The lessons of Lanco Infratech

In the foyer of Lanco Infratech Ltd’s opulent Gurgaon office, there is a sculpture of a tiger wrapped in a bedroll after a hunt, wounded, or more likely dead. That sums up the state of the conglomerate which burst on to the Indian corporate landscape in the 1990s by rapidly expanding across businesses such as engineering, procurement and construction (EPC), power, solar energy, coal mining and infrastructure, but is now bogged down by the ₹ 37,526 crore debt on its balance sheet as of 31 March 2015.

Of late, the group, once known for setting up India’s first independent power project at Kondapalli in Andhra Pradesh, is making headlines for the wrong reasons: its managing director was caught in March 2007 at Hyderabad airport with about ₹ 34 lakh in allegedly unaccounted-for cash; a few months later, the firm was disqualified after winning the bid for India’s first ultra mega power project at Sasan in Madhya Pradesh on charges of misrepresentation; and for a period its employees went without salaries.

“There are two aspects. One is the ground reality of how the assets are performing and the issues with the assets. That is reality,” said L. Madhusudhan Rao, executive chairman, Lanco Infratech, adding, “the second is perception.”

“I think on the perception side, we are at rock-bottom,” Rao admitted in his first interview in two-and-a-half years.

Rao has his reasons for avoiding media interactions. Lanco Infratech reported a loss of ₹ 2,036 crore in financial year 2015 on revenue of ₹ 9,681 crore. High fuel costs and low capacity utilization increased its financial stress. The company’s market capitalization stood at ₹ 879.39 crore on 4 August, a steep fall from ₹ 18,777.19 crore on 28 December 2007.

While Rao was positive about a turnaround—“Things of this kind will come here and there but (at the) end of the day... we are a very committed organization...”—analysts were critical of the company for soaking up debt during better times.

This comes at a time when the stock markets have punished companies that soaked up debt during better times and those with wobbly fundamentals, on worries there won’t be any interest rate cuts in the near future to help prop up their fortunes.

The UPA years

One cloud that has always hung over Lanco is that it owes its initial success to political clout. Rao denies that charge. “Even if my brother is in politics, he is a first-time politician. So, I don’t think he has got anything to use as influence to get anything done.” Rao was referring to his older brother, Lagadapati Rajagopal, a former Lok Sabha member of the Congress, more famous for using pepper spray in Parliament to protest the creation of Telangana in February 2014.

Lanco, like other companies in the power sector, was hit by the slowdown in the second term of the United Progressive Alliance (UPA) government. The sector was beset by slowing economic growth, high borrowing costs, delays in securing environmental clearances and completing land acquisition as well as fuel—coal and gas—shortages.

“Lanco Infratech is one of the casualties among over-leveraged EPC companies in India. The company rode the infrastructure wave of 2007-2010 in India to reach a stock price of ₹ 74.7 (August 2010) and then fell to ₹ 4.70 (June 2015). The company is exposed to a multitude of risks, both operational as well as financial. The earnings per share fell from 2.02 in FY10 to -3.99 in FY14 and the negative EPS has also continued in all the quarters of FY15,” said Sambitosh Mohapatra, partner (power and utilities) at PricewaterhouseCoopers in India.

The problem goes beyond Lanco, Rao said.

“The basic issue is that the entire infrastructure space we are in has serious macro issues and most of the macro issues came out, I would say, sometime in October-November 2011... That was the time when, one after another, the macro surprises kept coming. And various policies kept coming out,” Rao said.

One such policy reversal that he blames for a dip in business is related to the sale of merchant power. Merchant power is sold as a commodity on the spot market and not to pre-identified customers under long-term agreements and hence fetches higher prices. It was initially allowed and promoted in 2007 and then discouraged by 2012 by the UPA government. Once those high revenues evaporated, banks, too, stopped lending to the sector. That led to a liquidity crunch which impacted both power generation companies and also state-owned distribution firms, their primary consumers.

The impact was felt across the board. According to the India Energy Exchange, an electricity bourse, the monthly average merchant power tariffs in January 2012 were at around ₹ 3 per unit, down from a high of ₹ 10.78 per unit in April 2009.

A former Indian power secretary, requesting anonymity, confirmed that the change in the merchant power policy had an impact on many private generation firms, including Lanco.

