Analysts flag risks of Tata Power’s Welspun buy

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Tata Power’s acquisition of Welspun Renewables’ solar and wind power assets is the biggest deal in India in the renewable space.said the acquisition was strategic and won’t burden its financials. But some experts begged to differ, pointing to a couple of contentious issues.Tata Power had on Sunday announced the acquisition of Welspun Renewables’ 1,140-megawatt (Mw) — solar (990 Mw) and wind (150 Mw) — power generation assets for Rs 9,250 crore.An analyst with a leading domestic brokerage firm, who did not want to be quoted, said, “Tata Power has not adequately factored in the possibility of low (PLF), high operation and maintenance (O&M) costs, higher interest cost and delay in payment from state electricity boards (SEBs) especially when nearly 1,000 Mw of Welspun’s capacity is operational and generating profit. Besides, a large solar portfolio with power purchase agreements (PPAs) has been contracted a high tariffs (levelised tariff of about Rs 8 a unit) for 25 years.”The company might have to bear higher O&M cost due to earlier version of solar photovoltaic (PV) installations done by Welspun, the analyst said. “However, to get (RoE) of 16 to 17 per cent, all solar power plants will need to operate at 20 per cent and the interest rate be less than 10 per cent with super efficiency on O&M.”ICICI Securities’ Executive Director Ajay Saraf said he was not worried. “Assets are of high quality with PV module being sourced from tier-1 manufacturers and backed by performance guarantee. Tata Power will make a RoE of around 16 per cent, which is better than CERC’s benchmark return of 15.5 per cent, coupled with no execution risk owing to the operational nature of assets.”Among other concerns, though the company said the debt (nearly Rs 7,000 crore to fund the deal) would be easily serviced by the already operational assets of 990 Mw (and another 150 Mw to be commissioned in two months), analysts said there was a risk as the company’s balance sheet was already leveraged with gross debt of about Rs 37,000 crore.Moody’s Investors Service said it was not taking any rating action at this stage given the limited information about the transaction and, hence, the uncertainty around the potential impact of the proposed transaction on Tata Power’s credit profile. Any rating action would depend on 1) a binding offer being made, 2) the ultimate terms of the deal, funding structure, and potential impact on TPC’s capital structure and financial metrics, and 3) Moody’s assessment of the impact on TPC’s business profile.Tata Power CEO & MD said the deal value stood at approximately Rs 7.7 crore a Mw. “From the revenue generated through solar assets today, almost 90-95 per cent show up in your bottom line and, therefore, whatever we expect to earn out of our own organic establishment we expect to earn the same if not more, not adding the future capacity addition that we can do at a lower prices but as it exist today. Options to refinance is always evaluated time to time; shareholder have been very cooperative.”Welspun’s assets generated revenue of Rs 768 crore for 2015-16, which some analysts said can rise to Rs 1,600 crore (with net profit of Rs 250-270 crore), assuming the entire 1,140 Mw was made operational.Analysts at IIFL, who have a buy rating on the Tata Power stock, said the acquisition would increase the company’s balance sheet risk in the near term. Tata Power would have to resort to sale of strategic investments or raise equity in the near future or explore raising equity in the RE (renewable energy) subsidiary (Tata Power Renewable Energy) through an initial public offering or stake sale as the company’s other projects, including Mundra UMPP and Delhi and Mumbai discoms, were encountering cash flow challenges, they said.IIFL analysts also said: “We remain concerned on consistent collapse in rates of PPAs signed by RE developers (Rs 4-5 per unit) and sustainability of older PPAs signed at Rs 8-9 per unit. Change in such PPA terms due to weak financial health of the SEBs and flux of RE projects present key risks to the acquisition economics.”The per-Mw cost of setting up a solar power project has been on a decline in the recent years due to rapidly falling prices of solar PV panels and a slew of incentives, including viability gap funding offered by the government.Analysts at Kotak Institutional Equities, who have an ‘Attractive’ rating on the stock, echoed the concern. According to a June 14 report by the research house, solar power plants were currently being set up with capital cost of Rs 5.3 crore per Mw and competitively bid tariffs of as low as Rs 4.8 a unit, which might pose an off-take risk to the Rs 8 per unit feed-in tariffs of the acquired capacities. “We also highlight that the current net debt-to-equity ratio of 2.3x could rise significantly to 2.9x,” it added.However, Tata Power has also highlighted availability of excess land (more than 500 acres) with evacuation infrastructure, and the comfort of attractive feed-in tariffs as deal sweeteners that prompted them to take the inorganic route, as opposed to setting up solar capacities at lower capital cost through the organic route. These, however, might require additional funding besides the time-lag to set up the equipment and more importantly, PPAs that would ensure off-take of power produced.On the way forward, Kuljit Singh, partner-transaction advisory services at E&Y, said long-term PPAs would ensure revenue certainty and reduce risk as the older solar and wind projects, which have a relatively higher cost, cannot do without a PPA. “Various reports have mentioned an acquisition price to book of around 1.8 to 2 times. At such an acquisition price, the acquirer may have considered a pipeline of future projects and/or some innovative financing to reduce the cost of capital deployed for such acquisition. But, returns are typically not the only driver for such acquisitions as may also consider ability to scale up, ability to meet green targets while assessing such acquisitions,” he added.

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