Indian infrastructure funds face rocky road ahead

India is always said to have the potential to become the world's third largest economy. Following the global economic crisis, India remains as one of the few countries with as much as 7% economic growth per year. However, the infrastructure deficit has tempered this growth, as according to official estimates, annual growth could be as high as 9% if local infrastructure were able to keep pace with the economy.

Although infrastructure development has been the single-largest challenge within the country, it has emerged one of the biggest opportunities for private equity investors in recent years. Private equity investment in infrastructure reached $4 billion in 2010, up four-fold from 2006, according to a 2011 report from Bain & Company. Deal values are also tipped to grow 25-50% annually over the next three years.

"Given public resource constraints, the government has realized the need to invite the private sector to fulfill the nation's infrastructure needs," says Archana Hingorani, CEO of IL&FS Investment Managers. "Consequently, Public Private Partnerships (PPPs) have emerged as a core element of the government's strategy to finance the infrastructure deficit in the country."

The government's efforts to draw private investors into the sector have seen significant results. Investment in infrastructure as a percentage of GDP - which has increased to 7.5%, from 5% in 2007 - is expected to reach 9.5% by 2017. The government is also targeting $1 trillion of investment into infrastructure within the coming five years. Half of this amount is expected to be contributed by private sector.

"If we apply a debt-equity-ratio of 70:30, $150 billion is required from private equity and this provides an urge for larger private equity funds," Deepak Bagla, partner at 3i, tells AVCJ.

Larger funds

IDFC Project Equity will launch its second India infrastructure fund worth of $1 billion later this year, M.K. Sinha, IDFC Project Equity's CEO, told AVCJ in April. Its predecessor India Infrastructure Fund (IIF), which closed in 2009 on INR38 billion ($927 million), is almost fully invested. The vehicle bets on long-term equity investments in a diversified portfolio of infrastructure projects in India. Its target sectors include transport, energy and utilities, telecommunications and urban infrastructure.

Sinha is certainly not the only person who aims to launch a billion-dollar fund. 3i Group, which held the final close of its 3i India Infrastructure Fund on $1.2 billion in 2008, has been looking to raise at least the same amount for its successor. Last October, Macquarie Group and State Bank of India (SBI) also set up a $1-1.5 billion target for their second India-focused infrastructure fund.

"The smaller the fund, the more likely it is that the manager will be forced to target smaller assets, which are well within the reach of many private equity investors and so are typically heavily competed for," says Suresh Goyal, head of Macquarie Infrastructure and Real Assets India. "The ability of the manager to raise a large fund has kept many of the classic private equity managers out of this space so far."

The increasing ticket size of infrastructure investments has also pushed GPs to scale up their investment vehicles. What could be India's largest ever private equity deal was recently announced: the buyout of Reliance Infratel, a telecoms tower unit owned by Reliance Communications. The Carlyle Group and The Blackstone Group reportedly paid INR150-200 billion ($3-4 billion) for 95% of the unit - the equivalent of INR310-410 million per tower.

In the road sector, meanwhile, investors are no longer bidding for 100km toll projects but mega highways that cover 550 kilometers and cost over INR7.5 billion.

"When the government bid out road projects several years ago, a $100-200 million deal was already considered to be very big in size and you could see seven to eight players running for it," Bagla says. "Recently, the government bid out a road project worth over $1 billion and received interest from more than a dozen players."

Tough fundraising

There is no doubt that India requires more sizable funds to speed up the country's infrastructure development. However, long-term investors who target steady yields and returns from the asset class are yet to reach a critical mass. In many cases, infrastructure funds are only talking about an IRR up to 20%, less than many of other sector-focused funds.

GPs are facing a capital drought in the domestic market as the Indian state controls the country's largest pension funds and financial institutions, and no more than 10% of their assets under management can be invested in equities of any kind. Foreign investors - who hardly have on-the-ground knowledge about Indian infrastructure - often require management teams to provide proven records of returns and steady yields. However, established track records simply don't exist in some cases.

"It is challenging to find experienced infrastructure investment specialists at this time," says Gautam Bhandari, head of Morgan Stanley Infrastructure Asia.
"It's a paradoxical world; while infrastructure projects require increasing capital, the fundraising environment has posted challenges for GPs to raise a sizable fund."

Apart from having concerns over returns and the experience of GPs, LPs also worry about the financial impact of changes in policy on their investments, despite the fact that the regulatory framework in many of the key infrastructure segments in India is fairly well-defined, with the government fully allowing foreign direct investment across the sector.

The power sector is a case in point. Although India holds 10% of global coal reserves, the country has struggled to meet power producers' needs due to delays in environmental clearance, land acquisition and price uncertainty. While India's coal demand is set to jump to 981 million tons by 2017, output in this period may only be 715 million tons. Last year, 3i-backed Adani Power delayed its plans to expand its capacity by 6,500 megawatts due on the opaque environment on coal issues.

"There is a concern between PE players as to whether they can manage to achieve the typical 15-20% IRR if they just depend on imported coal," says Vikram Utamsingh, head of transactions & restructuring services at KPMG India.

India is on the road to becoming a more established and favorable investment environment, but right now professionals who have an on-the-ground presence are better positioned to understand the issues in India and to make the right investment decisions. "It is not the ‘complexity', if there is any, of the regulatory environment which provides an edge to existing private equity players," says IL&FS' Hingorani.

The professionals at Macquarie Infrastructure and Real Assets India, for example, have all been brought up in India and have hands-on experience investing or managing funds in the country. Non-banking engineers and developers are also recruited with the aim of driving the investment decision process.

"The key differentiator in favor of existing home grown players is their ability to access deal flow, to be able to work with the developers and understand the nuances of operating in India."

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• Topics
• South Asia
• Infrastructure
• Fundraising
• India
• Macquarie Group
• IDFC Project Equity
• IL&FS Investment Managers
• Morgan Stanley
• 3i Asia Pacific
• Infrastructure
• Fundraising