Infrastructure financing guide india by netz capital advisors

1. Netz Capital Advisors LLP
2011
A Basic Guide to Infrastructure Business,
Investing and Financing in India
By Atul Khekade &
Ritesh Kakkad

2. About Netz Capital Advisors LLP
Netz Capital Advisors LLP advises companies in industries such as
infrastructure, Aviation, real estate, manufacturing and others in arranging
Finance for business expansion through Banks, NBFCs, Private Equity Funds
and Investment Trusts in India and globally. Netz Capital Advisors has
presence in USA, UK, India and Singapore. Netz Capital has advised transaction
in excess of $200 million and currently has mandates for $1 billion + in
Financing.
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3. Table of Contents
1. Introduction
2. Indian Infrastructure Industry Facts
3. Sectors in Infrastructure
4. Type of Contracts
a. EPC Contracting
b. Built Operate Transfer (BOT)
5. Focus Areas for Infra Companies
6. Financing in Infrastructure
a. Equity
b. Debt
7. Banking Guidelines on Infrastructure
a. Domestic Banks and Funds
b. International Banks and Funds
8. Summary
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4. 1. Introduction - Purpose of White Paper
Everyone staying in the India understands that India has always lagged in it's
infrastructure as compared to the growth of its population. With the growth in
Manufacturing, IT and many other industries, India has become a destination for Foreign
Direct Investment. Citing the lag of infrastructure as compared to India's growth, the
Government has given special boost to the infrastructure sector, especially the roads,
bridges and power.
Several business groups are increasingly foraying in to Infrastructure Industry to
catch the boom. Many investors are choosing to invest in infrastructure stocks.
Netz Capital has successfully advised various infrastructure businesses to arrange
expansion capital in various forms through banks, NBFCs, private equity funds and
Investment Trusts. Netz Capital through this white paper intends to make the reader
aware about the basics of Infrastructure business, opportunities in it and its various
financing models. Netz Capital understands that success from an infrastructure project
can only be enjoyed with a good financial management of the project in parallel to
delivering the quality.
Infrastructure is a tricky business and as most of the infrastructure contracts are
allotted by a bidding process, the budgets can get tight. That produces a risk of negative
cash flow and even bad infrastructure quality. It is a well understood fact that a
Successful Infrastructure company develops quality infrastructure within its assigned
budget and manages its finances in the right way and focuses on its core activity. This
White paper should give a basic understanding to an investor looking into infrastructure
stocks and businesses trying to catch the infrastructure boom and are looking into areas
of foray within infrastructure. By reading this document, a reader will be able to
understand the actual point from vast announcements and news that happen in the
infrastructure industry.
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5. 2. Indian Infrastructure Industry Facts
Just to know the gigantic figures of India's infrastructure industry and its need, here are
some basic facts:
• Investment Required in India's Infrastructure Industry by 2019 - $1 Trillion
o Roads Requiring - $427 Billion
o Power Requiring - $288 Billion
o Railways Requiring - $ 281 Billion
• India's spending on infrastructure in the Year 2011 - $50 Billion
• Target Set by Ministry of Transport and Highways - Developing 20 Kms of Road
Every Day
• India will issue tax-free infrastructure bonds with a minimum tenure of 10 years,
which will have the potential to raise about $6.5 billion in fiscal year 2010/11,
according to government estimates, and the number could rise in 2011/12.
3. Sectors in Infrastructure
• Transport
o Roads and Highways
o Bridges
o Railway Lines
o Metro Rails
o Airports
o sea Ports
• Power
o Electricity Generation
o Electricity Transmission and Distribution
o Oil and Gas Pipelines
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6. • Urban Infrastructure
o Dam
o Water Supply
o Solid Waste Management
o Sewerage and Storm water Drainage
• Industrial and Commercial Infrastructure
o Special Economic Zones (SEZ)
o Industrial Park
• Mass Market Housing
o Townships
o Cluster Development
4. Type of Contracts
a. EPC Contracting (Engineering, Procurement and Construction)
Most of the work in the infrastructure segment is typically handed out to
contractors on EPC Contracting basis after a bidding process. Government initiates a
project such as Highway, bridge, metro, airport or a sea port and it floats a tender
which details about subcontractor deliverables, time frames and Budget. Estimating
Government's budget, several eligible contractors then bid for the project.