State electricity board distress

It’s been a vicious cycle for the sector. State electricity boards (SEBs) initially purchased the expensive merchant power from Lanco and others. Owing to political pressures, they then sold the power to customers at low rates, instead of the market rate they bought it at. After several years of such poor practices, their finances are a mess, banks have pulled back from lending to them and SEBs are saddled with a cumulative debt of ₹ 3.04 trillion and losses of ₹ 2.52 trillion to date. For the financial year ended March, various cash-strapped SEBs owed Lanco ₹ 2,626 crore, and there are no power buyers in sight.

“Now, when projects are ready to produce, people don’t want to buy... People started reading the lines of the contracts (power purchase agreements or PPAs). People want to see the PPAs—commas, full-stops, etc,” Rao said. Four of the five agreements that Lanco signed with different SEBs went into litigation.

“State-owned distribution companies calling for PPAs have been slow and sluggish. This obviously spelt trouble for some generating companies who may have gone for overkill,” said Anil Razdan, a former power secretary during whose watch Lanco’s bid for the Sasan ultra mega power project was cancelled.

“The major issue here is the sector itself is in difficulty. And these are all large capital plays. And what is happening today, I don’t think is unique to Lanco. I think it affects almost 90% of the players,” said Rao.

True enough. About 14,305 megawatts (MW) of gas-fuelled power projects, or more than half the installed capacity of 24,150MW, does not have access to domestic supply of gas. The rest work at a low plant load factor—a measure of average capacity utilization—due to limited domestic gas supply.

“We have an unprecedented situation with respect to power projects that are completed but stalled or being partially used due to lack of long-term contracts and depressed short-term rates. There are projects that have contracts and access to fuel but are stuck for transmission corridors,” said Debasish Mishra, senior director, consulting, Deloitte Touche Tohmatsu India Pvt. Ltd.

“It’s a learning for the country,” Rao said.

Survival strategy

In an attempt to pare its debt, Lanco Infratech has sold some of its assets to billionaire entrepreneur Gautam Adani and Hyderabad-based Greenko Energies Pvt. Ltd. Among them are the 1200MW Udupi power project, 70MW Budhil hydropower project and two smaller plants of 5MW each. It raised ₹ 6,300 crore from the Udupi sale and €77 million from Greenko. The sales came in the wake of a corporate debt restructuring agreement that the company entered into with its creditors.

More sales could be on the cards, including that of a 35MW solar project in Gujarat. The company is currently looking for a buyer.

“Asset sales will happen once we complete the projects,” Rao said, adding that the company was evaluating its existing portfolio “but is yet to take a call” on what will be put on the block.

The sales apart, Lanco is hopeful of a revival in the Indian power sector, given the National Democratic Alliance government’s promise to supply 24-hour power to all households in a chronically power-short country. Around 280 million Indians lack access to electricity in a country where per capita electricity consumption is one-fourth the global average.

“We believe there is a tremendous opportunity in the country, especially under the current leadership. It may not happen now because of so many issues but it will happen, probably 24 months from today. We are getting the organization ready for that opportunity,” Rao said.

That includes completing projects under construction—3,960MW of coal-based power plants.

The government, too, is stepping in and offering liquefied natural gas to gas-based power plants at subsidized rates as part of a bailout package for the sector.

The perception problem persists.

R.S. Sharma, former chairman and managing director of state-owned NTPC Ltd, said, “Any company which creates an asset should be able to run it. If you create an asset and decide to sell it, then there are some fundamental issues. While they (Lanco) are better at project execution, from the asset management point of view, their capability to retain employees is on the lower side.”

Lanco has slashed its employee strength from a high of 7,000 employees in 2011 to around 4,000 now.

“Long-term survival then becomes a challenge in the absence of talented employees. Any business shouldn’t lay off employees. Business is a cycle. This is the worst strategy for any organization,” said Sharma, who was also the managing director of Jindal Power Ltd.

Analysts aren’t convinced either. “The company has received initial support from lenders towards cost escalation in three under-construction thermal power projects... However, securing the balance PPAs will be critical for these projects,” Edelweiss Securities Ltd wrote in a 30 May report.

In what sums up Lanco’s future strategy of caution, Rao, who ushered in the era of low tariff bids by quoting ₹ 1.19 per unit for the Sasan project in 2006 that Lanco won before it was revoked, admitted, “Today, regulated tariff is the best tariff because there is no risk in that.”

“It’s good we didn’t get Sasan,” Rao said, adding that he wouldn’t be quoting anything less than ₹ 2.50 as his fixed cost, in comparison with the 90 paise fixed cost per unit quoted for Sasan.

The years seem to have taken their toll.

This is the third in a series that looks at four infrastructure companies weighed down by debt that they are struggling to repay.