Recently, we talked about how increased investment in world-class infrastructure is the overarching need of the Indian economy, and why India is placing a big bet on it to drive economic growth.
A major step in this direction would be the launch of the POWERGRID Infrastructure Investment Trust (‘PGInvIT’) IPO. While this would be the largest public InvIT IPO till date, it will also be the first InvIT backed by a Maharatna PSU. The IPO size would be about ₹ 7,735 crore, taking the market capitalisation of the Trust to approx. ₹ 9,100 crore (after factoring the 15% stake being held by Sponsor). Upto 75% of the Offer is reserved for Institutional Investors (including Anchor Investors), while atleast 25% of the Offer would be reserved for Non-Institutional Bidders.
Most investors are unfamiliar with an InvIT structure since the regulations in India are fairly recent and there are only 2 other listed InvITs till date (i.e. the IRB InvIT and the IndiGrid InvIT).
In simple terms, an InvIT is basically a business trust registered with and regulated by SEBI, with a very well-defined governance framework and set of regulations which it needs to follow throughout its life. Think of it as a special holding vehicle created to hold a portfolio of infrastructure assets. Having a body similar to mutual funds, InvITs are a trust in legal sense and come with the corporate governance of a listed company with far greater unitholder rights.
Infrastructure financing has typically been an institutional business since the requirement is for long term funds. InvITs now enable investors to become beneficiaries even for small amounts, and provide liquidity and returns similar to listed entities. InvITs as well as investors also enjoy certain favourable tax treatment leading to better returns, making it a lucrative investment opportunity.
Let us now understand how the PGInvIT will be structured
i. Trust – PGInvIT, set up as an irrevocable trust, registered as a public InvIT with SEBI and would be listed on NSE and BSE
ii. Trustee – IDBI Trusteeship, an independent third-party tasked with ensuring compliance with the SEBI regulations, as well as monitoring activities of Investment and Project Manager
iii. Sponsor and Project Manager – Power Grid Corporation of India Limited
- A listed ‘Maharatna’ Central Public Sector Enterprise (CPSE) under the Ministry of Finance, GoI, it is also the 3rd largest CPSE in terms of gross block as per the Public Enterprises Survey 2018-19
- Largest power transmission company in India in terms of length of transmission lines measured in circuit kilometres – with more than 85% share in India’s cumulative inter-regional power transfer capacity
- Internationally the 3rd largest transmission utility as of October 25, 2019 (Source – World Bank) and ranked as one of the ‘Fastest Growing Electric Utility’ in the ‘Asia/Pacific Rim’ region for 7 successive years since 2014 (Source – Platts Top 250 Global Energy Company Rankings)
- Apart from the Initial Portfolio assets (‘IPAs’), the Sponsor owns 2 other Tariff Based Competitive Bidding (‘TBCB’) operational projects comprising of 28 transmission lines (2,699 ckm), with a total power generation capacity of 3,000 MVA. The remaining Sponsor TBCB Projects (about 11 of them having estimated project cost of ₹ 12,200cr) are at different stages of development, scheduled for completion by FY23
iv. Investment Manager – Powergrid Unchahar Transmission Limited
- Wholly owned subsidiary of the Sponsor, who will be responsible for managing the InvIT including the Initial Portfolio assets as well as undertaking investment decisions relating to the assets
- Has relevant infrastructure sub-sector experience owing to its involvement in the construction and operation of transmission systems
- It will also be employing various key personnel, all of whom possess relevant industry experience of about 20-25 years
v. Initial Portfolio Assets (IPAs)
- The InvIT would be acquiring a 74% stake in the 5 IPAs. The balance 26% would continue to be held directly by the Sponsor till the completion of the lock-in period, post which it would be purchased by the InvIT mostly through debt-financing. However, no contractual agreements to this effect have been entered, and as per the management, the transfer will happen at arms length price based on an independent valuation report
- Each IPA has consistently achieved annual average availability of more than 98% and earned incentives
- The IPAs are located across five states of India. The projects comprise 11 transmission lines, including six 765 kV transmission lines and five 400 kV transmission lines, with a total circuit length of approximately 3,698.59 ckm, and three substations with 6,630 MVA of an aggregate transformation capacity and 1,955.66 km of optical ground wire
