IFR India Offshore Financing Roundtable 2016: Part 2

IFR: Sumit, can you comment on infrastructure and in terms of whether you see demand on both sides of the capital intermediation coin and the preparedness of investors to buy into the infrastructure story with long-term capital?

Sumit Khanna, Deloitte: We are looking at several infrastructure transactions where there is growth capital coming in, where assets are being taken out by yield players and where a lot of debt restructuring is happening for projects that went sour. Essentially, what needs to be understood is that the Indian government probably ran the largest PPP programme on the planet when they came up with the programme for development, be it roads or power plants.

In some ways it was unchartered territory and the developers were hungry. They took on much more than they could chew. Infrastructure, by definition, is not a yield play to begin with. There is a development cycle and there is development risk. There’s also construction risk and only after that on completion do you have a yield play. So infrastructure investors at various stages of the project are going to be different by definition.

While the banks will necessarily need to fund the project at inception and the promoter will need to inject significant amounts of equity, once the project is completed there needs to be a mechanism to be offer projects to yield players; quasi-debt players on the basis that exposure doesn’t remain equity-only. So it’s debt-like in nature but there is equity upside if you expect there to be yield compression going forward.

If you expect the interest-rate curve will go the other way, there will be a deflation in the capital value of those assets. The market was not deep enough for that but now it seems that we are able to reach critical mass.

Secondly, the market was not there structurally to facilitate yieldcos, which is why a few real estate investors tried to list overseas in Singapore and other places. One did succeed in listing in Singapore. Very quickly the government came down on certain mechanisms that were being used to offshore assets from India. The problem with the Indian market is this: it’s a global market now so when you do an IPO, global investors come and their demand invariably far outstrips the domestic institutions.

But there could be problems with the charters of certain investors, given India’s ratings, which forces them to stay away. This element may be taken away if you go to Singapore or Switzerland. Structurally, double taxation was preventing listing of these yielding assets. Hopefully once everything on the InvIT platform gets ironed out from a tax perspective it will become a very friendly instrument for people to come and partake in long-term yield investments.

IFR: Abhimanyu: how do you read the tax structure for InvITs?

Abhimanyu Battacharya, Khaitain & Co: In the last budget proposal the government exempted dividend distribution tax from the SPVs to the trust. Even at the hands of the holders it’s not taxed further. That was a clarion call that was required for InvITs and REIT structures to be effective and has provided important relief, at least from a structuring perspective.

SEBI released a consultation paper in relation to continuous disclosures for InvITs, so regulators are taking a fairly proactive role in getting these new products rolled out. The REIT structure was already well-developed overseas and a lot of stakeholders in India have worked on this. The regulations are fairly favourable, although we haven’t seen any REIT play in India per se.

InvITs have also taken off insofar as applications are at least being made to the regulator and hopefully sooner rather than later we’ll have InvITs being listed in India. From that perspective, I think both from a tax perspective and from a securities regulator perspective, we have made great strides in the last 24 months to move things along.

IFR: Bharat: as I mentioned at the beginning there is a burgeoning IPO pipeline in India. I’ve counted a baseline of some 36 companies that have formally said they want to list or that have filed with the regulator to get issues underway that the quantum of issuance is around US$10bn-equivalent, including Vodafone India.

A lot of deals that have printed of late have done extremely well in the aftermarket. Is your sense that this phantom pipeline is achievable? Some of the size ranges are quite big, but assuming that issues price at the top, is there enough capacity on the demand side for these issues to perform well?

Bharat Reddy, JP Morgan: The IPO pipeline is quite robust. Having said that, as you know over the last few years there was a bit of a lull. There is a certain amount of pent-up expectation and pent-up demand. You know what they say about the commodities business: when prices go up demand goes down. When you have a situation where there is valuation froth, more money goes after the market.

Over the last three or four months, the Indian stock market has gone up by 25%-30% on the back of a good monsoon, GST, seamless succession at the RBI etc. The fact of the matter is the market is doing exceedingly well. Expectations of promoters who have observed other companies getting burned in the past have led to the pricing of IPOs leaving a bit of money on the table and being reasonable.

