Mumbai: Infrastructure is set to be one of the biggest gainers of private equity (PE) investments in India in 2011, with fund managers expecting investment in the sector to grow at 25-50% over the next 6-12 months, according to a report by consulting firm Bain and Co.
Since 2006, annual PE investment in infrastructure has grown fourfold, from about $1 billion (Rs4,450 crore today) to $4 billion in 2010.
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Investment in infrastructure in India is growth investment with the majority of assets still being built or in the greenfield stage, unlike developed markets, where the assets are already operational and generate a steady income.
As a result, PE fund managers in this sector will prefer investing in the holding company or construction company level rather than the special purpose vehicle (SPV). Stand-alone SPVs have limited investor appeal because they are self-liquidating at the end of the public-private partnership concession period and, thus, offer no economies of scale or scope, according to Indian Private Equity Report 2011.
When asked in Bain’s survey of 50 PE investors whether they would be inclined to make infrastructure investments using asset SPVs alone, most respondents answered in the negative.
Gautam Bhandari, managing director of Morgan Stanley Infrastructure Partners (MSIP), which has $4 billion under management, explained the rationale. “We like to invest at the same level as the entrepreneur. This ensures that we always see eye to eye on the business,” he said. “Investing at the corporate level does have the added advantage of easier exits and liquidity.”
In 2010, MSIP and a group of other investors put $425 million in Asian Genco Pte Ltd, which was the biggest investment in the sector in 2010.
Since 2006, PE funds have invested approximately $13 billion, equivalent to one-fourth of the total capital flows to India, in the infrastructure sector. Over the past three years, the power sector has attracted the most interest from PE investors, increasing to 45% of total PE infrastructure investment between 2008 and 2010. Telecom infrastructure has become the next biggest target for PE investment, attracting $1.9 billion over the same period, said the report.
Investors expect the deal size to get bigger too because of industry consolidation, the growing size and complexity of projects, larger fund sizes, and investors’ plans to participate in more deals that result in their gaining majority control. Fifty percent expect average deal size to exceed $50 million.
Limited partners (LPs), investors in the PE funds, are also increasingly looking to exercise the co-investment option where they invoke the right to invest along with the fund manager they have invested in. In December 2010, Siguler Guff India Advisers Pvt. Ltd, an LP of Baring Private Equity Partners (India) Ltd, co-invested along with the PE fund in Cethar Vessels Ltd in a deal worth $90 million.
According to Suman Saha, head of the $300 million infrastructure fund being raised by Kotak Investment Advisors Ltd, the co-investment option was always there, but it’s only now that LPs are looking to exercise this as investors perceive the Indian infrastructure market to be a growth area. The focus is on higher returns than other markets. The Kotak fund is being raised in partnership with Japan’s largest bank Sumitomo Mitsui Banking Corp. and Canada-based asset management firm Brookfield Asset Management Inc.
Political, environmental and regulatory risks were rated the highest for infrastructure investment, according to the respondents. Asset financing risk is inherent, points out Saha, because a majority of the funding is greenfield project financing where investors have a minority stake. “We don’t have control over the destiny of the project,” says Saha.
While India’s talent pool has developed and matured over the years, the process bottlenecks remain, feel investors. “Some sectors have made more progress than others in this area. However, there have been cases where clearances were revoked and had to be redone,” explains Bhandari of MSIP. Such uncertainty increases risk and, hence, the eventual cost to the public in public-private partnership programmes. “This is a critical area where real progress will have to be made in order for the government to attract private capital and succeed in its next five-year Plan,” he adds.
Another reason prompting investments in the sector is the many exits in the pipeline. Exits from infrastructure investments in 2010 totalled approximately $1.3 billion spread over some 21 holdings, the most in the last five years. There are plenty more exits in the PE pipeline. More than one-third of the 28 deals made in 2004 and 2005 have not yet seen exits, says the report. In fact, about 100 deals made between 2004 and 2007 remain in PE portfolios.