“The return is relatively high in Indonesia”

E. Syahruzad, Executive Vice-President and Head, Financing and Investment, PT Sarana Multi Infrastruktur (Persero) [SMI] Indonesia, views deals selection, quick project completion, and financial leverage as critical factors for achieving investment success in Indonesia’s infrastructure space. SMI is wholly owned by the Indonesian government. Established in February 2009 with a mandate to provide long-term financing for infrastructure projects, the company also provides advisory and project structuring services to government entities developing infrastructure projects. Southeast Asia Infrastructure brings you excerpts of Syahruzad’s comments at a panel discussion on opportunities for private equity investment in infrastructure in Southeast Asia. The panel discussion took place during the AVCJ Asia Real Assets Forum on October 3, 2013 in Singapore.

On the role of SMI…

SMI has been given the mandate by the government to accelerate infrastructure development in Indonesia. At present, we mostly deal with project financing for local infrastructure. We also work with the government to create a bankable concession agreement, because in Indonesia, I believe the development risk is too high, as there is no standardised bankable concession agreement.

The governments purpose behind setting up the SMI by the is to provide access to long-term financing for infrastructure projects. At the moment, most of our investments are in the senior debt portion. We also have a little portion in subordinated and mezzanine debt.

On key success factors for infrastructure investment in Indonesia…

If we are talking about the infrastructure space in Indonesia, perhaps most of the subsectors of infrastructure are at a very early stage since there are no proven bankable concession agreements yet. Land acquisition is handicapping the development of infrastructure. I think the key to investing in Indonesia’s infrastructure is that you have to have developers’ expertise. This, I think, is the most important. It is quite difficult to find mature infrastructure assets in Indonesia because we are in the stage of development now. So, developers’ expertise is one of the key success factors for investing in Indonesian infrastructure.

Secondly, in my view, deal selection is most important, since the faster you can complete the project, the higher the probability of you making returns and exiting your investment in infrastructure. So the second important thing is quick execution/quick completion. In infrastructure, it is not something that you expect to get a quick return, but infrastructure in Indonesia is something that you can expect to preserve the value of your investment.  The relatively higher IRR in the Indonesian infrastructure space is justified by its development risk.

SMI provides relatively longer terms of financing for infrastructure projects, and if the project is structured well, we can even provide relatively higher leverage financing. So, I think, leverage in infrastructure space and access to long-term financing in Indonesia is the third most important thing for success.

And aside from these three factors, sector-specific knowledge is also important for investing successfully in infrastructure in Indonesia because each sector has different risks. For example, the telecommunications sector is very mature where the concession agreement with the public sector is governed by a sophisticated regulatory framework. On the contrary, if we are talking about transport, for example ports and airports, you would have to deal with state-owned companies because there is no standardised concession agreement to offer any certainty with regard to financial closure. The water sector is also different because financing in this sector in Indonesia is subnational credit. So you have to possess the understanding on how to mitigate the political risk at the sub-national level. Therefore, sector-specific knowledge is something important in Indonesia.

Despite the challenges, there have been many improvements from our perspective. In the public sector, there’s been an improvement with regard to the building of the concession agreement. For example, for the last two toll road projects that we’re closing as a senior lender, the disbursement is conditional upon the completion of 100 per cent land acquisition. So, the public sector entities with whom we have the lending agreement are aware of this and they have taken responsibility for land acquisition.

On the slow pace of progress of the government’s infrastructure development plans…

With regard to MP3EI, some of the projects are actually good, but others, in terms of project preparation, are still struggling. However, projects that involve state-owned-enterprises (SOEs) are doing well. For example, the Tanjung Priok port expansion project is quite good; it has been well prepared by the contracting agencies.

Aside from the development risk that I mentioned before, the return is tremendously high in Indonesia. For example, there is a case of a dispute between the water utilities in Jakarta and the local government. However, the water utilities have enjoyed a return on equity of more than 25 per cent over the past five years. So, aside from the regulatory and land acquisition risks, the return is extremely high in Indonesia. Once you can cut the deal and get it completed on time, you can enjoy the extra-high returns.

On the experiences of infrastructure funds in Indonesia…

Some private equity funds that have been successful in the infrastructure space, such as the funds managed by the Saratoga Group, are looking for the most advanced concessions. They have built up a business case whereby they invest in an aggregate portfolio of power projects – some are in the operational stage and a few in development stage. Second, they deal with commercial banks which allows them to have quite an aggressive financing structure.  There are others that have invested in toll road projects.

Those looking to invest in the Indonesia growth story, probably, may succeed by aggregating a portfolio starting with one, two, three, four, five projects and building it to a  size big  enough for them to exit whether through buyouts or initial public offerings.

On the impact of the upcoming elections on foreign investment in the infrastructure space…

Elections have a more direct impact on public equity rather than on private equity, since the market has factored in, or taken into account, the political risk from elections into the deal. I agree that in areas where the regulatory framework has yet to be built by the current government, I think this may be an issue, but regulatory changes have to move forward. Also, for some big projects or mega projects, there may be some delays faced by the developers, especially, for example, if those projects are linked to SOEs that have to go through the budget process since there may be political intervention here and there with regard to the budget approval. But, for others, like hydropower and the electricity sector, there is a better landscape for investors and private equity, especially on the developers’ front.