Policy for investment in equity of power projects

Transcription

1 -1- Policy for investment in equity of power projects 1. Background a) Rationale Financial intermediaries like IDFC, HDFC, IL&FS, PTC Financial Services, banks, LIC & other insurance companies etc. have been regularly investing in capital market related products. Equity investment business is generally considered as a logical extension of debt business. Since PFC has attained remarkable experience in power sector debt financing during its over 20 years of operations, the stage seems to be now set for PFC to make a mark in the area of equity investment. PFC can leverage its immense financial strength, large debt providing capability and domain expertise in power sector to invest in instruments other than debt like equity, mezzanine products etc. in attractive power projects. The profits from a skillfully built equity portfolio are expected to go a long way in maximizing the shareholders' wealth. b) Main Characteristics of Equity - High risk- high return instrument - Long gestation period (3-5 years or even more) - No returns during gestation period - Returns are not certain and come in the form of dividends and/or price appreciation in later years - Unlike term loans, the funds are not repaid and thus, get blocked for uncertain period and as a result not available for re-lending to other borrowers - Expected to provide better returns than debt in the medium-long term - Calls for a stringent appraisal mechanism and sound business/ financial acumen to choose the prospective winners at an early stage c) Instruments for investment in Equity The exposure in equity can directly/indirectly be taken mainly through the following instruments : - Equity shares - Preference shares - Sub-ordinated Debt with equity conversion option - Bonds with warrants/equity conversion option - Convertible Debentures d) PFC s experience in project equity so far PFC has not directly invested in equity of any power project. However, PFC has options to convert Senior debt-b (in the nature of Sub-ordinated debt) into equity in a few power projects. 2. Overall exposure limits Annexure to Policy Circular No.4:07:Policy (B8):Equity Investment : /04 dated Page 1 of 6

2 -2- The exposure norms as defined in PFC s Prudential Norms and the investment limits as stipulated in DPE guidelines would serve as overall ceiling limits for any kind of equity investment. The various sub-limits mentioned in the equity policy guidelines are within the aforesaid ceiling limits. The extant limits as mentioned in Prudential Norms and DPE guidelines are presented below: Prudential Norms for exposure in equity PFC s Prudential norms stipulate the following net worth/owned funds related exposure norms for investment in equity: - Investment in the shares of a single Government Sector entity 15% - Investment in the shares of a single Private Sector entity 15%* - Investment in the shares of a single group of companies in private sector- 25%* - Overall equity exposure in all the companies - 30% *Additional Investment Exposure of 5% and 10 % of owned funds for a single & group respectively also allowed, if it is on account of infrastructure investment within overall lending plus investment limits. In addition to the above, exposure in equity shares of a Private company shall be limited to 11% of the total subscribed capital of the company (the limit may be enhanced to 26% on the basis of project and promoter strengths in exceptional cases with the approval of Board of Directors). DPE guidelines for investment in Joint Ventures The extant DPE guidelines empower the Board of Directors of PFC to undertake equity investments to establish financial joint ventures and wholly owned subsidiaries in India or abroad with a ceiling of 15% of the net worth in one project limited to Rs crore. The overall ceiling on such investment in all projects put together has been stipulated to be 30% of the net worth of PFC. 3. Classification of investee companies The companies have been divided into following four broad groups for the purpose of equity investment. a) Central Public Sector utilities(cpsu) or a SPV in which a CPSU has minimum of 51% equity stake (Group1) b) State Public Sector utilities(spsu) or a SPV in which a SPSU has minimum of 51% equity stake (Group 2 c) Companies u/s 619-B of Companies Act, 1956 i.e. companies where at least 51% stake is held jointly by any combination of Central Govt./State Govt./one or more Government Company(Group 3) d) Private Companies (Group 4) The broad risk profile of equity investment not only varies across above categories but also within a single category, the perceived risk profile undergoes change depending on the institutional and financial strength of the companies. Annexure to Policy Circular No.4:07:Policy (B8):Equity Investment : /04 dated Page 2 of 6

