For at least three years now, Private Equity (PE) funds’ PR challenges in the Western world, about supposedly excessive rewards for the partners in such funds, have been repeated ad nauseam. In India, there isn’t as much press coverage of these funds, partly because they keep to themselves and partly because they simply aren’t as big here as they are in the Western world. However, tucked away in serviced offices in five-star hotels, PE funds are wrestling with a major challenge – how to invest successfully in Indian infrastructure.
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Given that even the Government has said that India needs $150 billion of private sector capital to finance the country’s infrastructure build over a five-year period, the per annum requirement is $30 billion. Applying a standard 70:30 debt to equity ratio means that around $10 billion of private sector equity capital is required for investment in Indian infrastructure every year. However, when we look at fresh infrastructure capital raised on the stock market this year (around $3-4 billion) and add to that new infrastructure raised by PE funds this year (around $1bn), we reach a figure of $4-5 billion, well short of the $10 billion private sector equity capital requirement.
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As is evident from this calculation, stock market investors are ultra keen to put money into infrastructure companies. They have bought into the infra story wholeheartedly. The people who seem to have lost interest in Indian infra are the global super-rich, endowment and pension funds in the Western world. Their reluctance means that private equity funds (often backed by these mighty sponsors) in India are having a very hard time raising money for infrastructure funds.
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So, why are these well-informed, experienced, well-heeled investors in Europe, America, Japan and the Middle East shying away from Indian Infrastructure funds? And should you, like them, throttle back on your exposure in Indian infrastructure stocks?
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My discussions over the past fortnight with half a dozen PE industry insiders suggest that the global super-rich have lost interest in Indian infrastructure because:-
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A. Our Government perpetually promises reform which never arrives. The latest example of this is our highway minister’s global roadshow which generated a lot of press publicity but very little by way of substantial reform. “Global investors are tired of visiting Mumbai and seeing the same gutted roads and slums year after year. They see Chinese cities like Shanghai surging ahead and they know which horse to back,” said an Indian fund of funds manager.
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B. “India can’t finance infrastructure without a long-term debt market. Without such a bond market, projects are left at the mercy of Indian banks who do not lend for more than seven years and even these loans come at punishing interest rates in the mid-teens,” said another local PE fund manager.
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C. A rapacious political-beauracratic system can extract rents from every layer of an infrastructure project because these projects need so many Governmental sign-offs. This rent extraction generates the double whammy – it erodes the cash returns of the project (because the cash goes into the wrong pockets) and it increases the risk profile and hence the return required by investors to invest in such projects.
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Thanks to this cocktail of problems, a PE fund manager working in one of best known infrastructure funds told me that “while publicly we run around trying to raise PE capital to invest in Indian infrastructure, privately we have given up trying to compete with a roaring stock market which simply does not price in any of the risks that Indian infrastructure projects face.”
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So, is the stock market wrong to be so enthusiastic about Indian infra stocks? I think so. And while no analyst from a reputed brokerage will go on record saying this (for fear of losing fund-raising mandates from infra companies), I think investors need to use their common sense before piling into power companies which are priced at 3-4x book value without having ever generated a single megawatt of power.
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Investors need to look at the consolidated FY09 balance sheets of these infra companies and note just how much capital is being sucked off these Balance Sheets to “unknown” third parties who might never return that capital. Investors need to question whether promoters, who whack out QIPs every 18 months, are worth backing. India will not be built in a year or even in a decade. So, just as global super-rich are doing, stock market investors need to wait for the Indian infra bubble to dissipate before backing the Indian infra story.