By Viswanathan Iyer
Disruption is a topical subject and the term in recent times has been mostly used in a manner to suggest that it only afflicts new age industries or sectors, more particularly those with a touch point to high end technology. It is, however, useful to see business disruption through a broader prism, which will help us explain in a better fashion the churn happening in even some of the traditional manufacturing sectors, which seemed rather dour and unassailable till now. To my mind, a distortion in the business model with a significant redundancy of the long term business forecasts would qualify as a disruption for that particular sector. In addition to the oft mentioned factor of technological innovation; aspects related to regulation, globalization, protectionism, and even esoteric factors like climate change contribute to disruption. A few examples culled out from recent developments will hopefully buttress this point.
The power sector in India was long considered a sunrise sector in many ways, given the growing demand for power aided by both demographics and strong economic growth. This meant a solid business case which not surprisingly led to an investment binge in the thermal power sector during the second half of the previous decade. That optimism seems distant memory today, with the sector lying in shambles almost across the board. Solar power threatens to corner the new demand requirements, state utilities are unwilling to buy power due to stretched finances, coal supply linkages only exist on paper and for some of the fixed tariff based plants, the feedstock price which was supposed to be fixed escalated overnight due to regulatory changes in a distant country.
The global thermal coal sector which attracted investments by the droves till very recently is now been pronounced as a sunset sector. A business case built for investment in this sector even 5 years back would be redundant today. Some of those lofty investments planned in developing gigantic coal mines to cater to the demand from China appear wobbly, given that China itself is moving towards cleaner forms of energy and cutting its reliance on thermal coal. Closer home in India, the sector also got wildly disrupted when a judicial decision to correct a perceived regulatory anomaly ended up cancelling all coal licenses granted to private operators over the past 25 years.
There has been a dramatic change or a reversal in fortunes of the Oil industry. The price movements over the past couple of years, the demand/supply balance and irrelevance of OPEC cuts has turned the sector’ fortunes on its head. The term “peak oil” as a term was in wide use just about a decade back to explain the supply side of oil when prices were soaring. The same term is used today but with an exactly opposite connotation; various estimates now suggest that we will hit “peak oil” by 2030 but on the demand side. A world which seemed to be running out of oil a decade back is expected to be awash with oil by 2030. Shale, renewables, electric cars, greater energy efficiency are the factors which will drive this profound change of fortunes for the once unshakeable oil sector.
The last of the examples is the telecom sector in India. It has been a fall from the cliff for the sector from the heady years of the early 2000s. From more than ten players we are down to potentially four players over the coming year, and in terms of valuation, the sheets are full of red. Regulatory uncertainty, a greedy exchequer and more recently the entry of one large and resourceful player has broken the back of most of the incumbents who tragically are also overburdened by debt.
As an aside, what does all this mean for conventional debt financing for greenfield projects in traditional manufacturing sectors in the years to come. If the threat of disruption (in the broad sense as articulated earlier) is as prominent in these sectors as the new age ones, can debt finance be a viable source for funding such projects? All startups as we know them today, are almost entirely funded by equity or similar instruments. The uncertainty in the business model and the resultant impact on cash flows makes debt financing unviable. If traditional manufacturing sectors start falling under the same bracket, we might need to tweak the norms for debt financing even for such projects. Possibly the equity component in financing such projects will need to go up to reflect the increased uncertainty, or the debt providers may also need to get some equity flavor to ensure a share in any potential upside at a later date. After all, why would you lend to a project (loaded with uncertainty and risk) for a fixed coupon without any potential upside, when the potential loss for you and the equity holder is going to be practically the same. But that’s a separate discussion for another day as it opens a myriad of possibilities and financial engineering!
About the Author:
Mr. Viswanathan Iyer is the Director of Charoite Carist Private Limited. The firm provides advisory services to financial institutions and mid sized corporates in ares related to Capital, Risk and Strategy.