M&As have helped in rating upgrades for road sector projects: K Ravichandran, ICRA

In a chat with ET Now, K Ravichandran, ICRA, says while there was a lull during the demonetisation phase, from February 2017 onwards, we have been observing improvement on the traffic side.

Edited excerpts:


The Icra report points to the case for increased M&A activity in the road sector. What really is the case that you are making for this? What really is the potential that you can see here?

We see a lot of traction in the M&A space, especially because of the policy relaxation done by the government in May 2015 wherein government allowed 100% exit by the road developers. That was a big trigger and because of that, several investors got interested in this space. Earlier, while 75% was allowed to be sold by the developers, many private good investors were looking at 100% control over the assets which they were willing to buy.

Ever since the relaxation we have been observing a flurry of deals in this space and we believe more would be coming especially because we believe that on the traffic front things are improving. While there was a lull during the demonetisation phase, from February 2017 onwards, we have been observing improvement on the traffic side. Inflation has been inching up because of these two reasons and we believe that overall toll collections can improve by about 10% per annum on an average for the developers.

That coupled with the fact that interest rates have been coming down in the economy would be another trigger for the M&A deals. We have observed that wherever these deals have happened ,there have been rating upgrades because the new sponsors with better financial strength have been able to refinance the debt with longer maturity at a lower interest rate that has given relief on the cash flow front to these companies. We also observed that ratings have improved in at least 40-50% of these cases wherein the deals have happened.

You are making a case for seeing a turnaround and in a sector that has been languishing due to high debt and low investments as well. Let us talk a little bit than about the relaxation of the exit policy for projects before 2009 and that helped increase the PE participation. What more do you think can be done to attract increased M&A in the space?

The new investors - whether they are financial investors or the companies who are already operating in this space now -- are essentially looking at the kind of SPVs which have at least five to seven years or track record because of a big concern for any buyer with regard to traffic certainty.

We have observed that regarding new road projects, there is lesser level of certainty with regard to traffic. In SPV variant, you would have more certainty on the traffic growth rate and any leakages that would be possible and also if major maintenance has been completed, that would give more comfort.

So from the developer, from the buyer’s point of view, that is an important thing which they look for and also with regard to approval processes -- whether it is environmental approval or whether railway related or forest approvals – all are getting streamlined now. As and when there is more traction on this front, we would see more activity on new road construction space. That would mean more road projects would be coming in the M&A arena in the coming years.

It is important to recycle capital in this early capital business so that the stressed companies can exit through these kind of M&A deals. Also of late, the InvIT is another opportunity for the developers to exit some of the projects. While four or five developers have already filed prospectus for InvIT, we are yet to see InvIT issue in the market but we believe that it is just a matter of time before InvIT gets acceptance from the investor community. We we have to ensure that the new instruments find acceptance on the investor class.

You are talking about new instruments finding acceptance within the investor class. As per your findings, 31% of the PE deals in the infra space have given negative returns. That obviously would dissuade investors to come into the market or come into the sector. What can be a good way to mitigate risk and enhanced returns?

In majority of these cases, the traffic potential would have been very high initially when they considered this project but because of the various macro economic reasons, the actual traffic was much lower than whatever they would have forecast initially. Also the fact that many of these entities were highly leveraged. So wherever you find that returns have been negative, those are the cases wherein the developers were highly leveraged and there were stressed and they wanted to get out of the space.

At the same time there are also projects wherein financial investors were there as the owners, they have made smart returns by selling their stake wherein and got IR of anywhere from 10% to 14% and there are also deals slightly more than that. From the buyers’ point of view, the moment they buy when they do refinancing, there is further upside to returns doing the balance concession period of this particular SPVs.