Extended Annual Review Report

Project Number: 30711 Investment Number: 7134/7135 October 2012

Equity Investment Asian Infrastructure Mezzanine Capital Fund and the Asian Infrastructure Mezzanine Capital Management Limited (Regional)

This XARR contains information that is subject to disclosure restrictions agreed between the Asian Development Bank (ADB) and the relevant sponsor or recipient of funds from ADB. Recipients should therefore not disclose its content to third parties, except in connection with the performance of their official duties. ADB shall make publicly available an abbreviated version of this XARR, which will exclude confidential information.

CURRENCY EQUIVALENTS Currency Unit – United States dollars ($)

ABBREVIATIONS

ADB – Asian Development Bank AMF – Asian Infrastructure Mezzanine Capital Fund AMFCL – Asian Infrastructure Mezzanine Capital Management Limited DAI – Darby Asia Investors Limited Darby – Darby Overseas Investors Limited DMC – developing member country FIRR – financial PAII – Prudential Asia Infrastructure Investors Limited PRC – People’s Republic of China XARR – extended annual review report

NOTES

(i) The fiscal year (FY) of the company ends on 31 December.

(ii) In this report, "$" refers to US dollars.

Vice-President L. Venkatachalam, Private Sector and Cofinancing Operations Director General P. Erquiaga, Private Sector Operations Department (PSOD) Director R. van Zwieten, Capital Markets and Financial Sectors Division, PSOD

Team leader A. Taneja, Principal Investment Specialist, PSOD Team member T. Aquino, Investment Officer, PSOD

In preparing any country program or strategy, financing any project, or by making any designation of or reference to a particular territory or geographic area in this document, the Asian Development Bank does not intend to make any judgments as to the legal or other status of any territory or area.

CONTENTS

Page

BASIC DATA i

EXECUTIVE SUMMARY ii I. THE PROJECT 1 A. Project Background 1 B. Key Project Features 1 C. Progress Highlights 2 II. EVALUATION 3 A. Project Rationale and Objectives 3 B. Development Impact 3 C. ADB Investment Profitability 5 D. ADB Work Quality 6 E. ADB’s Additionality 7 F. Overall Evaluation 7 III. ISSUES, LESSONS, AND RECOMMENDED FOLLOW-UP ACTIONS 8 A. Issues and Lessons 8 B. Recommended Follow-Up Actions 9

APPENDIXES 1. Private Sector Development Indicators and Ratings 10 2. Key Features of the Asian Infrastructure Mezzanine Capital Fund 12 3. Effect of the Asian Financial Crisis on the Infrastructure Sector 13 4. Summary of Investments 15 5. Funds in Asia: Industry and Operations Review 17 6. Investment Summary of the Asian Infrastructure Mezzanine Capital Fund 21 7. The Asian Development Bank’s Cash Flows from the Asian Infrastructure Mezzanine Capital Fund 24 8. Assessment of Fund Performance 25

BASIC DATA Equity Investment: Asian Infrastructure Mezzanine Capital Fund and Asian Infrastructure Mezzanine Capital Fund Management Limited (Investment No. 7134/7135- Regional)

Key Project Data As per ADB Investment Actual Documents ($ million) ($ million) Asian Infrastructure Mezzanine Capital Fund: Total Project Cost (target fund size) 500.0 246.0 ADB Investment: Equity: Committed 25.0 25.0 Disbursed 24.1 Returned (as of 31 December 2011) 21.5 Risk Rating E

Asian Infrastructure Mezzanine Capital Fund Management Limited: Total Paid-In Capital 10.0 ADB Investment: Equity: Committed 2.0 0.0 Disbursed Returned (as of 31 December 2011) N/A Risk Rating N/A

Key Dates Expected Actual Board Approval 17 December 1996 Signing Date 22 December 1997 Effective Date 22 December 1997 Initial Disbursement 29 December 1998

Financial Internal Rates of Return (%) Appraisal XARR Gross Financial Internal Rate of Return of Not specified 2.1% Portfolio Net Financial Internal Rate of Return to Investors Not specified (2.0%) (AMF)

Project Administration and Monitoring No. of Missions No. of Person- Days Fact-Finding Data not available Appraisal

Project Administration 3 3

XARR Mission 1 2

() = negative, XARR = extended annual review report

EXECUTIVE SUMMARY

In December 1996, the Board of Directors of the Asian Development Bank (ADB) approved an investment of $25 million in the Asian Infrastructure Mezzanine Capital Fund (AMF) and up to $2 million in the Asian Infrastructure Mezzanine Capital Management Limited (AMFCL). The fund was formed during a period of rising demand for infrastructure among ADB’s developing member countries. Since the fund was conceptualized prior to the Asian financial crisis, it was envisaged that private capital would complement and draw support from continued government investment in meeting the vast financing needs of this sector.

AMF was structured as a closed-end fund with a term of 12 years and an option to extend the term for up to 2 years. The fund was to focus on making investments, principally through mezzanine financing structures in private sector companies developing infrastructure projects in the region. AMFCL, the fund manager, was to be jointly owned, 80% by Prudential Asia Infrastructure Investors Limited (PAII, a wholly owned subsidiary of Prudential Company of America, or Prudential) and 20% by ADB. However, due to certain differences related to capitalization of initial expenses, ADB did not participate in AMFCL. Further, in 2002, as a part of its global business , Prudential decided to exit from its investment management activities. As a consequence of that, Darby Overseas Investors Ltd. (Darby) acquired the assets and operations of PAII and took over operations of AMFCL.

The Asian financial crisis occurred shortly after the fund’s first closing. This resulted in much lower in the fund and was the main reason behind the fund not meeting its target of $500 million in committed capital. The fund had its final closing in January 1998, with $246 million in total committed capital from 11 investors. The crisis also substantially reduced the pace and the profile of the fund’s investments. The fund invested a total of $276.5 million in nine portfolio companies, of which about 80% was invested in the power and telecommunications sector and nearly 18% in the internet and broadband sector. The fund’s investments were in the range of about $1–70 million and were made in India, Indonesia, the People’s Republic of China (PRC), the Philippines, and the Republic of Korea. Overall, the fund concept was adequately structured and aligned to the needs of the sector. However, the onset of the Asian financial crisis completely altered the investment climate, the overall private sector interest, and the flow of capital for such investments. The fund distributed $242 million to its investors from , interest, loan amortization, and exit proceeds of its investments. ADB received a total of $21.49 million in distributions, resulting in a net financial internal rate of return (FIRR) of –1.99%, and a multiple to cost of 0.89 times (i.e., a loss of capital). A somewhat positive aspect has been the ability of Darby to recover capital from some of the large and intensely distressed investments initially made by the fund.

In reference to private sector development, the fund is rated less than satisfactory, due to its lack of constructive impact on the investment environment and its limited ability to disseminate new industry knowledge or demonstration effects outside of its organization and stakeholders. No follow-on funds have replicated the AMF investment strategy, which invalidates any direct or indirect demonstration effect by the fund.

The fund’s financial performance and its modest contribution to incremental infrastructure capacity in the region translate into unsatisfactory ratings on business success and economic sustainability-related parameters. The below-expectations performance of AMF was caused by investment conditions in the post-crisis years and shortfalls in the fund’s investment strategy. It was also, to some extent, due to weak internal processes being run by AMFCL in the initial years of AMF’s operations. While it was not clearly defined in the report and recommendation of

iii the President, the fund’s documents mention a targeted return of the prevailing Treasury yield, plus a spread of 700–800 basis points. Against the target of net FIRR of about 13%, AMF’s FIRR of –2% is significantly short, implying an unsatisfactory rating for ADB’s investment profitability. One of the reasons for this poor performance has been the substantial write-downs (27%–35%) on some of the large investments made by the fund. This does not bring forth the fund’s success in extracting capital from other severely distressed investments, which perhaps should have been avoided in the first place.

