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 ($) ABBREVIATIONS ADB – Asian Development Bank AMF – Asian Infrastructure Mezzanine Capital Fund AMFCL – Asian Infrastructure Mezzanine Capital Management Limited DAI – Darby Asia Investors Limited Darby – Darby Overseas Investors Limited DMC – developing member country FIRR – financial internal rate of return PAII – Prudential Asia Infrastructure Investors Limited PRC – People’s Republic of China XARR – extended annual review report NOTES (i) The fiscal year (FY) of the company ends on 31 December. (ii) In this report, "$" 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. Private Equity 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 Insurance 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 restructuring, 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 interest 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 dividends, 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 bond 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