Driving Excellence in Capital Structuring

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Meeting the ambition of high growth, expanding both market capitalisation and revenues, requires skill, foresight and commitment. When it must happen in the context of existing high debt and higher leverage, it demands a dual focus on expansion at one end and the ability to improve capital structures at the other. For CFOs operating in the Indian infrastructure space, enabling funds availability has been, and will remain, among the most challenging tasks. Karthikeyan TV, CFO, L&T Infrastructure Development (L&TIDPL) is one who has successfully generated long-term monies by using longer-term, lower-cost instruments, and by widening relations with a spectrum of financial institutions.

Mr Karthikeyan leads Finance in an industry that demands long-term, patient capital, but which has also seen huge volatility after a long period of decline. He was instrumental in creating India’s first privately placed Infrastructure Investment Trust (InvIT), which received over 55 per cent of its funding from global investors. The Trust will act as a platform to unlock the value of projects and infrastructure in India and churn capital within its portfolio. Debt to the tune of Rs 33.5 billion was retired, and the EBITDA-to-interest ratio rose from 1.23 in FY17 to 1.59 in FY18.

Mr Kathikeyan, along with his well-experienced Finance team, conceptualised a unique cash-pooling mechanism to make funds fungible between multiple subsidiaries. Under his guidance, debt has been restructured to optimise the capital mix and risk-returns trade-off, and to diversify the sources of funds. This has improved the combined valuation by over Rs 1 billion. His efforts, in this trickiest of industries, has enabled the business to continue investing in growth.

Various initiatives to recapitalise or restructure debt have unlocked value to the tune of Rs 3,650 crores across three subsidiaries. Illustratively, redeemable NCDs were issued at a coupon rate of 8.6 per cent to repay IDFC’s long-term debt capital. This was executed in the same timeframe as other debt-restructuring measures – which improved cash flows in some projects, unlocking over Rs 100 crores, and brought down interest rates. Resultantly, several independent projects saw a jump in valuations.

Mr Karthikeyan believes that a modern day CFO needs to be, for the most part, a marketing officer who can communicate with investors consistently and transparently. To him, the management of potential conflicts amongst investors and shareholders is a very high priority. His mantra is, ‘Investors can stand losses, but hate surprises.’

The article contains an in-depth assessment of Karthikeyan TV’s role in restructuring and raising capital to optimise shareholder returns.

The Big Picture

1. What are the L&T IDPL’s strategic goals for the next 3-5 years?

Being an infrastructure development company, our objective is partnering with the government in nation-building through active participation in the PPP sector, and providing higher returns to shareholders by unlocking value at the right time. In the immediate short term, we are looking to improve our cash flows by pursuing and realising certain long-outstanding claims on the authorities, as well as refinancing certain completed projects. We are also on the lookout for growing our power transmission-line portfolio – both Greenfield and Brownfield. We are also pursuing opportunities in the roads sector, such as NHAI projects on a hybrid-annuity model, and toll projects. We also plan to leverage our O&M experience in the roads sector especially in the wake of Toll Operate & Transfer (TOT) projects.

In the medium term, we are looking at value enhancement through: (a) monetising mature assets using our InvIT platform; (b) adding value-accretive projects in existing lines of business and (c) exploring emerging sectors in the PPP mode such as water and sewage treatment, city gas distribution.

L&TIDPL’s objective is partnering with the government in nation building through active participation in the PPP sector and providing higher returns to shareholders by unlocking value at the right time.

2. Where is Finance positioned in achieving these objectives? What role does Finance play to enable the business to effectively manage change?

Being primarily an investment-cum-development company in the infrastructure concession business, Finance has played a pivotal role. I believe that it is in the tougher times that the role of Finance function comes to the fore. The ability to cut losses (not limited to cost-reduction) and conserve both cash and valuations becomes quintessential to survive. Hence, the Finance function needs to take the lead and propel the organisation away from the threats that challenge it.

Finance function’s role becomes critical especially during tougher times. The ability to cut losses (not just cost) and conserve both cash and valuations becomes quintessential to survive.

3. Which risks would you identify as key? Conversely, what are key opportunity areas?

In the infrastructure space, counterparty risk is probably the most significant since it is not possible to price this in. Both the ability and intent of counterparties in meeting their commitments and obligations under the contractual framework are of paramount experience; even more so because the contracts or concessions are not negotiated but provided by the authority – usually the central or the state government. Being highly leveraged, finance risk – the availability of funds for the required period and the volatility of its pricing – too is a large risk, but with experience it can be priced in. The willingness to pay by the users of the utility has remained a challenge.