AMF’s performance on environment, social, health, and safety-related aspects has been satisfactory, as the fund’s investee companies have not reported any instances of material breaches of local environmental regulations. While the fund’s reporting and monitoring practices could be improved further to meet best practices, the overall arrangement was acceptable.

The review highlights that ADB’s performance and contribution, on factors which aggregate to define its work quality and additionality, were less than satisfactory, even after factoring in the substantial impact that was made in the post-crisis fundraising period for AMF. A shortfall in the initial screening and appraisal activity was perhaps an incorrect assessment of the impact of the Asian financial crisis on the investible pipeline for the fund, and the immediate outlook for financing infrastructure projects from private sector resources. This substantially reduced the fund’s investment selection and timeline. Further, more attention should have been paid to the selection of the fund’s team and reviewing its internal processes. During AMF’s operation stage, ADB periodically reviewed the fund’s activities and raised concerns about issues like , the need to organize periodic board meetings, and better governance and reporting. One critical aspect that was either overlooked or remained unresolved, was the lack of independent contribution and supervision in the investment selection process by the fund’s investment committee.

While ADB’s presence was critical for the closing of the fund, more was expected from ADB by the other contributors, since ADB was to be a shareholder of AMFCL and potentially an active contributor. With both these considerations in mind, ADB’s additionality is rated less than satisfactory.

The main lessons being drawn from this review exercise relate to (i) the need to align the financing products and structures with the risk and return profile of the target sector, (ii) assessing the impact of smaller fund size on portfolio diversity and performance, and (iii) notwithstanding the presence of well-reputed and dominant investors and fund managers, focusing on selection of the fund management team and ensuring rigor in their internal processes.

I. THE PROJECT

A. Project Background

1. In December 1996, the Board of Directors of the Asian Development Bank (ADB) approved an investment of up to $25 million in the Asian Infrastructure Mezzanine Capital Fund (AMF) and up to $2 million in the Asian Infrastructure Mezzanine Capital Management Limited (AMFCL). In December 1997, one year after internal approvals were made, ADB completed the documentation and the formal procedures to invest in the fund and in AMFCL. ADB invested $24.1 million of its $25 million commitment to the fund.

2. The fund was formed during a period of rising demand for infrastructure among ADB’s developing member countries (DMCs). The commitment to the fund was made as part of a wider strategy, outlined in ADB’s Medium-Term Strategic Framework (1993–1996), which was to mobilize long-term capital to develop the infrastructure sector in DMCs. Since the fund was conceptualized prior to the Asian financial crisis, it was envisaged that private capital would complement and draw support from continued government investment in new infrastructure projects. ADB committed a total of $92 million to five infrastructure private equity funds during 1994–1997, including AMF.

B. Key Project Features

3. AMF was organized as an exempted company under the laws of the Cayman Islands. It was a closed-end fund with a 12-year term, and an option to extend for up to 2 years. The fund was focused on making investments via: senior ; straight ; subordinated debt with equity options and/or warrants; preferred shares; convertible bonds; and equity shares issued by companies developing infrastructure projects in the surface transport, power, telecommunications, ports, and water supply sectors.

4. AMFCL, the fund manager, was initially conceptualized to be jointly owned, 80% by Prudential Asia Infrastructure Investors Limited (PAII, a wholly owned subsidiary of Prudential Insurance Company of America, or Prudential) and 20% by ADB. However, due to certain differences related to capitalization of initial expenses, of periods prior to the formation of the fund, ADB did not participate in AMFCL.1

5. PAII acted as the fund’s sole investment advisor. PAII was founded in March 1996, as an investment unit of Prudential Asia, the Asian investment arm of Prudential. PAII’s 10 investment professionals had experience in and project and had worked in multinational firms such as Lehman Brothers, Citibank, Bank of America, and HSBC. AMF was the first and the sole fund advised by PAII at the time. Some of the key project features are given in Appendix 2.

6. In 2002, as a part of its global business restructuring, Prudential decided to exit from its investment management activities. As a consequence, Darby Overseas Investors Ltd. (Darby) acquired the assets and operations of PAII and took over operations as the fund manager. Darby, a private emerging markets firm, is a subsidiary of Franklin Resources, one of the largest

1 In response to PAII’s proposal, ADB made an offer to defer the inclusion of these expenses as a part of the fund’s start-up costs, until certain targets were achieved. These targets were related to fund size and internal rate of return. This offer, which does appear to be fair, was not accepted by PAII, who opted to be the sole investor in AMFCL.

2 fund managers in the United States, with nearly $300 billion of funds under management.2 As part of the acquisition, PAII was renamed Darby Asia Investors Ltd. (DAI). Darby’s involvement with the fund started at a time when about 45% of the fund’s committed capital was not deployed, and nearly 70% of the outstanding invested portfolio was in distress. This had a bearing on the fund manager’s strategy and raised the issue of simultaneously deploying undrawn capital, while restructuring and recovering the existing investments.

7. During the investment period, AMFCL charged a of 2.25% of committed capital. This was lowered to 2.00% of the subscribed capital commitments, reduced by the cost of investments that were realized, distributed to investors, or written down, during the period. Considering the specialized focus of the fund and the intensity of due diligence required for such transactions, the fee structure is broadly acceptable. However, given the delay in the investment activity of the fund in the initial years under PAII’s management, and the absence of any local presence in the investee markets, the rationale for this fee structure is disputable.

C. Progress Highlights

8. The Asian financial crisis occurred shortly after the fund’s first closing. This resulted in much lower interest in the fund and was possibly the main reason why the fund did not meet its target of raising $500 million in committed capital. The fund had its final closing in January 1998, with $246 million in total committed capital, from 11 investors. Despite the challenging conditions, the fund was able to raise about $100 million from insurance companies and institutional investors based in Japan, which can be attributed to the substantial participation of Prudential as the sponsor entity, and also to ADB, as a prominent investor in the fund. Appendix 3 discusses the impact of the Asian financial crisis on the infrastructure sector.

9. The fund made its first investment in 1999, 2 years after ADB made the commitment to the fund and nearly 18 months after its financial closure. The fund invested a total of $276.5 million in nine portfolio companies. Of this amount, about 46% was invested in the power sector, 36% in the telecommunications sector, nearly 17% in the internet and broadband sector, and about 1% in the transport sector. Deal sizes were in the range of $1–70 million. The investments were made in India, the People’s Republic of China (PRC), the Philippines, the Republic of Korea, and the Pacific region. Appendix 4 gives the counter-party, sector, and country-related details of the fund’s investments. While the concentration of funds was high in the power and telecom sectors, this is partially due to the private sector’s focus on them in Asia in general, and the limited investment opportunities in other sectors. Further, as the fund avoided investing in some of the more severely crisis-impacted countries, the country concentration (in India and the PRC) was high.

10. The fund drew down $268 million from its investors, equivalent to 109% of committed capital. The fund received $300.5 million from investee companies and returned $242 million in capital to investors. As of September 2012, the fund has completely exited all of its investments and has fully liquidated and distributed its remaining assets.

2 With specific reference to infrastructure and mezzanine capital, Darby sponsors and manages funds that invest in Latin American and other emerging-market private-equity transactions and high yield fixed income securities.

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II. EVALUATION

A. Project Rationale and Objectives

11. The rationale for ADB’s investment in the fund was principally to address the massive capital outlay required for the infrastructure needs of DMCs, and the necessity to complement public resources with private sources of long-term capital. The more specific and targeted objectives of the fund, as stated in detail in the report and recommendation of the President, included (i) mobilizing significant amounts of mezzanine capital for infrastructure investments in DMCs, (ii) attracting investments from life insurance companies and other major institutional investors from Organisation for Economic Co-operation and Development (OECD) markets, and (iii) establishing the first ever fund in the region, which focuses on long-term mezzanine debt capital for private sector infrastructure projects.

