Netz Capital Advisors LLP

2011

By Atul Khekade &

Ritesh Kakkad

A Basic Guide to Infrastructure

Business, Investing and Financing

in India

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About Netz Capital Advisors LLP

Netz Capital Advisors LLP advises companies in industries such as

infrastructure, Aviation, real estate, manufacturing and others in arranging

Finance for business expansion through Banks, NBFCs, Private Equity Funds

and Investment Trusts in India and globally. Netz Capital Advisors has

presence in USA, UK, India and Singapore. Netz Capital has advised transaction

in excess of $200 million and currently has mandates for $1 billion + in

Financing.

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Table of Contents

1. Introduction

2. Indian Infrastructure Industry Facts

3. Sectors in Infrastructure

4. Type of Contracts

a. EPC Contracting

b. Built Operate Transfer (BOT)

5. Focus Areas for Infra Companies

6. Financing in Infrastructure

a. Equity

b. Debt

7. Banking Guidelines on Infrastructure

a. Domestic Banks and Funds

b. International Banks and Funds

8. Summary

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1. Introduction - Purpose of White Paper

Everyone staying in the India understands that India has always lagged in it's

infrastructure as compared to the growth of its population. With the growth in

Manufacturing, IT and many other industries, India has become a destination for Foreign

Direct Investment. Citing the lag of infrastructure as compared to India's growth, the

Government has given special boost to the infrastructure sector, especially the roads,

bridges and power.

Several business groups are increasingly foraying in to Infrastructure Industry to

catch the boom. Many investors are choosing to invest in infrastructure stocks.

Netz Capital has successfully advised various infrastructure businesses to arrange

expansion capital in various forms through banks, NBFCs, private equity funds and

Investment Trusts. Netz Capital through this white paper intends to make the reader

aware about the basics of Infrastructure business, opportunities in it and its various

financing models. Netz Capital understands that success from an infrastructure project

can only be enjoyed with a good financial management of the project in parallel to

delivering the quality.

Infrastructure is a tricky business and as most of the infrastructure contracts are

allotted by a bidding process, the budgets can get tight. That produces a risk of negative

cash flow and even bad infrastructure quality. It is a well understood fact that a

Successful Infrastructure company develops quality infrastructure within its assigned

budget and manages its finances in the right way and focuses on its core activity. This

White paper should give a basic understanding to an investor looking into infrastructure

stocks and businesses trying to catch the infrastructure boom and are looking into areas

of foray within infrastructure. By reading this document, a reader will be able to

understand the actual point from vast announcements and news that happen in the

infrastructure industry.

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2. Indian Infrastructure Industry Facts

Just to know the gigantic figures of India's infrastructure industry and its need, here are

some basic facts:

• Investment Required in India's Infrastructure Industry by 2019 - $1 Trillion

o Roads Requiring - $427 Billion

o Power Requiring - $288 Billion

o Railways Requiring - $ 281 Billion

• India's spending on infrastructure in the Year 2011 - $50 Billion

• Target Set by Ministry of Transport and Highways - Developing 20 Kms of Road

Every Day

• India will issue tax-free infrastructure bonds with a minimum tenure of 10 years,

which will have the potential to raise about $6.5 billion in fiscal year 2010/11,

according to government estimates, and the number could rise in 2011/12.

3. Sectors in Infrastructure

• Transport

o Roads and Highways

o Bridges

o Railway Lines

o Metro Rails

o Airports

o sea Ports

• Power

o Electricity Generation

o Electricity Transmission and Distribution

o Oil and Gas Pipelines

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• Urban Infrastructure

o Dam

o Water Supply

o Solid Waste Management

o Sewerage and Storm water Drainage

• Industrial and Commercial Infrastructure

o Special Economic Zones (SEZ)

o Industrial Park

• Mass Market Housing

o Townships

o Cluster Development

4. Type of Contracts

a. EPC Contracting (Engineering, Procurement and Construction)

Most of the work in the infrastructure segment is typically handed out to

contractors on EPC Contracting basis after a bidding process. Government initiates a

project such as Highway, bridge, metro, airport or a sea port and it floats a tender

which details about subcontractor deliverables, time frames and Budget. Estimating

Government's budget, several eligible contractors then bid for the project.

