Large Indian companies have come out with mega investment plans in recent months. How realistic are these plans and where is the money going to come from? By Rex Mathew
Should we feel excited or worry when the Indian corporate sector announces fresh industrial investments, the aggregate of which exceeds the GDP of many medium sized countries? Do we take it as a sign of the rising confidence of India Inc or call it 'irrational exuberance'?
Aggregate investments announced by large companies in recent months exceed Rs7 lakh crore or $150 billion. That is huge even by global standards. In some cases, the investments being planned are more than the current revenues of the companies announcing them. Are these companies really serious? If they are, do they have the money to walk the talk?
Among the large Indian corporate groups, the Tata Group and Reliance have the most ambitious plans. Last month, the Tata Group said it is looking at investing Rs1.2 lakh crore, or more than $25 billion, over the next three or four years in new projects. The Bulk of its investments will be in steel, followed by power, telecom, FMCG, automobiles and IT.
On the other hand, the aggressive Mukesh Ambani's Reliance Industries has announced plans to spend around Rs27,000 crore, or close to $6 billion, in a new oil refinery and around $10 billion (not yet confirmed) in the proposed mega township in Navi Mumbai. The company's retail foray would require Rs25,000 crore while oil & gas exploration and petrochemicals expansion would see investments of at least Rs20,000 crore.
Its sibling, the Anil Ambani-controlled Reliance-ADAG has announced investments of over Rs50,000 crore in the power sector besides a few billion dollars in telecom.
The Aditya Birla Group is planning to spend Rs20,000 crore for expanding non-ferrous metals capacity and $2 billion in a retail venture.
Among PSU companies, ONGC is leading the charge with investments of around Rs25,000 crore being planned to expand the refinery and a new petrochemicals complex at Mangalore. The oil major would also spend an equal amount in oil & gas exploration.
Most of the investments from foreign companies are coming into the metals sector. Posco has already started work on its Rs40,000 crore steel plant in Orissa while Arcelor-Mittal is expected to spend a similar amount in a green-field plant in Jharkhand.
Among other domestic steel companies, JSW Steel's ambitions are bigger than has even Tata Steel's. JSW has just announced that it is planning three new steel mills by 2020, each costing Rs25,000 crore. The company is also looking at acquiring mining rights on a large scale.
Apart from Tata Motors which is planning an investment of around Rs10,000 crore, Maruti also has plans to invest an additional Rs3,000 crore.
Foreign auto companies like Hyundai, Volkswagen and GM are planning to invest around $1.5 - $2 billion between them. Hyundai has already made the country an export base for small cars, while others may also look at exports. The highly capable and competitive domestic auto ancillary industry has also helped in making the country an attractive destination for global auto majors.
If the ultra-mega power projects announced by the government attract enough interest, the power sector would see massive investments. The number of projects under consideration has increased to eight from the earlier four. Each project would have a capacity of 4,000 MW with an investment of around Rs16,000 crore and aggregate investments would touch Rs1.2 lakh crore. Now the power ministry is talking of increasing the number further to around two such projects in every large state!
Large investments have also being announced in infrastructure development and development of SEZ's. Hospitality and tourism would also see significant investments, like the DLF-Hilton combine's plans to invest $2 - $2.5 billion.
Where is the money?
Now for big question. Can these corporate groups raise enough funds to finance these mega projects? Would they resort to large scale borrowing, which may lead to higher interest rates and non-availability of sufficient finance for smaller companies due to overcrowding? Is the domestic capital market deep enough to absorb the public issues that may be announced to finance some of these ventures?
Finance should not be much of an issue for the large groups as they have very healthy cash flows from existing operations. Moreover, their track record and reputation would help them raise sufficient equity and debt financing from the domestic and international markets.
Reliance Industries has already tied up the required funds for its new refinery, which is being implemented through a separate subsidiary with Chevron as partner. Assuming that it can maintain its free cash flows at the current level of around $3 billion annually, the company would have a surplus of $12 billion over the next 4 years to fund its new ventures.
ONGC, the most profitable domestic company, is also generating sufficient cash surplus to finance its plans - including acquisition of overseas oil assets.
The Tata Group is on a slightly trickier wicket, as free cash flows of some of the individual Tata companies, which are planning mega investments, like Tata Steel, Tata Power and VSNL, may not be sufficient. They may have to look at equity dilutions, especially Tata Steel, which has announced expansion plans of over Rs55,000 crore.
