With a USD 2.2 billion order book to build nearly 4,000 km (2,500 miles) of road lanes across India and its bank credit tapped out, KMC Constructions turned to private equity for funding.
"I have a limitation on how many projects I can take, how much borrowing I can do," said Shashank Shekhar, vice president for business development at KMC Constructions, which in March landed a USD 111.5 million investment in a subsidiary from UK-based 3i India Infrastructure Fund.
"So you must go for private equity to capture more and more and stretch your capacity," he said.
Private equity investors are poised to play a faster-growing role in financing much-needed infrastructure projects in a country infamous for clogged roads and power outages and lacking a mature local bond market to provide long-term project funding.
Indian companies that long balked at the idea of yielding a degree of control and ownership to private equity players are showing more appetite for deals, in part because of the scarcity of alternatives given high borrowing rates and an unwelcoming equity market.
Friendlier government policies are also helping to make building projects easier, though delays and red tape remain problematic.
Private equity investment in infrastructure in India has grown from about USD 1 billion in 2006 to USD 4 billion last year, a recent Bain & Company report found, predicting activity could grow 25-50% a year over the next three years.
"Low levels of deal activity in the past had less to do with a lack of willingness to invest than with bottlenecks in the project pipeline and the need for a smoother government process for approving deals," the report said.
"Those barriers are now beginning to fall."
Private equity represents a modest share of the USD 1 trillion government says must be spent on infrastructure in 2012-2017, about half of which would come from private sector funds, compared with a target of one-third in the previous five years.
The government is on course to meet its target to fund a third of infrastructure growth privately in the five years to 2012, but there are wide disparities between different sectors.
Telecoms has received 82% of funds from private hands, compared with just 16 percent in roads and 4% in railways, government data showed in a review last year.
For commercially unviable projects, the government injects more cash, known as viability gap funding (VGF), as an incentive to the builder, or can sweeten a deal with lucrative real estate concessions alongside a road or a metro line.
To bring more funding into the sector, the government also plans to roll out a much-awaited USD 11 billion debt fund that could tap sovereign and insurance funds.
New Delhi has missed many of its targets both for construction and funding in the past. Red tape and corruption are notorious, while delays over land acquisition and environmental clearances can derail billion-dollar projects.
"The challenge is to make sure we are able to present opportunities to investors in a commercially robust and viable form," said Anoop Seth, co-head of Asian infrastructure at AMP Capital, a unit of top Australian wealth manager AMP.
Last week, Morgan Stanley's global infrastructure fund said it was investing up to USD 200 million in a joint venture with a unit of Spain's Grupo Isolux Corsan, which holds rights to build three highway projects in India.
"Before the global financial crisis, investors looked at India cautiously, and to be fair a lot of the infrastructure projects back then were very nascent," said Gautam Bhandari, who heads the Morgan Stanley India infrastructure fund.
"The reality is much of the India infrastructure story is still in its first innings and this is a baseball game so there are nine innings. It has ways to go," Bhandari said.
The largest infrastructure-related private equity deal in India is a USD 982 million investment for a 20% stake in a power project in Orissa built by GMR Energy, a unit of GMR Infrastructure, by a consortium led by IDFC India Infrastructure Fund in 2009, according to research firm Preqin.
Cash up front
Indian infrastructure firms such as KMC, whose projects include a 225-kilometre, six-lane highway from the outskirts of Delhi to Jaipur, typically build a road and operate it, collecting toll fares for a fixed period under the build-operate-transfer (BOT) model, which needs lots of cash up front.
"One of the reasons why I had to go for private equity was when we started picking up BOT projects, I was completely under-capitalised in terms of equity requirements," said KMC Managing Director Goutham Reddy.
KMC also considered an initial public offering, but Reddy worried over the market price. "The IPO market in the last two years has not exactly been great," he said.
Other funding options are limited. Commercial banks in India mostly issue shorter-term loans and since infrastructure projects typically have an investment life of more than 15-20 years, the banks run the risk of high asset-liability mismatch.
Relatively high borrowing rates in India also make debt raising an expensive option for the companies.
The Indian capital market has also not been very kind to infrastructure firms on worries about delays in project execution and long payback periods in a thinly regulated sector.
"Because the market is imposing a discipline that you better have something running before coming to an IPO, it is helping the dialogue between private equity players and developers in trying to get the projects to some stage of completion or some stage of construction before they hit the market," Bhandari said.
The slew of big-ticket infrastructure projects have raised the return expectations of the private equity players, raising the cost of capital for the companies who are in urgent need of capital to start the projects.
On the other hand, competitive bidding processes for major public utility projects will likely moderate the returns for private equity funds, Gopal Sarma of Bain & Company said.
"They will have the comfort of quasi-monopoly assets, but on the flipside given that these are public utilities there is going to be some natural banding of returns," he said.
"Given that a lot of these are going to be competitively bid out ... you're not going to see high 20s returns, you're probably going to see late teens, early teens returns -- slightly more moderate than what you would have in normal private equity, so that's one of the things that private equity needs to get accustomed to."