Contractors and their bids are evaluated based on various factors such as past

experience, financial strength, management team and the project is handed over to

the eligible contractor. In EPC Contracting, Government is assumed to have taken

care of the land acquisition part on which the project is to be developed. The project

may well be on the Government land itself.

EPC Contracting has been a cash cow for various infrastructure firms which

were in existence even before India's recent growth and infrastructure boom.

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b. Public Private Partnerships (PPP) and Built Operate Transfer (BOT)

India has so much infrastructure deficit that the Government has recently

chosen to give greater boost to infrastructure development by inviting private

parties to join hands with the Government. This frees up Government budget

and gives private parties the flexibility to fetch return from project over a longer

period of time such as 5-60 years in return of the equity infusion required up

front.

A Public Private partnership is called for when the economic benefits of

the infrastructure project go beyond its development value and time frame.

Public Private Partnerships may be required from raw stages of the project such

as land acquisition. Infrastructure projects under Public Private Partnerships get

required Government approvals and development rights. In return, the private

party acquires necessary land, develops the project, recovers it's investment

from the project's economic value and then hands over the project to the

Government after certain time frame which can go up to 100 years.

5. Focus Areas for Infra Companies

Ideally, an infrastructure company that wins a bid develops the project itself, however

due to the growth, competition and opportunities in the space, there is a clear cut focus

that infra companies have to develop while outsourcing rest of the activities to a

specialist.

• Sourcing of Contracts and Outsourcing:

Companies that focus on Contract sourcing have a strong management team with

infra expertise, quality development portfolio and strong financials. Many such

companies (prime contractors) are listed in the stock market and many will continue to.

These companies leverage their strengths to win contracts from the Government and

grow their order book on year on year basis. Job of these companies is to manage their

cash flows and outsource the work to quality subcontractors. Personnel working in

these companies have their expertise on Management, Financing, Government

Liaisoning and Project Planning, Architecture etc.

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• Contract Execution Development - Subcontractors

The most common job of a Subcontractor is building works and civil engineering.

Subcontractor expertise lies in recruiting mass construction worker manpower.

Subcontractors have to manage Raw Material supply required for the project, earth

moving and construction equipment.

• Equipment Operator

Equipment Operator companies come in with some equity infusion in the business to

make the down payment for the equipments they are required to buy to provide on a

contractual basis to the subcontractor or the prime contractor. Equipment Operator or

leasing companies get their equipments financed from the bank and carry the risk of

monthly lease rentals which have to be met in addition to generating profit from

supplying or leasing their equipments.

Various Equipments used by Equipment Operators include :

o Soil Compactors

o Tyre Rollers

o Concrete Mixtures

o Concrete Pumps

o Piling Rigs

o Generators

o JCBs ..etc.

• Raw Material Supply and Processing

Raw Materials suppliers have access to natural resources such as mines which

contain basic raw material for infrastructure development. Companies focused on

Raw Material Supply and processing excavate raw material from the mines, process

it and supply it to contracting companies or companies that use the same material to

manufacture a next level raw material.

Basic Raw Materials include some of the following:

o Coal

o Sand

o iron

o Steel

o Glass …etc

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6. Financing in Infrastructure

The purpose of this document is to create awareness about the financial system for

infrastructure. India has always grown and will keep growing. The only people that will

benefit from this are those with Financial Intelligence, those who can get the right

financing for infrastructure business. A successful investor will be the one who invests in

a financially sound infrastructure company. The difference between big players and

small players in any industry like infrastructure is the size of their balance sheet and

their ability to leverage their balance sheet and Banks to arrange timely capital to

manage projects and subcontractors. All those who are not able to leverage the boom

through right understanding of financing, find themselves with empty pockets.

Intention of Netz Capital to write an Infrastructure white paper focusing on it's

financing is to educate the businesses and investors so that they can benefit from it by

adding wealth. Having the basic understanding of infrastructure, one can see the

difference between a company with Financial Strength and strong business model and

focus and a company without financial strength.

a. Equity : Built Operate Transfer, Public Private partnerships

Infrastructure unlike any other industry is a long term game. It takes time to

segregate natural resources such as land, clear litigations and plan a infrastructure

project. Public Private Partnerships and Build Operate Transfer projects need significant

upfront investment. The purpose of this investment can be land acquisition, setting up

critical initial infrastructure till the monetization is realized. This process gives long

term returns which is not financeable by a typical Debt Instrument in the banks. Simple

reason is that once a corporate draws down debt, it has to start paying the interest

immediately. In long term infrastructure projects, revenue generation and profit

realization takes significant time like 3 to 5 years.

