Attracting Equity

Changing risk profile calls for innovative financing mechanisms

India’s ambitious targets, record capacity additions and a steep fall in tariffs in 2016-17 have attracted global attention, with domestic as well as international investors and developers expressing interest in the country’s renewable energy sector. This rapid capacity addition has necessitated financing through non-conventional mechanisms. An estimated $100 billion of asset finance will be required to realise the 175 GW by 2022 target. To this end, equity financing has emerged as a successful mechanism for funding renewable energy projects.

Equity financing

Equity finance enables a financier to own a permanent share in the project. Unlike debt, where the investor is repaid the borrowed amount with a certain interest, equity finance not only provides funds for the project but also diversifies the ownership, thereby distributing the risks associated with the project. In other words, equity-based investments pay for themselves even after the investment has run its due course. This reduces the cost of capital for developers by precluding the need for them to pay interest and thereby increasing the net profit from the project.

Financing through equity enables developers to share their business and expand it. It also enables them to raise capital and acquire professional expertise about the sector from investors. Moreover, equity financing is a popular option for companies that are looking to invest in green projects but lack the core competency to develop them. For projects being developed by new entrants and start-ups, the infusion of capital in exchange for stake in the project can help the developers avail of multiple benefits to grow and use the funds to bid for new tenders.

Multiple methods of raising capital through the equity route are prevalent in the Indian renewable energy market, including private funding, publicly raised funding, mergers and acquisitions, and infrastructure investment trusts (InvITs).

Private funds are typically raised by companies that usually do not participate in public trading and, therefore, the money is directly injected into the company. Another innovative mechanism has emerged in the recent past that allows financiers to invest capital directly into projects in lieu of partial ownership of renewable power plants. While this decouples the investor from the risks associated with the company, it also reduces the risk of the capital being diverted for purposes other than what it is intended for. Considering the high risk component associated with greenfield projects, this type of financing is restricted to only operational projects.

In public funding, capital is raised through an initial public offering or through a divestment of company shares on the stock exchange. Declining power tariffs, large orders and low returns have compelled companies to go public and dilute their ownership to generate sufficient money for fulfilling their project commitments. In addition, public funding opens up the investment space for renewable energy and provides a common platform for both companies as well as individuals to purchase shares of renewable energy companies listed on the stock exchange.

Mergers and acquisitions (M&As) provide another alternative for raising funds. This form of equity financing is becoming increasingly popular, with big market players being acquired by even bigger players. With steeply declining tariffs, many companies lacking competency and funds are finding it difficult to compete with big market players for upcoming projects. To this end, merging two companies or the acquisition of one company by the other is becoming popular, thus benefitting both parties. An example of this is the recent acquisition of Welspun Renewables by Tata Power Renewable Energy Limited (TPREL). The move has been advantageous for both companies as Welspun lacked the requisite expertise and funds to win project bids and TPREL was seeking expansion of its resources for developing more projects. In addition, M&As have increasingly become the preferred tool for new companies or financiers wanting to enter the renewable energy market. In February 2017, Japan-based JERA, Inc., a joint venture between the Tokyo Electric Power Corporation and Chubu Electric Power, acquired a 10 per cent share in ReNew Power Ventures Private Limited for $200 million to enter and take advantage of the growing renewable energy sector in India.

InvITs too have found significant application in the Indian renewable energy space owing to the policy and regulatory amendments by the Securities and Exchange Board of India (SEBI) and the Reserve Bank of India, and greater tax benefits. InvITs are useful for making the developers’ tied-up capital available for investment, as well as attracting foreign equity and lowering the loan exposure of domestic lenders. Recently, IL&FS and Mytrah Energy floated wind energy-specific InvITs, which are awaiting SEBI’s approval.

Challenges

Equity finance for renewable energy projects comes with its own set of challenges. Funds raised through this mode have a larger gestation period, given the contractual formalities for the transfer of ownership. While this may not be an issue for a developer with no or completed assets, it could prove to be detrimental for those with approved or under-construction projects. Moreover, developers need to ensure high returns for investors as compensation for the risks.

Equity investments in India are heavily skewed towards companies focusing on low-risk renewable energy segments like wind and solar power. This inhibits investments from being channelled into other green technologies such as small-hydropower, waste to energy, biomass energy and geothermal energy. Additionally, the renewable energy market is tightly controlled by government policies. In India, the sector being relatively new, the policies are revised within short durations, thereby increasing the risk factor. Moreover, there is confusion regarding policies, and lapses in implementation by the regulatory authorities are common. Given the steep fall in tariffs discovered in the first competitive bidding for 1,000 MW of wind projects, the risk of power purchase agreements signed at higher tariffs being dishonoured and delayed payments have increased. In addition, since there are only a few renewable energy-rich states, investments could be limited to projects that are developed only at these locations with attractive policies and investment benefits not finding their way to underserved areas. The need for low-interest debt requires the equity-based capital to remain invested in a project for a long duration of time.

Conclusion

Renewable energy investments in India have seen a major shift in the past year with players from national and international markets showing interest in funding solar and wind projects. Although the market offers significant opportunities to investors in terms of the quantity of projects envisaged, the quality of returns has dwindled over time due to various factors. Although innovative funding mechanisms are being explored and promoted by the government, policy and regulatory bottlenecks need to be managed in order to remove investor inhibitions. Moreover, multiple operational issues exist in this space that requires immediate solutions to lower the risk of capital for projects. With falling margins and depleting returns, the renewable sector could be faced with waning investor interest, which can only be countered through innovative equity financing mechanisms.

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