12. In addition, the fund was expected to address some broader objectives of having a significant development and demonstration impact, as it was to serve as a prototype for similar investment vehicles. AMF was to simultaneously complement ADB’s strategies of infrastructure and capital market development in the region.

13. Overall, the fund concept was adequately structured and aligned to the needs of the sector. However, the onset of the Asian financial crisis completely altered the investment climate, the overall private sector interest, and the flow of capital for such investments. While this should have required substantial amendments and realignments in the fund’s investment strategy and focus, such measures were not taken to the extent needed. Delays in the investment activity of the fund and the selection of relatively weakly structured projects and investments were possibly related to fallout from the Asian financial crisis—given the limited investment options available.

B. Development Impact

1. Private Sector Development

14. While AMF may be viewed as a prominent fund in its asset class, infrastructure constituted only a small proportion of the private-equity capital allocated to the Asian region in that period. AMF was 1 of the 7 private equity funds focused on investing in the infrastructure sector in Asia during this period. Data from Preqin shows that during 1994–1998, 53 funds, with a total deployed capital of $28.6 billion, had part of their capital resources committed to Asia.3 The infrastructure-focused funds comprised less than 5% of this deployed capital. This data shows that despite the need for capital and a perception of substantial investment opportunities and attractive risk-adjusted returns, private infrastructure, as an asset class, turned out to be less appealing to investors participating through the private-equity mode, compared to other sectors, investment themes, and modalities.

15. However, the fund was the first in the region to provide long-term mezzanine capital for private sector infrastructure projects, indirectly leading to increased awareness of such financing structures in the market. Post investment, the fund’s structure, mandate, and achievements provided some insight to the fund manager and investors, such as ADB, and helped structure

3 Refer to Appendix 5 for details on private equity funds in Asia.

4 future decisions regarding investment in similar funds. A successor fund set up by DAI4 has benefitted from some of the lessons learned from the experiences of AMF.

16. The fund is rated less than satisfactory due to its limited positive impact on the investment environment and its limited ability to disseminate new industry knowledge, outside of its organization and stakeholders. Apart from DAI’s successor fund, no follow-on funds have replicated the investment strategy of AMF, which limits the possibility of a demonstration effect.

2. Business Success

17. The fund distributed a total of $276.1 million to its investors from interest, loan amortization, and exit proceeds. ADB received $21.49 million in distributions resulting in a net financial internal rate of return (FIRR) of –1.99%, and a multiple to cost of 0.89 times, indicating a partial loss of capital.

18. The unsatisfactory performance of AMF was caused by multiple factors, including prevailing market conditions, shortfalls in the fund’s investment strategy, and to an extent, weak internal processes on the part of AMFCL under the ownership of Prudential. The Asian financial crisis had a negative effect on fundraising, and the pace at which capital was deployed by the fund. Insufficient due diligence of proposals, non-adherence with initial investment guidelines and criteria (specifically counter-party limits), and a less objective investment committee are identified as some of the factors that led to AMF’s portfolio suffering from material capital losses. While AMF was successful in making five profitable investments, this was not adequate to recover the capital losses and the fee paid during the fund’s life. Appendix 6 gives details on the performance of the investments made by the company, and includes a descriptive note on a select few.

19. Based on available data, only 6 other infrastructure-focused private equity funds operated in Asia during 1994–1998, including the 4 funds in ADB’s portfolio. The nominal net FIRR of these funds ranged from –6.2% to 14.0%. It is not possible to generate a benchmark from this sample, given the small number of funds and very wide diversion in performance. However, the negative nominal gross FIRR of AMF establishes its unsatisfactory rating on ADB’s investment profitability parameter.

3. Economic Sustainability

20. Insufficient data is available to determine adjusted gross FIRR derived from the portfolio of the fund’s investments as a proxy for the economic internal rate of return (EIRR), based on aspects like investment and project externalities, and contribution to regional development. Also, as a private equity fund may have in excess of 15 or 20 investments, this will make assessing each of these investees individually, a highly resource-intensive exercise. Instead, a qualitative assessment is proposed here.

21. Given the size of any individual fund, and the massive gaps in financing in this sector in the DMCs, no fund, including AMF, can expect to make a significant impact in terms of incremental infrastructure capacity. Also, for better risk diversification and lower concentration, it would be desirable that a fund like AMF make smaller investments in projects, rather than large

4 This successor fund, called the Darby Asia Mezzanine Fund II, about 6 years into its fund life, is expected to perform better than AMF. Many of the investment guidelines, decisions, and internal processes have been based on DAI’s experience of AMF. This new fund does not focus on the infrastructure sector, and instead invests in small and medium enterprises, using mezzanine financing structures.

5 or prominent financial commitments to fewer projects. Nonetheless, AMF’s investments, in several instances, did bring about results of infrastructure capacity expansion. 5 In several instances, no direct relationship can be drawn between the fund’s investment and creation of new infrastructure capacities, as these investments (loans, convertible debt) were deployed for refinancing or asset acquisition purposes, which reflects market conditions after the Asian financial crisis. Appendix 4, which gives summary information on the end-use of the proceeds, shows that only about 50% of AMF’s investments were deployed towards new capacity.

22. Some of the fund’s exits were made through listings on local exchanges. The sale of shares in 21CN CyberNet Corporation, NOIDA Toll Bridge Company Limited, and Pacific Energy were made on the open market, potentially making a minor contribution to the development of the local stock markets of these countries (Australia, India, and PRC). However, it would be exaggerated to conclude that AMF’s holding in these entities facilitated their listing in local stock exchanges.

23. On aspects related to economic sustainability, the fund is rated less than satisfactory. Based on a qualitative assessment, the fund made a limited contribution to economic sustainability, as its impact on infrastructure capacity building, or economic development in the DMCs did not achieve levels envisioned at the start of the investment.

4. Environmental, Social, Health, and Safety Performance

24. The fund was required to monitor investee companies, and ensure sufficient evidence to confirm their compliance with local environmental laws and regulations at the time of the investment. The investee companies, wherever applicable, were also required to deliver an acceptable environmental impact assessment report. The fund was also required to ensure that investment projects do not result in involuntary resettlement, and inquire about each project’s effect on indigenous people.

25. The fund hired external consultants to verify the investees’ compliance with environmental, social, health, and safety (ESHS) standards during due diligence. In instances of noncompliance, the fund was to work with the investee company to formulate a reasonable remedial plan and monitor ongoing compliance. During the life of the fund, no material breaches were reported of local environmental regulations by the investee companies. Minor instances were found, in which investee practices were within legal limits, but could be improved to meet best practices.

26. The fund is rated satisfactory, as it complies substantially with ADB requirements, with regards to environmental and social safeguard assessment. However, the manner of reporting this compliance could have been improved, as early reports by the fund did not include adequate details and assurances that investments were meeting minimum compliance standards. In addition, in no instances did the fund go beyond meeting minimum compliance.

C. ADB Investment Profitability

27. The fund invested $276.5 million in nine investee companies in India, the Philippines, the PRC, and the Republic of Korea. The fund has fully exited all of its investments at gross FIRRs

5 The investment in Pollen Electric (PRC) partially financed about 1,600 megawatts of incremental power generation capacity. The NOIDA Toll Bridge project (India) resulted in the construction of a bridge, with a 97,000 vehicles per day traffic handling capacity. Spice Telecommunications (India) grew its mobile phone subscriber base from 100,000, at the start of AMF’s investment, to about two million at the time of exit.

6 ranging from negative 35% to positive 24%. ADB’s investment profitability can be judged against the minimum targeted risk-adjusted returns on the capital employed for the specific private equity investment. The fund’s memorandum stated a target net FIRR to investors, equivalent to the 10-year US Treasury bond yield prevailing during the commitment period, plus 700–800 basis points. The average annual yield during this period (1997–2003) was 5.4%, which results in target net FIRR in the range of 12.4%–13.4%. The fund’s net FIRR of –1.99% is short of this target. The fund is rated unsatisfactory in terms of ADB’s investment profitability. Appendix 7 documents ADB’s cashflows related to the fund.

