Smart money goes green

EARLY 2009. Satish Mandhana, a senior partner at Infrastructure Development Finance Company’s private equity fund, is sitting with a team from Green Infra, a New Delhi-based, less-than-a-year old, clean energy producer. “At worst, we won’t succeed,” Mandhana tells them, referring to the prospect of an ambitious buyout.

Green Infra was debating the idea of acquiring BP Energy India, a 100 megawatt (MW) wind energy subsidiary of BP. The London-based energy giant was in a hurry to exit the business here to focus on the U.S. Its wind farms in Maharashtra and Karnataka had the ideal wind speed. And it had world-class machinery—the farms were less than two years old.

Mandhana’s proposition to Green Infra: Take it as a first-hand exercise in mergers and acquisitions. He had chanced upon the BP opportunity in conversations with people in the business and immediately sensed that its acquisition, through Green Infra would boost IDFC’s clean-tech business in India. A year earlier, in April, the financial institution’s PE arm had funded 100% (Rs 440 crore) of Green Infra, seeding the idea of what might become India’s largest independent power producer in clean energy by 2015.

But Mandhana was also aware that Green Infra alone was no match if BP decided to call for bids. There were signs that Anil Ambani’s Reliance Power, PE firm Actis, and Tata Power were interested in the assets. He needed to use the network he had cultivated in London since the ’90s to contact BP directly. The 51-year-old was the first Indian to occupy a senior position at the Commonwealth Development Corp. (now CDC Group), the British government-owned development finance institution, in 1996.

In fact, Mandhana had then suggested that CDC become a founding shareholder in what would be IDFC. He wanted IDFC to take the lead in India’s still-nascent infrastructure development. A CDC investment committee member in London had asked what this could achieve: “Why will Indians pay for infrastructure, when they expect the government to do it for them?” Convinced of India’s private infrastructure future, Mandhana showed the member a photograph of a local train in Mumbai, bulging with commuters. “These people are emotionally connected to the train,” he replied. “They will pay for better infrastructure if it is done right.” IDFC was born in 1997, and the CDC experience gave Mandhana profound influence in both the financial institutions, and helped expand his network. Moreover, during his CDC days, he had interacted with BP extensively.

Now, Mandhana reached out to BP’s global M&A team directly. He positioned Green Infra as a company exclusively into clean energy and wholly-owned by IDFC PE. The hard sell worked, but BP wanted to close the deal by March 2009, before the financial year ended.

Green Infra offered to sign the papers before March, but make the payout of Rs 462.20 crore a few months later. It sought the time to sort out regulatory approvals and permission. BP took the bait. For Green Infra it was a big step, and an even bigger one for IDFC PE. Mandhana had first invested in clean tech in 2007 when he had put in $100 million as part of a consortium in Moser Baer Solar, and $9 million in Doshion, a water management company. But Green Infra was owned entirely by IDFC PE.

The most productive season for wind energy in India is April to July, which Mandhana knew could help recover most of his investment quickly. Green Infra recouped its investments in BP Energy India by September. “If the season had turned out to be bad, the losses would have been ours because of the deal structure,” says Sunil Jain, chief operating officer.

Green Infra now has an ambitious target to achieve 5 gigawatt (GW) of capacity in the next three years. (On average, an Indian clean-tech producer’s target for the period is 1 GW.) It is ambitious since its current capacity includes just 230 MW of wind and 10 MW of solar, built in the last four years.

MANDHANA, NOW HEADING IDFC PE as managing partner, relishes the BP move. “It was a smart step that gave better returns on equity.” He is also emerging as an evangelist of clean energy. At the multistorey Naman Chambers in Bandra-Kurla Complex, Mumbai, from where Mandhana operates, signboards instruct passersby to use stairs to lower the company’s carbon footprint (or, save energy used by the elevator).

IDFC PE is today India’s largest private equity investor in clean energy with a kitty of more than $300 million—almost a quarter of its overall $1.3 billion (Rs 5,700 crore) corpus. It has bet on solar (Moser Baer), clean-development advisory (Emergent Ventures), wind (Green Infra and Suzlon, which bought out the IDFC PE stake in SE Forge in 2010), and waste-water treatment (Doshion). The bulk of the fund, however, is in oil and gas, power, transportation, and urban infrastructure. But whenever he gets an opportunity, Mandhana bridges the two broad sets of investments. He convinced Doshion’s managing director Ashit D. Doshi to bag a water treatment and management contract worth Rs 250 crore at the newly-built Indira Gandhi International Airport, New Delhi. IDFC PE has a stake in GMR Infrastructure, which built the airport.

