India cleantech: Expansion time

When IDFC Alternative was looking to invest a renewable energy-focused independent power producer (IPP) five years ago, it found few companies to choose from. The group's solution was to use capital from IDFC PE Fund II and Fund III to create Green Infra, with a mandate to invest in renewable power generation assets. 

"There was compelling logic in creating a company, investing at par, and creating value in the process as opposed to investing in an existing platform," says Raja Parthasarathy, a partner at IDFC. "We would likely have come in at a premium given the environment in 2008, when entrepreneurs were expecting investment at a price that that was based on the vision of a pipeline rather than the economics of operating assets they had on the ground."

The number of IPPs in the renewables space has since expanded to 15-20, and the industry continues to attract capital while GPs scale back infrastructure investment elsewhere. Other PE firms have taken majority stakes: Goldman Sachs controls ReNew Wind Power, which has received $385 million in investments since 2011, while last year Morgan Stanley Infrastructure Partners bought Continuum Wind Energy for INR12 billion ($210 million).

Most investors are putting their money into two segments of renewable energy - wind and solar, where projects are the quickest to commission. Even a greenfield facility can start generating cash within 9-12 months.

There is also an option to acquire turnkey projects from turbine engineering, procurement and construction firms such as Suzlon, Vestas or Gamesa, who buy the land, get the approvals and deliver a completed package to IPPs.

Wind is the largest sector - it comprises 70% of all renewable energy generation, excluding hydroelectric power. Analysts estimate that PE-backed power producers control around 50% of the wind IPP market, while in the fragmented solar segment they have less than 20%.

ReNew and Green Infra feature in India's 10 largest developers, alongside listed players such as BlackRock and IDFC-invested Mytrah Energy and GIC Private-backed Greenko. Strategic players such as Tata Power, IL&FS, Reliance Power also have some renewables exposure. However, so far there isn't a single wind IPP of any scale in India. The largest operator, China Light & Power (CLP), has an installed operational capacity of about 500 megawatts, built over five years.

There's plenty of scope for growth - India has about 80,000 MW of wind potential, of which 19,000 MW has been built - and the government target of doubling renewable energy output to 55 gigawatts by 2017 relies heavily on growth in this space.

The market is, therefore, waiting for dominant players to emerge, although a combination of cyclical and systemic cost factors won't make it an easy journey.

"Three years ago, a company with 100 MW capacity would be a large wind sector player. Today it would be medium-sized and tomorrow a marginal player," says Sanjay Chakrabarti, a partner at Ernst & Young. "From a talent attraction and vendor management perspective it is very different when you are one of the larger players and trying to get the right sort of contracts or talent vis-à-vis when you are a marginal player."

Going for growth

As the companies race to reach at least 1000 MW of capacity, one of the strategies being used to expand is consolidation.

Much of the installed capacity was set up to earn government tax breaks, with individual investors and corporates such as property developer DLF and motorcycle manufacturer TVS Motors building up assets. This subsidy expired in 2012, causing debt-laden corporates to sell off their interests. All of J.P. Morgan-backed Leap Green Energy's capacity is from assets bought in these stake sales. Green Infra, meanwhile, bought a 100 MW wind farm from BP in 2009 and last month added nearly 60 MW of wind farms to its portfolio through an acquisition from TVS Motors' energy unit.

"In wind, if you have an existing asset you have the data on generation and you can predict the revenue you're going to make," says Chakrabarti. "The other critical part is how good you are at financing. If the loans for the acquired asset are at a very high rate, and the investor buying into the asset can get a cheaper loan, then immediately the IRR escalates."

Another expansion strategy is building greenfield assets, but it is a capital-intensive business - it can cost INR60 million ($958,863) to put up 1 MW of wind energy. In order to grow a renewable energy portfolio, you need substantial access to capital and constant investment.

However, the steady interest in India's renewable energy sector has fallen recently because of the general deterioration in the investment environment the volatile currency. Interest rate hikes are hitting everyone, leading banks and equity providers to become more conservative.

"People are holding back on investments, and a lot of deals in the space over the last few years have been mezzanine transactions with relatively fewer straight equity plays," says Sumant Sinha Chairman and CEO of ReNew Power.

