Summary:

Welspun Enterprises (WELE IN) is a special situations opportunity in India which we think will lead to over 300% upside in two years with strong downside protection due to a discount to the cash on the books let alone total asset value. The company is under a long-term monetization strategy under the guidance of Apollo private equity (which is a 21% shareholder and has control rights) which we think will lead to this return being realized with the key catalyst potentially occurring as soon as 2H15. Finally, early stage assets which we mark at 0 have the potential to take the return to 600%+ and the key catalyst here will be in 2016. The below table summarizes the situation

Summary WELE Sum of the Parts

Background Timeline:

The company is a recently emerged spin-off with a mishmash of assets in the process of being transformed by Apollo into a simplified operating concern. The key assets today are cash, a 15% equity stake in Welspun Renewables (one of India’s largest solar companies), oil & gas exploration assets via a 35% stake in a joint venture with the Adani Group (Adani Welspun), and infrastructure assets primarily consisting of highway toll roads under Welspun Projects.

Apollo has been driving value creation at WELE even before WELE emerged as a new company. WELE was initially a subsidiary of global oil and gas midstream pipe manufacturer Welspun Corp (WLCO IN). Apollo invested in WLCO in 2011 and negotiated a shareholders rights agreement with the Goenka family, which previously controlled WLCO, such that Apollo and the Goenkas would essentially have joint control with no party being able to act without the other’s consent. Apollo then helped catalyze the WELE spin-off in mid-2013, with the shareholders rights agreement continuing to apply to WELE.

In India, a spin-off can take over 12 months to occur given the court process required. During this time period Apollo facilitated WELE selling its stake in Leighton Welspun (an engineering joint venture in partnership with the large Australian contractor Leighton). As such, when WELE officially listed in July 2014, it emerged with a cash position of ~ 8B INR primarily from this divestiture.

Several months after the spin-off, WELE sold its ownership in Max-Steel, a money losing sponge iron plant with significant debt and contingent liabilities, to JSW Steel (one of India’s largest steel companies) for a nominal purchase price, thereby eliminating this asset’s liabilities and cleaning up WELE further.

In their next move, Apollo and WELE are merging the 39% of Welspun Projects WELE doesn’t own into WELE, eliminating Welspun Projects and further cleaning up the structure. Welspun Projects is a highway toll road and infrastructure company which WELE had a controlling stake in and is listed with 39% of free float (WELS IN). This will occur in June 2015 via a share swap between WELE and Welspun Projects, and the discussion in this memo is pro-forma for this merger.

Continuing on the path, Apollo, WELE, and the Goenka family are planning to IPO Welspun Renewables given the enthusiasm surrounding solar assets in India under the Modi administration who has made solar and wind energy development a key plank in his platform. The company has said it is targeting 2H15 for this IPO, and WELE has disclosed it is planning to exit part of its stake in Welspun Renewables and will likely sell down further over time. We think the value of this stake could be nearly 2x the current market cap of WELE, and the IPO should serve as a key catalyst for recognizing this hidden value.  

While no concrete plans have yet been announced for monetization of Welspun Projects or the Adani Welspun JV, from speaking with the company we think Welspun Projects may also be sold over a 1-2 year horizon to a much larger infrastructure concern. Similarly, the company is waiting to see the results of its exploration activities (which other parties are funding as will be discussed below) and then would seek to monetize its stake in this JV as well.

These exits will all add to the existing ~ 8B INR cash balance and could take the cash balance to over 22B INR even including no value for the oil/gas JV. The total cash pile per the company will be used for a large acquisition which will be done under Apollo’s aegis. This will be the final step in simplifying a complex hold co structure into a simple, one asset operating company.

We think this plan will create tremendous value for WELE shareholders as there are two reasons for the large discount to asset value today. First, Indian micro-caps can trade at a discount to their net cash holdings as Indian promoters are known for poor corporate governance where large excess cash balances flow to the promoters’ families and not to minority shareholders. Apollo’s involvement and joint control dramatically reduces the typical risks of fraud, poor corporate governance, and poor capital allocation. Secondly, holding companies in India without a clear focus or business plan often get discounted, as in many cases Indian promoters hold various equity stakes for decades and are passed from generation to generation.

