Over the past one year, the Indian power sector has witnessed four major deals worth Rs 20,000 crore taking shape. Call it consolidation, but financial experts suggest that bankers are pulling the trigger on the companies which are under heavy debt and are not in a position to execute the project, resulting in eventual sale of the same. Meanwhile, it's a win-win situation for those who want to make their presence felt significantly in the power sector and always want to remain on top, even if through an inorganic way.
It is a mega discount sale for the festive season. And on offer, there are none other than large power projects at various stages of construction with a combined capacity of 65,000 MW. Yes, you heard it right. Assets which were once the crème-de-la-crème of the power sector are now in the process of turning into bad assets. It means, given a capital cost of Rs 5 crore per MW, upward of Rs 400,000 lakh crore are at risk and much of this is bank loans as these projects, typically came up with 80 per cent debt component.
In the coming years, the number of deals is expected to increase significantly. Given that there is likely to be greater certainty on the issues of compensatory tariff and coal block allocations, experts see a renewed interest in the sector. As of now, deals are only happening on the relatively "safe" assets. The value of deals is likely to remain similar to that seen in the recent past. If experts have to be believed, they see about $6-$8 billion assets changing hands. This will significantly depend on how the sector and sentiments improve.
Is it a conducive environment?
Here the question arises, why these assets, which saw aggressive bidding at one point, are now on the block for sale. The major reasons behind companies putting their assets on the block is the high debt burden, uncertainty with respect to domestic coal (both coal blocks and supply from CIL) and competitively bid tariffs which have become lower than the cost of generation (refer to Power Failure). Companies are under pressure to service debt and there is still no certainty on supply of coal, compensatory tariff, etc. Also, there are very few opportunities for long-term sale of power. The companies, with no option left, are knocking at the doors of bigger companies backed by big business houses such as Tata Power, Reliance Power, Adani Power and Essar Power as well as powerful public sector units like NTPC to evaluate assets on the block and buy them.
"The response to our expression of interest where 34 projects (totaling 55,000 MW) were offered for sale is an indicator of the number of companies who are keen to offload assets," says an official from NTPC who wishes not to be named.
According to him, NTPC will invest anywhere up to Rs 10,000 crore of its cash reserves to acquire thermal power projects while the balance amount will be raised as debt.
Meanwhile, there are very few buyers in the market. The valuations presently are definitely low with transactions for most projects happening without any significant premium/at a discount (refer to 'Deal seal'). Given the significant risks and uncertainty on coal and gas in the sector, there are plenty of opportunities to buy given that a number of companies are looking to cut the company level debt and meet their debt repayment obligations. However, it is likely that assets facing significant risks with respect to fuel supply or regulatory uncertainty will still not be able to find buyers. Looking at the above deals, the two major deals in the current year are the Lanco-Adani and the Jaypee-JSW Energy ventures. The Lanco Udupi project has not been able to command any significant premium as Lanco has been looking for buyers to cut its debt and meet its obligations. The Jaypee deal (with JSW Energy) is also not likely to happen at any significant premium given that the company (Jaypee) is looking to cut debt aggressively and there have already been issues closing the deal with Reliance Power and Abu Dhabi's TAQA in the last six months.
According to financial analysts, most of the assets on the block are regulated assets, which means, these bad assets are expected to give assured return on equity to the buyers. For instance, as per Central Electricity Regulatory Authority guidelines, for any coal-based power project, it assures a guaranteed 15.5 per cent of RoE, whereas for hydropower projects it is in the rage of 15.5 per cent to 16.5 per cent. (Refer to 'Cost per MW for RoE') Says Girish Kadam, Vice President, ICRA Ltd, "For a new player or existing player with sound financial position, it may be a right time to look into such assets for strategic acquisition which can allow the acquirer either to make a presence or to augment/diversify its existing capacity."