D. ADB Work Quality

28. Screening, appraisal, structuring. In reference to initial screening, this review considers that adequate due diligence was exercised, and based on expectations at the time, partnering with Prudential as a sponsor and manager of the fund was a correct and consistent decision.7 Prudential’s decision to invest up to $75 million in the fund, which is a significant contribution for that fund size and reference period, further supported ADB’s decision.

29. The Asian financial crisis altered the investment climate in terms of the lack of bankable projects and sources of financing (both debt and equity) for such long-term commitments. This substantially limited the fund’s investment process and timelines. Even though some realignment was made, this was not adequate to make the initially anticipated (pre-crisis) timeframes attainable.8 However, these factors were not sufficiently visible at the time ADB made its investment decision. On this basis, ADB’s screening and appraisal of the investment, is rated satisfactory.

30. Monitoring and supervision. In reference to monitoring and supervision of the fund’s activity, the overall level of work quality achieved by ADB is rated less than satisfactory.

31. ADB periodically conducted reviews of the fund’s operations and raised concerns on (i) valuation of some of the large and distressed investments of the fund, (ii) the need to organize periodic board meetings, and (iii) better governance and reporting related to the fund’s activities. While some efforts were made to keep a closer watch on the fund’s activities, one of the critical aspects that was either overlooked or not addressed was the lack of independent contribution and supervision in the investment process by the fund’s investment committee. The committee, which was to be appointed originally by AMFCL, in consultation with ADB, ended up being comprised substantially of PAII’s deal origination staff. Several of the initial investments made were not consistent with the guidelines (e.g., on counter-party limits) or on the overall sector selection approach of the fund (e.g., the investment in a high-risk satellite telephony project) and performed poorly.9 It is likely that adequate independent assessment on the part of the fund’s investment committee, and greater rigor and caution in the investment selection decisions, could have addressed these risks. Also, a more active presence of ADB as an observer, and a closer review of AMFCL could have illuminated these deficiencies. While this review is not defending ADB’s oversight of this aspect, it is possible that this issue was competing for ADB’s

7 Prudential was indirectly shouldering the responsibility as the fund manager, as PAII, its subsidiary, was selected as the investment advisor to the fund. 8 In the aftermath of the Asian financial crisis, the fund shifted its country focus to less effected markets like India and the PRC. Despite this, the reluctance of international sponsors to make new investments in the region and this sector was very significant. The project lender’s acceptability of hybrid mezzanine financing structures was also reduced, as they were looking at higher sponsor equity as a source for risk mitigation. 9 Some of the large exposures of AMF suffered substantial within 1–2 years of the fund’s investment, highlighting the issue of inadequate due diligence.

7 attention with other concerns, such as the discontent related to the fees being paid to AMFCL in the initial period, and the delay in the capital deployment process.

32. Role and contribution. This review considers that ADB’s role and contribution to the fund were most significant in the initial closing stages. Despite the substantial shortfall in targeted capital, the fund managed to raise $246 million in very challenging times, from a relatively new set of investors (insurance companies), and for more specialized financing purposes (mezzanine capital). The alignment of the fund with ADB’s overall strategy and policy, the previous investments and lending made by ADB in this sector, and ADB’s prominent contribution to the capital base, may have been important considerations in other investor’s decisions to participate in the fund. ADB made attempts to rectify some of the shortfalls in the fund’s operations, especially in the initial years, but the overall effect was modest. ADB could have potentially filled the gap in local market knowledge, had it been given an opportunity to contribute to that process. Overall, ADB’s role and contribution, even after factoring in the impact that was made in the post-crisis closing period for the fund, is rated less than satisfactory, leading to an overall rating for ADB work quality of less than satisfactory.

E. ADB’s Additionality

33. ADB’s presence was critical to the closing of the fund. While Prudential had substantial experience in mezzanine financing and was already present in Asia through its well-performing private equity fund, this would not have been sufficient for first-time investors to participate in the fund, given the financial turbulence generated by the Asian financial crisis.10 From that point of view, this fund would not have progressed to a financial closure without the involvement of ADB. Notwithstanding this, much more was expected from ADB by the other contributors, since ADB was to be a shareholder of AMFCL and potentially an active contributor overseeing the operations of the fund. ADB’s additionality on this aspect fell short of expectations. Overall, with both these considerations in mind, ADB’s additionality is rated less than satisfactory.

F. Overall Evaluation

34. Overall, AMF is rated unsuccessful. The rating is informed by the fund’s poor financial performance, partly attributable to its small size, the inadequacy of the fund’s internal processes, and the challenging economic conditions during its investment period. Some details related to the key achievements and shortfalls of the fund are given in Appendix 8.

10 Nippon Life Insurance Company, Asahi Mutual Life Insurance, Mitsui Trust & Banking were investing in an Asia focused infrastructure-sector fund for the first time.

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Table 1: Evaluation of the Asian Infrastructure Mezzanine Capital Fund and the Asian Infrastructure Mezzanine Capital Fund Management Company

Less than Indicator/Rating Unsatisfactory Satisfactory Satisfactory Excellent Development Impact Private sector development x Business success x Economic sustainability x Environment, social, health, x and safety performance ADB Investment Profitability x ADB Work Quality x ADB Additionality x Unsuccessful Less than Successful Highly successful successful Overall Rating x ADB = Asian Development Bank.

III. ISSUES, LESSONS AND RECOMMENDED FOLLOW-UP ACTIONS

A. Issues and Lessons

35. Need to align product and sector fit. The fund was assigned the mandate to focus only on mezzanine investments (subordinated debt or quasi-equity) for infrastructure projects. This review considers that, with the benefit of hindsight, there was a misfit between mezzanine investment structures and the cash flow and risk profile of infrastructure projects.11 The funding requirements of infrastructure investments are typically long-term debt and conventional equity, with little room for mezzanine capital, both from the financier and the investee’s point of view. The tendency of project lenders to view mezzanine capital with caution in the post-crisis period also reduced its applicability in financing such investments. Further, the margin between cost of debt and expected return on equity for infrastructure financing is also minor, making it difficult to position mezzanine financing in such a .12 Lastly, mezzanine investments in single-project companies generally have a limited upside at exit. ADB continues to focus on infrastructure financing in its DMCs, and private equity funds remain a critical channel for delivering capital to this sector. Understanding this structural misalignment and preventing it from recurring is an important lesson from this review exercise.

36. Fund size and impact on portfolio and performance. Given the shortfall in fund resources and the inherent lumpiness of infrastructure investments, the fund was not able to attain the anticipated level of portfolio credit-quality and diversity. Private investment in infrastructure has traditionally been acutely concentrated in the power and telecom sectors, as was the case with AMF. This impact was magnified by the less-than-diligent investment selection process. In such situations, as contributors to the fund, ADB may have to focus more on strengthening the rigor of the investment selection process. In the case of AMF, it was

11 Mezzanine financing has been used successfully with entities that are in a cash flow positive state, seeking additional capital for expansion, and where senior lenders are less tolerant of new debt, while equity holders are not looking for dilution in the pre-expansion phase. Greenfield infrastructure projects do not meet these criteria. 12 The average cost of debt for infrastructure projects has been 12%–15% in the period 1998-2002, while expected returns have been about 15%–18%. This leaves little room for pricing mezzanine financing, which does not have all the protection of and does not fully benefit from the upside of conventional equity.

9 possibly the lacuna in the fund’s investment selection process, and not its portfolio concentration,13 which resulted in its weak performance.