3 -3-4. Policy guidelines for investment in equity The various aspects of equity financing related to the above categories of companies are described below: Maximum Exposure (Lower of the two) Investment decision Group 1 Group 2 Group 3 (619 B Cos) Group 4 (Pvt) As a % of PFC s networth Navratna/ Miniratna A+ : 3% Companies operating in Grade IR1, CPSUs in any sector A : 2% power sector or companies IR2: 2% or CPSUs in power B : 0.5% in which power sector sector - 5% CPSUs have a minimum Grade IR3, equity stake of 26% - 5% IR4: 1% Other CPSUs 2.5% Other 619B companies - 2% As a % of equity capital of the Project company : 26% ( If the equity exposure proposed to be taken is more than 11%, then such cases shall be considered only when PFC has taken debt exposure) The grade for private sector shall be based on composite rating model of PFC. The total equity commitment (sanction) in a financial year shall be limited to 10% of the networth of PFC. Power sector CPSUs shall include the main plant equipment manufacturers for power sector like BHEL etc. Consequent to PFC s investment, the regulatory identity of the investee company should not undergo a change. The various aspects to be examined and assessed are: Techno-economic viability of the project as per criteria laid down in OPS. Tie-up of various project inputs and outputs. Bankability of project structure and contractual arrangements. Experience, financial strength and rating of the promoters in acceptable grade (as mentioned in para Exposure above). The entity in which the equity exposure is proposed should fall within Investment Grade as per PFC s categorization. Minimum targeted return should be 6% higher than minimum rupee interest rate of PFC for the concerned sector. The analysis of a project w.r.t. equity investment would entail assessing the potential return that the project could provide to the shareholders. The returns to equity shareholders would depend on the cash earning capacity of the project. The quality of contractual structure in project finance deals provides big comfort about the certainty of these cash flows. Hence equity appraisal would necessarily entail in-depth analysis of contractual arrangements associated with the project. In case of projects being set up by SPVs of state/central utilities, the ring-fencing from the core promoters in terms of a separate TRA arrangement for cash inflow/outflow would be ensured. While evaluating a debt proposal, PFC, like any other lender, uses conservative assumptions for financial analysis and ignores all the efficiency gains that may accrue to the promoters. While CERC stipulates 16% ROE, efficiency gains accruing from incentive derived from higher PLF, savings in O&M cost and heat rate, UI charges, merchant sales etc. enhance the ROE of the promoters to a large extent. Hence, while evaluating equity proposal, the efficiency gains ought not to be ignored. However, PFC would have to take a seasoned decision by assessing the possibility of accrual of such gains to the project taking into account plant quality & vintage, past experience of the promoters and other situation specific aspects on a case to case basis. In case of extension/ commissioned projects or green field projects nearing Annexure to Policy Circular No.4:07:Policy (B8):Equity Investment : /04 dated Page 3 of 6

4 -4- completion, equity may be considered to be taken at a premium. In such cases, the expert advice of an independent firm (I.F.) shall be sought by PFC so as to get an independent view on the valuation of the project company. The I.F. shall be appointed from the 'Panel of Investment Bankers' on the basis of price bids. Exit Strategy Generally, project with visible upsides like merchant power sales and superior characteristics like good hydrology, captive coal mines, etc. shall be preferred. Any project which is stalled or languishing for a long period but seems to have decent upside potential shall be considered for equity investment only with a proper and satisfactory restructuring package. A note on the breakup value of the investment should also be incorporated in the appraisal report for determining the valuation of the investment for accounting purpose. Normally, PFC shall not exit a project till it is commissioned. After commissioning, the decision to hold/sell shall be taken depending on market conditions, performance of the plant, dividend pay out, expansion plans of the project company etc. Also, at times, the exit is governed by the shareholders agreement which may stipulate conditions like necessary lock-in for a certain period, first right of refusal to promoters etc. The various methods for exit from equity investments are as follows: Trade sale (Trade Sale implies sale of the equity shares of a company to another company) IPO Buyback arrangement with promoters and/or company with a minimum guaranteed return In case of holding co. SPV structure, conversion of shares at SPV level into shares of holding company and selling shares of holding company through stock exchanges(secondary market)/trade sale/ipo Any other acceptable route. In private projects, where PFC enters at the Greenfield stage with equity commitment, it would normally insist on promoters and project company undertaking to provide an exit through trade sale or an IPO with minimum post-tax IRR of 18%-20%. In case exit through above routes with the desired return could not be accomplished, the promoters and/or company would normally be required to buyback shares providing the pre-stipulated minimum post-tax IRR to PFC. However, in cases where PFC enters at an advanced stage of project implementation, the exit options would be negotiated on a case to case basis. Further, in Government projects, exit may generally be possible through a Trade Sale or an IPO with no minimum IRR provision. Exit route / Conversion of equity shares of SPV into shares of the holding company shall be decided upfront. In all cases of equity investments, exit should necessarily be available to PFC either through trade sale or buyback arrangement. Additionally, exit through IPO may also Annexure to Policy Circular No.4:07:Policy (B8):Equity Investment : /04 dated Page 4 of 6