In the past few weeks, private sector players Reliance Power, JSW Energy and Adani Power have acted rather aggressively in acquiring distressed assets in the market. While R-Power signed an exclusive Memorandum of Understanding to acquire Jaypee Infratech's three operational hydropower plants having 1,891 MW generation capacity at a valuation of Rs 12,000 crore, the deal could not get finalised and finally it went to JSW Energy. Meanwhile, Gujarat-based Adani Power, which is also India's largest private sector power generator, bought the 1,200 MW Udupi power plant by shelling out Rs 6,000 crore from Lanco Infratech. Interestingly, both these companies have acquired assets despite having highly leveraged balance sheets. (Refer to 'Debt trap')
While Adani Power has a debt of Rs 22,317.20 crore and a cash surplus of only Rs 412 crore as reported on March 2014, Anil Ambani owned R-power has a debt of Rs 27,715 crore and cash of Rs 3,000 crore on its books. On the other hand, NTPC had Rs 15,311.37 crore as cash and bank balance on its balance sheet as on March 2014, whereas the company reported a debt of Rs 62,405.75 crore on March 2014.
Meanwhile, JSW Energy has a debt of Rs 4,837.30 crore and cash of Rs 314.60 crore on its balance sheet as on today.
"Developers with deep pockets are ready to buy as they have better holding capacity... given that the valuations of these stressed power projects are currently very attractive, the scenario also offers opportunities for buying these assets," says Arvind Mahajan, Head - Energy and Natural Resources, KPMG India.
Looking at the above table, since profit after tax has covered interest, huge profitability is eluding the stakeholders. Debt is diverting all the surplus. In case of Jaiprakash Power, profits are precariously perched on a thin branch.
Big deals on the block
At present there are very few takers who have bandwidth to buy out distressed assets. But there are many sellers such as Lanco whose assets are up for sale. With the closing of the deal with Adani, Lanco has now put up as many as three assets of 3,000 MW worth
Rs 15,000 crore which will help it to reduce its debts of Rs 36,000 crore. The decision to sell assets came soon after news surfaced that the lenders of these projects are likely to take control of the projects to recover their dues. The company has a portfolio of 4,732 MW under operation, 4,636 MW under construction and around 9,000 MW at various stages of development. Multiple investment bankers, including ICICI Securities, Edelweiss, Macquarie and SBI Capital Markets are advising Lanco on the sale of various power assets. AZB & Partners had advised Lanco Infratech on selling the Udipi power plant to Adani. It is expected that Lanco's 1,320 MW Babandh power plant in Odisha is likely to go first off the block as it sources its fuel from Mahanadi Coalfields and captive coal mine at Rampia and has all major clearances in place. This is likely to be followed by the 1,200 MW Anpara power plant in UP and a 732 MW gas-based power plant at Kondapalli.
In addition L&T too is looking out to sell some of their assets. According to sources within the company, soon the company will look forward to sell its 1,400 MW Rajpura plant in Punjab worth Rs 9,600 crore once it becomes fully functional. However, according to a senior analyst from HDFC Securities, the sale may fetch L&T as much as 27 per cent less than the amount invested on the project. "The project cost has been significantly high and it directly impacts the net worth of L&T," said a source close to the development. "It makes sense for the company to sell the plant instead of waiting for the cash flows and deploy the proceeds for other ongoing and future projects."
Meanwhile, it's just not Lanco and L&T's assets that are on the block, but according to industry sources, companies like Jaypee Group (500 MW), Ideal Energy, RKM Powergen, SKS, Monnet Ispat & Energy, Abhijeet Group, Adhunik Group, Visa Power, Emco, GVK (540 MW) and Shapoorji Pallonji Energy (2,460 MW) assets are too on sale. Apart from the above, some of the assets which are governed by State-owned power companies are also up for sale. For instance, 2,640 MW power projects have been put on sale by Bihar State Electricity Board as well as 1,200 MW by Uttar Pradesh State Electricity Board too. (Refer to 'Big ticket sale in the offing').
Meanwhile, industry observers are of the opinion that NTPC, which is scouting to buy assets, may opt to go for government-owned assets instead of private ones. But experts feel that, out of all the deals, only 10 to 15 per cent, which have cleared regulatory hurdles and have right valuation will see the light of day. The remaining 80 per cent will find it difficult to crack a deal and will require to restructure valuations.
