Financial Times

Lanka Ventures to expand focus on mini-hydro projects
Lanka Ventures Ltd. (LVL), the DFCC Bank venture capital subsidiary which has just reported a sharp rise in pre-tax profits in the third quarter, plans to focus on investing in mini-hydro power projects, given the lack of opportunities and high risks elsewhere.

LVL is forming a joint venture called LVS Energy Pvt Ltd. with its partner, VHS Hydro, which is involved in promoting private power generation and has already done several mini-hydro power plants.

Total investment in the new project on a Mahaweli river tributary in Ginigathhena is Rs 400 million with LVL's contribution being Rs 75 million. "We plan to have significant exposure to mini-hydro power generation," declared LVL chief executive officer Sumith Arangala.

The climate for venture capital firms is still restricted because of limited investment possibilities and exit opportunities, forcing the company to focus on areas like infrastructure as opposed to manufacturing firms which take long years to make profits.

"Because of the risks in start-up projects we have focussed on power generation projects," Arangala told The Sunday Times FT. "We've already invested in two mini-hydro power projects and we intend investing in one more this year."

LVL is also examining other options in this sector with the aim of getting a reasonable return on its investment. LVL is undeterred by complaints from private power producers of low tariffs paid by the Ceylon Electricity Board for the power they produce and believe tariffs are set to rise as promised in the last budget.

Under funding facilities offered to small and medium infrastructure projects such as alternative energy and mini hydropower projects, the government budget guaranteed a price of US$ 6 cents for mini hydro projects as an incentive.

Altogether 28 small hydropower projects have now been commissioned with 65 MW of installed capacity and 30 projects with 143 MW of capacity are in the pipeline. The CEB has issued letters of intent for 210 MW of small hydropower projects for future development.

This will raise the capacity only from small hydropower units of less than 10MW to around 300 MW. The government has said there are a large number of sites in Mahaweli regulated waterways with a large investment potential.

The government has also said it plans to exempt from VAT the supply of renewable energy sources providing electricity to rural areas. "In power generation, the risk of failure is virtually non-existent. This is one way to hedge risks," said Arangala.

LVL’s third quarter profit before tax has shot up 253 percent year-on-year to Rs 58 million which brokers Asia Research said were boosted by the sale of shares on the stock market. Pre-tax profit in the first three quarters ending 31 December 2004 was up 93 percent YoY to Rs 104 million.

"As a venture capital company, every now and then when we exit from an investment we get this income increase," said Arangala. "In this quarter, we exited from one investment which pushed up our income level. We get these spikes whenever we divest our long-term investments.”

Asia Research said LVL has high dividend potential and advised investors to "accumulate the defensive share on weakness for above average dividend yield." LVL is believed to have boosted profit before tax by booking capital gains on its sale of shares in Asiri Medical Services Ltd.

The whole venture capital industry has a very poor record with not more than five firms having gone public. Government tax concessions for VC firms three years ago have not yet helped expand the industry.

"The problem is that it is very difficult to find good investment opportunities," said Arangala. "Venture capital companies can't be investing in potty little firms. We have to target firms which are sizeable enough and which have potential to go public. We can't realise capital gains or a return on our investment unless the companies go public.”

"Firms that are eligible to receive venture capital are still only a handful," said Arangala. "We have to look for firms with independent management. When the sponsor himself manages the business there's not much interest for him to take the firm public."

The only source of income for venture capital firms is the capital gain realised or profit earned when they exit their investments. When firms do not take the exit option through the Colombo Stock Exchange there's very little VC firms can do to realise profits and they make a loss or end up writing off the investment.

"This is because of the lack of exit opportunities," said Arangala. "In other countries private parties may want to buy our stakes but this is limited in Sri Lanka. We always take a minority stake. It is of not much value for private parties to buy a minority stake."

VC firms have to look at other options such as how the companies themselves can redeem shares by issuing preference shares, instead of selling it to private buyers.

"The risks are very high and, although in the financial industry high risk means returns should also be high, in Sri Lanka that's not the case," said Arangala. "The firms that have given us high returns are not able to compensate for the losses we made."

LVL has invested Rs 75 million in listed shares which should give the firm some kind of dividend and long term capital gain.

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