Apollo and WELE’s plan to systematically exit the portfolio and use the proceeds for one large acquisition will eliminate both reasons for the discount – there will be no large cash balance and no holding company structure.  

If we assume this entire plan takes two years, this should lead to over 300% upside over that period on a sum of the parts basis, and carrying costs due to WELE G&A expenses are nominal. There are three sources of further upside. First, the oil & gas JV could have significant value above the 0 we have carried it for depending on the results of the wells being drilled this year – WELE management has indicated 10-20B INR additional value net to WELE could be possible. Second, we give no credit to Apollo’s deal-making abilities on the acquisition that is done potentially two years from now once existing assets have been monetized. Apollo will have an interesting deal thesis for this acquisition that could lead to further value creation subsequent to the two year mark. Thirdly, Indian equity markets are currently frothy and operating businesses frequently trade for multiples of book value. If this continues and the new simplified WELE trades for 2x book value, that would increase returns to over 600% even before any upside from the oil/gas JV or from Apollo/WELE creating value in their acquisition. 

Briarwood Capital Partners (BCP) has been following the WELE story since prior to its spin-off and began acquiring shares immediately after the spin-off in July 2014 and increased its holdings significantly post the Max Steel divestiture in late 2014. BCP currently owns ~ 9% of WELE, Apollo owns ~ 21%, and the Goenka family owns ~ 36%.

Below we present a brief discussion on each of the key WELE assets supporting the values used in our summary sum of the parts table.

Welspun Renewables:

Welspun Renewables is the Goenka family’s solar and wind power generation company in India. The focus is almost entirely on solar with over 480 MW of solar capacity and 30 MW of wind power. Solar power assets in India once operational have predictable cash flows similar to US solar power assets as they have 20-30 year power purchase agreements (PPAs) with high credit quality counterparties. There are advantages to scale in the solar power generation business due to purchasing power over solar panel producers and the fact that the largest players (including Welspun Renewables) have their own in-house solar plant construction companies so that the construction margin is kept in-house.

Welpsun Renewables is currently the largest solar generation company in India, followed by Azure Energy and then Acme. The company is growing rapidly with over 640 MW of solar capacity currently under construction and has been fundraising rapidly as well. In April of 2014, GE Energy invested $24M in one of the company’s solar plants and in June 2014, the Asian Development Bank (ADB) and the German Development Bank (DEG) invested $50M and $37M respectively at the Welspun Renewables level. Both of these investments were done at a ~ $350M valuation. Post this funding round, DEG and ADB own 25% of Welspun Renewables, Welspun Enterprises owns 15%, and the Goenka family owns 60%. GE owns 50% of the solar asset it financed with Welspun Renewables owning the other 50% - this project is 150 MW of out of the total of 480 MW.

Valuations of solar power companies in India have increased dramatically since this Welspun Renewables last valuation round as the new Prime Minister’s government took shape and his renewable energy goals have been announced. For example, Modi announced earlier this year (http://www.reuters.com/article/2015/01/02/india-solar-idUSL3N0UG13H20150102) a goal of increasing solar power capacity by a factor of 33x over the next 7 years and for solar to be 10% of India’s power mix.  From discussions with solar power executives in India in the private market (there are currently no listed solar power generation companies), investors are now paying not only for current yield but also for growth. Discussions with an energy investment banker in India suggest that the demand for a listed solar power generation company will be very high due to the lack of any such listed alternative today.

Welspun Renewables is planning an IPO given this backdrop to allow for liquidity for exits as well as further funding.  Per media articles from earlier this year, Welspun Renewables is targeting a valuation of $1B to $1.5B valuation.  While this is a large step up from the $350M valuation in June 2014, there is not only the increase in sector valuations due to Modi’s strong government support but also the fact that by the end of 2015 when the IPO may occur, there is projected to be a large increase in operational EBITDA as numerous plants Welspun Renewables has been developing have successfully come on line in the last 12 months. The company is forecasting $200M of EBITDA in 2015 with net debt at the end of the year of $900M; a 10x EBITDA valuation would be supportive of a $1B IPO valuation. Another method is to take the $200M of EBITDA, assume a 10% interest rate on the debt leading to $90M of interest costs, assume $4M of maintenance capital expenditures per the company’s guidance, and nominal taxes due the high D&A. This leads to ~ $100M of free cash flow which at a 6% dividend yield would be a $1.7B valuation; while 7% is below India’s current 10 year bond yield of 7.9%, many Indian equities trade at much lower implied earnings yields due to expectations for future growth, and Welspun Renewables is no exception given the aggressive solar expansion plans of the country (33x increase in capacity desired over the next 7 years). Finally, our discussions with solar power executives in India suggest a 10-14x EBITDA valuation range is the level currently being sought by the large Indian solar power companies. Azure (the 2^nd largest solar power company) is also planning an IPO and depending if Azure comes to market first, there is the potential for a clear comp for Welspun Renewables.

