Asian infrastructure: Building blocks

The potential of Asia's infrastructure roll-out has been widely touted for years, as much for its profit potential as for the progress it represents. Multilateral lenders shy away from giving specific numbers, but general projections for an all-in price tag have been in the region of $8-9 trillion.

"I hesitate to get into specific numbers because they depend on factors like government estimates, which use different metrics. But anything in the trillions sounds about right," Sumeet Thakur, India-based infrastructure manager at International Finance Corp. tells AVCJ.

Targets range from high- speed trains to water purification to urban renewal, ports and airports, with a huge second tier of social infrastructure - mostly hospitals and schools - on the drawing board. But it is the core areas like roads, power generation and transmission that have been the main investment focal points, certainly for private equity. In recent year, renewable energy has also become a priority.

China and India's collective bill is estimated to amount to 75% or more of the aggregate regional total. According to McKinsey & Company, China and India will pave 5 billion square metres of road by 2025 and India will manage half that. China is also likely to need 28,000 kilometers of metro rail to India's 7,400 km. In terms of power, India's installed capacity is on course to reach 185,000 megawatts in 2012, an increase of 60,000 MW on 2007. Chinese capacity reached reached 900,000 MW last year and McKinsey estimates that up to 900,000 MW more is required between 2005 and 2005 to maintain the current pace of urbanization.

Contrasting markets

They are very different markets, however. The prevalent view of the Chinese market - at least among non-Chinese infrastructure players - is that because of the deep pockets at various tiers of government mean there is only a peripheral role at best for foreign private capital to play.

"The Chinese government has funded most of the infra projects from its balance sheet," says Lachmi-Niwas Sadani, managing director and CIO of Nomura Infrastructure Investment Management. "At central and provincial level there is ample capital available and that makes it difficult to get the kinds of returns we would like."

India is another story, though - and there is significant private sector activity to prove it. Ashoka Buildcon and GVK Power & Infrastructure both want to tap PE sources for capital for its road projects, while 3i Group took a $115 million stake in similar projects run by KMC Construction.

In the energy sector, 3i paid $45 million for a minority stake in Ind-Barath Energy (Utkal) in March while Actis and Government of Singapore Investment Corp. (GIC) each committed $77 million to GVK Energy. The Blackstone Group has been particularly active, investing $60 million and $100 million in such as Monnet Power and Moser Baer Projects Private, respectively.

"Private sector involvement in infrastructure only increases in India," says Johanna Klein, an investment specialist with the Asian Development Bank. "The latest Five-Year Plan targets infrastructure investment of $1 trillion, with 50% to come from private sources."

She adds that investor confidence has been supported by the Indian government's commitment to public-private partnerships (PPPs). In countries with historic state ownership of infrastructure, PPPs develop aspects of these assets by leveraging private sector investment and expertise to meet societal needs.

But even in India - the most advanced Asian exponent of the PPP model - the environment remains challenging, according to a recent report by PricewaterhouseCoopers (PwC).

First, projects tend to be heavy on the technical detail and light on overall financial and commercial risk. As a result, information distortions have led to large variations in bids and offers received during the procurement process. Second, the process is overly prescriptive rather with the priority being to conform to public sector requirements - which are often not much concerned with value for money. Third, securing funding is difficult because long-term financing and instruments have been in scarce supply.

There is also uncertainty over regulation.Major infrastructure projects are governed by concession agreements signed between public authorities and private entities, but tariff determination and the setting of performance standards varies somewhat by sector.

In September the government released a draft of national PPP policy adjustments aimed, among other things, at heightening transparency. The proposed changes include setting up a dedicated resolution mechanism to address issues related to the bidding and awarding of PPP projects - including the controversial land use aspect.

According to one prominent industry player, the entire land acquisition process needs to be reformed, and to that end there is a land acquisition reform bill pending in parliament. At present, the process suffers huge delays due to a problematic, multi-layered law as well as discrepancies and distortions in information flows. There also is great mistrust, the industry player adds, and a degree of corruption, which varies significantly by sector and state. Together, these factors contribute to unpredictable costs and delayed ROI.

A move toward greater transparency is also evident in Indonesia, which many in the infrastructure space tip as the next market of size to come onstream. The country is in the classic bind of possessing a young, fast-growing and urbanizing population, but lacking the infrastructure to accommodate change.

"Much of Indonesia's infrastructure is of poor quality compared [even] to other countries in the region," a report by the AusAID noted. "Poor road infrastructure, for instance, often deters potential overseas investment, as do regular power outages which retard productivity growth, making business uncompetitive."

However, the situation is improving. The Indonesia Infrastructure Guarantee Fund, established in December 2009, is gaining momentum. It is designed to offer a complete framework for financing PPP infrastructure projects against potential risks from policy changes that may have an impact on investments. A showcase project was the implementation and assurance of the Central Java 2X1000 MVV steam power plant this month.

