Welspun deal positive for Tata Power

High return on equity earned by former's renewable assets justify the deal's premium valuation

Acquisition of Welspun Renewable Energy with a capacity of 1,140 Mw takes Tata Power closer to its objective of generating 30-40 per cent of power through renewable energy by 2025. With 990 Mw capacity dedicated for solar energy, the acquisition will help Tata Power scale up its renewable portfolio to 2,300 Mw (the current comprises operating capacities of 550 Mw of solar energy and 240 Mw of wind power, 245 Mw of solar power is under execution).

While the Street wasn’t enthused, given that the Tata Power stock after registering a 52-week high on Monday, ended flat at Rs 75.75 a share, the deal at premium valuations will be earnings-positive for Tata Power.

The purchase consideration (Rs 8,778 crore) works out to Rs 7.7 crore per Mw. Analysts say it is higher than the cost of expansion in solar energy, as the outlay for setting up solar plants has reduced to Rs 6 crore per Mw in recent years. However, all operating assets are backed by power purchase agreements (PPA) of 25 years and the fact that Welspun’s PPA realisations at Rs 8 a unit (levelised tarrif), are ahead of the current bid price for solar power (Rs 4.5 a unit), justifying the valuation.

While the all-cash deal will see Tata Power’s debt levels rise, even as the balance sheet is already leveraged, the revenues and profit earned by the Welspun assets should more than take care of interest costs. Tata Power said it would be deploying its current free cash of Rs 1,210 crore as equity for the deal and Rs 7,500 crore by taking fresh debt. This will push up consolidated debt from Rs 34,296 crore as of March 2016 and net debt-to-equity ratio by 2.4-3 times.

These assets earned revenues of Rs 768 crore in FY16 at 70-75 per cent capacity utilisation. At full capacity (assuming plant load factor of 20 per cent), these should generate annual revenue of Rs 1,100 crore. Given the high operating profit margin, most of it will trickle down to earnings before interest, taxes, depreciation and amortisation, helping the company easily service debt of renewables assets and earn a good return on equity (RoE).

Notably, Tata Power’s renewable assets currently operates at a RoE of less than five per cent. This deal will boost the blended number to a respectable level, which the management in an analysts’ call said would be close to 15 per cent. The markets tend to reward companies with higher RoE. What’s more, Tata Power’s management has indicated there is surplus land available in existing capacities. If the land is used for commissioning new capacities at the present cost structure, it would add to RoE.