37. Need to be aware of risk-return profile of infrastructure sector. The notion that infrastructure investments have a low-risk profile is certainly valid when these projects attain their operational phase, when the initial construction and start-up risks have been addressed. However, green-field investments are much more risky. The initial start-up risks, the long gestation periods, and the extended repayment profile of senior debt (which results in back- ended cash flows for equity and mezzanine capital providers) limit the profitability of such funds. Also, given the limited upside related to project-based investing, investment in infrastructure funds requires particularly thorough scrutiny of the business model and implementation plans, and setting realistic return expectations.

38. The review underscores the need to exercise greater diligence and thoroughness in the selection of fund management staff and assessment of their internal processes. Less reliance must be placed on the perception of their global skills and competencies. The other perception that has been put to the test is that financial crisis results in a sharp fall in government investment in the infrastructure sector, therefore providing an opportunity to build a sizeable portfolio of projects in a short period of time. AMF’s slow progress in investing was partly due to a lack of domestic capital for these projects in a post-crisis environment, notwithstanding the inherent demand and the fiscal contraction policies being pursued by the governments. Lastly, the sector’s reputation as low risk needs to be reconsidered. In the Asian financial crisis, some of the most prominent defaults and distress occurred on debt invested in infrastructure. From a private equity fund’s perspective, this pushes up the cost of debt and equity for such projects. Funds that have performed well in this asset-class, have put limits on their exposure to green- field projects.14

B. Recommended Follow-Up Actions

39. None

13 In the infrastructure development business, the resources and capabilities of sponsors and the scale of their projects and/or investments tend to be correlated. If fund managers choose to invest in projects backed by stronger sponsors and make a noticeable contribution to the overall financing, then this pushes up the amount of each investment. It is often seen that prominent well-established sponsors will deploy their resource base to develop well-structured larger-scale projects. This would indirectly imply that a fund, with its narrow capital, can potentially build a concentrated portfolio of such better risk-profile projects, backed by stronger sponsors. Less resourceful sponsors often target smaller projects, and a fund which is creating an asset base of small sized investments, may end up with a highly diverse but overall weaker investee portfolio. 14 Infrastructure funds are typically larger, and rely more on operating infrastructure assets for their returns, putting a limit on their exposure to green-field projects (25%– 30% of the fund’s capital), in order to reduce their risks.

10 Appendix 1

PRIVATE SECTOR DEVELOPMENT INDICATORS AND RATINGS

Indicators Ratings Justifications/Annotations Impact to Potential Impact Combine Impact to Date Date (sustainability) and d Rateb Risk to its Realizationa c c d 1. Beyond Intermediary and Investee Impact Impact Risk Company Impacts 1.1. Private sector expansion and institutional N/A N/A 1 The fund made a relatively small impact contribution to the available risk capital for infrastructure projects in the 1.1.1 Contributes to pioneering or materially region. increasing the private sector share and role in the economy The fund’s poor performance may have some negative demonstration 1.1.2 Contributes to institutional development by effects.

o improving supply of risk capital in the Lessons learned from the project are market; limited to the fund manager, its o demonstrating the merits of private equity advisor, and its investors. funds to the public, firms, banks, and others; o bringing liquidity to local stock exchanges with IPOs; o helping a private equity industry take root and become more efficient along with maturing capital markets; and o increasing private equity expertise via migration of fund manager staff to other funds, etc.

1.2. Competition. Contributes to new competitive 1 N/A N/A 1 There were no noticeable pressures in key investee markets and/or in the contributions to competitive pressures financial sector for risk capital and finance in the investee markets that the fund participated in. 1.3. Innovation. Helps introduce effective new 2 N/A N/A 1 The fund was the first mezzanine debt products, services, and technologies, as well as fund geared toward the infrastructure replicable new business strategies in investee sector in the region. A key lesson from companies, or in the way the fund operates, the investment is the possible misfit thereby supporting reform and transformation of between mezzanine debt instruments business sectors, industries, and/or maturing and the demands of the infrastructure financial markets (item 2.2) sector in the region. However, the fund may have contributed somewhat to the growing market familiarity and acceptance of mezzanine fund structures in the region, especially in other sectors such as and SME financing.

1.4. Linkages. Relative to size of investments, N/A N/A The fund investment had no material adds notable upstream or downstream link effects linkage effects. to investee and/or financial markets for growth 1.5. Catalytic element. Catalytic finance, or The fund was in the market during the contributes to wider improved debt or risk capital Asian financial crisis. The support of supply from local and foreign investors to 1 N/A N/A 1 ADB and the fund’s investors, at the investees and to local financial sectors generally cost of financial losses, came at a time when support for the sector and the region was much needed.

Appendix 1 11

Indicators Ratings Justifications/Annotations Impact to Potential Impact Combine Impact to Date Date (sustainability) and d Rateb Risk to its Realizationa 1.6. Affected laws, frameworks, regulation. 2 N/A N/A 2 No lobbying activities were Contributes to improved legal and regulatory, implemented by the fund to benefit private business, or sector frameworks, or to laws, frameworks, or sector improved financial sector regulation, such as by regulations. observed lobby activity. Fund manager reports on significant dialogue affecting reform. 1.7. Wider demonstration of new standards. 1 N/A N/A 1 The fund complied with the ESHS Complies with good standards, and sets standards established by ADB. Its replicable new standards in, among others, participation on the board of its corporate governance, transparency, stakeholder investees ensured that minimum relations, ESHS, and energy conservation; governance was in place, except in demonstrates governance standards and one extraordinary case where the improved transparency, including as a result of sponsor actively went against preparing investee companies for listing on stock commonly accepted levels of markets (item 2.2) governance (Spice Communications). 2. Direct Intermediary and Investee Company Impacts with Wider Potential 2.1. Skills with demonstration and wider 2 N/A N/A 2 The fund manager and/or advisor dissemination potential. Through achievements organization, learned lessons from the in new managerial strategic and operating skills, investment and the sector that were contributes to successful investee enterprises applied by management to with potential for more widespread demonstration subsequent funds. However, this is and replication. mostly limited to the organization with Achievements in developing skills in private limited potential to be disseminated to equity deal structuring, instruments, and new other parties. ways to invest can be applied by fund staff in follow-on funds, or when joining new private equity groups, banks, or other financing. 2.2. Demonstration and new standard-setting 2 N/A N/A 2 The fund had five successful potential. Demonstrates new ways of operating investments, where the companies businesses and competing, and investee invested, performed well, and performance that is comparable with relevant best generated returns for the fund with industry benchmarks and standards positive demonstration effects. However, its other investments did not meet the fund’s profitability targets and were not able to operate in a way that had positive demonstration and standard-setting potential. 2.3. Improved governance. As evident in set 2 N/A N/A 2 Insofar as its profitable investments standards in corporate governance and are concerned, the fund benefitted stakeholder relations from good corporate governance practices of their investee companies. However, the fund also experienced the negative effects of a poor corporate governance structure in some of its less successful investments. Overall PSD Rating 2 N/A N/A 2 ESHS = environmental, social, health, and safety; IPO = initial ; N/A = not applicable; PSD = private sector development; RRP = report and recommendation of the President; SME = small and medium-sized enterprise. a The fund has already been liquidated and there are no future benefits or issues expected. b The combined rating should weigh impacts and risks to its sustainable realization. c Excellent (4), satisfactory (3), less than satisfactory (2), unsatisfactory (1). The rating is not an arithmetic mean of the individual indicator ratings, and these have no fixed weights. Consider already manifest actual impact (positive or negative) and the potential for impact as well as risk to its realization. d Low (4), modest (3), medium (2), high (1).