The Tata Group has to ensure that group holdings in individual companiesm, which are mostly at sub-optimum levels, do not fall further because of possible equity dilutions to finance new ventures. The free cash flows of Tata Sons - the group holding company - have declined after TCS was hived off into a separate entity.
If all the announced projects reach the implementation stage, the Tatas may have to look at selling a minority stake in holding company Tata Sons - either through a public offer or by roping in strategic investors. By virtue of its holdings in various Tata companies, Tata Sons would be one of the most valuable domestic companies when listed.
Since the domestic markets aren't likely to be able to absorb such a big issue, a major part would have to be offered in international markets.
For R-ADAG, financing its telecom plans should not be a problem as cash flows from the business would increase in future. Its ambitions in the power sector are just too big and may see investments from strategic partners, if the projects reach implementation stage.
As most projects by the larger groups would be financed through a combination of internal accruals and international debt and equity offerings, it is unlikely that there would be any significant strain on domestic financial markets - both equity and debt. Only the smaller corporate groups would have to rely on public issues and debt financing and there is sufficient liquidity in the system to absorb such offerings.
The '90s experience
The last time when Indian corporate sector went on an investment spree in the mid-'90s, it ended in disaster for many companies. The environment was very similar with the economy growing fast after liberalisation, affordable interest rates and healthy demand. Most of the large investments during that period went into the oil and metal sectors, just like the current plans.
Of the three new steel projects set up in that period - Jindal Vijayanagar (now JSW Steel), Essar Steel and Ispat Industries - only one, JSW Steel, can be called a real success after a decade. Of the other two, Essar would be left struggling if metal prices decline from these levels while Ispat has been in the red except for a brief period when steel prices were at record highs. All three companies had very high accumulated losses and had to go through debt restructuring after repayment defaults.
Similarly, of the three new oil refineries set up in that period - Reliance, Essar and MRPL - only Reliance could pull off its investment successfully. MRPL, initially promoted by the Aditya Birla group with PSU oil marketing companies, turned around only after ONGC took it over and refining margins improved as crude prices rallied. Essar's refinery is only now getting completed after prolonged delays and it remains to be seen how profitable would it be if refining margins decline further.
Could history repeat itself and leave a majority of the recently announced mega projects in a similar lurch in future?
The most significant factor, which affected projects set up in the '90s was the downturn in the economy. After growing at an average of around 7 per cent, economic growth faltered in the absence of further reforms and slower global growth. Commodity prices dropped and margins vanished as demand projections made earlier turned out to be too optimistic.
Whenever analysts and commentators say "this time it is different", most often the same events repeat themselves. Having said that, the economy does appear to be in a much better position now. Growth is more broad-based and looks more sustainable while growth rates are even higher. Companies are much more competitive and resourceful and, unlike in the '90s, most of the new projects are being planned by serious players with good track record of successfully executing large projects.
Also, global opportunities for Indian companies have increased considerably over the last decade because of increased international trade. Indian products are much more accepted in global markets than in the nineties. Hence a slowdown in the domestic market need not mean the end of the road for these new ventures.
It is also not that these companies have suddenly woken up to announce large investments. Capital investments have been on an upswing for the last few years. A study conducted by a leading business daily found that capital investments by nearly 1,500 large companies was close to Rs1.1 lakh crore during the financial year 2005-06, as compared to around Rs85,000 crore for the previous financial year.
However, the massive capacity additions being planned in some of the sectors do arouse concerns. If all the recently announced steel plants take shape, which looks unlikely, the country's annual steel capacity would triple in less than a decade. Would domestic demand grow at a fast pace to make these new plants viable? Global steel capacities are also rising and exports may also be become unviable for domestic steel companies.
The debt poison
Most of the large projects set up in the '90s had a high proportion of debt financing. To their misfortune, interest rates surged as the projects were being implemented and saddled the balance sheets of these companies with rising liabilities which remained unpaid for many years. Higher interest charges made these ventures virtually unviable and most of the companies had to go through a painful financial restructuring to survive.
Since well-established groups and companies with healthy cash flows are implementing most of the recently announced mega projects, the debt component in new venture financing would be relatively low. Very healthy capital markets would also help these companies to be less dependent on debt financing.
But smaller groups and companies may face trouble if interest rates rise further as they start implementing the projects. After rising for more than a year, interest rates are expected to stabilise and even decline by early next year. However, if inflation remains high, rates may start rising again. Hopefully, promoters have learnt from the experience of the failed entrepreneurs in the nineties and would decide not to load up on debt.