We assume an IPO valuation of $1.4B which for WELE’s 15% stake implies a value of ~ 12.6B INR.

Adani Welspun:

Adani Welspun is an oil & gas exploration JV in which WELE owns 35% and Adani Group (a large Indian conglomerate) owns 65%. WELE’s equity investment in the JV is ~ 3B INR at cost and the JV has pursued eight offshore blocks for early stage discoveries – of these eight blocks, five have been written off and three are currently being developed. Of these three, there have been discoveries in two blocks in the Kutch region of India, and the Indian state oil company (ONGC) has been brought in to develop appraisal wells to determine if the discoveries are commercial. ONGC will spend the vast majority of the associated drilling costs, putting WELE in a strong position to monetize its stake should the blocks prove commercial with limited additional risk. The third block, an offshore area off the coast of Mumbai, is a highly prospective area as it is adjacent to one of India’s largest offshore oil fields. Similar to the two blocks in Kutch, ONGC has been farmed-in to spend the drilling costs on this parcel and it will be known later this year whether there is a discovery. If so, ONGC will likely elect to drill necessarily appraisals wells to determine if the block is commercial similar to the two Kutch blocks.

The company estimates each Kutch block has potential value of 10B+ INR to WELE based on current oil and gas prices should a block be proved commercial. Mumbai provides further upside should a discovery be made. The results of the appraisal wells on the two Kutch block will be known in late 2015/early 2016.

If all three blocks show no success, there is a ~ 1B completion guarantee which WELE would be responsible for as in return for providing offshore development rights, the government requires drilling a minimum number of wells. At this stage we do not deduct this from our sum of the parts valuation nor do we include any positive asset value from the Kutch or Mumbai blocks.   

Welspun Projects:

Pro-forma for the merger, WELE will own 100% of Welspun Projects which is the subsidiary that owns the company’s infrastructure assets. The key asset at the Welspun Projects level is a 50% stake in a highway toll road project called Dewas Road. Operating toll road assets such as Dewas Road are generally good assets as they are long-lived (often 25 year concession terms), the investment has already been made with minimal maintenance capital expenditures required, and cash flows improve over time due to natural growth in traffic. Welspun Projects’ equity value in this project is ~ 1.5B INR net of debt, and it is a project that we think could be readily monetized. In addition, Welspun Projects’ own a diversified portfolio of smaller toll road assets which carry book value of ~ 500M INR net of debt.

As such, we value Welspun Project at 2B INR. Note we fully impair the company’s Dewas water project which is a municipal water infrastructure asset which has suffered from weak demand/onerous government restrictions and utilize the company’s cash balance to offset the 600M INR debt at the project level. The company believes it will be able to recuperate its investment through a new agreement with the local government authority, and if so this could provide 1-2B INR of upside. 

Technical Note:

On Welspun Enterprises’ consolidated financials, the cash balance will show up at 7.0B INR instead of the 7.9B in the company’s 5/29/15 press release (which we use in our sum of the parts table) and the debt balance will show as 4.3B INR instead of the 2.7B in the company’s 5/29/15 press release (and which we use in our sum of the parts table). The cash difference is due to an inter-company deposit which is equivalent to cash but does not show up in cash in the financial statements. The debt difference is due primarily to Indian accounting regulations of joint ventures where shareholder loans made to a JV show up as debt in the parent company’s financials when in fact they just represent the investment made by each partner in the JV as a shareholder loan. The debt outstanding to banks is 2.7B INR.