12 Appendix 2

KEY FEATURES OF THE ASIAN INFRASTRUCTURE MEZZANINE CAPITAL FUND

1. The Asian Infrastructure Mezzanine Capital Fund (AMF) had several unique features that made it an attractive vehicle for investment in the infrastructure sector. First, it was sponsored and structured by The Prudential Insurance Company of America (―Prudential‖), the largest US insurance company at that time. Prudential was the second largest manager of mutual funds in the US and had a total of $314 billion in funds under management at the end of 1995. In Asia, it established the Prudential Asia Private Equity Fund L.P., which focused on investing in higher-income countries in Asia and the Pacific and had a committed capital base of $500 million. Prudential committed $75 million to AMF.

2. Second, the fund was structured as a mezzanine debt fund, a structure that was unique to Asia and to the sector at the time. A mezzanine debt structure was initially envisioned to lead to greater capital mobilization for the infrastructure sector compared to conventional financing. It was anticipated that senior lenders would feel more confident due to the mezzanine debt’s subordinated position, which would enhance senior debt service coverage. Further, it would increase the borrower’s ability to raise additional debt financing through its effect of lowering the borrowers’ debt-to-equity ratios. To lenders and investors, mezzanine debt was seen as preferable due to its stable cash flows and the upside potential of features such as attached options and warrants. It was also attractive to insurance companies and other entities that prioritized regular yield. AMF was seen as a pioneering effort that, if successful, would lead to greater development and demonstration effects, and would serve as a prototype for future investment vehicles in the region.

Appendix 3 13

EFFECT OF THE ASIAN FINANCIAL CRISIS ON THE INFRASTRUCTURE SECTOR

1. Shortly after the approval of the fund, the Asian financial crisis struck, which led to a substantial slowdown in investment and infrastructure project implementation. The crisis was characterized by massive capital outflows from the region and substantial distress in the banking system, leading to a liquidity vacuum and complete loss of investor interest in any long- term capital commitment in the region. The chart below reflects the impact on the infrastructure sector, which was perhaps even more severe than in other sectors.

Figure A3.1: Investment Commitments to Infrastructure Projects with Private Participation in Developing Countries, 1991–2007

Source: World Bank and the Public-Private Infrastructure Advisory Facility, PPI project database. 2. Aside from the sudden withdrawal of investor commitments, even capital outlays in developing countries in the region fell substantially.

Figure A3.2: Trends in Total Private Investment in Infrastructure Projects in Asia

PRC Indonesia Malaysia Philippines Thailand Vietnam

PRC = People’s Republic of China Source: World Bank.

14 Appendix 3

3. The fund was negatively affected by the crisis in many ways. It had difficulty in raising funds outside the region, and as a result, was only able to raise $246 million of the targeted $500 million in committed capital. Prior to the crisis, overseas investors in the Asian region had steadily built up infrastructure-related investments (both equity and loans) (figures A3.1 and A3.2). The Asian financial crisis and the resultant misalignment of exchange rates and withdrawal of liquidity led to large-scale financial distress and defaults in these investments, severely limiting investor interest in such projects. The fund also had difficulty in making investments in the period immediately following the crisis due to the shortage of qualified projects in the region. This was also partially attributable to a near-complete withdrawal of government and public investment in the sector, which was initially expected to play a complementary role. Lastly, the crisis profoundly affected the risk appetite of project lenders, who sought equity financing in preference to mezzanine debt, due to its more subordinated position and the absence of required coupon payments. The crisis damaged the fund’s ability to meet its overall financial goals, compounding certain weaknesses in the fund’s concept and structure.

Appendix 4 15

SUMMARY OF INVESTMENTS

Table A4.1: Chronological Investments of the Asian Infrastructure Mezzanine Capital Fund (as of 31 December 2011, $ million)

Total Portfolio Country of Investment Year Companies Operation Deal Type Industry Cost 1999 Pollon Electric PRC Refinancing Power 45.0 Power Company

1999 PSNL/ACeS Regional Start-up Wireless 30.0 Telecommunications

1999 Spice India Expansion Fixed line 69.8 Communications Telecommunications Group

2000 NOIDA Toll India Transportation 4.5 Bridge Company Limited

2000 CITIC 21 CN PRC Expansion Internet Infrastructure 8.5

2000 Pacific Energy Regional Expansion Power/Transportation 1.2

2002 Enterprise Republic of Expansion Internet 37.5 Networks Korea

2003 First Philippine Philippines Refinancing Power/Transportation 35.0 Holdings Corp.

2004 Meiya Power PRC Refinancing Power 45.0 PRC = People’s Republic of China

Table A4.2: Breakdown of Investments by Country (as of 31 December 2011)

Percentage of Percentage of Country of Number of Amount Invested Total Invested Total Fund Operation Investments ($ million) Amount Commitment PRC 3 98.5 35.6 40.0 India 2 74.3 26.9 30.2 Republic of Korea 1 37.5 13.6 15.2 Philippines 1 35.0 12.7 14.2 Regional 2 31.2 11.3 12.7

Total 9 276.5 100 PRC = People’s Republic of China

16 Appendix 4

Table A4.3: Breakdown of Investments by Industry (as of 31 December 2011)

Percentage of Percentage of Number of Exposure Total Invested Total Fund Industry Companies ($ million) Amount Commitment Power 4 126.2 45.7 18.6 Telecommunications 2 99.8 36.1 14.7 Internet 2 46.0 16.6 6.8 Transportation 1 4.5 1.6 0.7

Total 9 276.5 100

Table A4.4: Investments of the Asian Infrastructure Mezzanine Capital Fund According to (as of 31 December 2011)

Company Straight Debt Straight Equity Mezzanine Guarantees Pollon Electric 45.0 Power Company

PSNL/ACeS 7.8 22.2

Spice 40.0 20.0 9.8 Communications Group

NOIDA Toll Bridge 4.5 Company Limited

CITIC 21 CN 8.5

Pacific Energy 1.2

Enterprise Networks 37.5

First Philippine 35.0 Holdings Corp.

Meiya Power 45.0

Total 47.8 79.2 139.7 9.8

% 17.3% 28.6% 50.5% 3.5%

Appendix 5 17

PRIVATE EQUITY FUNDS IN ASIA: INDUSTRY AND OPERATIONS REVIEW

Table A5.1: Asia-focused Private Equity Funds with Vintages 1994–1998

Fund name Vintage Fund size Industry focus Location focus PRC Walden 1994 100.0 Communications, ICT, PRC Venture Investment software, electronics, semiconductors

Lombard Nogales 1994 41.0 Consumer services, Asia, North America Radio Partners transportation, manufacturing, financial services, electronics, chemicals

Pantheon Asia Fund 1994 66.5 Diversified Asia I

PineBridge Asian 1994 861.0 Transportation, infrastructure Asia, India, Philippines, PRC, Infrastructure Republic of Korea, Taiwan, Partners I ** Thailand,

SV Life Sciences 1994 100.0 Healthcare, life sciences, Europe, North America, Fund I biotechnology, medical devices India, Sweden

USIT I 1994 70.7 Retail, distribution, consumer Japan services, manufacturing, ICT, biotechnology, software, electronics, restaurants

Warburg Pincus 1994 2,022.0 Technology, healthcare, Asia, Europe, North America, Ventures industrials, communications, Global media, financial services, ICT, life sciences, energy, education/training, business services, natural resources, property

2i Capital PCC: 1995 170.0 Technology, telecoms, India Growth Strategy healthcare, financial services, engineering, ICT, infrastructure

Asian Corporate 1995 60.0 Diversified Singapore, Asia Finance Fund

Boston Capital 1995 73.0 Consumer services, software, Asia, Europe, North America, Ventures III marketing South America,

DLJ Real Estate 1995 680.0 Property Asia, Europe, North America Capital Partners

GS Capital Partners 1995 1,750.0 Diversified Asia, Europe, North America, II Global

JAFCO G-6(A)(B) 1995 103.6 Retail, distribution, consumer Japan services, manufacturing, ICT, biotechnology, software, electronics, restaurants