Key Financial Data
i. Increase in revenue in FY19 and FY20 is principally attributable to commissioning of all elements of each of the IPA
ii. IPAs have consistently earned an EBITDA margin of 97%
iii. Incentive income accounted for 2.7%-3.3% of total revenue in each of these periods
iv. Net debt majorly consists of loan received from Powergrid at concessional rate of 6-8%
- The revenue and cashflow numbers are fairly constant across the 3 year period
- There appears to be a slight misunderstanding for 2022 and 2023, since the entire revenue from operations of each SPV cannot be said to accrue to the InvIT, since 26% stake would continue to be held by Powergrid directly – pending to be clarified by management
- As per management, the InvIT is expected to receive average cash distributions to the tune of ₹ 1,150 crore for the next 3 years – out of which minimum 90% would need to be distributed
- The total enterprise value of all 5 assets is ₹ 10,385 crore while the total equity value is ₹ 5,439 crore. Please do note that only 74% value can be attributed to the InvIT in the initial years
Utilisation of Offer Proceeds – End use
While the total IPO size is ₹ 7,735cr, it consists of ₹ 2,741cr pertaining towards the Offer for Sale units – the proceeds of which will directly accrue to Powergrid Sponsor. ₹ 4,994cr received by the Trust would be used to provide loans to the Initial Portfolio Assets for repayment of debt, including any accrued interest (all loans have been currently advanced by Powergrid itself) . It is proposed that such a loan will carry an interest rate of 14.5% p.a. and shall be used to pull out funds from the assets to the InvIT, and in turn distributed to its unitholders. Net net, Powergrid will end up receiving funds to the tune of the IPO amount, which it will utilise to finance new projects.
Why should one subscribe?
Consistent and stable cash flows from assets: Revenue for electricity transmission is derived from contracted transmission charges which are fixed for the entire term of the TSA (i.e. 35 years). There is minimal price risk, since the charges are based on the availability of the line irrespective of the quantum of power transmitted through the system. Further, once a project is commissioned, it requires low-level of O&M expenditure, which translates towards higher EBITDA margins as a % of revenue. Counter-party risk is minimised since most players are government owned enterprises and there are clauses to charge surcharges/interest to compensate in case of delay in payments. Lack of alternative supply arrangements deter payment defaults.
Regular distributions to unitholders: As per the InvIT regulations, the InvIT would be mandatorily required to declare distributions every quarter, which too shall not be less than 90% of the net distributable cash flows. As disclosed by the management on the investor conference call, the average distributable cash flows for the next 3 years would be about ₹ 1,150 crore. Accordingly, investors can assume a pre-tax yield of about 8-10%. Distributions indicatively would be in the ratio of 50:30:20 (Interest:Dividends:Capital repayments, respectively) throughout the life of the asset, accordingly non-resident investors can expect higher IRRs due to reduced rate of tax on interest distributions.
Ability to scale using debt: InvIT regulations permit leverage upto 49% of total value of assets (which can further increase to 70% post satisfaction of various conditions). Currently, the PGInvIT is nearly debt-free on a consolidated basis, and hence there is ability to finance future acquisitions (including purchase of balance 26% stake of Initial Portfolio Assets) without substantial dilution to the existing unitholders.
Strong lineage and support from Sponsor, including Government support: The experience and expertise of Powergrid provides a competitive edge within the power transmission industry. The Sponsor also has a huge portfolio of operational as well as pipeline assets, which can easily be flipped in the InvIT at a later date. Further, the Government has also been supportive in securing the settlement of outstanding dues from the distribution companies (‘DISCOMs’). Overall, all these factors help in creating a stable operating business environment for the InvIT to grow and prosper.
High barriers to entry: Power sector supports national defence, vital emergency services as well as day-to-day life of citizens and industries, and hence is very critical and strategic. Most of these projects are awarded on a BOOM basis, with competitive tariff based bidding. PGInvIT is in an advantegous position to capitalise on opportunities that may arise by utilising their existing right of way, since developing alternate new lines may be challenging for a new entrant.