However, we see a big opportunity here if we get our pricing right. The government is also coming up with new models to rejuvenate the private participation by a more equitable allocation of risk such as in hybrid annuity models where the traffic risk is eliminated for the developer. The recent amendments to the Arbitration Act and the introduction of IBC are expected to shorten the timeframe for legal pronouncements. With most weak developers falling by the wayside, bids are expected to become more rational and to provide us with stronger balance sheets and better governance, and ultimately, a much better ‘second innings’.

4. Your capital restructuring was driven by the need to retire a huge debt pile on the books on the one hand, and to finance the growth agenda on the other. How did you balance the short-term need of deleveraging and the long-term agenda of organic and inorganic growth?

High leverage is, per se, not an issue if the cash flows are adequate to service debt promptly. In India, infra funding especially Greenfield is mainly done by commercial banks with a medium-term focus while infra needs, as everybody on the street understands, real long-term loans. Hence, our strategy is to refinance projects with a track record of at least two years of operations by replacing the existing loan from banks with a combination of bonds and loans with a shorter tail period. This eases the pressure on cash flows.

In India, infra funding especially Greenfield is mainly done by commercial banks with a medium-term focus while infra needs real long-term loans.

Optimising the Capital Structure

1. You spearheaded the formation of India’s first privately held InvIT, with 55 per cent funds coming from international investors. What were the objectives, mechanics and outcome of floating the InvIT?

To keep user fees as low as possible it is necessary to have longer concession period for the investor to realise capital with reasonable returns. Internationally, concessions are as high as 60 years as compared to road concessions of 20-25 years in India. At the same time, project execution risks are much higher in India, leading to a change in risk profile as the project evolves. It is important, therefore, that the class of investors, too, moves along with this. Investors with high risk appetite and high return expectations are replaced with an investor class that prefers steady and consistent cash flows and have lower risk appetite as well as lower return thresholds.

The key advantages of the InvIT are:

  • Replacement of bank loans with units issued to long-term, patient capital such as pension funds, insurance companies, long-only funds, sovereign wealth funds, etc.
  • Regular cash flows to unitholders (even quarterly disbursements)
  • Tax efficiency – lower withholding tax of 5 per cent, exemption from dividend distribution tax, deferment of capital gains tax for developer
  • d. Monetisation platform for operational projects; funds for the developers for reinvesting in new infra assets
  • The support of sponsors who are also sector experts
  • Stronger governance framework (SEBI regulated)
  • Liquidity through the listing of the units
  • Growth in (toll) revenues arising from growing traffic and a WPI-indexed annual upward revision of toll rates
  • Perpetuity of trust by the acquisition of assets from the market as well as from the sponsor portfolio
  • Asset holding (at least 15 per cent) by sponsors for a period of at least three years
  • Reduction in risks related to a specific asset, as risk is shared among various investors of the InvIT

InvITs can play a crucial leading role in meeting India’s significant infrastructure requirements gap

2. How much was the overall debt that was retired as a result of InvIT? What was the impact on EBITDA?

Through the InvIT transaction, IDPL has already exited five matured road assets with an enterprise value of over Rs 52 billion, retiring loans to the extent of Rs 33.5 billion, including mezzanine debt of Rs 4 billion, releasing net cash of nearly Rs 8 billion. The debt retirement helped in improvement in EBITDA to interest ratio from 1.23 in FY17 to 1.59 FY18.

3. L&T IDPL is the third company to take the InvIT route to monetise some of its operational projects, and the first to raise funds through private placement solely from institutional investors. What are the key lessons that you learnt? How feasible is InvIT for infra developers in India? What are the key risks, for companies and for investors?

The introduction of InvITs has been viewed with high potentials as this innovative new vehicle can play a crucial leading role in meeting India’s significant infrastructure requirements gap, estimated to be Rs 50 trillion between FY 2018 and FY 2021.

InvIT as a platform enables developers of infrastructure to monetise their assets by pooling multiple projects in a single entity (trust) rather than individually selling the assets. A company may have multiple SPVs, where individually it is very difficult to unlock value, but when clubbed together under InvIT, it provides investors a healthier and stronger stream of cash inflows.

