Infrastructure companies in India

Even as Reliance has been on a deleveraging drive, the Adani Group has been on a leveraging binge. Devangshu Dutta, in a rare example of excellent reporting on corporate India, raises red flags on Adani Group's debt fuelled growth. Sample the deceptive numbers about Adani Gas,

AGEL had consolidated 2019-20 income from operations of Rs 2,548 crore with profits before tax of Rs 74 crore and a net loss of Rs 61 crore, after finance costs of Rs 995 crore. Adjusting for exceptional items, depreciation and amortisation, finance costs, and others, the operating profits (Ebitda) would have been around Rs 1,580 crore for an impressive operating margin of 62 per cent. The problem is debt. AGEL has an equity base of Rs 2,356 crore. It has debt (current and long-term) of just over Rs 14,000 crore.

And this pattern of high debt-to-equity ratio is replicated in every listed group company. But it is the narrative about the company that rivets investors,

Professor Aswath Damodaran of Stern School of Business, New York University says that the valuation of investments are based on narrative or on numbers. The narrative about the Adani Group is compelling. It is a major infrastructure player, which has grown at great speed as it moved into sector after sector. It is India’s largest private port operator. It is a power producer and transmission player. It is a big player in city gas distribution. It has interests in coal. It has successfully bid for multiple airports and would be the biggest private airport operator, once the civil aviation sector gets going post-pandemic. It is a major renewables player. It has an agricultural joint venture. It’s looking at a huge data centre operation. It is looking at water management. The group has delivered roughly 20x growth in the past 15 years.

And this narrative has been underpinned by problematic corporate governance issues, 

The strategic “structure” is fascinating. There is an “incubator” in the holding company, Adani Enterprises. Once a business looks to have matured, it is spun off and listed. Managing the regulatory environment is crucial for infrastructure plays and the group’s closeness to the current government helps in this respect. Like most group that have grown quickly, this one has also made its share of bad bets. It ran into problems with Indonesian coal imports. The legal issues there are still live. It has faced environmental backlash while developing coal operations in Australia. Mundra Port has been accused of many environmental violations. Reports suggest serious investor resistance to the current attempts to delist Adani Power. The numbers indicate the group has massive debt distributed across the balance sheets of many sister-companies. How much debt there is, is hard to ascertain, given the many unlisted subsidiaries and SPVs (Special Purpose Vehicle) which take care of projects. Various group companies including listed and unlisted ones have borrowed from each other, and invested in each other, and also borrowed from banks, floated bonds, tapped overseas funding, pledged shares etc. It’s hard to get a complete picture. The complex chain of financial relationships implies a problem in one business could spiral to impact apparently unrelated businesses.

And the numbers raise more questions, 

The listed companies all have high debt:equity ratios. Other key ratios like interest cover and debt: Ebitda are also in what may be considered dangerous territory. Sovereign downgrades have meant downgrades of overseas borrowings, and a falling rupee represents another danger. Most Adani businesses like ports, gas, power, airports, are in regulated areas with set tariffs. These are difficult times. Port traffic is down; power demand is down; aviation traffic is down. Hence, top-line growth is hard to generate. But the group has not defaulted. It has met its debt commitments.

But this is the nub of the matter

But the group has not defaulted. It has met its debt commitments. Given easy money regimes from central banks, it may be possible for the group to lower the interest burden and extend debt-tenure. Marrying the narrative to the numbers, the group has to keep scaling up since that allows it to raise more money. Can debt be reduced to reasonable levels? The answer to that question is critical.

In many respects, it cannot be denied that it could be accused of being India's biggest infrastructure Ponzi. At the extensive margin, get into more sectors. At the intensive margin, deepen presence in each sector. And being a large infrastructure company helps on both margins with getting new projects. Further, at both margins, a new project adds to the assets side, thereby enabling the company to add more leverage and generate cash flow. 

The problems are two-fold. One, most of the group investments are in greenfield projects. This, in turn, means there will be problems of commissioning and cash flow generation by the projects in the future. There is the near certainty of cost over-runs and delays with all these projects. One can be certain that there were strategic misrepresentations in the financial closures of all these projects. But then, globally, optimistic project viability is critical to attracting investors into risky infrastructure sectors, especially greenfield ones. See this paper.

Two, related to the first point is the tenuous balance in cash-flow management. The low cost debt availability aside, there is the issue of managing the cash flows among these complex interlocking related parties. There are too many moving parts with uncertainties (not risks) at every node. We know what happened with one similar infrastructure group, and that too not too distant back. 

For banking and securities regulators looking at Adani Group and wanting to decipher the numbers from the narrative, Wirecard is only the latest example. This FT investigation of the Group should count as a rare example of investigative journalism in the financial markets.

But the issue also presents another perspective. The Adani Group has been instrumental in developing PPPs in ports, airports, and city gas projects. And that too investing mainly in the risky greenfield projects. It is perhaps the country's best bet in the emergence of a major player in solar panel manufacturing. In all these areas, even incumbents have displayed reluctance to assume risk, bid and invest in new projects.

It therefore begs the question whether for a country at India's stage of development, atleast in terms of risk appetite and ambition, isn't is desirable to have a handful of Adanis and Reliances? Also, isn't the history of private participation in infrastructure sector countries in their early development trajectories filled with stories of such risk appetite and corporate governance and financial sustainability concerns?

In any case, the scale of ambition and risk appetite is unmatched, even by global standards. And that is important in a country with chronic scale entrepreneurship deficit.

But this view has to be matched with the systemic risks and other concerns, which are significant.