Mumbai: After investing $1.15 billion (around Rs 5,300 crore today) in the power sector last year, private equity, or PE, firms have become cautious as the returns estimated have declined by 2.5-3 percentage points, experts said.
Uncertainty over coal linkages, land acquisition and environmental clearance has made investors wary.
“These challenges have only increased and the situation has become tougher,” said Satish Mandhana, managing partner, IDFC Private Equity Co. Ltd, one of the largest infrastructure funds with $1.3 billion under management.
In the first eight months of 2011, there have been deals worth $671 million in the sector, roughly half that of last year, according to data from VCCEdge, a financial research platform.
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In 2010, power accounted for more than 50% of all investments in infrastructure.
“Today, PE firms have become selective on power investments, given the significant uncertainties relating to execution of power projects— coal, clearances, land acquisition, power purchase agreements signed based on historical costs,” said Bhavik Damodar, executive director, transaction services, KPMG India Pvt. Ltd.
The strategy of global funds of taking more greenfield risks may not necessarily give expected returns, investors said.
Global infrastructure funds have a mandate to invest in so-called yield projects that are already operating and have steady cash flows, translating into lower risk and returns.
However, many funds have invested in greenfield projects that have higher risk, similar to growth equity deals.
“Many firms that have invested in power generating companies were not fully aware of the risks or the fact it will take time to overcome the challenges,” Mandhana of IDFC said. “They were not factored in when the whole euphoria to invest in power took over. The challenges have only increased.”
According to a February report by Preqin Ltd, a London-based research firm, of all unlisted infrastructure funds targeting a single country within the emerging markets, the highest proportion is focused on India. There are currently 38 unlisted infrastructure funds with a preference for investment in India, 25 of which have already held a final close raising $9.5 billion.
“New project announcements have come down and capacity expansion plans have slowed. As a result, valuations in the sector have sobered,” said Karthik Ranganathan, head, investments, alternate energy and engineering service, Baring Private Equity Partners India Ltd.
According to Damodar of KPMG, some funded projects which are under development have either been delayed or have experienced cost overruns and investors have not been able to realize value as planned. “It will be interesting to see how non-infrastructure funds, which have invested in the power sector, will structure exits and returns on power assets,” he said.
Typical PE investors expect a 20-25% net internal rate of return but pure infrastructure funds would have lower hurdle rates, given the large gestation period of such investments and the steady cashflows associated with such assets.
Some of the big deals that took place last year include a $425 million investment in Asian Genco Pte Ltd by a consortium of General Atlantic Llc, Goldman Sachs Investment Management, Norwest Venture Partners India, Everstone Capital Management, Morgan Stanley Infrastructure Partners and PTC India Financial Services Ltd; $326 million invested in GVK Energy Ltd by a consortium of 3i India Infrastructure Fund, Actis LLP, GIC Special Investments Pte Ltd.
According to Ashish Sonal, founder and chief executive of Orkash Services Pvt. Ltd, a risk advisory firm, there has been a correction in the returns as local capital has also become costly, with the increase in interest rates.
The Reserve Bank of India (RBI) has raised its key policy rate 11 times since March 2010, from 3.25% to 8%, to fight persistently high inflation in the world’s second fastest growing major economy.
Even the pace of bank lending to the sector has declined from 49.5% between July 2009 and June 2010 to 34.5% in the July-June period in 2010-2011, according to RBI data.
Indian banks are at an increased risk of defaults on loans to companies linked to the power sector, as mounting losses in state electricity boards and delays in execution of new power plants have made recovery difficult, analysts said.
In a research note on the bank exposure to the sector in June, Emkay Global Financial Services Ltd analysts Kashyap Jhaveri and Pradeep Agrawal said it had been a key driver of bank credit in the last two years. “However, with significant rise in the losses of state electricity boards (SEBs), we believe that the risks of NPAs (non-performing assets) or probability of restructuring the loans from the power sector exposure are rising,” they said. “The risks of NPAs or restructuring can come not only from direct exposure to SEBs but also from the fact that the health of merchant power producers depends upon the health of these SEBs.”
Investors can still make returns if risks are mitigated.
“In order to mitigate these risks, we look to back projects which have fuel and geographic diversification,” said Mandhana of IDFC.
Deals India, published jointly by Mint, Dow Jones Newswires and The Wall Street Journal, is a one-stop destination for investment professionals following deal flow, deals news, private equity and venture capital activity in India.
Graphic by Yogesh Kumar/Mint