Deleveraging India Inc. via InvITs

It is that time of the quarter when the results of the previous quarter have been loudly announced and widely debated. Against the backdrop of a stock market correction and the persisting liquidity crisis, a common topic of discussion in conference calls with investors is deleveraging.

Some legal entities are becoming increasingly complex in business operations as they grow, and measuring the credit risk is equally increasingly complex. Doctoring measurements of credit risk has undoubtedly been the single major reason for the collapse of IL&FS. Forensic audits following the collapse of IL&FS had determined that a complex web of subsidiaries had concealed indicators of credit weaknesses. However, other large and complex companies choosing to deleverage may find restructuring as an onerous task.

For example, Reliance Jio Infocomm Limited (RJIL) would potentially demerge its passive tower and optic fibre network into separate entities having arrangements for long-term uninterrupted use. A big chunk of $40B investment has been allocated to establishing this infrastructure, and as RJIL intends to be a telecom service provider, not an owner and operator of infra assets, this restructuring would simplify both business operations and the balance sheet.

In all likelihood, an InvIT structure that is allegedly being formed for the tower assets in collaboration with Brookfield would be an instrument listed but privately placed to institutions and HNIs, like listed NCDs. RJIL shall pay for usage of tower and fibre assets at a rate lower than the prevalent market rate under the anchor status, in addition to having the right of first refusal (ROFR) on future asset creation within the special purpose vehicles (SPVs).

While the InvIT structure isn't new to the Indian corporate world, it has been largely uncommon for various reasons. IRB Infrastructure Ltd was the first company to float an InvIT's IPO in May 2017, receiving high demand. However, IRB’s InvIT made a muted stock market debut with its units listing only at a slight premium to the fund’s initial offering price.

That rubbed off on India Grid Trust InvIT whose public offering coincided with IRB InvIT’s listing. But that fared even worse, with the IPO struggling to find investors. Thereafter, players such as L&T floated a private placement for their InvIT offerings while Anil Ambani’s Reliance Group and Gautam Adani’s Adani Enterprises called off their plans to float an InvIT.

Interestingly, liquid InvITs - those of IRB Infrastructure and Sterlite Power - in the past have at times delivered substantial negative returns, while the illiquid InvIT co-sponsored by L&T has performed better.

Regardless, $15.41B of liabilities are being moved from RJIL into these new entities having a simpler risk profile. As has traditionally been, with REITs and InvITs, insurance companies and pension funds are target investors for the trust's units, offering a share of the revenue of operational long-life assets.

Technically, demerging immovable assets into separate legal entities holding SPVs can be a deleveraging mechanism for several other highly-leveraged companies.

Last month, in the results conference call of Azure Power, the management team had announced that they would also begin to deleverage their balance sheet, and it comes without saying that Azure Power has grown to be a complex company - an independent power producer (IPP) having in-house engineering, procurement and construction (EPC), and operations & maintenance (O&M) business units. As has been seen with companies like Adani Green Energy, this is a fairly complex risk profile. Each segment has a different risk profile e.g. counterparty risk is a significant risk for the IPP business, while exchange rate risk is a significant risk for the EPC business.

Similar to the demerger of RJIL's tower and fibre assets, Piramal Enterprises and CPPIB have signed a pact for a renewable energy generation-focussed InvIT. CPPIB had recently also invested in the InvIT of L&T IDPL, and KKR had acquired a stake in Sterlite Investment Managers and their InvIT - the India Grid Trust, India's first InvIT in the power sector.

Facing a shortage of funds to execute its ambitious highway development programme, the National Highways Authority of India (NHAI) will explore options like securitisation of toll receipts and launch of an infrastructure investment trust (InvIT).

The rising interest of private equity firms and strategic players in InvITs is not a surprise. In fact, despite the early hiccups, many InvIT sponsors and operators are either actively looking to raise capital or acquire assets to increase their asset base.

This is after the capital markets regulator Securities and Exchange Board of India (SEBI) approved increasing the leverage limit for InvITs and real estate investments trusts (REITs) to 70% of assets from 49% to boost newer InvITs to float their offerings and help the current ones raise more capital.

Now, given that the richest man of India, Mukesh Ambani, and the NHAI, might potentially choose the InvIT to monetize their assets, will this be the holy grail for InvITs?

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.