MONETISATION OF INFRA, ENERGY ASSETS

Executive Summary

Meeting of overall Objectives – Overwhelming response to ?7.7K crore PowerGrid InvIT is a proof of need for more bolder, efficient, and futuristic models of monetisation of assets. With the goal of raising non-debt capital revenue, meeting of true objectives is unclear: (1) to monetise un-optimised public sector assets including future project execution which incentivises innovation, reduces project lead time, and benchmark driven Asset O&M (2) to generate revenue to put for public use, and (3) to not to be in the business of business.

Choice of methods/Models – World over principals have moved towards Asset light, Opex based, and ‘portfolio and stakeholders management’ focused way of asset DBOM (design, build, operate, maintain) methodology. InvITs is the least effective model in this regard. Significant unlocking of capital, expansion and diversification through comparatively much lower Capex, diversion of capex to enterprise value sensitive items like digitalisation, Climate change resilience, participation of infra funds in core sector PPP projects is happening due to other models listed below.

1. InvIT – Raising equity without ceding control, operation, and ownership.
2. Getting green field expansion done on existing assets through DBOM (BOO/T basis).
3. Bundle an Asset Class and disinvest/dilute.
4. Create new Infra through Open Licensing and merchant operation basis overseen by an independent Regulator.

Way forward – Strict categorising of assets and provision of capex only for Category 1 assets (1) Critical Asset, retain ownership/ control, operate, and maintain, (2) Essential Asset, Third Party ownership but be anchor/captive customer, and (3) Peripheral Asset, using common carrier Assets Merchant operation.

INTRODUCTION: MONETISATION OF INFRA, ENERGY ASSETS

This article examines the latest “Asset monetisation” measure of InvIT in light of the following overarching industry and commerce global trends :

1. Instead of “Capex intensive” mode, expansion through an “Asset light” and “Opex” based mode.
2. Strict classification of both existing and future assets into Critical (own, control, operate), Essential (captive or anchor customer control, no ownership or operation required), and Peripheral (Common carrier, outsource, no control, ownership, or anchor/captive customer-ship required).
3. Infra and Energy Cos focussing on key strengths of Stakeholder management, market share, branding, Business model, optimisation & technology management, best practices, trading, pricing, Regulatory Advocacy Thought and Policy leadership, CRM etc rather than creating and managing distribution and service infrastructure.

On April 29, 2021, PowerGrid Corporation of India Ltd launched a first of its kind IPO by a PSU, an Infrastructure Investment Trust (InvIT). The ?7,735 crore issue was oversubscribed by almost 5 times (received bids for 205 crore units against 42 crore units on offer). Encouraged by the overwhelming response to its first InvIT issue, PowerGrid is already planning to bring another 18 assets with project cost of ?22,500 crore under the InvIT.

This is the first time in the history that Government of India has a clear policy to monetise assets to unlock the potential of PSUs’ assets. While InvITs are an innovative way to free locked up capital from operating assets, they are most ineffective way to monetise infrastructure assets. Especially in this case, because PowerGrid is using InvIT to replace debt with equity.

Effectively, no asset sale has happened, no capital is unlocked for future infrastructure projects, and PowerGrid retains the control of the assets. The government/PSUs need to quickly adapt more efficient and effective models of monetisation to catch up with the rest of the world.

EFFECTIVE METHODS TO MONETISATION OF EXISTING AND FUTURE INFRA ASSETS

1. InvITs – Raising equity without ceding control, operation, and ownership.
2. Getting green field expansion done on existing assets through DBOM (BOO/T basis).
3. Bundle an Asset Class and disinvest/dilute.
4. Create new Infra through Open Licensing and merchant operation basis overseen by an independent Regulator.

A BRIEF DESCRIPTION OF InvITs

InvITs help infrastructure developers to recycle capital locked in long-term infrastructure projects such as roads, transmission lines, or renewable assets. Potential Investors for InvITs have a lower cost of capital than that of the entity monetising the asset (“Entity”) and they are not interested in operations and maintenance of the asset i.e. operation and maintenance of the asset remains with the Entity. However, if Entity is not interested in operations, investors can outsource the operations.