Ergo, despite being burdened heavily with debt, the rush to acquire as many power assets in a short time is seen as a strategic move of these companies. Power Today, while speaking to consultants understood that most of the projects under transaction process are operational assets which will serve the debt by their own cash-flows. The acquirer has to arrange for the equity investments and as experts have witnessed many of the power developers have started the process of increasing equity by going through various routes including QIP placements, etc.
"This gives an opportunity to the cash-rich players to multiply capacity overnight at a reasonable acquisition cost as compared to the cost of developing such greenfield assets," says Umesh Aggarwal, Associate Director - Energy, Utilities & Mining, PwC. Indeed, the observation was in line as companies like Adani Power, Tata Power, JSW Energy and Reliance Power are in the race to increase capacity to remain on top. Tata Power has set its target to add 18,000 MW by 2022 followed by Adani which is 20,000 MW by 2020, Lanco Infratech 15,000 MW and JSW Energy 11,700 MW by 2015.
At present, the current capacity of Tata Power is 8,613 MW and it has plans to add another 799 MW; Adani Power with 8,620 MW has plans to add 1,200 MW, Reliance Power's current capacity is around 5,185 MW and has plans to add 3,770 MW and JSW Energy which has 3,140 MW has plans to add 8,630 MW. Financial analysts also feel that apart from meeting their targets, these opportunities also helps them in getting their average cost per MW relatively lowered.
"This is a very positive development leading to consolidation in the sector and investors would look at these positively," says a senior official from Reliance Power. He further adds: "Power is a capital intensive business with typical gearing of 3:1 and so it is natural to have high debt levels."
So the issue is not about the level of debt but the fact that cash-flows from projects are impacted by various issues coming from aggression in bid strategies followed by the developers in the competitive bids as also the developments around coal prices and availability, foreign exchange movements, delays in project completion, etc. Says Vivek Singh, Director, Grant Thorton India LLP, "Power projects by design have a high debt equity ratio. While there are firms (Adani Power and Reliance Power), who have highly leveraged balance sheets, their ability to raise debt at lower cost provides an advantage vis-a-vis other players thereby allowing them to buy assets by leveraging the balance sheets further."
Interestingly now, there are companies which are not in the power sector but are cash rich, and are reevaluating the power sector and planning to buy such assets. In addition, financial companies too are in the fray to acquire assets. In fact, it's not just domestic investors who are looking at these assets but foreign players from countries like China, Japan and Korea too are looking for investing in India through the inorganic way.
In the current scenario experts don't feel that deals have gone overboard. Existing valuations of power plants are low in their opinion if one were to compare them to the new norms issued by the Ministry of Power for Ultra Mega Power Projects (UMPP) on DBFOT which requires the transfer of the asset post the concession period. Given these new norms while all the private players have pulled out of the bidding process leaving only NTPC in the fray, overnight the value of the existing power plants will increase as ownership for these is non-transferrable.
To sum up, power companies with good corporate backup can raise money and manage attractive valuation proposition despite debt component. And once power purchase agreement and fuel sources are in place, these power projects will certainly give assured return on investment, but it is up to bankers to decide to extend further credit to the companies as banks already have already heavy exposure to the power sector. Ideally, the falling global prices of coal should also benefit companies which have tied up international linkages (the biggest one being Adani's Queensland deal). However, a few analyst that Power Today spoke to opine that the landed cost of imported coal works out to be around Rs 3,600-4,000 per tonne as compared to domestic price of Rs 2,000-2,600 crore, after accounting transport cost. Hence, the power assets, which are linked with domestic coal resources, seem to be a profitable and viable proposition for investors. Ergo, in a rush to acquire maximum assets, the power sector is again witnessing aggressiveness. But only time will tell whether the quest to remain on top will break or make these companies.
Cost per MW for RoE
Assuming the project cost at about Rs 6 crore/MW, fixed cost of generation based on normative principles itself is estimated at about Rs 2 /kwh which includes about Rs 0.45 /kwh of Return on Equity. From debt servicing perspective, break-even fixed cost of generation is estimated at Rs 1.5-1.6 /kwh, provided the plant can declare 85 per cent normative availability and fuel cost variation is a pass-through.
