India offers investors a new slice of infrastructure pie

Falling interest rates should be good news for India's prospective new asset class – infrastructure investment trusts – as long as issuers price the first few deals to perform.
India offers investors a new slice of infrastructure pie

Institutional investors are set to gain access to a new way into India’s infrastructure market, as the first wave of Indian infrastructure developers start spinning off projects into initial public offerings.

Local rating agency ICRA recently forecast that infrastructure investment trusts, or Invits, could raise $3 billion from the IPO market over the coming 18 months. However, this may prove an underestimate, given that the first four deals alone hope to raise just shy of $2 billion between them.

All four of the initial Invit deals are at various stages of marketing their offerings, with IRB Infrastructure Invit likely to launch first. It is awaiting comments from the local regulator, the Securities and Exchange Board of India (Sebi).

Declining interest rates

Bankers and investors agree that Indian Invits are coming at a fortuitous time for Indian equity markets. Unlike China and the US, India is still on a declining interest rate cycle, making yield products an attractive proposition.

This is one of the main reasons why Jon Thorn, founder of India Capital Fund, is so bullish about Invits.

“We’re very excited about these products for two reasons,” he told FinanceAsia, a sister publication to AsianInvestor. “Firstly India is in a disinflationary environment, which is good for yield assets. The liberalisation of the economy is freeing up supply and reducing the country’s historically high inflation.

“Secondly, it’s very hard to find yield assets in the Indian equity markets,” he noted. “Capital constraints mean companies hold onto cash, and even banks typically yield less than 1%.”

Indian 10-year government bonds yield 6.8%. Given that global real estate investment trusts (Reits) and infrastructure trusts typically yield 250bp to 300bp over sovereign debt, this would suggest that Indian Invits need to offer a dividend yield around the 10% mark, after accounting for an IPO discount.

One US benchmark – New York-listed InfraReit – is yielding 5.4%, or 297bp, over US Treasuries. Analysts say it is valued around 11.58 times forward EV/Ebitda.

Return expectations

Bankers say most investors are pushing for low double-digit yields, while issuers are hoping to price closer to mid single-digit levels. However, they believe it is critical for Indian issuers to accept the need to price the first couple of deals to sell, to set the market off on a firm footing.

“The regulations governing these deals have been thoroughly thought through and they should go well,” one banker commented. “But we’re dealing with a new asset class, which is never straightforward.

“We’ve already had quite a few investors tell us they’re finding them quite complex to understand,” the banker added. “They’re contemplating sitting on the sidelines and seeing how the first few deals perform.”

One factor, which may help push yields slightly closer to where issuers would like like them to be, is the potential for dividend growth. Similar to Reits, Indian Invits offer the prospect for organic growth in tandem with India’s GDP, as well as through asset injections.

Issuers are also well aware that many investors have long wanted to play India’s infrastructure development, but have been wary of all the associated greenfield risks dealing with a country where construction timelines are elastic, capital is constrained and politics often hinders projects from reaching completion.

As one banker put it: “There’s huge pent-up demand for completed assets where the cash flows are transparent and it’s easy to measure the upside and downside risk.”

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