Indian Energy Company Raises $552 Million

The share price for Suzlon Energy's qualified institutional placement was reduced after the new U.S. energy bill failed to extend tax credits for wind farm developers beyond 2008

Suzlon Energy, India's largest and the world's fifth largest manufacturer of wind turbine generators, has raised approximately $552 million from the sale of new shares through a qualified institutional placement (QIP). The deal, which is among the larger QIPs in India this year, saw solid demand, especially from existing shareholders, and the bookrunners were able to use part of the upsize option to increase the offering above the initial $500 million.

However, investors also made it clear they weren't prepared to pay just any price even for this fast-growing company and the price was ultimately fixed below the initial guidance at Rs1,917 per share. When the books closed on Friday evening (after 18 hours of bookbuilding), the plan was to price the deal at the bottom of the Rs1,935 to Rs2,007 range, which would have equalled a 1.2% discount to Friday's Mumbai close of Rs1,958.65.

However, this being a QIP there was a lag between the close of the book and the time when investors had to make a final commitment on their orders, and when the share price dropped 6.7% on Monday, sources say the investors came back asking for the price to be lowered. Even so, the final price did end up slightly above the floor price of Rs1,912 that was set earlier by the regulators and represented a 2.9% premium to yesterday's closing price of 1,862.25 and a 0.4% discount to the five-day average close, making it still an okay outcome for the company.

The stock has also rallied about 55% from just under Rs1,200 before it was announced the winner of the bidding war for Germany's REpower in late May, and despite the recent drop, is still trading relatively near its all-time closing high of 2,094.25 that was reached in November.

The sharp drop in the share price apparently had nothing to do with the company's fund raising efforts, but rather was a reaction to the news that the US energy bill that was passed on Friday did not extend the production tax credits for wind farm developers beyond 2008. It also failed to make it a Federal requirement that utilities source 15%-20% of their power from clean and renewable sources by 2020 — and therefore applicable to all states. So far, this requirement is in effect in 21 of the 48 states.

The failure to extend the tax break in particular was seen to create more uncertainty for the wind farm operators and in its extension for the companies that supplies the wind turbines. Suzlon generates about a quarter of its sales (in megawatt terms) from the US.

In a research note issued yesterday, Citi noted that this development could make it difficult for Suzlon to get incremental orders from the US and there may also be question marks regarding some of the company's existing US orders that are to be executed after December 2008. However, the report also noted that it cannot be ruled out that the production tax credits will get extended in a separate bill before December 2008.

After the initial fall on Monday, Suzlon's share price gained 1.9% yesterday.

The QIP, which was arranged by Citi, DSP Merrill Lynch and JM Financial, was launched at a fixed size of $500 million plus a $250 million upsize option with the number of shares set to vary depending on the price. Based on the final price of Rs1,917, the company ended sold 11.386 million new shares, or just under 4% of its existing share capital.

Sources say the book was about 1.3 times covered at the base size of $500 million and dominated by long-only funds, including some "quite chunky" orders from existing shareholders. According to the QIP regulations, the placement was restricted to a maximum of 49 accounts.

Investors like the company because it has started to make more and more of the components that goes into wind turbine generators in-house, which allows it to reduce its manufacturing costs and also gives it greater control over the supply chain for key components. The acquisition of Hansen, the world's second largest gearbox and drive train manufacturer for wind turbine generators, in May 2006 was part of this integration strategy and marked the Indian company's first move into gearboxes.

At present it is also in the process of setting up facilities to manufacture forging and foundry components that are required for the manufacture of wind turbine generators. These facilities are expected to become operational in the second quarter of fiscal 2009 which ends in March 2009. Together with a new integrated manufacturing facility in China and a new rotor blade manufacturing plant in the US, the forging and foundry plant in India should increase its capacity to 4,700MW by fiscal 2009 from 1,500MW today.

"With its backward integration strategy, Suzlon appears much better placed to withstand key component shocks going forward and exploit the robust outlook for wind turbine generator growth," Citi's analyst team says in yesterday's report. "With Suzlon's vertical integration, we believe there is plenty of room to accelerate top-line growth and improve margins,"

The bank projects net profits will grow at a compound annual growth rate of 49% in fiscal 2007-2010 as Ebitda margins stabilise at 15%-17% and has set a target price for the stock of Rs2,227. The latter suggests further upside of about 20% from yesterday's close.

On the back of the �1.3 billion ($1.8 billion) REpower acquisition, Suzlon is also seen to be in a prime position to accelerate its growth in Europe, both within the onshore and offshore technology markets. The company has said it will be able to increase volumes at REpower, while reducing input costs and improving margins. At the same time, the acquisition has left the Indian company with a high net debt to equity ratio of 2.2, which could impact on the pace of expansion in the near-term.

Suzlon said it will use the money raised from the placement for capital expenditure and working capital requirements and for the repayment of outstanding loans related to the REpower acquisition. Some of the money may also go towards the potential purchase of additional REpower shares from Martifer and Martifer Energy Systems. Suzlon currently controls 86.5% of the German manufacturer of wind turbine generators.

Observers say the placement was also supported by the continued strong demand for Indian equities, although the benchmark Bombay Sensex index has fallen slightly over the past four sessions after recording a new closing high of 20,375 points last Wednesday (December 12).

"The markets are still quite vibrant in India and I think we will see more deals before the end of this year," one source says.

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