Andrew Yee, global head of Standard Chartered Bank's infrastructure principal finance business and joint CEO of Standard Chartered IL&FS Asia Infrastructure Growth Fund, adds that Indonesia's macroeconomic environment has also made significant progress. "Some highly intelligent, competent private practitioners and being appointed to key areas of the government bureaucracy," he says. "This means good business and commercial decisions are now being made which will serve them well over the longer term."

Fitch Ratings led its peers in raising Indonesia's sovereign credit rating in February. The country is expected to climb the one more notch required for investment grade next year.

Mixed performance

These upbeats aside, however, AVCJ's pan-regional numbers suggest more mixed results. Private equity investment in infrastructure totaled $920 million from 15 transactions for the first three quarters of 2011; at the same point last year, $7.9 billion had been committed to 29 deals. Total funds raised in 2011 stood at $1.3 billion in September, compared to $550 million last year, but this is still well short of the $2.1 billion notched up in 2009.

The statistics reflect the concerns about market risk in India, the principal investment target in the region, although industry participants see the recent setback in valuations as a potential game changer.

"I've been concerned for a few years about how overpriced some of the Indian and Chinese infrastructure companies or projects have become. But now? Most are trading on single digit price-to-earnings ratios, for 2010 and 2011, and I'd expect that to continue. And the price-to-book ratio for many listed India infrastructure companies have come down from around 3x to below 2x," Yee says.

He adds that paying 2x book value for an infrastructure business is still a challenge but getting access to quality assets at or below around 1.5x offers a high chance of a decent double-digit return, given the high growth opportunities in Asia.

Archana Hingorani, CEO & Executive Director of IL&FS, notes that the economic and investment environment in India has gone through a sea change, driven by global economic integration along with factors endemic to a growth economy. The result has been a marked correction in capital market valuations in general, and those linked to infrastructure in particular. This has widened the risk-return matrix.

"Rising interest rates on account of ‘sticky' inflation, enhanced project execution risks and the overall slowing of the economy have created a huge valuation mismatch," Hingorani tells AVCJ. "Some of these are sector specific, such as land acquisition and fuel supply issues. As a consequence, investors and entrepreneurs alike are finding it challenging to agree on performance parameters and related valuations."

She says there is adequate debt provision, despite rising interest rates, but admits that if this trend continues in the long-term it could make banks hesitant to fund projects.

The availability of debt capital is an issue that concerns infrastructure investors across the region. The ADB's Klein argues that there is a massive opportunity for debt funds if structures can be introduced to correlate project risk profiles and capital market risk appetite, but she notes that it is hard to replace debt with equity.

Nomura's Sadani blames the lack of debt funding in part on India's regulatory regime. "India has what are called ECB Guidelines, which prevent companies from raising US dollar-denominated debt," he explains. "There are many reasons why those guidelines exist. But the end result is they are stifling the growth of the infrastructure market. And while the government recognizes this, they have their own issues and so seemingly can't do much about it."

The government has responded by introducing infrastructure debt funds (IDFs). These are intended to give local infrastructure developers access to money from insurance and pension funds from India and overseas, even as bank lending to roads and power projects is constrained by limits set by the central bank.

IDFs fall into two categories - trust-based vehicles that issue units and non-banking financial company (NBFC) that issue bonds. The latter lends mainly to PPP projects and the credit risk tied to a particular project is borne by the company. There are also plans to allow NBFCs to sell bonds to refinance PPPs after construction, offering longer-term funding at lower cost commensurate with the lower risk.

Risk assessment

Of course, in the broader context, regulatory risk in infrastructure is always top of mind, not least because of the long lives of individual projects. But here too seasoned players see light at the end of the tunnel.

Anil Ahuja, Asia head at 3i, notes that India has made significant progress in certain areas. He cites, as an example, new model concession agreements that are being put in place to make it easier to negotiate with the government and acquire land for roads projects. Anuja also praises efforts to remove capital constraints.

Though the regulatory environment might be improving, promoter risk continues to be a cautionary zone. In a "murky" industry like infrastructure with multiple business structures, there are various ways that value can be captured on one side while investors are lose out on another. Industry participants all stress the importance of knowing the people you are working with and what motivates them.

"The key in this part of the world is that whatever is said or debated or written, you've got to structure your deals correctly, understanding local customs, local partners and local rules," say Standard Chartered's Yee. "You've got to get a real alignment of interests."

• Tweet  
• Facebook  
• LinkedIn  
• Google plus  
• Save this article  
• Send to  

• Topics
• Infrastructure
• South Asia
• Greater China
• Southeast Asia
• Infrastructure
• India
• China
• Indonesia
• Standard Chartered Private Equity
• IFC
• IL&FS Investment Managers
• 3i Asia Pacific