To address your question directly, there is clearly appetite for Indian paper right now, whether that’s supported by domestic institutions and retail investors, or by FII investment coming in cross-border. We don’t see that this demand has a particular limit at this particular time, given the pipeline of IPOs so I believe they should be fairly successful.

IFR: Do you think valuations will continue to be reasonable?

Bharat Reddy, JP Morgan: That’s always the challenge. As the market does better and you see listings happening at healthy premiums and aftermarket performance being robust, the promoters next in line think that they can be a

little wiser and perhaps price their offerings a little more aggressively. So it remains to be seen how this plays out but clearly that’s a challenge moving forward.

IFR: Can I ask you that question from the corporate side, Mithun? What’s your approach to deal valuation and the extent to which you need to leave anything on the table for investors?

Mithun Gole, Sterlite Power: Valuation is a case-by-case decision depending on market conditions. Obviously you can’t sit there and decide that you do not want to leave anything on the table otherwise, what’s in it for investors? We have to take a balanced decision in close consultation with investors and bankers, the key objective being to ensure that the issue gets a good response from investors and there are reasonable returns for the promoter as well.

IFR: Your comparative metrics would be India companies in your sector or will you look at global comparables?

Mithun Gole, Sterlite Power: Our business typically gives us annuity cash flows at the asset level, whereas at the platform level, there is some element of development risk because we have capital invested in both operational projects and under-construction projects. Any typical investor will attribute a higher cost of equity to an under-construction project compared to an operational project that has a stable cashflow pattern.

There is no element of development risk being factored in at the asset level for the purpose of the InvIT. To that extent, InvIT as a product stands out compared to a typical equity market instrument at the platform level, which has a combination of operational-plus-developmental risk. InvITs involve purely operational risk that any global investor is willing to take and that brings down the expected risk premium substantially. The benchmark yield on these instruments is a certain spread over the domestic risk-free rate of borrowing (government securities).

IFR: Valeria, on the valuation point, you made reference earlier to business models that are perhaps better understood outside India where maybe you get better multiples. How does that message translate in the mindset of Indian companies?

Valeria Ceccarelli, SIX Swiss Exchange: Some of the companies that are interested in looking at offshore markets are companies that are either IP-driven or that want to get a better valuation for their IP. They say there’s no track record in India to evaluate those kinds of assets so they look at markets where these are more common and better understood by investors. In some cases there are Indian companies that have IP sitting outside India, the majority in life sciences.

Tarun Gupta, T&A Consulting: There are many large Indian pharma companies that have their European or global holdings in Europe and they hold IP patents out of those entities. Some of them are also looking to carve out their research arms and are looking to list that part of the business.

Secondly, not as a direct impact but in that broad direction, there have been some regulatory changes. If you look at it from the Indian context we have this notion of Place of Effective Management (PoEM) while at the worldwide level we have the Base Erosion and Profit Shifting (BEPS) initiative. A lot of Indian groups have more independence now and decision-making structures, including independent boards. As a result these businesses are more autonomous and the parent companies, the Indian conglomerates, are open to dilution at the entity level.

Clearly, where you talk about IP, not only is there lack of a peer group, there is also valuation arbitrage. We’re talking about businesses where fundamentally there is a business reason to look at offshore listings.

Life sciences plays into this but then you also have Indian businesses that made a lot of acquisitions in the 2005-2007 period. Some of them went through a lot of pain and were forced into restructurings. Clearly those are not restricted to particular sectors but there are businesses in this category which could be potential candidates for listing.

IFR: Sumit, we talked about the corporate approach to valuation; how do promoters generally look at the world when they want to raise capital or exit? Do they buy into the notion of fair valuation and fair pricing?

Sumit Khanna, Deloitte: They are promoters because they are extremely smart people and very shrewd. We have seen phases of irrational exuberance but while they don’t want to leave anything on the table and want to suck every last penny out, at the same time they want to make sure that they can get the money when they want it. Whether it’s a full exit or whether it is a capital-raise where they’re raising money for growth or are cashing out, they are increasingly cognisant of the fact they need to have money available so don’t wait for a better valuation. That understanding and realisation is very strong and increasingly people are going with it.