“Clean technologies and the culture of saving energy will become as ubiquitous in a decade as smartphones are today,” says Mandhana. That is when, he thinks, IDFC PE’s clean energy investments will bear fruit. But perhaps because he is a money man, Mandhana believes that for the green way to become sustainable, entrepreneurs need to evaluate opportunities in business terms, and not just from some do-good notion of making the world a better place. “The environmental sustainability of a project should not distract investors or managers from its economics,” he says, adding that the focus has to be on the quality of the green asset and capital. For him, green investments are no different from infrastructure investments: in both, returns come over time.

Mandhana’s philosophy is echoed by Green Infra as well. “Pacing growth and diversifying across fuel types such as solar, wind, bio-mass, and small hydroelectric projects (a conventional infrastructure) is crucial,” says Shivanand Nimbargi, MD and CEO of Green Infra. His strategy factors in cost, location, efficiency levels, and the gestation period of each source. After all, the economics are often stacked against green. A solar plant costs about Rs 10 crore per MW to install. Its actual energy yield is just over 20% of maximum output. A small hydroelectric plant costs Rs 3 crore to Rs 4 crore per MW to install with yields of 60% to 80% of its maximum output, though it takes more time to build than a solar plant.

BETWEEN 2007 AND 2011, PE and venture capital (VC) funds infused nearly $3 billion in clean energy here. In just 2008, nearly $1 billion was pumped in (mostly in wind), until the global meltdown marred the show.

Green investors made their strongest comeback last year with $709 million in funding, partly heartened by how renewable energy prices were stabilising, even as coal-based and hydroelectric energy were becoming more expensive. “Conventional energy sources are very intensive in the use of environmental resources, including water,” says Vijay Kelkar, economist and former chairman of IDFC PE. “The days of cheap energy are over.”

Clean technologies have also found applications in areas where electricity was never available. According to the International Finance Corporation (IFC), a venture and project funding arm of the World Bank, over 400 million people in India live without modern lighting and power because they fall outside the power-transmission grid. Around 75 million of them spend $2.2 billion each year to power up on kerosene. Clean-tech products can replace kerosene for this large and diverse customer base, though subsidies are a challenge.

Today, every investor and entrepreneur is waking up to what Mandhana saw five years ago: build or mould a business model that can be monetised, and can reduce carbon emissions. Then execute. The benefit to the environment will follow. That’s what players such as Hyderabad-based Greenko Group and Mytrah Energy are doing to breach the 1 GW capacity by 2015. These are listed abroad, but the focus is on India.

This creates a happy ecosystem. When regulations to lower carbon emissions are strictly enforced, large local conglomerates could take over renewable-energy projects, giving investors an exit. “Large Indian businesses interested in growing captive capabilities could become buyers of renewable energy,” says Pravan Malhotra, head of clean technology investments, IFC Climate Business Group. For instance, in April 2011, the Aditya Birla Group acquired Swedish bio-refinery firm Domsjö Fabriker for $340 million. Chairman Kumar Mangalam Birla acknowledged its environment-friendly technology as much as its state-of-the-art bio-refinery. Clean-tech analysts noted that the conglomerate now had access to a variety of renewable sources it lacked exposure to. Such deals may now happen in India.

However, firms such as IDFC and IFC operate in an environment that’s highly regulated. For instance, d.light design, a Delhi-based manufacturer of solar lamps has had more success in Africa where there are no subsidies on kerosene. This, despite proactive government policies here such as the National Solar Mission that aims to set up 20 GW of capacity within the next decade.

Then, energy and water resources are tied to contracts with, and payments from, the government. In water-recycling or solid waste management, it means transacting with municipal corporations and various state agencies. “The entrepreneur has to think of business goals such as developing and commercialising a product, while achieving government goals,” says Sandeep Singhal, co-founder of Nexus Venture Partners, a Mumbai-based VC firm that has invested in four clean-tech ventures, including d.light.

Finally, there is the hassle of getting land, which is the key to building scale. First-generation entrepreneur Hemant Kohli attempted a venture in small hydroelectric and solar energy in early 2010. It was frustrating for his team to get land approvals and environmental clearances, and he eventually chose to create e-commerce portal BookAdda instead. Kohli, renowned as the co-founder and CEO of IT&T (which iGate bought out in 2003), says his startup could have harnessed alliances with solar panel manufacturers.

Mandhana, however, senses that IDFC PE has a competitive advantage over the rest in navigating regulation. The IDFC platform, as well as his team’s experience and knowledge of regulation, have helped it develop better policy insights and take better regulatory calls.

One such is a gas pipeline company that IDFC PE invested in when Luis Miranda was its CEO. GAIL, a Government of India undertaking, and Gujarat State Petronet (GSPL; a potential IDFC PE investment) were in a court battle over laying a cross-country pipeline. GAIL felt it had the exclusive right to lay the pipeline, and wanted the Gujarat government to stop GSPL from doing so.

