IPO Review: IndiGrid's InvIT is high on stability but low on yield

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Being the second to list its investment trust (InvIT) and the first in the power transmission segment, IndiGrid's initial public offering (IPO) is interesting. Backed by Sterlite Power Grid Venture (SPG) as the sponsor, IndiGrid may offer investors an opportunity to directly participate in India's power transmission and distribution (T&D) theme. Ambit Capital in its report mentions that InvITs in the T&D space may be a better bet among listed companies given the limitation of capital misallocation that can take place under the InvIT structure.

Operations

Assets of IndiGrid would be derived from its sponsor SPG, which is among the leading independent power transmission companies in the private sector. It owns 11 inter-state power transmission projects having a total network of 30 power transmission lines (7,733 circuit kilometres or ckms) and nine substations having 13,890 megavolt amps (MVA) of transformation capacity. Out of the 11 projects, SPG would transfer two projects to IndiGrid, which have a network of eight power transmission lines of about 1,936 ckms and two substations having 6,000 MVA of transformation capacity. The projects were awarded to SPG under the 'tariff based competitive bidding' (TBCB) mechanism on a build-own-operate-maintain basis. The assets are contracted for 35 years under Transmission Service Agreement (TSAs), though their useful life could stretch to 50 years through periodic maintenance. These projects receive availability-based tariffs under the TSAs irrespective of the quantum of power transmitted through the line, which secures the income stream for IndiGrid. Tariffs under the TSAs are billed and collected by 'point of connection' (POC) mechanism or a pooling system which ensures that payments are made to a central payment pool and the proceeds are distributed proportionately to services providers. This again provides stability and certainty to IndiGrid's cash flow. Going ahead, IndiGrid has a right of first offer or ROFO to acquire eight of SPG's assets. The transfer, which is expected to conclude by FY22, should help IndiGrid's revenues increase from an estimated Rs 6,348 crore in the financial year (FY) 2017-18 to Rs 16,230 crore in FY22.

Financials

Bogged by high-interest costs and depreciation, IndiGrid's financials are unimpressive. However, this should change if Rs 1,600 crore of IPO proceeds is deployed to reduce debt from Rs 3,452 crore in FY17. Also, as the assets mature and the pool of assets is contributed by those wherein costs of construction is well absorbed due to depreciation, that should also help the numbers look better. However, for now, investors need to take note of operating profit margins at 90.4 per cent in FY17 indicating that efficiency of IndiGrid is at par with the industry. Margins are typically higher due to the very nature of the business, which involves transmission of power from one point to another. Power Grid's margins, too, range between 89-90 per cent.

Valuations

With an enterprise value of Rs 3,766 crore, the issue at Rs 2,250 crore does not fully absorb the value of assets. This explains why the yield of 10.7 per cent (post tax at 30 per cent slab is 7.5 per cent), based on FY18's projected cash flows of Rs 417 crore, appears low. Investors comparing IndiGrid's return profile with IRB InvIT may be disappointed. However, IndiGrid's revenue streams are nearly risk-free and as SPG operates in a domain which has high entry barriers, the risk profile is unlikely to alter.

But, the biggest risk is any delay in transferring assets from SPG to IndiGrid. IndiGrid will be perpetually dependent on SPG's ability to build its order book. Any delay or slowdown in that may hurt future prospects on IndiGrid. According to the Ministry of Power, only eight out of 30 upcoming interstate transmission projects are likely to be bid under TBCB mode. While in value terms, TBCB pipeline offers comfort (Rs 4,697 crore out of Rs 8,407 crore), the limited pipeline may result in intense bidding.

Who should invest?

InvIT as a product is designed to suit high net worth individuals and institutional investors given the minimum lot size of 10,206 units equivalent to Rs 10,00,000 at lower price band. For these investors, given IndiGrid's credit rating of AAA, those looking for risk-free avenues could treat the issuance like a bond and subscribe to the IPO.

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