Contractors and their bids are evaluated based on various factors such as past
experience, financial strength, management team and the project is handed over to
the eligible contractor. In EPC Contracting, Government is assumed to have taken
care of the land acquisition part on which the project is to be developed. The project
may well be on the Government land itself.
EPC Contracting has been a cash cow for various infrastructure firms which
were in existence even before India's recent growth and infrastructure boom.
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7. b. Public Private Partnerships (PPP) and Built Operate Transfer (BOT)
India has so much infrastructure deficit that the Government has recently
chosen to give greater boost to infrastructure development by inviting private
parties to join hands with the Government. This frees up Government budget
and gives private parties the flexibility to fetch return from project over a longer
period of time such as 5-60 years in return of the equity infusion required up
front.
A Public Private partnership is called for when the economic benefits of
the infrastructure project go beyond its development value and time frame.
Public Private Partnerships may be required from raw stages of the project such
as land acquisition. Infrastructure projects under Public Private Partnerships get
required Government approvals and development rights. In return, the private
party acquires necessary land, develops the project, recovers it's investment
from the project's economic value and then hands over the project to the
Government after certain time frame which can go up to 100 years.
5. Focus Areas for Infra Companies
Ideally, an infrastructure company that wins a bid develops the project itself, however
due to the growth, competition and opportunities in the space, there is a clear cut focus
that infra companies have to develop while outsourcing rest of the activities to a
specialist.
• Sourcing of Contracts and Outsourcing:
Companies that focus on Contract sourcing have a strong management team with
infra expertise, quality development portfolio and strong financials. Many such
companies (prime contractors) are listed in the stock market and many will continue to.
These companies leverage their strengths to win contracts from the Government and
grow their order book on year on year basis. Job of these companies is to manage their
cash flows and outsource the work to quality subcontractors. Personnel working in
these companies have their expertise on Management, Financing, Government
Liaisoning and Project Planning, Architecture etc.
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8. • Contract Execution Development - Subcontractors
The most common job of a Subcontractor is building works and civil engineering.
Subcontractor expertise lies in recruiting mass construction worker manpower.
Subcontractors have to manage Raw Material supply required for the project, earth
moving and construction equipment.
• Equipment Operator
Equipment Operator companies come in with some equity infusion in the business to
make the down payment for the equipments they are required to buy to provide on a
contractual basis to the subcontractor or the prime contractor. Equipment Operator or
leasing companies get their equipments financed from the bank and carry the risk of
monthly lease rentals which have to be met in addition to generating profit from
supplying or leasing their equipments.
Various Equipments used by Equipment Operators include :
o Soil Compactors
o Tyre Rollers
o Concrete Mixtures
o Concrete Pumps
o Piling Rigs
o Generators
o JCBs ..etc.
• Raw Material Supply and Processing
Raw Materials suppliers have access to natural resources such as mines which
contain basic raw material for infrastructure development. Companies focused on
Raw Material Supply and processing excavate raw material from the mines, process
it and supply it to contracting companies or companies that use the same material to
manufacture a next level raw material.
Basic Raw Materials include some of the following:
o Coal
o Sand
o iron
o Steel
o Glass …etc
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9. 6. Financing in Infrastructure
The purpose of this document is to create awareness about the financial system for
infrastructure. India has always grown and will keep growing. The only people that will
benefit from this are those with Financial Intelligence, those who can get the right
financing for infrastructure business. A successful investor will be the one who invests in
a financially sound infrastructure company. The difference between big players and
small players in any industry like infrastructure is the size of their balance sheet and
their ability to leverage their balance sheet and Banks to arrange timely capital to
manage projects and subcontractors. All those who are not able to leverage the boom
through right understanding of financing, find themselves with empty pockets.
Intention of Netz Capital to write an Infrastructure white paper focusing on it's
financing is to educate the businesses and investors so that they can benefit from it by
adding wealth. Having the basic understanding of infrastructure, one can see the
difference between a company with Financial Strength and strong business model and
focus and a company without financial strength.
a. Equity : Built Operate Transfer, Public Private partnerships
Infrastructure unlike any other industry is a long term game. It takes time to
segregate natural resources such as land, clear litigations and plan a infrastructure
project. Public Private Partnerships and Build Operate Transfer projects need significant
upfront investment. The purpose of this investment can be land acquisition, setting up
critical initial infrastructure till the monetization is realized. This process gives long
term returns which is not financeable by a typical Debt Instrument in the banks. Simple
reason is that once a corporate draws down debt, it has to start paying the interest
immediately. In long term infrastructure projects, revenue generation and profit
realization takes significant time like 3 to 5 years.