18 Appendix 5

JAFCO R-3 1995 59.0 Communications, ICT, Asia, North America software, internet Lyonnaise Asia 1995 300.0 Natural resources Asia Water

Asia Direct 1996 200 Diversified Asia

Asia Pacific Growth 1996 278.0 Technology Asia, North America Fund II

DLJ Real Estate 1996 101.0 Property Asia, Europe, North America Mezzanine Capital

Lone Star Fund I 1996 400.0 Property Asia, Europe, North America

South Asian 1996 31.1 Technology, telecoms, retail, Asia Regional Apex Fund distribution, manufacturing, media, biotechnology

TVG Asian 1996 157.0 Technology, communications, Asia Communications media Fund

Whitehall Street VII 1996 323.0 Property Asia, Europe, North America, & VIII Global

AEA 1997 1997 1,000.0 Consumer products, retail, life Asia, Europe, US Investment Program sciences, chemicals

AIG Indian Sectoral 1997 90.8 Telecoms, transportation, India Equity infrastructure, power

Crimson Asia Capital 1997 435.0 technology, retail, Asia biotechnology, internet

Headland Private 1997 525.0 Technology, consumer Asia Equity Fund 2 products, industrial, manufacturing, electronics

JAFCO G-7(A)(B) 1997 106.5 Retail, distribution, consumer Japan services, manufacturing, ICT, biotechnology, software, electronics, restaurants

Lombard Asian 1997 252.0 Consumer services, Asia, North America Private Investment transportation, manufacturing, Co construction, financial services, oil & gas, electronics, chemicals

Pantheon Asia Fund 1997 169.0 Diversified Asia II

PineBridge Asian 1997 1,671.0 Telecoms, transportation, Asia Infrastructure infrastructure, power Partners II

Starwood 1997 830.0 Property Asia, Europe, North America Opportunity Fund IV

Appendix 5 19

USIT II 1997 89.9 Retail, distribution, consumer Japan services, manufacturing, ICT, biotechnology, software, electronics, restaurants

Warburg Pincus 1997 800.0 Technology, healthcare, Asia, Europe, North America, Ventures industrials, communications, Global International media, financial services, ICT, life sciences, energy, education/training, business services, natural resources, property

Westbrook Real 1997 743.0 Property Asia, Europe, North America, Estate Fund II Global

Whitehall Street Real 1997 622.8 Property Asia, Europe, North America, Estate IX & X Global

WLR Recovery Fund 1997 200.0 Industrials, construction, Japan, US energy, diversified, infrastructure

Zephyr Korea 1997 15.0 Diversified Republic of Korea

Asian Opportunity 1998 22.4 Diversified Asia Fund 1998 - Serie II

Capital International 1998 600.0 Telecoms, healthcare, media, Argentina, Colombia, India, Global Emg Mkts financial services, ICT, Indonesia, Republic of beverages, mining Korea, Russia, South Africa, Taiwan, Africa, Eastern Europe, emerging markets

Colony Investors III 1998 1,000.0 Retail, consumer services, France, Hong Kong, Japan, financial services, gambling, Mexico, Philippines, Spain, property UK, US, Central America, North America

Credit Suisse First 1998 680.0 Diversified Asia, Europe, Global Boston Intl Equity

GS Capital Partners 1998 2,780.0 Diversified Asia, Europe, North America, III Global

India Auto Ancillary 1998 15.0 Technology, transportation, life Asia Fund sciences

Lone Star Fund II 1998 1,200.0 Property France, Germany, Japan, Republic of Korea, US, Asia, Europe, North America

Macquarie 1998 72.7 Diversified Australia, Japan, New Alternative Zealand, US, Australasia Investment Trust

Prime Enterprises II 1998 180.0 Diversified Singapore, Asia

Private Equity Welt I 1998 70.0 Diversified Asia, North America, Western Europe, Global

Swisstech Venture 1998 22.0 Technology India

20 Appendix 5

Capital Fund

Tech Ventures I 1998 12.9 Technology, diversified Canada, Philippines, PRC, US, Asia

Warburg Pincus 1998 5,000.0 Technology, healthcare, Asia, Europe, North America, Equity Partners industrials, communications, Global media, financial services, ICT, life sciences, energy, education/training, business services, natural resources, property

Westbrook Real 1998 1,242.0 Property Asia, Europe, North America, Estate Fund III Global

Total 28,593.8 ICT = information and communication technology, PRC = People’s Republic of China Source: Preqin

Table A5.2: Asia-focused Infrastructure Private Equity Funds with Vintages 1994–1998

Fund Size IRR Fund Name Vintage ($ million) (%) PineBridge Asian Infrastructure 1994 861.0 (6.2) Partners I Asian Infrastructure Fund 1994 780.0 3.6 PineBridge Asian Infrastructure 1997 1,671.0 7.0 Partners II AIG Indian Sectoral Equity Fund 1997 91.0 14.0 Asian Infrastructure Development 1997 345.0 (0.9) Asia Equity Infrastructure Fund 1998 127.0 (1.0) Total 3,875.0 ()= negative, IRR = internal rate of return. Source: Asian Development Bank, Preqin.

Appendix 6 21

INVESTMENT SUMMARY OF THE ASIAN INFRASTRUCTURE MEZZANINE CAPITAL FUND

Table A6.1: Investment Summary of the Asian Infrastructure Mezzanine Capital Fund (as of 31 December 2011)

Total Realized Total Value Annual Date Date Investment ($ Gross $ FIRR Invested Exited Company Country ($ million) million) Multiple (%) Power Jun 1999 Jun 2001 Pollon Electric Power PRC 45.00 61.14 1.40x 18.50 Company Oct 2000 Jul 2003 Pacific Energy Regional 1.20 0.70 0.60x (18.70)

Jul 2003 Dec 2009 First Philippine Philippines 35.00 57.07 1.60x 10.90 Holdings Corp.

Jul 2004 May 2008 Meiya Power PRC 45.00 69.24 1.50x 16.00

Telecommunication Jul 1999 Aug 2008 PSNL/ACeS Regional 30.00 11.90 0.40x (27.00)

Nov 1999 May 2006 Spice India 69.80 69.30 1.00x (0.10) Communications Group

Broadband/Internet Sep 2000 Oct 2004 CITIC 21 CN PRC 8.50 9.85 1.20x 3.70

Jul 2002 May 2008 Enterprise Networks Republic of 37.50 7.90 0.20x (35.50) Korea Transportation Jul 2000 Oct 2005 NOIDA Toll Bridge India 4.50 13.39 3.00x 23.90 Company Limited

Total 276.50 300.50 1.10x 2.10 FIRR = financial internal rate of return.

A. Profitable Investments

1. NOIDA Toll Bridge Company Limited. The Asian Infrastructure Mezzanine Capital Fund (AMF) made a $4.48 million investment in NOIDA Toll Bridge Company Limited (NTBCL) in July 2000. The NOIDA toll bridge was the first toll bridge in India to be managed through a public–private partnership, between Infrastructure Leasing and Financial Services Ltd. (IL&FS) and the local government, through a build–own–operate–transfer agreement. The 5.8 kilometer bridge was built to connect Delhi with NOIDA, a rapidly expanding business hub and special economic zone in the Gautam Budh Nagar district of Uttar Pradesh, managed by the New Okhla Industrial Development Authority (NOIDA). The investment was made through a subscription of 20 million ordinary equity shares of NTBCL, notably not a mezzanine financing structure. The main bridge opened in February 2001, while the connecting Ashram Flyover was completed in October 2001. Due to a shortfall in traffic and delays in construction of other linkages, NTBCL was unable to service its , and had to undergo a substantial debt-restructuring work out with its lenders. NTBCL was listed on local exchanges in December 2002 and the fund was able

22 Appendix 6 to sell its shares in 2005, through a managed sale over a 5-month period. The fund earned a gross financial internal rate of return (FIRR) of 24.9%.