Infrastructure Focused Private Equity Funds like IDFC offer a long term Debt in the

form of equity to the infrastructure project where revenue generation takes time.

Once the project is stabilized after 3 to 5 years, equity investor can get significant

valuation for its equity stake in the project resulting in a reasonable rate of return.

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b. Debt :

Most of the infra companies dealing in EPC contracting, equipment operation and

raw material supply have Debt as their favorite instrument due to the ability to

immediately generate income and profit to repay the Debt interest.

• Revolving Credit Line for Subcontractors

Focus and benefit of Prime Contracting company lies in bagging Government

Contracts and growing their subcontractors. Their focus is managing the cash flow and

revenue delays between costs involved in development and payment from the

Government.

A Typical finance required for an infrastructure company is revolving line of

credit from the banks that allow them to meet raw material cost and subcontractor

payments while the Government releases it's payments in the phase wise manner.

Due to this, the prime contracting company can focus on project planning and

bagging extra contracts while the subcontractor can focus on quality development and

timely completion.

• Equipment Finance

Banks like HDFC Bank or NBFcs like SREI Equipment Finance use their funds to

buy the equipment (asset), calculate it's use of term and offer it to contracting

companies on a model where contracting companies can make reasonable monthly

hire or leases to carry out construction. Private Investors or equipment leasing

companies work on the same principle.

• Working Capital

Working Capital is a basic type of finance required for infrastructure companies to

meet their internal financing needs. A Working capital might be used for hiring

workers, buying assets, advertising and marketing.

• SBLCs

A Standby letter of Credit is used by the raw materials importer or purchaser to

issue to a raw material exporter to guarantee the payment while the raw material is

purchased on Credit. The importer needs to be issue a SBLC from a Bank. The importer

needs to convince the bank that he can actually buy the raw materials and might need

to issue personal or corporate guarantees and/or collateralize assets.

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7. Banking Guidelines on infrastructure

a. Domestic Banks Policy for Indian Infrastructure

Reserve Bank of India has categorized "infrastructure lending" as a separate sector

and has allowed banks to lend to the sector with lower interest rate and relaxed credit

norms. Even Non-Banking Financial Institutions (NBFCs) which have more than 75% of

it's exposure to infrastructure segment are now categorized separately as

"Infrastructure Finance Institutions". These institutions enjoy benefits such as lower

capital adequacy, relaxed credit norms and increased credit limits. This is a very

favorable arrangement considering the longer term return nature of infrastructure

projects.

b. International Banks Policy for Indian Infrastructure

Foreign Banks lending or investing into Indian infrastructure is qualified as ECB

"External Commercial Borrowing" and even for ECB, Reserve Bank of India has

announced friendly policies for "infrastructure lending". The ECB is however under

"Approval route" meaning there is a formal application to be made to RBI before

bringing down overseas money into Indian infrastructure. There is a $500 million limit

on ECB per financial year that can be brought down by a single company.

8. Summary

Infrastructure is a tricky sector. Companies in infra sector suffer small margins, cost

overruns and Debt burdens that result from long term nature of this industry. This

makes is particularly difficult and important to manage cash flow behind the infra

sector. Businesses in infra and investors need to be very alert about the financial risks

yet have to be enthusiastic about the vast opportunities in the industry and global

capital that is coming in to India waiting to be invested in the sector.

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Contact Information:

Mr.Anil Yadav

President-Finance

Netz Capital Advisors LLP

Email: anil at netzcapital dot com

Phone : +91 932484716 /91-22-28631151

http://www.netzcapital.com

Disclaimer

Whilst every effort has been made to ensure the accuracy of the information contained in this publication,

neither the netz capital nor any of its members past present or future warrants its accuracy or will, regardless of

its or their negligence, assume liability for any foreseeable or unforeseeable use made thereof, which liability is

hereby excluded. Consequently, such use is at the recipient’s own risk on the basis that any use by the recipient

constitutes agreement to the terms of this disclaimer. The recipient is obliged to inform any subsequent recipient

of such terms.