Infrastructure Focused Private Equity Funds like IDFC offer a long term Debt in the
form of equity to the infrastructure project where revenue generation takes time.
Once the project is stabilized after 3 to 5 years, equity investor can get significant
valuation for its equity stake in the project resulting in a reasonable rate of return.
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10. b. Debt :
Most of the infra companies dealing in EPC contracting, equipment operation and
raw material supply have Debt as their favorite instrument due to the ability to
immediately generate income and profit to repay the Debt interest.
• Revolving Credit Line for Subcontractors
Focus and benefit of Prime Contracting company lies in bagging Government
Contracts and growing their subcontractors. Their focus is managing the cash flow and
revenue delays between costs involved in development and payment from the
Government.
A Typical finance required for an infrastructure company is revolving line of
credit from the banks that allow them to meet raw material cost and subcontractor
payments while the Government releases it's payments in the phase wise manner.
Due to this, the prime contracting company can focus on project planning and
bagging extra contracts while the subcontractor can focus on quality development and
timely completion.
• Equipment Finance
Banks like HDFC Bank or NBFcs like SREI Equipment Finance use their funds to
buy the equipment (asset), calculate it's use of term and offer it to contracting
companies on a model where contracting companies can make reasonable monthly
hire or leases to carry out construction. Private Investors or equipment leasing
companies work on the same principle.
• Working Capital
Working Capital is a basic type of finance required for infrastructure companies to
meet their internal financing needs. A Working capital might be used for hiring
workers, buying assets, advertising and marketing.
• SBLCs
A Standby letter of Credit is used by the raw materials importer or purchaser to
issue to a raw material exporter to guarantee the payment while the raw material is
purchased on Credit. The importer needs to be issue a SBLC from a Bank. The importer
needs to convince the bank that he can actually buy the raw materials and might need
to issue personal or corporate guarantees and/or collateralize assets.
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11. 7. Banking Guidelines on infrastructure
a. Domestic Banks Policy for Indian Infrastructure
Reserve Bank of India has categorized "infrastructure lending" as a separate sector
and has allowed banks to lend to the sector with lower interest rate and relaxed credit
norms. Even Non-Banking Financial Institutions (NBFCs) which have more than 75% of
it's exposure to infrastructure segment are now categorized separately as
"Infrastructure Finance Institutions". These institutions enjoy benefits such as lower
capital adequacy, relaxed credit norms and increased credit limits. This is a very
favorable arrangement considering the longer term return nature of infrastructure
projects.
b. International Banks Policy for Indian Infrastructure
Foreign Banks lending or investing into Indian infrastructure is qualified as ECB
"External Commercial Borrowing" and even for ECB, Reserve Bank of India has
announced friendly policies for "infrastructure lending". The ECB is however under
"Approval route" meaning there is a formal application to be made to RBI before
bringing down overseas money into Indian infrastructure. There is a $500 million limit
on ECB per financial year that can be brought down by a single company.
8. Summary
Infrastructure is a tricky sector. Companies in infra sector suffer small margins, cost
overruns and Debt burdens that result from long term nature of this industry. This
makes is particularly difficult and important to manage cash flow behind the infra
sector. Businesses in infra and investors need to be very alert about the financial risks
yet have to be enthusiastic about the vast opportunities in the industry and global
capital that is coming in to India waiting to be invested in the sector.
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12. Contact Information:
Mr.Anil Yadav
President-Finance
Netz Capital Advisors LLP
Email: anil at netzcapital dot com
Phone : +91 932484716 /91-22-28631151
http://www.netzcapital.com
Disclaimer
Whilst every effort has been made to ensure the accuracy of the information contained in this publication,
neither the netz capital nor any of its members past present or future warrants its accuracy or will, regardless of
its or their negligence, assume liability for any foreseeable or unforeseeable use made thereof, which liability is
hereby excluded. Consequently, such use is at the recipient’s own risk on the basis that any use by the recipient
constitutes agreement to the terms of this disclaimer. The recipient is obliged to inform any subsequent recipient
of such terms.
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