Q: How has the infrastructure investment landscape evolved over the past two decades?
MS: There are very distinct phases in the evolution of private infrastructure investment in India. Between 1993-98 we had a period where, conceptually, infrastructure was opened up to private participation. There was a lot of initial interest from private and foreign infrastructure developers but that faded away quickly due to lack of comfort with the regulatory and policy framework and lack of long-term domestic financing. All the foreign developers came and they bid, but the bids were all subsequently cancelled or had to be modified. So, I see that as a period of opening up to the private sector.
Then there was a period between 1997-03 which, I would say, was the most critical period, because that is when the policy and regulatory framework was conceived, ensuring a level playing field for private sector investment in infrastructure. Independent regulators were set up, concession agreements were framed, policies were drafted and amended.
That set the stage for 2003-08, a period of very frenzied activity from the private sector. During this period, I would say all stakeholders were very enthused and ignored some of the risk. It was almost an irrational exuberance. I think close to 50 percent of investment in infrastructure came from the private sector, largely in thermal power and roads. Banks also lent money without considering the risks, and there were EPCs that came into the infrastructure development space but did not have the holding power.
Then in 2008-13, we entered a period of reflection, where all the implementation issues came to the fore. In the roads sector, we figured that the National Highways Authority of India was really not equipped to deal with the administration of concession agreements. Elsewhere, there were also coal block cancellations, spectrum cancellations…
A lot of the flaws in the concessioning, regulatory policy framework came to the fore. EPC players were struggling because they had grown on the back of leverage and they weren’t able to raise more capital to correct the leverage. The banks obviously suffered as a consequence of both the flawed implementation of the concession agreements and weak sponsors.
Since then, we have seen a period of consolidation, with the market gravitating towards its natural form, where banks will be more disciplined about lending; the government has corrected a lot of the flaws with concession agreements; the EPC players will limit themselves to EPC; the long-term asset owners will now be the owners of these assets. As such, I am now optimistic that private sector participation will reach 2003-08 levels.
Q: Do you think India has seen as much foreign capital coming in as it should have?
MS: Quite honestly, no. We’ve seen a lot of capital come into other sectors, but not infrastructure. Direct investors in infrastructure are looking for a very classical investment case, where all the risks are appropriately allocated, there is clarity of policy and there is proper contract enforcement. Unless investors know that contracts will be enforced and in a timely fashion, it’s going to be hard to attract investment because contracts are meant to protect your investment over 20 to 25 years, so investors need to be comfortable. Long-term investors will come in only if there’s comfort around contract enforcement, which is an elephant in the room. And the government needs to ensure that there are no retrospective changes to policy.
Q: IDFC Alternatives is the only infrastructure fund manager to have raised a second India-focused fund. In your view, what has worked for the firm?
MS: What worked for us is being disciplined about investing. During the first phase I talked about, a lot of the EPC contractors got into the game and were all looking to flip into the IPO market, and a lot of infrastructure investors basically invested in opportunities that were ‘discount-to-IPO’, without paying a lot of attention to the underlying quality of the investment. We didn’t invest in discount-to-IPO opportunities, because that involves market risk and not asset risk. We were focused on investing at the asset level, closer to cashflows.
We made some mistakes in the first fund, but that was a function of the market opportunity at that time—we were compelled into under-construction opportunities and minority equity positions. Now with minority equity positions at the asset level, exits become a bit of a challenge and with under-construction assets, we had land acquisition issues, coal block cancellation issues, environmental permit issues, which delayed us.
The good news is that, since we picked the right assets, we have the best track record in terms of exits. It’s been difficult, and it’s been a long, arduous negotiation for the exits, but we’ve returned 80 percent of the fund and we will get to about a 1.3 times TVPI, so we will be the only fund of that vintage that will not only return the money but also earn a return.
We changed our strategy completely for our second fund, and we’ve invested only in controlling stakes. We own, operate and control our assets and we’ve invested only in operating assets. We’ve executed on a roll-up strategy for the roads, renewables, freight terminal and telecoms tower sectors – and in these, we have not gone after the big deals. We’ve bought relatively small assets and then aggregated them into four platforms, which are valued at about $1.25 billion.
Q: Everyone looking at India speaks of renewables. But what about conventional power? Are there still opportunities in that space?
MS: I think everyone globally has effectively written off thermal power for multiple reasons – some have written it off because of environmental issues and climate costs; others are betting on renewables taking over because of costs (including storage) coming down. But I think, if growth picks up in India, we will be back to base-load, coal-fired thermal power plants. If we again start hitting the 8-9 percent growth rates that we had seen earlier, and if the capital cycle revives, then the demand for base-load power will go up and I don’t think storage costs are compelling yet for renewables to take over base-load power.
And what we are seeing, quite honestly, is a frenzy in the renewables sector in India. We will meet the capacity targets that we’ve set for renewable power, but we will have a situation where a lot of projects will be ‘all dressed up with nowhere to go’, because of inadequate transmission. I think everybody is ignoring that transmission projects have a longer lead time – you can set up renewable capacity very quickly and at a low cost, but if the transmission infrastructure does not keep up pace, we will have a lot of damaged renewable projects.Q: What are some of the other opportunities?
MS: I am also quite optimistic about roads. I think roads will continue to be an opportunity, but more through the Toll-Operate-Transfer framework, rather than greenfield. Distressed thermal power is a huge investment opportunity as well. And so are airports: we have seen an incredible 20 percent passenger growth annually so there will be opportunities there.
Transmission and distribution in the electricity sector is a huge opportunity, like I said, for renewables to be supported. Another is port capacity – at some point in time we will start hitting a constraint there, and we have smaller opportunities like riverside freight terminals or rail freight terminals, which can be aggregated into large opportunities. Another opportunity is the upgrade of railway stations and bus stands.
Q: Where is the most work still to be done in terms of facilitating private investment in the infrastructure sector?
MS: I think inspiring confidence in long-term investors that India is a country in which contracts can be enforced in a timely manner. In my view, that is the single biggest confidence-building measure.
India is the largest infrastructure investment opportunity in the world right now. If only we can give comfort that contracts will not be changed retrospectively, then we will attract a lot of capital.
Of course, sometimes there may be a political need to reopen contracts. The private sector should understand that infrastructure, at the end of the day, has strong public interest attached to it. But, likewise, government should understand that the private sector is investing for profit. There has to be mutual understanding, and both parties have to be flexible, so that government can, in the short term, meet its political objectives, but, in the long term, assure private investors get a certain minimum base return.