"Given the relatively stable cash flows in the wind sector, it has lent itself more to that kind of a structure where people are happy getting a stable return, which is possible because of the cash flow nature of the business. The initial investor or entrepreneur can tap the capital markets for the upside they feel might be there."

While investors are attracted by the opportunity in the renewable energy space, the principal challenge with a straight equity investment is the frequent disconnect between buyer and seller on the valuation. Structured equity investments are a way around this - these are instruments that are largely equity-like in nature and don't represent fixed annual cash obligations as would be the case in straight debt.

But debt is costly in India. "It costs around 13% in rupee terms for the wind sector so a lot of players have gone for external commercial borrowing (ECB)," says Debasish Mishra, senior director at Deloitte. "Many of these borrowers have managed 4-5% US dollar interest rates in the ECB market." Of course, rupee depreciation can make these loans more expensive.

Hence developers are looking hard for more equity financing. The Asian Development Bank (ADB) made its first equity investment in an Indian private sector renewable power generation company in May, when it committed $30 million to NSL Renewable Power (NRPPL). According to Martin Lemoine, ADB's senior investment specialist, many renewable energy developers have approached the bank for equity.

M. Vaidyanathan, CFO at NSL Group, explains why: "Other than senior debt, which constitutes 70% of the project cost, mezzanine funding is also available as a bridge to meeting the equity requirements, but this comes at higher cost than the bank financing and would typically be in the mid-teens with some upsides."

Rupee depreciation is not expected to have a major impact on equipment cost in the wind sector, as most of the manufacturing is done in-country. Solar panel costs have come down by more than 50% over the last 3-4 years, but most of these are imported, which means the cost of production has risen by INR0.35-40. According to Deloitte's Mishra, if the rupee stabilises around INR60 to a dollar, the impact will be nullified in 2-3 months because of falling costs.

Expensive real estate

Another factor in greenfield expansion is the cost of land. Nearly 85% of India's wind power is generated in just five of its 28 states: Tamil Nadu, Maharashtra, Gujarat, Karnataka and Rajasthan, and most of the highest potential sites have been acquired. Of the 69,000 MW in unrealized wind potential, the land for 20,000 MW of it is owned by the likes of Suzlon, Enercon and Gamesa.

"Things were a little bit easier in 2007-2008 because the competition was not as fierce and there were some good sites available. Now the number of good sites is decreasing and land acquisition has become challenging," NSL's Vaidyanathan says, adding that land rates have tripled and project timelines have lengthened due to these issues.

Apart from looking for newer sites and exploring opportunities in other states, there are other ways IPOs can offset land price increases and create an extra percentage point or two of returns.

One option is supplying directly to third parties, outside of the state utility off-take agreement. This is currently complicated as it involves breaking an existing power purchase agreement, but could be done through smaller greenfield projects, which are dedicated to serving these open access consumers, or getting into captive arrangements with consumers who have a stake in the IPP.

Renewable energy tariffs have become competitive with conventional energy. Wind energy has already reached grid parity in many places, at INR4-5 per unit. In the state of Karnataka, the listed off-take price for wind is INR3.70 compared to INR5 for thermal energy from new coal plants. Solar is currently at INR7-7.50 and expected to reach grid parity by 2016.

According to Chakrabarti, Ernst & Young is in the process of starting a request for quotation (RFQ) for a multinational company which wants to supplement and off-take almost 5-7 MW of solar.

Other, more mainstream ways to offset rising land costs include negotiating better on equipment purchases, entering into schemes such as the group capital schemes that offer a slightly higher tariff to what the IPP might be able to procure purely by selling under a long-term power purchase agreement to the grid, and creatively structuring the financing of the wind asset to boost equity return.

The government has also re-introduced incentives for wind farms to generate more power, instead of using tax subsidies to bring in more investment.

"Given that wind projects generally operate on mid-teens IRRs and that many of the wind IPPs are currently backed by PE funds that have cost of capital in excess of that, the reality is that every percentage or two of IRR makes a difference. So the generation-based incentive has given investors greater confidence in achievable returns from investments in the wind sector," says Parthasarathy.

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