Embedding Financier’s & Lenders perspective in design of Power Distribution Franchisee

One recent success for Distribution Franchisee model in the country was first debt funding to Essel DF project at Nagpur. SBI Caps was involved in Debt Syndication partner role. Rahul Bagdia from pManifold Team recently spoke to Mr. Sudarshan Mohotta, VP Project Advisory & Structured Finance Division, SBI Capital Markets. Mr. Mohotta and his team were instrumental in closing this deal. He has around 17 years of experience in project & corporate finance and banking including financing of infrastructure projects. At SBI Caps, he has been actively involved in structuring and evaluating infrastructure projects and arranging funds with focus on power, port and road sector.

This interview focuses upon ‘What will bring confidence amongst investors to invest in Power Distribution Franchisee models?’ The below shared are the author’s personal views and not to be associated with any of his company’s and other associations.

1. How are Bankers seeing about investing in DF model?
   • PPP projects in power distribution sector are plagued by the stereotyping of PPP models in place with the current bleeding distribution utilities, especially among the commercial banks. The PPP models proposed in power distribution space are generally Input based Power Distribution Franchisee models, wherein the appointed Distribution Franchisee (DF) purchases power from state Discoms and bills and collects revenue directly from the end consumer. Thus, the DF is dependent on end consumer for revenues and not the bleeding discoms as against the misconception of the banks arising due to their lack of awareness of the DF model in this space.
   • Banks are only now beginning to appreciate the key differences in the business models of DFs and Discoms. Also, amongst most banks, the overall power exposure (which includes generation, transmission and distribution sectors) have either reached or crossed the internal prudential sector exposure limits creating further roadblocks in access to bank funding in power distribution space. Irrespective of these hurdles, banks do take on projects with strong Sponsors, however, small players or weak sponsors would find it difficult to access bank funding inspite of the merit of the projects being funded.
2. What are key elements of their appraisal consideration?
   • The key considerations by the banks during any appraisal would typically include the following:
     • Sponsor strength and track record in DF experience or related areas
     • DFA provisions and restrictions
     • Security cover available
     • Political and prevailing power scenario of the relevant state
     • Consumer mix and willingness to pay in the particular DF
     • Implementation strategy
     • Historical track record of the Discoms in terms of regular tariff revisions, prevailing state demand – supply situation, commitment to loss reduction, etc.
3. What specific best practices and challenges have you seen while evaluating any particular state DF (Maharsahtra, MP, Jharkhand, Bihar etc.)?
   • While states like Maharashtra, MP with a good track record of collection efficiency and therefore willingness to pay pose lesser challenges in terms of load shedding and load growth support by respective discoms; states like Jharkand and Bihar which lack the willingness to pay, find lower acceptability amongst bankers, when it comes to any strategies in improving collection efficiency in such areas besides reduction in technical losses.
   • Also an indication of smooth takeover of operations by the DF in the circle by way of acceptability and / or minimal resistance among key stakeoholders including existing employees, consumers, etc plays an important role in the initial success of the project.
4. Essel Nagpur DF financial closure is seen as a good start in the industry. Can you share top view on the deal, and how do you see DF market evolving?
   • With financial closure of Nagpur DF with a consortium of 5-6 lenders with SBI taking the lead, banks have started deriving confidence in the business model and acceptability of the same is expected to improve in the future.
   • Capex light models evolved in Orissa is a positive development to allow easier entry for smaller players with B2C expertise, which would help in bringing down commercial losses which typically accounts for a significant portion of the AT&C losses in a bid out DF area
5. What minimum but necessary design change you will suggest in current RfP and DFA?
   • RfPs need to necessarily provide visibility on the other miscellaneous taxes, duties, subsidies, etc that have been paid in each year upto the year of bidding. Also certain DFAs need to provide a clearer security structure as to the extent of first claim of the relevant Discom in the event of enforcement. The DFA should provide the DF with the right to create first charge on all DF receivables in favour of Working capital lenders funding receivables of the DF
   • In order to provide comfort to Lenders to a DF project, DFAs also need to provide for the following:
     • Adequate termination payment for all the assets created by the DF till the date of termination, irrespective of the cause of termination.
     • Substitution Right for an DF event of default as well as Lenders right to trigger termination of DFA in event of default by DF on Financing Agreement provisions
6. Please elaborate an ideal Escrow Mechanism from Bankers view point?
   • An ideal escrow mechanism between would typically stipulate the following:
     • A range of 50-60% of daily collection paid to Discoms towards part settlement of payables of Discoms would leave some room for banks funding the project
     • The payables invoicing cycle of Discoms should be aligned as far as possible to thr 45 – 60 days receivables cycle of the DF. A 30 days Discom invoicing cycle would be ideal, especially when a partial cash sweep escrow mechanism is in place with the Discom
     • Escrow mechanism should have provisions for invocation of SBLCs without any delays / concessions
7. Any further financing innovation you see could expedite DF model scale-up?
   • With a operational track record of DF operations, securitization opportunities could arise in the event of better than forecasted operational metrics (eg: achieved AT&C loss reduction, other cost savings, etc.) and increasing consumption / load growth in DF circles. This would help generate incremental free cash for Sponsors for further investments in other DF circles.