Asset monetisation means receiving present value (PV) of the future cash flows to be generated by an existing operating infrastructure asset from the Trust. The Entity agrees to use the asset on “Use or Pay” basis in future. Operations of the asset mostly remains with the Entity. The condition here is that PV of net cash flows received through monetisation should be higher than or at least equal to the PV of net cash flows had the business been run as usual i.e. cost of capital of the Trust should be less than the cost of capital of the Entity. In case of the PowerGrid issue, the NPV of InvIT is not disclosed so investors cannot compare the NPV with other InvITs and have no transparency w.r.t. to the cash flow projections that are used to calculate the value of assets, thereby, constituting a major risk for investors.

A CRISIL Ratings analysis shows InvITs and REITs can potentially raise up to ?8 lakh crore of capital for India’s infrastructure buildout over the next five fiscals.

In India, InvITs are governed by SEBI (Infrastructure Investment Trusts) (Amendment) Regulations, 2016, which defines various conditions that must be followed. For example, the InvIT must distribute at least 90% of net distributable cash flows to the unit investors and the leverage cap is fixed at 70% of the net asset value. Moreover, the publicly traded InvITs cannot bear exposure to assets under construction and the sponsor should hold a minimum 15% of the units issued by the InvIT with a lock-in period of three years from the date of issuance. Currently, there are only 11 InvITs (including Real Estate Investment Trusts, REITs) in India but they are gaining popularity for private equity funds to hold operating infrastructure assets and for Business Entities to monetise their assets and free up locked capital.

In 2019, the Securities and Exchange Board of India had reduced the minimum investment limits on InvITs to make them more accessible. The minimum subscription limit for InvITs is currently ?1 lakh (?10 lakh earlier). InvITs invest in infrastructure projects such as transport (road, bridges, railways), energy (electricity generation, transmission, distribution), communication, etc. The complete list of Harmonized Master List of Infrastructure Sub-sectors as notified by the Ministry of Finance is attached as Annexure 1.

Potential investors for an InvIT include, (1) foreign investors with dollar funds may potentially provide lower cost of capital as dollar rates of interest are substantially lower than the Rupee interest rates, and (2) financial investors, who look for pre-decided yield on investment, but may not be interested in operations and maintenance of the assets. 25% of the PowerGrid InvIT issue was reserved for non-institutional investors with a minimum amount of ?1 lakh.

All things said and done, while InvITs are investment into infrastructure, the PowerGrid InvIT do not directly lead to development or growth of infrastructure in the country.

INEFFICIENCIES ALL THE WAY

The PowerGrid InvIT’s portfolio contains 5 main assets comprising of 11 transmission lines. These 5 assets include the following Special Purpose Vehicles (SPV):

• PowerGrid Vizag Transmission Limited (PVTL)
• PowerGrid Kala Amb Transmission Limited (PKATL)
• PowerGrid Warora Transmission Limited (PWTL)
• PowerGrid Parli Transmission Limited (PPTL)
• PowerGrid Jabalpur Transmission Limited (PJTL)

All the above SPVs are 100% wholly owned subsidiary of Power Grid Corporation. This method of self-own and operate asset creation model results in heavy and unnecessary capital outlays, development of layers of expensive, permanent, and non-scalable resources to build, operate, and maintain assets.

The funds raised through the InvIT would be utilised primarily for repayment of debt and interest accrued on the initial portfolio assets. Consequently, the debt is being replaced with equity (unit holders will be paid variable dividends instead of a fixed interest), and inefficiencies, if any, incurred in the form of high debt and accrued interest are being passed on to the InvIT investors, and would stay with the project through its entire lifecycle.

Furthermore, PowerGrid has proposed to follow the same arrangement for 18 more assets with project cost of ?22,500 crore. In fact, 16 out of the 18 identified assets, constituting ?17,000 crore out of the ?22,500 crore project cost, are still under construction. As these assets become operational, they will progressively come under the InvIT in the years to follow. In effect, the same cycle of would repeat – owning and controlling assets by PSUs, accumulating high-cost debt and accrued interest, and finally, issuing InvITs to pay off the accumulated debt and interest, and replacing with equity in the most ineffective way.

