EXECUTIVE CHAIRMAN of Mumbai-based Infrastructure Development Finance Corporation (IDFC), Rajiv Lall, 55, makes no bones about his displeasure when people describe his organisation as yet another finance company involved in transaction businesses. The newly-promoted Lall, who returned to India in 2005 after spending more than two decades with global heavyweights such as Warburg Pincus, Morgan Stanley, World Bank, and the Asian Development Bank, points to IDFC’s mission statement. “You will realise that our goals are far more ambitious—creating enduring values and promoting infrastructure, and nation building in India and abroad, through a knowledge-driven financial platform.”
However lofty that may be, a bad economy coupled with policy indecision is forcing IDFC to become more transactional on the ground to achieve growth, its biggest challenge today. Lall doesn’t admit to IDFC fundamentally altering, but he does say some degree of adaptability is built into it. “One of our successes has been our ability to read the changing macroeconomic situation early, internalise it, and change direction in response to an evaluation of risks.”
One way to interpret this is to see IDFC shifting from being the country’s premier project financier, funding both greenfield and brownfield projects of India’s top 20 infrastructure companies, to becoming a refinancier of operational assets, or even helping some of these marquee firms reschedule their principal payments because their projects haven’t taken off or have stalled midway.
While IDFC refuses to divulge names of companies citing confidentiality, it is clear that most of its clients, whether in energy, transportation, or telecom, are struggling. Take IDFC’s eight-year association with the GMR Group. In an e-mailed response, GMR’s chairman G.M. Rao calls IDFC the one “institution” behind GMR’s evolution and growth: “IDFC was not only an investor, but our true ambassador.” The story of GMR’s barrage-mounted gas-based power plant is instructive.
Originally commissioned at Mangalore, Karnataka, in 2001, it ran successfully with naphtha as fuel till April 2010, before it moved to Kakinada (Andhra Pradesh) in July 2010 to use cheaper gas from the Krishna-Godavari basin. But with the promise of gas having come unstuck because of a sharp fall in the Krishna-Godavari basin’s output, GMR’s project is in jeopardy. As are nearly 2,000 MW of other projects (GVK’s Jegrupadu Extension and Konaseema Gas Power, Lanco’s Kondapalli Stage II, etc.). All these projects will require rescheduling of their principal payments.
Vikram Limaye, IDFC’s managing director and CEO, says it makes sense to push back the repayment schedule of gas-based assets because ultimately “these are fundamentally viable”. His optimism is based on complex political and economic math that takes into account the government raising gas prices, as it did late last month; Reliance Industries, the primary operator in the Krishna-Godavari D6 basin discovering more gas (it recently announced new finds); and importing shale gas from the U.S.
So here’s what IDFC is doing differently. It is taking on the debt of distressed companies from the banks because they have issues of asset-liability mismatch, and then either taking it on its books or parcelling it out to other banks under new terms as a restructuring exercise. That way, the company has to pay just the interest on the loan and not the principal, giving it some breathing space. Equally, it allows IDFC to increase the size of its books without creating new assets.
There are many ways of refinancing operating assets, explains Limaye. For instance, if a highway project starts generating more cash than was originally envisaged because of greater traffic, or a power plant reports more robust cash flows, then IDFC can provide it with more funds because it can accommodate more debt than before. The extra cash allows these companies to invest in new projects. Similarly, certain infrastructure projects, like hydropower projects that have a concession period of 40 years, but only a 12-year tenure of debt, are also provided with more debt by IDFC.
Indeed, as part of its low-risk strategy, the company has not only pared its growth estimate to 10% to 11% next year from 20% to 25% earlier, but has also decided to fund only the larger, better capitalised groups with multiple businesses and revenue streams, because smaller ones are far more vulnerable to a liquidity squeeze in an adverse environment. “A flight of capital to more capitalised groups is the most natural response in times of a crisis,” says Limaye.
Even a few years ago, IDFC’s focus would have been elsewhere—as a project finance outfit, it would have been helping companies, new and old, raise capital through both debt and equity—for specific projects. “The original vision for IDFC was to address the scarcity of long-term financing for private infrastructure projects in India. India needed (as it still does today) to develop its infrastructure to sustain its economic growth and the demand for infrastructure investment was expected to grow substantially in line with the level of industrialisation and urbanisation,” says Diana Noble, CEO of London-based CDC Group. CDC, along with a few domestic financial institutions such as the International Finance Corporation, Asian Development Fund, and foreign investors like Government of Singapore Investment Corporation, hold 6.1% in IDFC.