5 -5- Draw down of Equity Board Nomination Shareholder s Agreement (SA) Valuation be available. In case of buyback arrangement, PFC shall also have the right to sell the equity holding to third party in the unlikely event of project promoters/company not being able to execute buyback due to any reason. PFC shall negotiate one or more exit options with the promoters depending on the merits of the case. There could be two ways of putting in equity by strategic financial investors like PFC - (i) Last Mile (LM), (ii) Pro-rata with other shareholders without participating in upfront equity (PWU) Last mile equity shall be the last installment(s) of equity payable for the project as per the latest cost estimate and cash flow statement approved by the lenders. LM is the most favored mode by strategic investors like PFC while promoters would push for PWU. However, the issue is generally negotiable. Hence, PFC may prefer to follow a pragmatic approach while negotiating various issues related to equity financing with the core promoters on a case to case basis. The minimum LM limit for different kinds of companies is presented below: Group 1 Group 2 Group 3 Group 4 Navratna/ A+ & A : Companies operating Grade IR1& Miniratna CPSUs 75% in power sector or IR2: 50% in any sector or companies in which CPSUs in power B : 100% power sector CPSUs Grade IR3& sector 50% have a minimum IR4: 75% equity stake of 26%: 75% Other CPSUs- 75% Other 619B companies- 100% The PWU option would normally be applicable for any borrower only if PFC is also a lender to the project, otherwise the entire equity shall be invested by PFC as Last Mile equity. In case of projects involving long gestation period (with construction period more than four years), PFC shall insist on subscribing to last mile equity irrespective of the grading of the project. PFC shall insist on securing a right to appoint nominee director on the board in all cases of equity financing. However, the right shall be a pre-requisite in following cases: Group 1,2 & 3, where Group 4, where PFC's equity stake is 15% or more PFC's equity stake is 7.5% or more Shareholder s agreement (SA) defines issues like Board composition, management control, ratio of shareholding, transfer of shares, terms of exit, arbitration, issue of further shares in instances like cost-overrun, expansion projects etc. Moreover, SA in case of private projects generally has certain provisions in favor of PE/strategic investors. These include drag along rights, tag-along rights, buyback arrangement with minimum guaranteed return, promoter-lock-in, price protection, put/call options etc. SA would be negotiated on a case to case basis depending on strength of the promoters as also the prevailing market practice. The equity, in case of green field projects, would normally be taken at par value. In case of extension/ commissioned projects or green field projects nearing completion, equity may be considered to be taken at a premium. In such cases, services of an Independent Firm shall be used to obtain an independent view regarding valuation of the Project Company. 5. Structuring on a case to case basis Annexure to Policy Circular No.4:07:Policy (B8):Equity Investment : /04 dated Page 5 of 6

6 -6- PFC could take direct equity stake or invest in other equity related instruments like Preference shares, sub-ordinate debt with equity conversion option, bonds with warrants convertible debentures etc. The equity deal could be structured on case to case basis on merits and prevailing market practice so as to balance risk-reward matrix. In special cases, where it is more advisable w.r.t exit option, risk reward position, higher flexibility etc., PFC may explore the possibility of investing in a holding company which owns one or more power projects. In such cases, all the operational projects & underconstruction projects as well as future plans of the company would be analysed. Generally, views of an Independent Firm regarding valuation would be considered while taking equity at the holding level. 6. Operational aspects of the policy a) Equity Investment Group (EIG) shall receive the proposals from the clients (through the State- In charge) regarding equity funding by PFC. b) The procedure in vogue and the roles of various units within PFC like Technical Pool(TP), Entity Appraisal(EA) and Legal & documentation(l&d)/consortium Lending Group(CLG) for debt appraisal for private companies shall be the same for all equity proposals also, except that one executive of EIG shall also join the appraisal team. The equity proposal shall first be screened by the Screening Committee and later, if shortlisted, be put up to Competent authority as per the following delegation of power: Maximum limit for equity investment-private sector ( Rs. crore) Maximum limit for equity investment-government sector ( Rs. crore) Competent authority Upto Upto 25 CMD More than upto 25 More than 25 upto 50 Committee of functional directors More than 25 upto 125 More than 50 upto 250 Loans Committee More than 125 More than 250 Board of Directors * Government sector shall be as defined under Prudential Norms. The above delegation of power shall also be applicable for relaxation of eligibility & other conditions, if any, at the time of sanction of financial assistance. Further, any relaxation/modification/waiver of pre-commitment/pre-disbursement/other conditions, at a later stage, shall be approved by CMD. c) However, all the equity proposals shall be submitted to the Board of Directors till such time decision is taken to operationalize the above delegation of power. Further, any modification of the policy should be submitted to the Board of Directors. d) Proposal for JVs, if conceived will be brought before the BoD for approval. e) All the post sanction matters will be handled by EIG along with L&D unit/clg who will handle all documentation & legal matters. All proposals for relaxation of condition(s), if required, shall be jointly processed by EIG and the other concerned appraisal unit(s). ****** Annexure to Policy Circular No.4:07:Policy (B8):Equity Investment : /04 dated Page 6 of 6