To reduce upfront capital costs and execute the contract through an OpEx model, the Government/PSUs should consider the DBOM (design, build, operate, maintain) model for more active private participation/monetisation of assets. Under the DBOM model on BOO basis, the PSU should grant concessions or offer themselves as an anchor customer to private companies, who in turn will undertake the responsibilities of financing, implementing, and managing a particular project under a portion of return assured by the anchor customer on a long-term basis. This offer can be made more lucrative by making the model ‘non- captive.’ In addition, as a ‘win-win’ incentive, other support measures (use of land, sharing of infra, etc.) for capacity expansion can be built-in, where the BOO operator can sell more as a merchant operator (in addition to the anchor customer) thereby lowering the unit cost of the ‘Anchor Customer.’

STRUCTURING INFRASTRUCTURE DEALS UNDER DBOM MODEL

A DBOM model operates on a Public-Private-Partnership (PPP) mode, where an infrastructure fund invests in developing a greenfield infrastructure asset, usually, with a PSU as an anchor customer which allows the infra-fund to earn long-term (15-20 Years) assured annuity return.

Asset building by PSUs (augmentation/upgradation or development of greenfield assets) should be built and operated by classifying assets under the below categories. In fact, a large project should be split into smaller assets under the following three categories:

1. Critical Asset: must own and control. (E.g., Licenses, Key branding outlets, Key Technology pacts, Refineries/ Manufacturing units, Trading rights, Base line storage, and distribution infra required to mark strategic presence).
2. Essential Asset: control captive portion of capacity but ownership can be with an external fund or investor. (E.g., Storage and Distribution Infrastructure, ancillary or auxiliary units like Hydrogen, Nitrogen, Water handling, Captive power, by-product handling units, conversion and retail units, and networks).
3. Peripheral Asset: neither own nor control, buy in captive capacity and first right of refusal asset. (sub-units of entire sourcing, storage handling, transportation infrastructure like pipelines, transmission lines, tanks and terminals, port facilities, and warehousing).

Once the project classification is complete, private participation can be invited for investment in essential and peripheral assets. These investments are usually made on Build-Own-Operate (BOO) or Build-Own-Operate-Transfer (BOOT) basis to cover a long-term period of service provision. Many other variant types of arrangement exist such as BTO (Build-Transfer-Operate) or simply BOT (Build-Own-Transfer) basis, with no involvement of private investor in operations of the asset. The BOO/BOOT project must be clearly specified, including the allocation of risk and a clear statement of the service output requirements. The long-term nature of BOOT contracts and specification of contingencies are considered and modelled in advance. For instance, Revenue models, Return on Revenue (ROR) models, and Return on Investment (ROI) models on BOO/BOOT basis of various assets.

The DBOM model can even be tried by “Licensors” who have won their License through an open auction conducted by an Independent Regulator.

An indicative list of investment packages is proposed below for City Gas Distribution, an infrastructure development area that is ripe for implementation of DBOM model.

INVESTORS RISK PROFILE UNDER DBOM MODEL VS. InvITs

Any DBOM agreement covering a long period into the future is naturally subject to uncertainty but so are the future returns under the InvITs. The biggest argument in favour of InvITs over DBOM model is that InvITs are investing in operational assets while DBOM model is considered for greenfield projects, hence, by definition, InvITs have a lower risk profile. However, this is not an absolute case and DBOM packages could have a similar low risk profile as well.

This is the first time in history that the Government of India has a clear policy in place for monetisation, on BOO/BOOT basis, of infrastructure projects. With a PSU as an anchor customer, the infra-fund would be assured of stable and predictable returns.

Given that asset monetisation is a new policy of the government, initially, the DBOM packages should be offered for smaller assets which are part of a larger greenfield or brownfield project. Hence, the PSU would invest multiple times more capital than the infrastructure fund and act as an anchor customer for the asset. For example, a National Oil Company (NOC) would need to spend upwards of ?30,000 crore to upgrade the capacity of a petroleum refinery. As part of the new policy, the NOC could offer development of non-critical assets (such as tank farms, hydrogen plant, nitrogen plant, captive power plant, water handling plant, workshops, incoming port to refinery crude pipelines, outgoing product pipelines, etc. with project cost ranging between ?200 and ?2,000 crore) to private players. Since these assets would be part of a bigger brownfield project, would be located within the same premises, and would have the NOC as the anchor customer, there is little or no risk associated with the greenfield project, provided that the infra-fund creates a Special Purpose Vehicle (SPV) with firms with the right credentials to build, operate, and maintain the asset. The same is true for InvITs as well – an investment’s future returns are only as good as the credentials of the firm operating and maintaining the asset.

