To IPO, or not to IPO
In recent days we were witness to a rare event– an Initial Public Offering (IPO) by a renewable energy company. Sterling and Wilson, the largest solar energy engineering, procurement and construction (EPC) company in India released its IPO on 6th August 2019. The IPO, which was originally sized at INR 3.13 billion (USD 436million), eventually had to be resized downwards to INR 2.8 billion (USD 401 million) (subscribed 92%) to reflect subdued retail appetite. Furthermore, the first two days of trading saw tepid interest in the scrip with it closing at INR 688 (down 12%) vs an offer price of INR 780. It will be important to track the activity in the next couple of months to gauge interest from retail investors. Other renewable energy companies which are still exploring this instrument to raise money are expected to leverage the learnings and outcome from this IPO. What explain the paucity of IPO’s in the renewable energy sector? More importantly, what is holding back companies from tapping this obviously large source of capital?
It’s important to appreciate at the outset that not all renewable companies are created equal. Their place in the renewables value chain, or segment, determines the nature, quantum and periodicity of their capital requirements. For example, developers are long term capital hungry engines. They require constant injections of capital in the form of equity, debt, and hybrids to grow their asset portfolios. But once operational, these assets usually require no subsequent funding. In contrast, engineering, procurement & construction (EPC) companies such as Sterling and Wilson are long term capital light, with operations of a nature that may be largely funded via short term working capital on an ongoing basis. Manufacturing companies lie somewhere in between. They need large doses of long term capital to set up their plants, but once operational, they also often frequently require working capital, for instance capital to bridge operational cash flow timing mismatches.
Given the range of segments and associated capital types, we analyse the suitability of IPOs for renewable energy developers, as several developers have signalled their interest in exploring this option. This segment of the renewable energy value chain is at the forefront of sourcing & deploying large volumes of long-term capital, the very kind that IPOs target. We analyse the return on capital employed (ROCE)  for six companies for whom data was readily available. These include Acme Solar Holdings Ltd., Adani Green Energy Ltd., Azure Power Global Ltd., Greenko Energies Pvt Ltd., Mytrah Energy India Pvt Ltd., and Renew Power Ltd. In doing so, we intentionally considered consolidated, rather than standalone parent, financials. While it’s true that an IPO is carried out by a single legal entity (usually the parent or holding company), it’s equally true that shareholders actually gain exposure to consolidated corporate structures rather than to parent or hold-co only financials. This is particularly pertinent for Indian renewable energy developers. Their patchy dividend up-streaming means the bulk of value often remains trapped at the wholly owned subsidiary SPV level.
So what did our analysis reveal?
In order to develop a segment level view rather than evaluating performance at an individual company level we aggregated company level data to arrive at a segment numerator & denominator, with simple division giving us a segment ROCE. We expected this figure to be in sync with falling tariffs & returns. However, we were intrigued to find segment ROCE steadily rising with decrease in tariff. The period of tariff decline has coincided with an increase in return on capital as can be seen in Figure 1 below.
Figure 1: Developers ROCE vs Average Bid Tariff
Source: CEEW-CEF analysis; using Ministry of corporate affairs database and annual reports. Year 2018-19 excludes Renew, Acme Solar, Mytrah and Greenko as FY March 2019 figures not released by them at time of writing, 2015-16 excludes Acme Solar given the nascent stage of operations at that point in time.
So how do we reconcile this apparent paradox?
Construction periods certainly result in lags between capital raises and their results manifesting themselves in earnings. However, this by itself not a sufficient explanation. One additional explanation is that an overwhelming proportion of discourse in this segment has so far been narrowly focussed on the subject of falling tariffs & returns. As such, it’s easy to lose sight of the big picture. The big picture here is that renewable energy developers are more than just prospective investors of marginal capital. They are also harvesters of annuity type cash flows that accrue from past investments. Even more importantly, they incur significant overheads of a fixed nature. Under these circumstances, even if scale is achieved by developers via subsequently lower marginal tariffs & returns, it can result in aggregate returns on capital moving in an upward trajectory.
Potential shareholders evaluate IPO’s from the perspective of actual & forecasted business performance, as well as valuation. Looking at Figure 1, it seems apparent that in the trailing years, the gap between actual performance at the time, and a level that would attract shareholder interest was perhaps excessive. After all, if aggregate capital was returning less than cost of debt, what was in it for shareholders? This seems to be changing. Slowly but surely, returns on capital are increasing and now surpassing the cost of debt. Of course, the principal still needs to be repaid, but what this broadly suggests is that potential shareholders will now be able to see a clearer path to cash realisation after senior lenders are repaid.
This holds important lessons for both developers looking to raise capital via the public equity markets, as well as potential shareholders sitting on the sidelines contemplating a piece of action. For some developers, scale may have helped them overcome the returns challenge, leaving price setting, or more precisely valuation, as the vital remaining consideration. The key lesson for potential shareholders here is not to be swayed by the headlines which sometimes focus on narrow issues at the cost of objective analyses. The common lesson for both is that price setting and risk perception should reflect the kind of returns that developers can be expected to deliver even in the best of circumstances - stable, not inordinately higher than cost of debt, returns with moderate growth and low risk. Hence going forward, we should not be surprised if we see renewable energy developers once again selectively testing the IPO waters to raise more capital to meet the 175 GW target and beyond. If adopted, elimination of dividend distribution tax, one of the amendments reportedly proposed on August 19, 2019 by a Direct Tax Code task force set up by the Government of India, will only add to the attractiveness of this form of capital raising.
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An initial public offering (IPO) is the process of offering shares of a private corporation to the public in a new stock issuance or an offer for sale of existing shares. Public share issuance allows a company to raise capital from public investors.
As per SEBI guidelines, Sterling and Wilson were successful in closing the IPO exercise as they received over 100% subscription for the QIB portion, that formed 75% of the allotment size.
 USD figures are based on conversion factor of 1USD = 71.68 INR as on Aug 20, 2019
 As per NSE data accessed on Aug 21, 2019
While EBIT/(LT Debt + Net Worth) is a generally accepted measure of ROCE, we have used EBITDA/(LT Debt + Net Worth) given the large non-cash depreciation expenses associated with developers.
Disclaimer - "CEF Analysis” is a product of the CEEW Centre for Energy Finance, explaining real-time market developments based on publicly available data and engagements with market participants. By their very nature, these pieces are not peer-reviewed. CEEW-CEF and CEEW assume no legal responsibility or financial liability for the omissions, errors, and inaccuracies in the analysis.