“The issue was: Should we go ahead and invest, or wait till the Supreme Court judgment because it could be against GSPL?” Mandhana recalls. The court ruled in favour of GAIL by interpreting the Gas Act, but IDFC PE still invested Rs 90 crore in GSPL in late 2004.

As it turned out, the legislation itself was changed later, and IDFC PE’s call on the regulatory framework proved correct. “We believed removing the pipeline that had been laid would not have been in public interest,” says Mandhana. IDFC PE had pre-empted the change.

GSPL then demonstrated the low carbon footprint possibilities of the pipeline, Mandhana adds. Without it, gas would have been transported by road in liquefied form, which is more hazardous and consumes more energy. When GSPL went for an initial public offering early 2006, IDFC PE made a return of 4.5 times on its investment.

­­REGULATION IS SEEN AS A REASON why subsidiaries of financial institutions have an edge over standalone VCs or PEs. Whether it’s IFC or IDFC PE, both possess the policy intelligence and networks to work around regulations. IFC, for instance, wields a strong influence here because overall it has a $4 billion corpus for India, the largest among the countries in which it is present. Of that, it has $250 million in 15 green projects and early-stage businesses such as husk power in Bihar and biomass-energy producer Shalivahana Green Energy in Andhra Pradesh.

Regulations can sometimes be beneficial as well. For the immediate future, investors see three sources of revenue for the energy entrepreneur—all from the government—and thus, a robust return on equity for themselves.

One, regulation demands that state electricity boards have to derive at least 10% of their energy output from renewable sources. This has boosted offtake from producers of clean energy. Second, if state utilities fail to source such energy, they can buy renewable energy certificates from power producers to make good the mandated quota of alternative energy. Third, given that almost all infrastructure development activities —rail, road, airport, and ports—in the country are initiated by the government, it comforts investors.

Mandhana, however, thinks government offtakes are unsustainable. “You should not have to depend on distribution companies, which are nearly bankrupt at this juncture, but give energy to creditworthy commercial and industrial enterprises,” he says. “The power producers can command a better tariff by being independent. Any subsidy-based strategy can fluctuate because of public interest,” he says, citing potential litigations for lower prices.

As a result, clean energy has become more about infrastructure projects here (as Mandhana keeps saying) than breakthrough products and applications. “In India, the price of a product or service is expected to be low. So, it is hard to bet on the technology side of clean energy,” says Sandeep Murthy, partner at VC fund Sherpalo Ventures. He also manages investments in India for Kleiner Perkins Caufield & Byers (KPCB), one of the largest clean-tech funds in the U.S.

Projects are more capital intensive than the $5 million to $8 million funding that VCs bring to the table. “It is also about finding a team that can think big, execute, and overcome all sorts of challenges,” says Mohanjit Jolly, managing director of VC firm Draper Fisher Jurvetson (DFJ) India. He backed an independent renewable power producer called Bharat Light and Power founded by Tejpreet S. Chopra, former CEO of GE India. Chopra qualified because his team largely comprised former GE employees.

DFJ has a relatively small portfolio in India—five green investments (grossing over $30 million) out of 16 overall. (It is involved with 60 clean-energy ventures globally.) It backed the Reva Electric Car until early 2010, when it exited and the vehicle’s founding family (the Mainis) sold the business to automaker Mahindra & Mahindra.

Though IDFC PE has not made much headway into products, Mandhana has hedged his bets with a small investment. Green Infra has put Rs 10 crore in De Core Science & Technologies, which is into white-light LED chip manufacturing. “With such energy-efficient assets, the paying capacity of municipal corporations may not be upfront,” Mandhana explains, “but the savings that they enjoy through LED lighting on the streets can provide a return to IDFC PE as an owner of the asset.”

Mandhana’s recipe: Clean-energy producers will have to build scale with a mix of operational (organic) and acquisition-led growth. Just one of these two won’t help as businesses jostle for land and resources. Many in the industry foresee that this race will become more competitive in less than a decade, quite like the battle for spectrum in the telecom industry. By then, the cost of generating coal-based power will be higher than wind or solar energy, whose costs are likely to keep falling. Already, there is a business case for solar energy (per unit tariff at Rs 9.11 across states) against diesel (Rs 16 to Rs 18 per unit) because of costs.

Anita Marangoly George, regional director of IFC Asia’s infrastructure and natural resources division, agrees. “India is a market where you can get scale, bring down costs, and get newer technologies closer to grid parity.” (Grid parity is achieved when the cost of a new source of energy equals that of existing fuels.) This is because civil work and construction costs in India are half that of Europe and the U.S. “If anyone can see the promise of reaching grid parity, it is India. It has a big role to play in making renewable energy sustainable. And it is important for our population.”