Indian financial services group, Piramal Enterprises, and the Canadian pension fund major, Canada Pension Plan Investment Board (CPPIB), have announced plans to set up an RE-focused infrastructure investment trust (INVIT). Initial corpus is expected to be USD 600 million with CPPIB and Piramal committing USD 360 million and USD 90 million respectively. Balance would come from other investors.
- INVITs are meant for yield seeking investors looking to buy into low risk assets;
- RE projects in India face unique and significant risks arising from several technical, operational and financial factors and as such are not an ideal yield play;
- The track record of publicly listed INVITs and RE developers who have explored this option is not encouraging;
The Piramal Group chairman, Ajay Piramal, stated last week, “The renewable energy sector is at an inflection point and is witnessing significant consolidation, the pace of which is likely to increase in the future. We believe the timing is, therefore, opportune for aggregating assets in this sector, given that the existing players are willing sellers, in light of a constrained capital market environment — both debt and equity.”
Indeed, the market has been ripe for consolidation for a long time but progress has been hampered by wide gulf in valuation expectations. Many transactions are also believed to be stuck due to regulatory and/or legal discrepancies discovered during due diligence process. As a result, consolidation is being driven in the sector by the primary market route.
The INVIT structure shrinks valuation gap marginally due to the 0.5-1.0% value arbitrage from various tax incentives. It is debatable, however, if these gains are sufficient to make this structure viable. The fundamental attraction of INVITs is to find a permanent home – investors seeking low but stable yields – for ‘low risk’ assets. RE fits this description in theory but the reality in India is different. Solar and wind projects in India face unique and significant risks arising from poor quality, refinancing, inflation, grid availability and offtake challenges. Moreover, we believe that the risk profile is likely to get worse over time as assets age and grid penetration of renewable energy increases. Consequently, Indian RE assets are not an ideal yield play.
Our study to estimate cost of capital for solar projects came up with some surprising findings and confirms this conclusion. The cost of capital arrived at using various ‘risk build up’ approaches is much higher at 12.50-16.50% in comparison to estimates of 7.40-10.50% arrived at from the more popular ‘market multiples’ approach. In other words, the financial investors driving the sector today are simply too optimistic (or aggressive) and ignoring risks.
Only four INVITs have started operations so far. The track record of two publicly listed entities – IRB (roads) and India Grid (transmission) – is not encouraging. They are trading at hefty discounts of 35% and 14% respectively to issuance price. Acme and some other developers and funds are already believed to have explored the INVIT option but with no success so far.