Investor reaction to news that Adani Power Ltd ’s proposed acquisition of Lanco Infratech Ltd ’s Udupi power plant suggests it is a sure-fire winner. After all, Adani is adding 1,200 megawatts (MW) capacity at the rate of ₹ 5 crore per MW.

That is not only lower than the replacement cost of such a unit, the Udupi plant has also sewn up long-term power sale agreements with Karnataka and Punjab. A captive jetty of 4 million tonnes per annum and an external coal handling system in the new Mangalore port that come along with the power plant are sweeteners.

But some details of the deal are still hazy. The first question which investors should ask is how Adani Power will fund the equity portion of this acquisition which is worth ₹ 2,000 crore. The company had cash worth ₹ 830 crore at the end of the last financial year. Raising more debt will only further strain Adani Power’s overleveraged balance sheet. The company’s net debt to equity ratio stands at 6.6 times. Despite accounting for compensatory tariffs, Adani Power had an interest coverage of 1.1 times in the last fiscal year, according to Kotak Institutional Equities.

Moreover, the Udupi plant has debt worth ₹ 4,000 crore which will add further stress to the Adani Power balance sheet. The only positive is that the interest on this debt is a straight pass-through to tariffs under Central Electricity Regulatory Commission norms and wouldn’t impact Adani Power’s cash flows.

How will the Udupi plant boost Adani Power’s profit and loss account? According to analyst estimates, the plant reported revenues of ₹ 3,000 crore and a net profit of ₹ 120 crore for the last financial year. Given that Adani is pumping in ₹ 2,000 crore as equity in this deal, that implies a return on equity of 6%.

Besides, “Udupi has been traditionally beset by regulatory hurdles and under-recoveries that have impacted financial results," point out analysts from Kotak Institutional Equities.

Which brings us to the second question investors should ask: The Udupi unit has receivables worth some ₹ 1,800 crore from state distribution companies (mostly Karnataka). This amount is being disputed at an appellate authority level. There is no clarity on whether it will be retained by Lanco or passed on to Adani. In the latter case, provided there is a favourable ruling, Adani could recover its ₹ 2,000 crore investment soon. But those are big ifs.

For Lanco, from the information available so far, it seems annual earnings may diminish by around ₹ 120 crore. But more importantly, the company will be able to trim its huge debt burden, which was necessary under the terms of a loan restructuring exercise. Its debt will still look swollen at ₹ 30,000 crore at the conclusion of this deal.

The cash which Lanco will receive will help fund at least a part of the equity requirements for projects under construction—currently estimated at ₹ 3,000 crore. In that sense, it is a positive step, even though the sale at a price to book of 1.1 times is hardly something to cheer about.

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