Now, the long-term infrastructure bonds that it occasionally issues to raise capital are being used to refinance companies rather than fund greenfield projects, its primary objective. Seen differently, today, as it reaches out to save distressed companies, IDFC is more of a corporate finance company than a project finance company. It’s not creating new assets but financially churning existing ones. “In the last one year, 50% of the company’s book size has grown through refinancing of operating assets—completed assets already generating cash flows—because it is a low-risk strategy,” says Limaye.
The markets have stayed indifferent to IDFC’s moves. Over the last 24 months, its market capitalisation has largely been at around Rs 20,000 crore, falling to Rs 13,413 crore towards December-end 2011 and rising to Rs 25,941 crore in January this year. Ashish Gupta, head of research at Credit Suisse, who has a buy rating on the stock, says the company remains fundamentally strong with a decent valuation. “It has de-risked its business by focussing only on operating assets and made enough provisioning for non-performing assets. The top management also has the ability to seek out better projects from select groups.” He adds, crucially, that IDFC understands the regulatory environment very well because it works closely with the government.
IDFC’s NEW THINKING compellingly tells a story about India’s infrastructure business. Back in 1997, when IDFC was created, it was believed that India needed a financial institution that would specifically finance infrastructure. IDFC then went on to start the public-private partnership (PPP) model for India. The big idea: The private sector would stump up the capital required to build infrastructure (roads, ports, power plants, airports, etc.) while the government would chip in with all regulatory clearances (land acquisitions, environmental clearances, etc). Even though the capital risk would almost entirely be with the private player, and delays would hurt, given the huge demand for infrastructure, this seemed like a great idea.
In the last two years or so, the PPP model has unspooled. Vinayak Chatterjee, chairman of Feedback Infra, an infrastructure consultancy, where IDFC is the largest shareholder, says the fault lies on both sides. He argues that many companies became overexuberant and bid too aggressively. Many overleveraged themselves without taking risks into account. Equally, the state didn’t do what it promised. “There are just too many interlinkages in infrastructure,” says Chatterjee.
Take roads. Often, getting land for building roads means dealing at the village level. In 1988, the National Highways Authority of India (NHAI) was created as the apex body to coordinate the building of highways and get all permissions required. NHAI is also often the ‘public’ partner in PPPs. If a project is stuck because permissions aren’t forthcoming, all that the private player can do is appeal to NHAI. There is no recourse to any higher authority. There is talk of setting up a road regulatory authority (along the lines of, say, the telecom regulator) in the next few months.
According to estimates by the finance ministry, nearly 215 projects are stuck across sectors, locking up nearly Rs 7 lakh crore in capital. IDFC refuses to divulge details of its investments in stalled projects. The company is most exposed to power projects (40% of outstanding loans), roads (25%), and telecom (21%).
Things are so bad that no greenfield power project has been announced in the past 18 months, no new player has entered the telecom tower business, and the road sector has seen little activity because existing players are still suffering from time and cost overruns because of their delays in getting regulatory clearances. “The reality is that the entire capex cycle has stalled not only in the infrastructure sector, but in others too. No new projects are coming up either in steel or auto because of an overall slowdown,” says Limaye.
Any hopes of an early resolution too have been belied because of policy paralysis within the government and bureaucracy, as well as a complete breakdown of trust between the government and the corporate sector. “Today, no one wants to take a decision because they fear that motives will be assigned and investigations launched against them after many years,” adds Limaye.
THE CURRENT SITUATION does offer some avenues for asset diversification. The last decade has seen a strong growth in the purchasing power of rural India because of rapid urbanisation, which has, in turn, created a lot of wealthy farmers. Moreover, telecom connectivity has made agriculture and mandis (rural markets) very efficient. So, IDFC has an opportunity to enter the rural infrastructure space—it has invested in post-harvest supply chains, warehouses, cold chains, and plans to enter micro-irrigation.
This includes a Rs 150 crore investment in Jaipur’s StarAgri Warehousing and Collateral Management, an integrated, independent, post-harvest management company, this February. StarAgri is present in 190 locations across 10 states with 750 warehouses that can store nearly 10 lakh tonnes of agricultural produce.
