Rs16,000 crore. It also walked away from a deal where lenders refused a haircut, and managed to beat down the valuation of one deal that it concluded.
“We have made no secret of it,” JSW Energy joint managing director and chief executive Sanjay Sagar said. “Given the stress in the sector, we have got this window of opportunity. We are fortunately one of the few companies who have the balance sheet to look at inorganic growth, and we intend to capitalize on this,” he said at the group headquarters in Mumbai’s Bandra Kurla Complex.
The company has evaluated 25-30 proposals of thermal power assets in the past year and continues to look at more assets which have long-term purchase agreements, fuel supply and an assurance of at least a 15% return on equity (RoE), Sagar said.
However, if JSW executives are to be believed, acquisitions are not an end in itself. In the past six years, India’s energy market has undergone a sea change, and the rules of the game have changed.
Like many other power producers, JSW Energy in the past focused on merchant power, or the power that’s sold in the spot market without a long-term power purchase agreement or PPA. At a time of power shortage—as was the case in 2009-10—a single unit of power fetched up to Rs8, prompting many private producers to set up merchant power capacities.
But six years have indeed been a long time. Power production has soared, pushing down price of merchant power below Rs3 in 2015-16. Alongside, a policy change that permitted merchant power producers to use only expensive e-auction coal altered the economics for these companies.
It was time to change tack. PPAs, where power producers agree to supply power to state level utilities for a long period were back in fashion. And JSW Energy, which had half of its capacity linked to the short-term merchant market, is now planning to get 60% of its capacity linked to long-term PPAs, with a target of 90% in the medium term.
“That is something I was very clear in my mind as the CEO of the company. We have been making a conscious effort to switch over to acquire assets, so that this ratio of short to long changes,” Sagar said.
So, even as the company goes ahead with its plans to snap up more assets, the focus is clear: One, the asset should have enough fuel supply; two, it should come with PPAs.
“One golden rule for the plant we acquire is that it should in the long run give us the normative rate of return. The idea is not to compromise on the profitability of the company. It should have fuel, and a sale agreement for the power,” Sagar said.
JSW Group joint managing director and chief financial officer (CFO) Seshagiri Rao backs Sagar: “Strategy cannot be static. Earlier strategy of JSW Energy used to be not to enter into long-term PPAs which are at a fixed price. They had a larger portion of power produced in the form of short-term PPAs and they made a lot of money because of this. But do they continue with this strategy? No,” said Rao.
Deals, made and unmade
At a time when India’s power sector is grappling with high debt, an investment drought and weak demand, JSW Energy has set out on a capacity buying spree.
In September 2015, JSW Energy bought two hydropower projects—Baspa II and Karcham Wangtoo—from Jaiprakash Power Ventures Ltd for Rs9,275 crore—lower than the originally agreed value of Rs9,700 crore. It also acquired the Bina thermal plant from Jaiprakash Power at an enterprise value of Rs2,700 crore—lower than the Rs3,000-3,500 crore it cost to build the plant.
Earlier in May, JSW Energy agreed to buy a 1,000MW thermal power plant in Chhattisgarh from Jindal Steel and Power Ltd (JSPL) for Rs4,000 crore, valuing it at Rs4 crore per MW. Setting up a new project of similar size costs about Rs6.5 crore per MW. The deal size would rise to Rs6,500 crore if JSPL manages to secure fuel supplies and find a long-term PPA by June 2018.
JSW Energy and JSPL are led by brothers Sajjan Jindal and Naveen Jindal, respectively.
The deal was struck with a two-year window on the belief that by 2018, a revival in the sector will bring in PPAs. In the interim, JSPL received Rs500 crore as advance payment to help it meet immediate cash needs.
“They are a very stressed company (JSPL) and that was the reason why in the very first place they went in for a sale... I bring the money to the table for JSPL, I write a cheque for a very large amount of money,” Sagar said on the rationale for the deal.
“In the JSPL deal, they don’t have PPA and they don’t have fuel supply. However, that deal will fructify in two years from now, and our belief is that in two years from now, there will be enough demand in the market,” Sagar said.
Rahul Modi, an analyst at Antique Stock Broking Ltd, said the acquisitions are positive in the long run as most of the capacity acquired will have long-term power sale tie-ups and assured return on equity. “As a business strategy, from a merchant player, they are now having a domination of PPA-based sales so the surety of income and stability of earnings is there.”
Every attempt at expansion has not been successful either.