ADDITIONAL BENEFITS OF DBOM MODEL OVER INVITS

DBOM projects offer excellent opportunities to incentivise innovation and reduce project lead time to complete, to lower project life-cycle costs, and to accelerate project returns. DBOM model is not regulated by SEBI and, if approached at the right stage, the infra-fund could have a greater participation in drafting the Express of Interest for the package to safeguard its interest and mitigate risks. With participation in projects right from the design stage, the infra-fund would have a greater check on the capital expenditure of the project and greater confidence in future earnings of the project as well.

In view of the government policy, many greenfield projects would be available going forward that can be offered under the DBOM model. The SPV created for the initial DBOM project would also be able to build credentials for future projects in the same arena and would also be able to develop a strategic connect with the PSU for selective opportunities.

Over time, once the infra-fund develops a portfolio of similar assets with strong alliances in the form of SPVs, the position of the infra-fund would be that of a portfolio manager working towards building enterprise value.

CHANGE OF REGULATORY MINDSET TO ACHIEVE KRA OF MONETISATION

The Central Government has set up a target of ?2.5 lakh crore by monetisation of public sector assets such as land, roads, and railways to finance an infrastructure push. However, months after the announcement, the monetisation plans appear to be going nowhere.

India is a world leader in manufacturing pharmaceutical drugs. Just like infrastructure projects, building the pharmaceuticals industry requires investments of thousands of crores of rupees, adapting world-class technology solutions, and meeting high standards of regulations and safety norms. The private sector in India has achieved these with great innovations and at extremely high efficiencies. Given an opportunity, the private sector can provide the same boost to India’s infrastructure inspirations. While there is a political KRA to achieve monetisation, the bureaucratic will is not there, primarily, to leave the ownership and control of assets.

Aggressively creating grounds for a common carrier ecosystem in Power and Oil & Gas sectors where the asset monetisation is most promising and has been minimal. This will require full disinvestment where possible (e.g., BPCL), debundling and restructuring of Pipelines, Tank Terminals, Transmission lines, etc. into portfolios, and disinvesting or diluting them to raise much more capex to focus on much bigger expansion by principals. For instance, aggregating and restructuring 550 plus Tank Terminals across 3 Oil Marketing Cos. into one Entity Merchant Operation Company and selling 49 % of its equity stake will fetch an amount equivalent to the entire Capex needs of these Companies for the next 5 years. Such unleashing of resources can fund massive projects like National Gas Grid and possible conversion of a significant share of transportation infra to use hydrogen as fuels in the next decade.

In theory, all disinvestment of equity in Central PSUs are handled by the Department of Investment and Public Asset Management (DIPAM) but in practice, everyone is involved. The Cabinet asked Niti Aayog to identify assets and a revenue model for monetisation. Niti Aayog is waiting on Ministries for information to create 4-year monetisation pipeline. Railway Ministry is waiting on Niti Aayog to create the suitable monetisation model for dedicated greenfield freight corridors. Oil PSUs have not been also to identify the pipeline stretches to put up for monetisation. The same back and forth is going on between Niti Aayog and various other Ministries as well (road, airport, etc.). While the government is closely studying the US and Canada models, it is not able to embrace the control it would bestow upon the private enterprise. In short, the role of the government would reduce to regulations and policy, as it must be in any progressive nation.

In conclusion, InvIT is just one method of asset monetisation and the least effective one. It is essential that government take stock of things and look to turnaround through following proposed methods:

1. Fully exit/disinvest from infra business entities (Shipping, Aviation, Mining, Power, Oil and Gas, etc.)
2. Promote, incentivise, and provide regulatory support to development of future essential and peripheral assets with private participation on BOO/BOOT basis.
3. Minimise creation of new assets and ask regulator to create common carrier assets through issuing open licenses on realistic terms.
4. Bundle up existing assets which need optimisation and turned into common carrier (Transmission lines, Storage and Terminals, Pipelines, Power Plants ) and sell off to private investors or dilute equity by transferring them into a SPV and unlock the potential of public sector assets thus achieving the original intent of monetisation.

For feedback /Consultation: [email protected]

Thanks to Mr. Arun K. Sharma, Former Director (Finance), IOCL and Achin Jain, Advisor, M&A Consulting at SANMARG Projects Pvt. Ltd. for their contribution.

Annexure 1: Harmonised Master List of Infrastructure Sub-sectors