The cost per MW for breaking even would depend on the project and risks involved. Projects whose tariff is determined under the cost-plus regime (Section 62 of the Electricity Act) do not face any significant risk of RoI, which is defined under the respective Tariff Regulations and relevant benchmarks defined by CERC. For competitively bid projects, the break-even and RoI would depend on the bid tariff and cost of generation. The issue being faced by most of the companies is that related to the variable (fuel) cost and not that of a fixed cost (cost per MW).
"Thermal segment is expected to witness M&A activities" - Girish Kadam,
Vice President, ICRA Ltd
Is this the most conducive time to buy distressed assets in the power sector for anyone looking for strategic investment (inorganic) in India's power sector?
Assets which are in the pipeline for sale, essentially belong to those corporate groups whose financial position has weakened arising out of significantly high debt burden associated with their large investment plans, and essentially as part of de-leveraging strategy for such groups. For a new player or existing player with sound financial position, it may be a right time to look into such assets for strategic acquisition which can allow the acquirer either to make a presence or to augment/diversify its existing capacity. However, such acquisitions are likely to be concluded relatively faster where issues regarding the availability of fuel, any pending clearances as well as tie-up of PPA with fuel pass-through provisions are not there. The projects which are fundamentally unviable due to tariff related & regulatory issues are unlikely to see any acquisition interest.
According to you which sub-sector in power will see major M&A activities? Will it be thermal, hydro, wind or solar which will suffer from distressed assets?
The thermal segment is expected to witness M&A activities, given that this segment is facing serious issues related to fuel shortage (both pertaining to domestic coal & gas), tariff related regulatory uncertainty given the legal challenges by off-takers in allowing tariff compensation, as well as delays in project execution/PPA tie-up in many cases. Within the thermal segment, gas-based capacity remains adversely affected due to deterioration in gas supplies for the power sector and as a result, about 18-20 GW (which includes the unutilised existing installed capacity & also, the capacity which is ready for commissioning but waiting for gas) remains currently stranded.
Also, for coal-based IPPs in the private sector (most of which have competitively bid-based PPAs), timely approval by SERC/CERCs and consequent implementation of tariff compensation in consent with the off-takers also remain extremely crucial for the fundamental viability of such assets in the long run.
Do you see any chance where the M&A space in the power generation sector in India is expected to gain further traction from hereon?
The M&A space in the power generation sector has seen some traction in the last 12-18 month period, as a result of de-leveraging plans in the power sector by some of the large corporate groups as well as likely exit from the sector by a few corporate groups who are facing significant implementation challenges in project execution. This trend is likely to sustain at least in the near to medium term.
Although the consolidation in the power sector is going on for the last one year, the first six months of the current FY has seen sudden activities in this space. Why is there a sudden increase in M&A activities? And what must have gone wrong, because companies are trying to put their assets on the block?
Large-sized multi-locational investment plans were announced by several players in the power sector during CY 2005-2008.
Among these players, quite a few players did not have any experience in execution of such large-sized projects, given that greenfield power project execution typically is extremely capital intensive (Rs 5-6 cr/MW) and also, construction period for implementation is up to a five-year period. On average, many projects in the private sector have now witnessed delays (averaging between one to two years) with cost over-run up to 25-30 per cent which is also attributed to multiple factors such as a) time over-run, which may be because of delays by EPC contractor or delays in land acquisition/approvals, b) change in law as well as c) INR-USD depreciation leading to escalation in USD denominated portion of project cost. In addition to this, many projects especially in thermal segment, remain exposed to increased fuel supply risks both pertaining to coal & gas, and also with change in mining law in overseas coal exporting countries & domestic fuel shortages.
As a result, companies/corporate groups which are now having unsustainable high levels of debt burden with exposure to project assets in power sector are mainly in the de-leveraging mode in order to correct their own balance sheet.
How sure are you that the company which will buy any of the distressed assets on the block will get assured RoI, which the earlier company was unable to and hence the asset is up for sale?