In July, a year after it had signed a non-binding agreement with Monnet Ispat and Energy to acquire Monnet Power Co. Ltd, JSW Energy dropped the plan, after the lenders rejected its demand that they take a haircut. JSW Energy received a thumbs up from its investors for calling off the deal, given Monnet Power’s projects have seen severe cost overruns because of a five-year delay.
Several analysts had cautioned that the deal would be a negative for JSW Energy.
“We received thumbs up because we did not compromise on the proposal that we had made to the lenders (of Monnet). So, we did not go in for a desperate acquisition,” Sagar said.
More to come
JSW Energy, which is currently India’s fourth largest private power producer with 4,531MW capacity, has a medium-term target of achieving 10,000MW of operational capacity. After accounting for its acquisitions, it will have about 6,000MW of capacity by 2018. Rival Adani Power Ltd wants to reach 20,000MW of capacity by 2020. Much older rival Tata Power Co. Ltd already operates above 9,000MW capacity.
“One can count with one hand and not two the number of companies that are profitable in the power sector. This is a company (JSW Energy) which followed a completely different strategy, of not taking the risk with assets that lacked PPAs and fuel. That made us withstand the problems in the power sector. Ability to raise further equity in JSW Energy is much higher compared to other companies,” group CFO Rao said.
There is headroom for more acquisitions of power assets in India and for coal mines overseas, Sagar said. “We are today sitting on a debt-to-equity ratio of 1:1.77 and we would be comfortable with 1:2.5. Having said that if after touching 2.5, if we come across a must-have asset, then we would think of breaching the 2.5 also,” he added.
The management also believes luck played a part— that JSW Energy happened to be at the right place at the right time. The fact that there are not many buyers of power assets in the market has also helped the company negotiate deals better, according to Pramod Menon, director of finance at JSW Energy.
“So far in all our deals, lenders have not taken even a Re1 hit. But those were low-hanging fruits. As we proceed, most projects are those where we would want some pain-sharing. Lenders need to make it a viable proposition,” he said.
Menon claims what has worked for JSW Energy and differentiated it from its peers is its financial prudence: Efficient allocation of capital, the ability to keep its costs per megawatt and overall built-up costs low, timely refinancing of completed projects to keep interest rates low, and a conscious effort to not leverage its balance sheet.
JSW Energy pursues an acquisition if there is a guarantee of at least a 15% RoE and if the target company lacks fuel supply or a PPA, it bargains hard, Menon said.
The company also does not believe in putting all its eggs in one basket, spreading its capacity across states. For example, the Bina plant is in Madhya Pradesh, a state JSW Energy did not earlier have exposure to. The JSPL plant, when acquired, will give it presence in Chhattisgarh and neighbouring states. The company, which already has plants near Rajasthan, Ratnagiri in Maharashtra, and Vijaynagar in Karnataka, also expanded its presence to Uttar Pradesh, Punjab and Haryana helped by its acquisition of the two Jaiprakash Power’s hydropower assets in Himachal Pradesh.
“When the environment was not conducive to organic growth, we pulled back investments. There was a period of three to four years between 2010-2014, when we decided to not make any investments and rather focus on consolidation. We worked on creating a stronger balance sheet during those years before we took a leap of faith by investing in the sector,” Menon said. “Like other projects in the sector, we also had our own share of pains, but since we had kept liquidity on the balance sheet and the lower leverage, we were able to sustain. You need to have the ability to sustain initial period of hiccups.”
Of the analysts covering the stock, 12 have a “buy” rating, 13 a “hold” rating and 4 a “sell” rating, shows Bloomberg data.
The company kept out of bidding for coal blocks on premium since it believed the process was flawed, Sagar said.
Many power assets in the market today are up for sale due to stress at their group level. Many of them set up plants at a time when the tariff expectations were high, attracting many companies which were traditionally not in the power sector. By the time they started generating power, there was a coal shortage, causing delays and cost overruns. “And a lot of people got disappointed by the power sector, people who were not primarily in the sector, but got in the sector looking at the merchant rates of Rs7-8 (per unit). They got disappointed that it was not meeting with their expectations of profitability,” Sagar said.
At a time when there are no new investments or capacity expansion in coal-fired power and the industry is looking to renewable energy, Sagar is a staunch believer in the opportunity of the thermal power sector.
Given India’s low per capita consumption of power—at 1,000 units a year compared to the world average of 3,000 units and the developed nation average of 8,000 units, he believes there is scope for adding at least 300,000MW in thermal power.
