Rising Asset Sales

M&A activity increases as distressed sellers seek to deleverage

Amid the uncertainty over land acquisition, fuel availability, regulatory delays and deteriorating finances, companies in the power sector are increasingly exploring opportunities for the acquisition of stressed assets. The past 12-18 months have seen increased merger and acquisition (M&A) activity in the power sector with the announcement of multiple deals.

In May 2016, Malaysian state-run power company Tenaga Nasional Berhad announced its decision to acquire a 30 per cent stake in GMR Energy for $300 million. While GMR will use most of the funds from the deal to repay its debt and strengthen its balance sheet, Tenaga will use this opportunity to get a foothold in the growing Indian power sector.

While most of the asset sales by debt-laden promoters have been driven by a need to deleverage their balance sheets and gain the much-needed liquidity, Tenaga’s investment in GMR is one of the few strategic investments in the power sector in recent times.

Another such strategic investment was undertaken by Singapore-based Sembcorp in 2014 when it acquired a 45 per cent stake in NCC Power Projects Limited for $175 million to strengthen its position in the Indian power sector.

Another major transaction, announced in May 2016, was JSW Energy’s acquisition of a 1,000 MW power plant in Chhattisgarh from Jindal Steel and Power Limited (JSPL). The deal is expected to be completed by June 2018. According to the agreement between the two companies, the cost of acquisition will be Rs 40 billion, excluding the net current assets as of the closing date. The total amount may increase to Rs 65 billion if certain pre-conditions regarding fuel security and power off-take are met. In addition to this, JSW Energy entered into an MoU with Jaiprakash Power Ventures Limited (JPVL) in September 2015 to acquire the latter’s 500 MW Bina thermal power plant in Madhya Pradesh. Earlier, in September 2014, it had concluded the acquisition of the 300 MW Baspa II and the 1,091 MW Karcham Wangtoo hydroelectric power projects from JPVL.

Some of the other deals include the sale of the Udupi power plant by the Lanco Group to the Adani Group for $1 billion, the acquisition of French energy firm Engie’s 89 per cent stake in Meenakshi Energy by India Power Corporation Limited (IPCL), and an investment of around Rs 7.8 billion by Macquarie Infrastructure & Real Assets (MIRA) in Ind-Barath Energy (Utkal) Limited.

There have also been a number of deals in the renewable energy segment. Some of these include the acquisition of Welspun Renewables Energy Private Limited by Tata Power Renewable Energy Limited for around Rs 92 billion; an investment of around Rs 7.6 billion by CLP India in Suzlon’s 100 MW solar project in Telangana; and Sembcorp’s acquisition of 60 per cent stake in Green Infra Limited for $227 million. Engie is also planning to acquire 80 per cent stake in Mumbai-based Kiran Energy for around Rs 120 billion.

Drivers

There is currently over 50,000 MW of stranded capacity due to inadequate fuel supply and the lack of long-term buyers for electricity. However, the situation is expected to improve in the coming months with the shift of power sector assets from weaker balance sheets to stronger ones through a series of announced and planned acquisitions. Most of these sales and acquisitions are driven by lenders’ pressure on developers to reduce debt in view of the latter’s distressed situation. Some of the larger conglomerates are also looking to improve their overall performance along with reducing their debt through the sale of assets.

The Lanco Group was laden with nearly Rs 390 billion of debt in 2014-15 when it sold its Udupi power plant. The company plans to sell three more plants for an estimated $2.5 billion.

On the other hand, many developers are increasingly opting for brown-field projects to expand their capacities rather than investing in greenfield projects, which come with challenges relating to land acquisition, grant of coal linkages and signing of power purchase agreements (PPAs). For instance, IPCL is looking to acquire three to four more stressed thermal plants in the near future as part of its plans to scale up generation capacity.

Going forward, the exit of strategic investors and the financially stressed condition of projects are likely to be the key drivers of asset sale in the sector. Capital market sentiments may not be supportive of the public listing of power companies, thereby resulting in secondary sale being the best exit option for investors.

The Reserve Bank of India’s (RBI) Strategic Debt Restructuring (SDR) scheme will also lead to the sale of several assets. The scheme gives lenders the power to turn around an ailing company, make it financially viable and recover their dues by selling the firm to a new promoter. However, this only postpones the treatment of non-performing assets (NPAs) in case the banks are not able to sell the company within the stipulated time.

There are two fundamental problems with the scheme. First, with the lack of required technical expertise, it is difficult for the lenders to preserve the value of the asset till they find a buyer. Second, it is difficult for the banks to find a buyer in the stipulated time. More so, because the SDR rules do not provide for a partial stake sale and banks have to sell their entire stake in the company to the new buyer.

Key issues

One of the biggest issues with respect to asset sales is the valuation expectations of promoters. Some of the projects are 10-20 years old, have obsolete technology and are not efficient. Also, some of these assets are under construction, which results in a lack of clarity on the additional investment requirements before commissioning. While valuation is not a key issue for state-run companies like NTPC (as an acquisition merely means a transfer of assets within state undertakings), valuation mismatches are certainly holding back the private sector from acquiring stressed assets.

In most of the cases, the lenders and the original promoters are taking significant haircuts on account of regulatory under-recovery, fuel quality, stranded capacity and payment delays, besides growth expectations.

Fuel issues also continue to be a hindrance in the growth of the power sector, including asset acquisitions. With only partial visibility regarding fuel availability, not many lenders are willing to take up the concerned assets.

The way forward

The government is taking a number of initiatives, including the Ujwal Discom Assurance Yojana and the Integrated Power Development Scheme, to address the issues affecting the sector. While these have lent a positive outlook to the sector, it will take some time to reinstate investor confidence.

The RBI has recently announced the Scheme for Sustainable Structuring of Stressed Assets, which aims to overcome the shortcomings of the SDR scheme.  The scheme allows banks to convert up to half the loans held by corporate borrowers into equity or equity-like securities. As per the new guidelines, the entire corporate debt does not need to be classified as an NPA and the existing promoters can continue to be part of the project. In most cases, the incoming investors would not be able to run the plant or complete construction without support from the promoters. Hence, there is a need for lenders as well as investors to incentivise the promoters.

To address some of the specific issues of the infrastructure/power sector, there is a need for specialised infrastructure restructuring companies to support the M&A activities.

Going forward, the focus is likely to be on domestic M&A activities and not on international strategic deals. The ongoing banking reforms around debt consolidation and restructuring are expected to boost deal activity in the future.

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