A Saga Of Hype And Losses

For almost a decade now, infrastructure has been an enigma to investors. On the one hand, the basic economic rationale of the sector is such that it should be a great investment. On the other hand, the actual experience that investors have had has been terrible.

On paper, the logic is simple. There can be no two opinions about the huge gap between the scale of infrastructure that India needs and what it has. When the demand is there, and customers can pay for the product, then the suppliers should be making money and generating wealth for their shareholders.

Unfortunately, this hasn’t happened. What has happened is a terrible cycle of hype and losses. In the couple of years leading up to the crash of 2008, infrastructure stocks were boosted up to stratospheric heights and when the markets crashed, investors made huge losses. That much was normal and expected and indeed happened to many companies across many other sectors as well. But what happened after the markets recovered didn’t feel normal. The recovery seemed biased against infrastructure stocks. Those who had invested at any point of time in 2007 or earlier never recovered anything close to their earlier investments.

It’s easy to assume that this is a normal cycle of a sunrise sector, similar to what happened to IT services companies during the 90s and then through the crash of 2000. Among tech companies too, there were many stocks that never recovered. However, I think there is a qualitative difference between the tech boom-bust and the current cycle in infrastructure. During the tech boom, there were a handful of exceptional companies, and there were also the IPO artists who were pretending to be tech companies to ride the boom. The genuine companies tended to be the big ones like Infosys, TCS, Wipro, HCL, (at the time) Satyam, etc. The IPO artists were the small ones.

In the infrastructure industry, the situation is different. Some of biggest ones have the most suspect antecedents. Take Reliance Power, perhaps the poster child for the sector’s problems. No investor now believes anything that the company says about how the huge quantity of IPO money has been deployed and what the prospects of its projects are. Unfortunately, Reliance Power is not the only such case. Practically the entire real estate development and housing sub-sector is filled with companies that are just as bad.

Thus the sector poses a special challenge to investors. On the one hand, there is the prospect of an expanding industry where there must definitely be money to be made. On the other hand, there are all these variables that are external to the operations of the businesses which can sour the deal for investors.

I think we should be reconciled to the fact that on these issues, we may not see much improvement. As the joke goes, ‘they are like this only’. And the driver for why they are like this only is political corruption. For large parts of this sector, getting government clearances and contracts is a major determinant of success. And a sector where success (or even mere existence) depends on politicians’ decisions is going to have ethical problems.

That’s a millstone that infrastructure investors will have to carry around their necks. The challenge is to identify companies where this effect is minimal and to derive value from them.