Tax efficient model: GoI has provided various exemptions as well as incentives to promote the use of the InvIT structure. For Powergrid, it enables monetisation of assets in a tax-efficient manner. Further, the InvIT has been accorded a pass-through status for interest and dividend income, thus making it chargeable directly in the hands of the unitholders (unlike a company structure wherein there is double taxation). Interest is chargeable at reduced rates in the hands of foreign investors, thus making it a lucrative investment opportunity. Various SWFs and Pension Funds are granted complete tax exemption subject to fulfilment of conditions.
Some points to keep in mind before investing
Cash flows are highly dependent on collections from DISCOMs: For each project, there is typically just one customer from whom payment has to be received, which is the distribution company (‘DISCOM’). In the past few years, there have been significant delays in rececipt of payment even though the government has launched various schemes such as the Aatmanirbhar Bharat package. Any delay/default in payments of such billed transmission charges can materially affect cash flows and results of operations, leading to significant hit on IRRs.
Fixed revenue vis-à-vis variable costs: Transmission charges under the TSAs are generally fixed. They may not be able to offset the increase in costs (incl. operation and maintenance costs). This may impact its business and financial condition.
Higher minimum investment amount: Retail investors need to invest ₹ 1.1 lakh minimum since the lot size is 1100 units. Further, all transaction on-market as well as off-market (i.e. rights issue, etc.) would happen in multiples of this lot size. Accordingly, it may not be attractive to retail individuals who do not prefer to block big sums in a particular scrip.
Lack of contractual agreements for related party transactions: The PGInvIT has not entered into any upfront agreements (including Right of First Offer ‘RoFO’) with the Sponsor for future acquisitions, including the purchase of balance 26% stake in Initial Portfolio Assets. Accordingly, it may very well be possible that future acquisitions are delayed or cancelled in case if Powergrid is able to monetise it by other means. This makes the InvIT dependent on the whims and fancy of the GoI, who is the majority shareholder of Powergrid. Further, the O&M fees have only been agreed for a period of 3 years, post which it will be mutually agreed. Accordingly, it is difficult to foresee future costs.
Non-disclosure of NAV, other key financial parameters: The net asset value (NAV) is a key parameter based on which it can be determined whether the issue is being priced at a premium or discount. However, the same has not been disclosed in the Offer document, nor during the conference call. Financial projections only upto 3 years are made, which does not allow investors to find out potential for future distributions or yield expectations. As per market pundits, a yield of 8-10% could be expected, however there is no clarity from management on the same. Further, the offer seems to be priced at a 3.5x multiple on the book value, which may be a bit higher as compared to peers.
Comparison with IndiGrid
India Grid Trust is an existing listed InvIT engaged in the space of electricity transmission, and hence would be an appropriate industry peer to analyse the current IPO
To sum up
An InvIT model de-risks the business of owning infrastructure assets in India, since only operating assets are allowed to be held, and thus altogether removing the construction and financing risk during pre-operating stage. InvITs are at the cusp of an inflexion point in India, taking inspiration from developed world economies.
The power sector is a key strategic and critical sector for India, and is set of a booming period ahead. The Sponsor of the Trust – POWERGRID is the major grid service player and has a robust experience and expertise in this field. A strong pipeline ensures that the future expansion opportunities for the Trust would be multifold and they would be able to easily scale up using debt sources, thus leading to minimum dilution.
It may currently appear that the Offer price is at a slight premium compared to its industry peers, however it is well positioned to take take advantage of the growth of the power transmission industry. It is a quasi-equity instrument, wherein there will be a combination of quarterly distribution (estimated to be about 8-10% yield) as well as capital appreciation gains (not significant and over a long term period). Investors who are applying for listing gains need to be cautious since there is no GMP currently available.
It may be a lucrative opportunity for investors who desire fixed returns over a long term perspective.
Investment in securities market are subject to market risks. Please read the Offer Document and other related documents carefully before investing. You may find the same here. Please consider your specific investment requirements, risk tolerance, investment goal, time frame, risk and reward balance and the cost associated with the investment before choosing to invest in the IPO. Any content above should not be relied upon as advice or construed as providing recommendations of any kind.
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