India's Rapid Economic Growth Offers Profit Opportunity

OK so I did not really go to India. But I did meet a man who had just returned from there and he told me of an interesting way to profit from India’s rapid economic growth. His name is Gary Neville, and his intention is to repeat in India the huge success that he enjoyed in this country with the building contractor John Laing.

At Laings he took responsibility for growing a business that generated an internal rate of return of 45% per annum and was eventually sold for £1bn to Henderson Investors. This business consisted of a portfolio of projects constructed under the Government’s Private Finance Initiative (‘PFI’) and, given that the PFI initiative has often been accused of feathering private pockets at the expense of the tax payer, I was interested to learn just how such handsome returns had been made.

The answer is that they come from three sources. First of all in any project, PFI or otherwise, a profit accrues to the developer as it passes through the various stages of planning and building towards completion. Next developers who are involved in more than one project can garner some economies of scale, for instance in the provision of maintenance or the purchase of insurance.

A gold mine for the private sector

But most of all PFI has proved to be a bit of a gold mine for the private sector. That’s because as the years have gone by, banks have become increasingly confident in the returns from these projects. So, at successive project refinancing rounds, they have been prepared to lend more and more money at finer and finer rates of interest – to the benefit of the projects’ equity investors.

A crucial feature of PFI projects – and one that clearly gives banks the confidence to lend – is that once construction is completed and the road or school or hospital is handed over, it is the Government that pays the bills, and at a pre-determined price.

This is also the case in India, where Neville now sees a fresh opportunity. While in the UK PFI is quite mature, India is only starting down this route and the potential size of the market is many times bigger. The Indian Government, piqued by knowledge that its growth rate is behind that of China, has identified the country’s infrastructure as a major sticking point and reckons that it is reducing the rate of GDP growth by 2% per year. So in its 11th five-year plan, which covers the period 2007-2011 and includes a target GDP growth rate of 9% per annum, it has said that investment into infrastructure needs to increase from 4.6% of GDP to 8% of GDP. This amounts to a required investment of US$488bn over five years, rising to $989bn in the 2012-16 period covered by the 12th five-year plan.

Plenty of opportunities for small foreign investors

This will only be achieved with substantial investment from both the domestic and foreign private sectors, so the door is open for foreigners. Giants such as Blackrock have already passed through it. But Neville believes that there are plenty of opportunities for smaller fry, especially those that have a demonstrable track record. That’s where he comes in.

Neville is chief executive of Bloomsbury Asset Management Advisors, the manager of Infrastructure India, a closed-end fund that was launched onto the main market of the Stock Exchange in July. He is interested in projects smaller than, for instance, the new Mumbai airport and is focussing on the transport and energy sectors.

He also wants projects that are substantially through the development phase and are nearing handover to the Government, and he made Infrastructure India’s first investment in June. This was into a hydro-electric project in the Narmada Valley, where it is by no means unique. The Narmada River runs for seven hundred and seventy eight miles through western India and it was back in the 1940s that India’s first Prime Minister, Jawaharlal Nehru, proposed to harness its power in a series of hydro-electric dams. Legal arguments and disputes amongst various states prevented anything from happening until 1979, but now a program to build twenty nine large and one hundred and thirty-five medium-sized dams is under way despite protests from environmental groups.

Infrastructure India took an initial stake of 20.5% in one of these dams in June, after a change of ownership caused a previous investor to pull out. Under the terms of the project that state of Madhya Pradesh will pay a price for electricity produced that protects the developers against any cost overruns, and Infrastructure India has said that the project offers an internal rate of return of 15%.

One young company the stock market should support

In August Neville struck a second deal, this time buying a 26% shareholding in a toll road in Central India. Part of the local state government sponsored road upgrade program, this is a single 125 km four-lane divided carriageway currently five months into construction and anticipated to open in Spring 2010.

These two investments have exhausted £25m of the £33m raised from the Stock Market, so Infrastructure India is clearly going to have to raise fresh funds to take advantage of some of the £100m worth of investment opportunities that it has identified. This is not the ideal time to be doing so. But still, given the experience of PFI in the UK, the vast India market and the prospect that ultimately a portfolio of mature PFI projects can be parceled up and sold to pension fund investors, this is one young company that the Stock Market should support and one that I’ll be keeping an eye on.

Tom Bulford
for The Penny Sleuth

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India's Rapid Economic Growth Offers Profit Opportunity

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