InvITs also aim to play a pivotal role in providing wider, long-term refinancing avenues, thereby creating headroom for banks to fund new projects and releasing developers’ capital for further deployment in new projects. From an investor standpoint, it is believed that InvITs will provide-risk-adjusted exposure to large infrastructure assets, which may provide a consistent yield coupled with relatively higher levels of liquidity.

Despite all its advantages, it became evident after several meetings in the East and West with several large investors, that we need to first sell InvIT as a product while the education on the portfolio and its performance is secondary. The confusion, however, in the minds of investors, especially the large investment houses, is whether the units are to be classified as debt or equity. Being a hybrid instrument, the units offer growth (unlike debt), carries equity like risks since the sponsor (under SEBI regulations) does not assure return on or return of capital, but cannot provide high returns offered by a listed entity.

Further, several large long-term players are not comfortable with a listed security since they need to book marked-to-market losses (or profits) if the scrip is traded. Such institutions prefer a ‘club deal’ whereby like-minded patient investors with an appetite to participate in the growth of the platform invest in the Trust.

I do not see many more InvITs coming up in India in the near future for more reasons than one. On the developer side, many established developers want to exit the sector and hence, do not want to create the platform and continue to discharge their responsibilities as a sponsor or project manager under the SEBI Regulations. Investors too look only at reputed developers with an attractive project pipeline on which the Trust can have certain rights to acquire to ensure perpetuity of the platform. Projects with a poor track record of revenues/cash flows cannot give the necessary comfort to investors on the return of or return on capital. I am of the opinion that a few strong Trusts for each sector – roads, power transmission line, metros, water treatment, gas distribution – would be adequate, and probably ideal.

4. You conceptualised a unique cash pooling mechanism which reduced the dependency of subsidiaries on L&T IDPL and made funds fungible for subsidiaries. How was the pool structured? What were the tangible outcomes?

To execute projects in the PPP mode, the authorities insist on special purpose companies (SPC) to be incorporated as the concessionaire under the concession agreement. The rationale behind this is to make sure that the Authority has a good handle on the operations of the SPC and monitors its cash flows better, and even takes over that SPC or substitute the concessionaire in case of a default. L&TIDPL has several such SPCs, each for a different road project.

We identified four road subsidiaries where we decided to replace the lenders of all the four with a single lender. With the approval of the authority we entered into loan agreements with this lender for pooling of cash flows for the purpose of debt service – this meant that while separate escrow accounts were still maintained with the lender, cash deficit to service debt, if any, in one project would be supported by surplus in another from the pool of four subsidiaries.

The lender also benefitted from the combined cash flows of four projects. The combined debt service coverage ratio (DSCR) became healthy, the rating of all four project loans improved and the interest rates became reasonable. As a sponsor, L&TIDPL benefitted as a weaker project could be supported by a stronger one, though they were different legal entities. A large share of the credit goes to Mathew George and Gaurav Chaturvedi from our Project Finance team, who thought through and successfully implemented this novel structure.

5. You managed to fetch an investment of Rs 2,000 crore by Canada’s largest pension fund at a time when investment in India, especially in infrastructure, was becoming scarce. How do you assess not just the price of the capital being offered, but also it’s true worth, including intangibles, over the long term?

Until recently, almost all developers were contractor-turned-developers with a low long-term risk appetite. With capital and debt intensive projects, book losses in the initial years are high due to amortisation and interest costs. Further, with several developers getting listed, there is significant pressure to deliver every quarter. What is required for the infra space (as is the case in developed economies) is a breed of investors who are not required to look at the stock prices daily or at results every quarter. CPPIB, Canada’s largest pension fund, was best suited as their philosophy is that ‘a quarter is 25 years’. Besides growth and risk capital, the entry of CPPIB enhanced our internal policies on corporate governance such as on anti-bribery and corruption, environmental, health and safety. This facilitated in attracting similar large foreign institution investors even for our InvIT.

What is needed for the infra space is a breed of investors who are not required to look at the stock prices daily or at results every quarter.

6. You oversaw L&T IDPL’s entire shareholding in L&T MRHL transferred to L&T. What was the cumulative impact of this reorganisation? Could you share more details about other initiatives?

