Equity for infrastructure

In the early days of the new telecom policy regime, private equity funds played an important part in providing resources to the emerging private presence in the sector. Warburg Pincus picked Bharti Telecom and earned sizeable returns on its investment when it chose to divest its stake. The Commonwealth Development Corporation, then a fund backed by the UK government, invested in BPL, which, a few years ago was acquired by Hutch, with attractive pay-offs for its original investors. These investments challenged the conventional view that infrastructure projects are best funded by long-term debt, given their relatively stable and unspectacular revenue characteristics. In hindsight, equity investments made sense in the telecom sector because initial penetration was so low that enormous growth opportunities awaited providers who could rapidly expand their network connectivity, while lowering prices to attract more subscriptions. This is the kind of upside potential that attracts equity investment, some of which will back the right horses. One important lesson from the telecom experience, though, is the importance of having the right policy framework in place. The original formula for private entry, the auction of licences, did not provide the right incentives to private investors. The policy amendment in 1999, shifting from an up-front bid for licences to a revenue-sharing model, radically changed the incentive structure, stimulating the virtuous cycle that generated such dramatic growth in connectivity and reduction in costs.

While there is legitimate cause for concern about the failure of other infrastructure sectors to emulate the telecom success, as has recently been reported, there are clear indications that the interest of major private equity players in these sectors is increasing. This is a very positive portent of two things. One, many of the incipient projects in these sectors are now within the returns horizon of equity investors. Of course, there is still the tricky question of picking the winners. Investors are dealing with this by investing in companies that offer a portfolio of infrastructure projects, within and across sectors, with the expectation that at least some of them will bear fruit relatively quickly. Two, more importantly, even as many observers express frustration about the snail's pace of reforms in some of these sectors, the incremental approach does appear to be taking the environment to a point where investors can see light at the end of the tunnel, with the same prospects of explosive growth in consumption accompanied by falling costs beyond it. As more projects get off the ground, however small they may be individually, greater confidence is created among investors, with respect to both the overall policy framework and the commitment of various levels of government to its implementation. The success of smaller initiatives will increase the willingness of investors to commit resources to larger ones. But, the lesson from the telecom experience should not be lost sight of. Equity investors live with the risk of failed projects and will not hesitate to pull the plug if the business environment does not appear to be shaping up in line with their expectations. The policy regime is the critical determinant of this, not so much in terms of design now, but certainly in terms of the ability and willingness of both the central and state governments to put good intentions into practice.