“The Western world, which is today suddenly so conscious about the ills of thermal coal, each of those countries has developed on the basis of thermal power,” Sagar said.
JSW Energy is also exploring if it can buy a coal mine overseas, purely for backward integration. It has signed an agreement for a so-called prospecting concession in a southern African nation and is hoping to find sufficient quantities of coal there to de-risk its fuel supply.
“It’s not like going and buying a shirt off the shelf. Good deals are not available internationally because it’s not just the coal, it’s also the logistics which is important. I might find a mine in Australia but it may take me a lot of money to ship it. We will buy a mine only for backward integration and securing our demand, and not for getting into coal mining business,” Sagar said.
Getting reliable long-term PPAs is easier said than done. For JSW Energy, about 30% of the acquired Bina power plant’s capacity still lacks long-term PPAs. Its Vijaynagar plant in Karnataka is waiting for the state to sign a purchase agreement.
“There are no PPAs in the market for JSW Energy,” said Anubhav Gupta, an analyst at Maybank Kim Eng Securities India Pvt. Ltd. “Within the current grids, power deficit is less than 2%. So, there is no urgent need for state electricity boards to sign new PPAs.”
“Karnataka has not finalized (the PPA) for the simple reason that there was good monsoon and demand for power was down. Demand of power in last week of July in Karnataka, which was about 130 million units a day, has already touched 200 million units in August. So, we are now hoping that they should do it sooner than later,” Sagar said.
According to an Edelweiss Securities Ltd report by analysts Manish Saxena and Santosh Hiredesai dated 26 August, power offtake across the country fell in the previous 45 days, with average short-term prices touching Rs2.16 per unit, the lowest in the past five years. “State discoms (distribution companies) have been using this opportunity to buy cheaper power and back down the expensive medium/long term power,” the analysts said.
“While JSW Energy’s plants await finalisation of PPAs to commence power supplies, delay in signing of the medium-term PPA coupled with rising coal prices could imply that current quarter earnings may be at risk,” the analysts wrote.
The surplus power situation will result in a net loss of around Rs8,000 crore this fiscal year for state power distribution companies, India Ratings and Research Pvt. Ltd said in an August report.
About 18 out of 35 states and Union territories are expected to be power surplus in FY17, as per the Central Electricity Authority’s Load Generation Balance Report 2016-17. “These discoms are likely to surrender some of the excess power they have tied up in past five to seven years, at a loss, thereby further weakening their financial position… Ind-Ra believes that there will be few invitations for bidding of long term power purchase, over the medium term,” India Ratings said.
In the past few years, power companies have been squeezed between inadequate coal supply and debt-laden utilities unwilling to buy expensive power. Most power companies are weighed down by debt, forcing some of them to sell assets. However, distribution companies have become more financially disciplined, procuring enough power for which they can pay rather than keeping dues with producers, said Menon.
Few good deals
There are enough acquisition opportunities, but deals are not translating on the ground due to gap in valuation expectations of various parties, according to Rao. “All the various stakeholders need to be aligned on the price they could get for an asset, and a sustainable price for a buyer to be interested.”
Tata Power in June agreed to acquire Welspun Renewables Energy Pvt. Ltd in a Rs9,249 crore deal. While Tata Power has maintained it continues to explore buyouts of stressed power assets, there has been no deal yet. Adani Power in 2014 acquired Lanco Infratech Ltd’s 1,200MW Udupi power plant in Karnataka in a Rs6,000 crore deal and the Korba power plant from Aantha Power and Infrastructure Ltd for Rs4,200 crore.
JSW Energy had a market capitalization of Rs12,718.63 crore as on Monday’s (26 September) close. This compares to Rs 20,501.09 crore of Tata Power and Rs9,185.01 crore of Adani Power.
Analysts do not expect either Tata Power or Adani Power to make any big-ticket acquisitions soon, given their high debt levels. As on 31 March, Tata Power had consolidated debt of Rs40,120.86 crore while Adani Power’s consolidated debt was at Rs 53,051.66 crore.
According to Gupta of Maybank, JSW Energy too, which had consolidated debt of Rs15,523.14 crore as on 31 March, is unlikely to make further acquisitions at least for the next two years as its focus would likely be on integrating the acquisitions. “JSW Energy has announced acquisitions worth around Rs100 billion already. It is critical for them to sustain PLFs (plant load factors) at existing plants even as demand for power is subdued. If demand continues to be subdued and if coal prices begin to rise, that could pressurize RoE for JSW Energy,” he said.