In case of operational projects, returns on acquired asset will be critically dependent upon a) availability of fuel, cost competitiveness and b) extent of long term PPA based capacity and pass-through of fuel price in PPA with off-takers (mainly being discoms).
In case of under-construction coal-based projects, viability would depend upon the extent of regulatory approvals in place and progress in implementation so far also with reference to extent of PPA tied-up, fuel linkage and soon.
"Valuations of power plants are low if compared to the new UMPP norms" - Vivek Singh, Director, Grant Thornton India LLP
Do you see a slim chance where the M&A space in the power generation sector in India is expected to gain further traction from here on?
The power sector is expected to gain traction further given the presence of several distressed assets combined with an economy raring to go. In the current scenario, the power sector will witness consolidation by key players who will build capacity across sources in particular renewable energy (segments) and hence acquisitions in both the thermal and the renewable space are expected to increase in the near term.
According to you which sub-sector in power will see major M&A activities?
Renewable energy, solar and wind, will witness increased M&A over the years as existing platforms of key investors will now look to consolidate their positions. Renewable energy has opportunities for consolidation as government incentives of Accelerated Depreciation (AD) and Grid Based Incentive (GBI) have resulted in players with very little power experience entering into power generation for other reasons. These power plants will/are already on the block.
Have the deals which happened in the first six months of the current fiscal gone overboard?
In the current scenario we don't feel deals have gone overboard. Existing valuations of power plants are low in our opinion if one were to compare them to the new norms issued by the Ministry of Power for Ultra Mega Power Projects (UMPP) on DBFOT which requires the transfer of the asset post the concession period.
Given these new norms while all the private players have pulled out of the bidding process leaving only NTPC in the fray, overnight the value of the existing power plants will increase as ownership for these is non-transferrable.
Is this the most conducive time to buy distressed assets?
Given the current situation in the country, the power sector will be a key priority area for the Indian government over the next 5-10 years and in particular the Prime Minister who turned around the State of Gujarat from being a power deficient State to a surplus one within a decade. It is only a matter of time before the "Gujarat Model" is replicated at a country wide level. Private sector share of installed power capacity in Gujarat stands at 75 per cent which reflects the ability of Narendra Modi to attract investments in the sector. Industrial growth cannot be achieved in the absence of power sector's growth and in light of this the current scenario.
Why is there sudden increase in M&A activities?
The presence of a stable government has added strength to M&A activities in the power sector. The current government has allotted Power, Coal and Ministry of New and Renewable Energy to Piyush Goel. The intent of the government is to try and address investor concerns around environment approvals, coal linkages and thus try and ensure that "processes will be set right". The current government has been hitting all the right notes- whether it be the National Solar Mission, environment clearances for power projects, etc.
And what must have gone wrong, since companies are trying to put their assets on the block?
There were quite a few conglomerates that entered the power space over the last few years but are now exiting the power business given their significantly leveraged balance sheets. Large number of businesses rushed to invest in the renewables space driven by accelerated depreciation benefits and grid based incentives (GBIs). The primary reason for a large number of assets on the block is delays in commissioning of the plant which has led to cost overruns and pressure on repayment schedule of loans. This has further weakened the balance sheets forcing companies to put power assets on the block.
In this case, how sure are you that a company which will buy any of the distressed assets on the block will get assured RoI?
As mentioned earlier, asset sale is primarily on account of leveraged balance sheets which have been stretched and are under considerable stress. Some of these assets are currently under duress due to high financial costs which have led to losses and unavailability of coal/natural gas.
The buyers on the other hand believe in their ability to provide coal linkages and/or low cost capital thereby allowing them to run the plants at a higher profitability. Also, the consolidation of capacity will allow players to leverage on economies of scale.
What are the reasons where despite burdened heavily by debt, some companies are buying out such assets?
Power projects by design have a high debt equity ratio. While there are firms (Adani Power and Reliance Power), who have highly leveraged balance sheets, their ability to raise debt at lower cost provides an advantage vis-a-vis other players thereby allowing them to buy assets by leveraging the balance sheets further.
- Rahul Kamat
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