2. Pollon Electric Power Company. The fund made a $45 million investment in Pollon Electric Power Company (PEPCO) in June 1999. The investment was made in the form of two senior notes with warrants to finance two of PEPCO’s base-load, coal-powered plants ($36 million of senior notes with warrants for the Jinzhou plant and $9 million of senior notes with warrants for the Shenhai plant). Both these investments utilized mezzanine financing structures. The Jinzhou plant had a 1200 megawatt (MW) capacity, and the Shenhai plant a 400MW capacity. The investment was exited through the prepayment of the notes in June 2001, resulting in a gross FIRR of 18.5% for the investment.

B. Unprofitable Investments

3. Spice Communications Limited and related entities (Spice). The fund made a total investment of nearly $70 million in two of Spice’s projects, through an initial disbursement of $60 million in November 1999, and subsequent disbursements in 2003, 2004, and 2006. Some of these subsequent disbursements may have been related to capitalized . The initial disbursement comprised $40 million senior subordinated debentures to Spice Communications Limited, $10.20 million in ordinary shares issued by Modi Wellvest Private Limited, and $9.80 million in ordinary shares issued by Distacom Communications (India) Limited. In April 2000, the fund also provided a $9.25 million guarantee on an $8.80 million loan by HSBC to Spice Communications Limited.1 Although the investment criteria were breached, AMF justified the initial investment of $60 million, by allocating $20 million of the mezzanine debt, and the equity investment in Modi Wellvest Private Limited, to the Punjab circle and $20 million of the mezzanine debt and the equity investment in Distacom Communications to the Karnataka circle.2 By 2000, a number of problems had surfaced with this investment, including: (i) the discontinuance of vendor financing from Motorola and Siemens and the group’s subsequent on these credit facilities ($98 million principal); (ii) the lack of a full-time chief executive officer and chief financial officer; and (iii) extremely poor corporate governance practices by the sponsor. The fund initiated the hiring of JP Morgan to advise the shareholders on an exit for the company and hired Kroll and Associates as representatives to monitor and conduct a forensic investigation on the company in 2002. In December 2005, the fund exited the investment through an offer from a consortia formed by Deutsche Bank and Ashmore. The fund received $68.6 million in exit proceeds from the company, a noteworthy and very positive outcome, given the severe problems with the project, the sponsor, and the fund’s lack of contractual leverage. The investment earned a gross FIRR of –0.1%. While this was structured as a mezzanine investment, it was fraught with risk, had a weak structure, and was made at a time when many problems with the project and the sponsor were already visible.

4. Enterprise Networks. The fund invested $37.48 million in Enterprise Networks (formerly GNG Networks Inc.) in July 2002, through subordinated notes with warrants ($29.3 million) and a 10-year subordinated ($7.60 million). Enterprise Networks is a facility-based internet network operator that ran an internet protocol-based fiber optic network and two data centers in the Republic of Korea. The investment was used for capital expansion and to establish a debt service reserve account. Despite the fund’s capital infusion, the company was plagued with issues related to its ability to continue as a going concern, the loss of its client-

1 Inclusive of the interest cover reserve. The amount guaranteed was adjusted to $8.55 million and $8.98 million to account for changes in the value of the rupee. 2 Punjab circle refers to the network servicing the Punjab region while the Karnataka circle refers to the network servicing the Karnataka region.

Appendix 6 23 base, and intense local competition. After filing for court protection in May 2004, due to the inability to pay outstanding collateral bond obligations, court-appointed administrators took over the management of the company. As part of the reorganization, 50% of the fund’s notes and bonds were converted into equity, 18% of the notes and 4.5% of the bonds were converted into zero coupon bonds, and the balance was written off. In June 2007, Sejong Capital acquired a majority stake in Enterprise Network. As part of the reorganization plan approved by the courts, the fund received $2.48 million as repayment for its outstanding bonds, and its equity holdings in the company were diluted from 24.3% to 1.14%. In May 2008, Sejong Capital agreed to acquire AMF’s shares in the company for a total consideration of $0.65 million. The investment earned a gross FIRR of –35.5%. While the fund structured these mezzanine investments with the objective of capturing the upside, this was driven more by perceptions of the internet and the broadband sector, and possibly an unrealistic assessment of the negative and weakening trends in the performance of the company.

24 Appendix 7

THE ASIAN DEVELOPMENT BANK’S CASH FLOWS FROM THE ASIAN INFRASTRUCTURE MEZZANINE CAPITAL FUND

(as of 31 December 2011, $)

AMF

Year Cash Flows 1998 (2,064,250.00) 1999 (12,857,400.00) 2000 (1,315,000.00) 2001 5,316,869.92 2002 (3,750,000.00) 2003 (4,120,934.00) 2004 (3,482,059.47) 2005 2006 7,723,576.00 2007 7,113,821.14 2008 1,270,325.20 2009 1,321,138.21 2010 2,196,073.43 Total (2,647,839.57)

() = negative, AMF = Asian Infrastructure Mezzanine Capital Fund Source: AMF, Asian Development Bank Private Sector Operations Department.

Appendix 8 25

ASSESSMENT OF FUND PERFORMANCE

1. Some of the significant positive aspects to come out of the evaluation of the Asian Infrastructure Mezzanine Capital Fund (AMF) include:

(i) The fund mobilized a noteworthy amount of capital in the post-Asian financial crisis period, which was a prominent act of confidence in showcasing the underlying strengths of the region and emphasizing the resilience of real sectors (like infrastructure), despite the massive setbacks in the banking and financial sectors.

(ii) AMF brought in a new set of investors, i.e., the insurance companies from developed-country markets (Japan), which have traditionally been providers of long-term capital to this sector, but have been reluctant to build exposures in developing countries.

(iii) AMF introduced mezzanine financing as a new mode of investment in this sector, and created a greater familiarity with new financing products in the region.

(iv) To a limited extent, the objective of meeting gaps in financing for projects and facilitating the creation of new capacity were met by the fund.

(v) The most significant accomplishment was in the change of the AMF fund manager, which facilitated recovery from earlier investments and limited the extent of capital lost.

(vi) The fund substantially enhanced the fund manager’s experience and brought forth issues and constraints in this particular product and sector combination. These were applied in the follow-on fund and provided critical inputs for designing the investment strategy and the focus of investment.

2. Some negative features of AMF that were highlighted in this review include:

(i) The fund is small in the context of the needs of the sector and the normative size of each investment.1

(ii) The fund had significant portfolio concentration, not primarily from external macroeconomic factors but weaknesses in investment selection, resulting in a large part of the invested portfolio coming under distress.

(iii) While the initial expectation was that telecom sector investments would be related to basic and mobile telephony projects (with a more established risk profile), AMF instead invested in satellite telephony and internet network projects, which had somewhat unclear developmental outcomes and were of a significantly higher risk profile. Also, one investment was not located in a developing country, which further distanced the investment from Asian Development Bank (ADB) objectives.

1 The median value for the size of unlisted infrastructure funds is $1 billion; Prequin. Infrastructure as an asset-class.

26 Appendix 8

(iv) In several cases, the investments were in holding companies and were not clearly linked to meeting the financing gaps for any specific project, and therefore did not make any direct impact on creating incremental capacity.2

(v) The negative returns from the fund, which are partially attributable to inherent aspects of the fund and partly to the earlier fund manager’s decisions, have dissuaded other investors from following a similar product-sector strategy.

(vi) While ADB played a prominent role in the fund-mobilization process, with the Asian financial crisis as the backdrop, its monitoring, oversight, and contribution to the fund’s operations were less than adequate.

2 While it can be argued that these investments helped sustain the flow of financing into the infrastructure sector and met specific needs of the investee companies, a more tangible and direct contribution to new capacities could have supported a better review of the fund’s operations.