The decision to move the stake in Hyderabad Metro to L&T, the parent company, was a strategic one taken by L&T considering several factors, inter alia, the massive size of the project, the need to negotiate with the local government on claims during the construction period, the large transit development requirements, etc. This, however, has released cash of over Rs 21 billion to L&TIDPL, which will fuel its growth in other projects. In terms of other measures, we have been consciously replacing bank loans with longer debt bonds with fixed interest rates. Of our total debt of over Rs 81 billion across our operating projects portfolio, nearly 40 per cent is in the form of bonds today. This has enabled us to bring down financing costs and improve valuations.

7. How do you identify the right sources of funds for optimum allocation of capital?

The growth phase of the company and the sector in which it operates provides guidance in identifying the kind of funds that should be raised. For a stable company with strong visibility of margins and cash flows, the business can sustain certain levels of debt. However, projects in the infrastructure sector are guzzlers of capital and therefore, there is a need for a higher leverage compared to a balance sheet funded project.

On the equity side, convertible instruments or mezzanine debt are also good options as they help reduce the cost of funding through lower coupons, while avoiding immediate dilution of one’s stake. On the debt side, since the project during the development phase would usually qualify for a BBB rating, bonds are out of the question. However, with a good revenue track record of, say, two years, the opportunity to tap the privately-placed bond market needs to be explored. This would help in replacing, either partially or entirely, more expensive medium-term bank loans with long-term (usually 5 years or longer) back-ended bonds with limited interest rate risk. While bank loans would be pegged to MCLR, which makes the rates volatile, bonds can be better structured with fixed rates. However, it is quintessential that at the holding company level, gearing is minimal and if at all, it is on long-term papers.

The growth phase of the company and the sector which it operates provides guidance in identifying the kind of funds that should be raised.

Targeting Investors

1. What was the biggest revelation you have had about the investor-relations side of being a CFO?

The CFO plays a crucial role in investor relations since he or she is the face of the company when the funds are first raised. Management of potential conflicts amongst the investor and shareholders would be on a very high priority. Investors can stand losses but hate surprises. Hence, consistent and ongoing transparent communication is critical.

2. Debt and equity markets have not been encouraging in the last 10 months. How did you manage to attract global investors to invest in L&T IDPL’s InvIT?

The right mix of assets in the initial portfolio, a long track record and a long list of projects in the pipeline definitely attracted large investors. The strong parentage of L&T and its brand value did most of the talking. Also, the decision of CPPIB – an investor with good knowledge of these assets – to take up a large stake in the Trust, also helped in a big way. We had also placed before the market a robust governance framework and an experienced dedicated team to manage the affairs of the Trust. I suppose these were the big contributing factors.

A successful CFO is a ‘Communicating Financial Officer’

Consistent and ongoing transparent communication is critical in removing the element of surprise, which investors despise.

On a lighter note

(Please provide sharp, witty and short answers)

1. Being a CFO to you means....

Almost always, the buck stops here (pun intended).

2. One important learning?

That all learnings are important. Most of your time goes in managing relationships than in managing cash.

3. Another CFO you look up to?

YM Deosthalee, former CFO of L&T, is my role model.

4. What was the toughest decision you had to make in your role as a CFO?

The most difficult aspect of a CFO’s role is decision-making. I would consider dropping our plans for listing as a business trust on the Singapore Exchange as one of the toughest decisions. The entire team, including bankers and lawyers, had put in a lot of effort in this in 2013-14, and we had filed our papers in record time with the exchange, though several approvals were required.

5. What comes to your mind when I say the following:

  • Communication and the CFOs:
    A successful CFO is a ‘Communicating Financial Officer’. Traditionally, Finance and accounts professionals are frugal with money, and even more so with their words, but the modern-day CFO needs to be, for the most part, a marketing officer where it is all about communication
  • CFO & Strategy:
    Strategy without the involvement of a CFO is as bad as a CFO without strategy.
  • CFO & Risk Management:
    Good CFOs are able to identify risk in almost everything; successful CFOs are those who know how to manage the risks.

6. Top three things on your bucket list:

  • Visit new places with my family and see the best that nature has to offer
  • Have a pet dog and go for long walks in serene surroundings
  • Learn astrology

7. Favourite book/movie:

Sherlock Holmes has been my favourite character, in both movies and books

8. Comfort food:

Anything vegetarian, be it Indian, Continental or Mexican or Thai.

9. What do you do to keep yourself operating at optimum level?

I keep myself very active, but at the same time make sure I am able to relax. This helps one remain unperturbed by situations, and in finding practical solutions.