It has parked another Rs 155 crore in a private dairy company called Parag Milk Foods, which has a strong pan-India presence in procurement, processing, and distribution of ghee and cheese. Parag processes over 1 million litres of milk every day and had a turnover of nearly Rs 880 crore in FY12. The capital will be used to build capacities in various product lines, strengthen Parag’s procurement infrastructure, and partly fund the exit of investors like Motilal Oswal Private Equity.
M.K. Sinha, managing director and CEO of IDFC Alternatives, which encompasses three different asset classes—IDFC Private Equity, IDFC Infrastructure Equity, and IDFC Real Estate Investments—says there are two main themes in India today: consumption and infrastructure. “The linkage between the two is called the supply chain. We have already made two investments in rural supply chains and we will migrate that way. But the long-term goal will be to move into consumption so that our private equity asset class becomes sector agnostic and goes beyond infrastructure.” In other words, enter any sector or company that is linked to consumption. Also, nobody said infrastructure or nation building was only limited to roads or telecom towers.
Another sector that IDFC is betting on is real estate because it still offers some returns. To keep risks limited, IDFC Real Estate (a fund) is investing in completed projects that are either already fully occupied or are in the process of being occupied. This will provide it with rental yields and capital appreciation. Last December, it completed its first investment of Rs 200 crore in Galaxy Mercantile, a 1.3 million sq. ft. project in Noida.
SUCH INVESTMENTS HOWEVER significant today, are small change for a Rs 71,000 crore company. For IDFC, the issue lies elsewhere. Does all this mean that financing of its traditional businesses such as power plants, roads, bridges, and ports are out of the company’s radar? No one in Lall’s team doubts the prospects of India’s long-term infrastructure story and believe that in 12 to 18 months things will start falling into place. There’s even talk of IDFC Infrastructure Equity, a part of IDFC Alternatives, raising another $1 billion (Rs 5,952 crore) by year-end to invest in new projects.
“My expectation in telecom is that the residual uncertainty—on what basis will spectrum be allocated to those who want it renewed—will get sorted out in the next 12 months,” says Lall. Thereafter, financing of telecom infrastructure, such as broadband and towers and related infrastructure around 3G and 4G, will come on stream again. But Lall’s real worry is the power sector because it will require judicial intervention to sort out the issues and, therefore, take far longer time to resolve.
The company has decided not to finance any more greenfield coal or gas-based power projects till the issues of coal linkages and gas availability have been resolved.
Lall, for his part, adds that the most obvious way of expanding footprint and diversifying the asset and liability base “is to pick up a banking licence”. If IDFC becomes a bank, not only will it have retail deposits, but will also be able to provide a suite of banking products, unavailable now because of its non-banking financial corporation status. The products include a bank guarantee, a line of credit to exporters, escrow accounts, and trade financing. Moreover, providing finance to other sectors will hardly be an issue. In other words, IDFC will have opportunities for both asset and liability diversification.
“I think a foray into banking could provide new planks for growth and further the reach and scale of IDFC. A banking platform can enhance IDFC’s ability to build on its core infrastructure platform. For example, its ability to access low-cost deposits would benefit its lending franchise,” says Sonjoy Chatterjee, chairman, Goldman Sachs (India) Securities.
Lall’s confidence stems from the fact that the central bank is not just looking at groups that can provide banking services but also innovative ways of financial inclusion. And that is where he believes he can steal a march over others because he, in his personal capacity, runs India’s biggest social impact firm, the $800 million Lok Capital.
To hear Lall describe it, Lok Capital finds “ways of investing, supporting and nurturing business models of entrepreneurs, which will improve the delivery of essential services in sustainable ways—the last-mile connectivity—to the poorest section of the society”.
Lok Capital’s first fund of $20 million was deployed fully by 2010. It has raised another $60 million and is targeting public health, education, and low-cost housing.
Lall believes he has a strategy in place: developing a cost-effective platform that uses technology and people in a different manner to drive down costs of delivery required to service the huge mass of unbanked Indians in this country. “It is not that models are not there, the only issue is to implement them.”
So how does he see the future of IDFC in the next five years? As an infrastructure development company that also works for financial inclusion, he says promptly. “That’s what nation building is really about.”
