Finding the right balance

Hans-Martin Aerts and Jayesh Desai, senior infrastructure specialists from APG Asset Management and Piramal Enterprises Ltd respectively, speak exclusively to Infrastructure Investor about their mezzanine partnership in India.

As enthusiasm for India’s infrastructure investment opportunities gains momentum across the globe, APG Asset Management and diversified company Piramal Enterprises Ltd have responded to India’s invitation to cross-border partnerships to partake in its ambitious growth strategy. Hans-Martin Aerts, head of the structured finance group at APG, and Jayesh Desai, co-head of the structured investment group (SIG) at Piramal Enterprises, discuss the opportunities and threats of rising to the challenge.

Q: You have launched a $1 billion platform to focus on private mezzanine investment in infrastructure companies in India. The investees will be infrastructure companies in India, but not necessarily India-based?

Desai: The investment strategy of the alliance will be to target its funding so that it is directed to Indian assets. So, the investee company may be located outside, subject to regulatory considerations.

Q: Why are you choosing mezzanine investment and what are the advantages and disadvantages inherent to this type of investment model?
Aerts: There is currently a mismatch between demand and supply of capital in India which provides a window of opportunity to make mezzanine investments in Indian infrastructure. Promoters have been awarded new projects and are looking for capital to fund these projects. Indian banks are currently facing some sector lending constraints which prevent significant growth in lending commitments to the sector. In addition, the corporate bond market in India is still in its early stage of development, further limiting the sources of capital available for the infrastructure sector.

Finally, valuation mismatches exist and promoters are generally not willing to dilute their stake and give up control. As such, mezzanine capital satisfies a market need by providing long-term stable capital while meeting the needs of promoters (in terms of not diluting equity). Hence, we believe the investment strategy of the platform is well suited for the current market circumstances.

The strategy of the alliance to focus on mezzanine investments in infrastructure projects in India ticks the right boxes for the pension fund clients of APG in terms of risk-return profile and high cash flow visibility. The mezzanine investment strategy limits the upside on investments, but we think mezzanine investments are well suited from a risk-return perspective.

Q: Returns for mezzanine investments average around 20 to 30 percent. Is that what you have in mind?

Desai: The expected return for the investments to be made through this alliance is 18 percent plus the return coming from an equity kicker, and would depend upon the risk profile of each investment.

Q: How much appetite is there from pensions and other institutional investors such as insurers in infrastructure in India? We see a lot of appetite in Europe (and other parts of the world) from pensions/insurers etc. for both direct investments and fund/platform investments. Is it the same in India?

Desai: Led by government efforts to improve the regulatory and policy framework for the infrastructure sector, we are seeing increasing interest from global institutional investors to look at investing in the infrastructure sector in India. Most of this interest is seeking exposure to brownfield or operating assets as global investors are still wary of greenfield risk in India. However, current regulations hamper Indian insurers / pension funds from making substantial direct investments as they are required by regulations to invest in high credit-rated instruments.

Aerts: APG is one of the few global institutional investors that have been investing in private infrastructure in India for a long time already. It views India as an attractive investment destination for long-term investors seeking to enhance the overall risk-adjusted return of their investment portfolio.

Q: Infrastructure mezzanine is a growing asset class – do you envisage much growth in infrastructure investment in India, and why? Will there be much of a role for bank lending going forward, or will this type of arrangement take the lead?

Desai: The domestic banks have traditionally been the source of senior debt provision, but the government is looking to introduce domestic pension and insurance companies, overseas financings, infrastructure bonds, infrastructure debt funds and/or government sponsored infrastructure financing companies to provide relief to the capital-constrained infrastructure sector.

The domestic banking industry is the most significant source of capital for India’s infrastructure sector and it is expected to continue being so. However, in order to provide some relief to the banks, the Indian government and the Reserve Bank of India are actively looking to introduce other sources of debt capital which will help to improve the current situation.

Q: How involved do you intend to be in investee companies’ management?

Desai: The alliance will have all significant protective rights to ensure due compliance of investment terms. This would include typical private equity investor rights such as board seats, affirmative rights on major decisions, debt covenants. In short, we will have strong governance rights to exercise adequate influence over our investments.

Q: Does your strategy reflect confidence from investors in the profitability of infrastructure in India in general, or in specific sectors only?

Desai: The alliance is sector-neutral within the infrastructure sector. However, the strategy is to do investments that have mitigated regulatory and policy risks.

Q: Has the strategic alliance defined preferred allocations with regard to infrastructure types and how likely is it that those will evolve significantly in the next decade?

Aerts: We will focus on operational and near-completion projects with limited execution risks and high visibility of cash flows.

Q: The platform is commencing with initial commitments of $750 million on a 50/50 basis from the two parties. There seems to be a trend in Europe and the US to create platforms of a similar size. Any particular reason why?

Aerts: Investors are putting a great deal of effort and time into selecting the right partners and forming long-term relationships. In the selection of a partner, alignment, requisite expertise and industry knowledge to add value through active ownership are important considerations.

Platforms allow investors to stay in control over capital allocation and to secure stronger governance rights. Working together with a small number of like-minded parties significantly increases the alignment of interests, which ultimately is expected to lead to better returns.

Q: Which of Modi’s promises have convinced you to step in and invest in India’s infrastructure?

Desai: The BJP government has a business friendly and pro-development charter. In its election manifesto, BJP has promised to introduce measures to support infrastructure, urbanisation and manufacturing to help revive the investment cycle. The political power change is expected to give a significant push to India’s economic growth, which benefits capital-intensive sectors such as infrastructure.