PPPs seen as risky

Public-Private Partnerships (PPP), an innovative method of roping in the private sector to engage in judicious government and infrastructural projects is currently seen as risky and dangerous, as more and more companies endanger themselves by borrowing recklessly to keep projects afloat. While potential returns can prove to be huge, there’s one catch. If private infrastructure players fail to finish the project on time, they will be penalised, usually at high rates, and this damages their prospects for bidding in future projects. Given the current market situation, infrastructure players are frantically trying to keep projects alive, albeit in a very unhealthy way—by loading up their balance sheets with debt.

According to a recent ICRA report, it is learnt that private infrastructural companies could be gearing up as much 20 times to keep their projects afloat. In other words, the holding/infrastructure company, if it is listed, will see a project decimated if its share price goes down by just 5%.

With so much gearing and little likelihood of generating cash flows, these companies will find it difficult to service their debt obligations in future and will soon go belly-up, which will lead to disastrous consequences across the economy, especially banks that are increasingly writing off loans, much the same way as Lehman Brothers went kaput.

The current challenging market conditions make it difficult to raise equity. Further, government policy inaction and vague tax laws have made private equities leery of investing in government projects, even attractive ones. This leaves infrastructure companies with no choice but to raise debt.

Typically, an infrastructure company, or holding company, will have several smaller subsidiaries or “special purpose vehicles” (SPVs), which are project entities unto themselves, merely owned by the holding company. The idea is assign a governmental project to each SPV, so as to keep management efficient. Each SPV has its own balance sheet. When you add all the SPV balance sheets, you will get the main holding company’s balance sheet. It is a neat thing to do. But the problem comes when there’s debt involved. Let us see how.

Sometimes, government projects require huge amounts of money to be raised by the parent company to fund the project. The private infrastructure players can raise money through bank loans, initial public offers (IPOs), from private equity firms and sometimes from its own coffers (either using parent company’s cash, or cross-subsidising from profitable SPVs and such).

The ICRA report explains, in detail, how infrastructure companies saddle SPVs with debt, which translates into a much higher debt for the holding company. In the report, it explains how companies can raise debt in three different ways and how they can affect its balance sheet. Since parts of the report are very technical, we will not be going through them in detail, instead give a brief overview of the methods of madness in raising debt.

a)    Funding of equity in projects SPVs by raising debt at holding company level resulting in high overall leverage

This is the most basic form of funding an SPV. Basically the holding company or the infrastructure company raises initial debt. By creating a SPV, it invests part of this initial debt in form of part-equity ownership in the SPV. Within the SPV, it uses the equity ownership to raise further debt, to finance the remainder of the project cost. Thus the leverage found here is seven times. So, if the holding company is listed and its market price moves down 14%, it will see the equity in a particular SPV wiped out.

b)    Part funding of equity contribution through EPC profits; availability of mobilisation advances further reduces the initial fund requirement for equity infusion

This is slightly more complicated. In the previous example, we had one part equity and one part debt. In this case, the equity part of the SPV is funded through cash flows from the project. Thus, there is less debt involved, but also less equity as well. Thus, at SPV level, the gearing for the holding company is now much greater, due to less equity. Here, the gearing is found to be roughly 12 times. It takes only 8% downside in market movement to put a project at a risk.

c)    Loan re-financing/securitisation as a means to upfront profits

This is the most complex of the three. Basically, it involves in ‘securitising’ of cash flows to secure even more debt. In other words, debt is being raised in the lieu of cash flows, which flows into the holding company as debt and not equity. Here, the gearing is found to be 20 times. In the most difficult of market conditions, securitising is usually followed, as it involves raising debt in small dosages, which over time becomes too big to handle. All it takes is just a 5% market downside to wipe off an SPV.