Jason Corcoran
04 February 2008
Top 10 infrastructure firms since 2003
Private equity’s participation in infrastructure has broadened the attractiveness of the asset class but has increased competition. The credit squeeze has led to a cut in returns.
Private equity firms short on big buyout targets are challenging infrastructure specialists such as Australia’s Macquarie and Babcock and Brown and investment banks including Goldman Sachs, Morgan Stanley and Credit Suisse.
Buyout groups raised 19 infrastructure funds worth $29.9bn (€20.5bn) last year, almost double that raised in 2006, according to UK research boutique Private Equity Intelligence. Its research showed there were 42 infrastructure funds targeting about $46bn.
CVC Capital Partners is the latest private equity group to launch an infrastructure fund, joining the pool of money dedicated to the sector. The UK-headquartered firm announced plans in December to raise $2bn for an infrastructure fund to buy utilities and public services.
US group Carlyle raised $1.2bn in November for its first infrastructure fund focused on North America where it believes public-private partnerships are set to take off.
AIG Highstar, a New York-based private equity group, closed its latest infrastructure fund in October at $3.5bn. Accountancy firm Ernst & Young said smaller private equity funds were looking to fund infrastructure projects valued at between $300m and $500m, smaller than big funds expect to tackle.
Tom Leman, a partner specialising in private equity at law firm Pinsent Masons, said: “Returns are about managing expectations in the infrastructure matrix. Classic infrastructure funds seek 9%-10% returns over 25 years. If inflation rates are about 4%, this is a great result. If private equity succeeds one out of 10 times, they are rightly looking for 20% margins.”
Infrastructure specialists are paying more for assets because they are seeking more stable and longer-term returns. Buyout funds seek higher returns and flip the asset after two or three years.
Investment banks have piled into infrastructure and industry specialists say their approach sits between buyout funds and specialists. Leman said: “Banks invest off their balance sheet and they can be flexible because no investors are knocking on their door demanding their cash back. Some buy and flip but generally they are more long term than buyouts.”
Jane Welsh, consultant at investment consultancy Watson Wyatt, advises her clients about investment opportunities and returns on infrastructure’s risk scale.
She said: “Specialists are more modest with low double-digit targets. Private equity funds and banks are targeting higher margins and will do messier transactions and will look at business bolt-ons such as services. There are also funds specialising in greenfield projects, which take on bid risk and usage risk.”
Investors new to the asset class regard it as a natural successor to commercial real estate – physical, real, tangible assets generating cashflows. Others view mature infrastructure as a substitute for long-term bonds with a hedge against inflation. The remainder regard infrastructure as a private equity play, with the focus on refinancing and restructuring a business to make capital gains.
Asieh Mansour, chief economist at Deutsche Bank Rreef Alternatives, regards infrastructure as a hybrid asset class, which shares common characteristics with traditional and alternative assets.
He said: “The bond-like, equity-like or real estate-like feature of any infrastructure investment depends on the individual asset and the stage of the asset’s maturity. Depending on the specific sub-sector and stage of development, infrastructure investments may range from a low-risk fixed-income substitute to a higher-risk, more volatile private equity-type investment.”
Charles Berkeley, managing director, financial sponsors, at RBC Capital Markets, believes each type of investor has its advantage.
He said: “The direct investor has less fee drag, while investment banking-sponsored funds are sometimes better able to use their global networks to originate deals. As in any market, innovators have a natural advantage and competitive access to capital.”
Buyout firms such as Carlyle and UK-listed 3i are changing tack to take advantage of opportunities in public-private partnerships. 3i has the best-known private equity fund in the sector. Despite its lacklustre start, its float was the largest listed infrastructure fund launch in Europe, according to the group. A big backer was the BT Pension Fund, which took a £98m (€131m) stake.
Consultants suggested the fund’s concentration on PPP contracts might lead to slow and steady returns, which pension funds favour. Although the lines are blurring, Leman believes buyouts will not change by adopting all the characteristics of infrastructure specialists.
He said: “Valuations are getting closer between the different camps but private equity funds have an edge. If you are trying to get management to run the assets, buyouts have the advantage because staff can realise capital gains in an exit within two to three years.”
Danny Latham, head of European infrastructure investment at Australian investment manager Colonial First State, agrees and does not envisage buyout funds providing 10-year covenants to satisfy public utility regulators.
He said: “Infrastructure specialists have a buy-and-hold strategy, whereas private equity has a buy-and-clip strategy. The issue is to ask about the attitude of vendors, who typically are not overly enamoured with the private equity industry. There might be a push towards more hybrid deals, such as UK service station operator Welcome Break. United Utilities is also pulling back to core utilities and is to sell its service businesses.”
With the raising of new funds and competition intensifying, the traditional definition of infrastructure has been extended to assets that have similar characteristics and returns, such as waste management and car parks.
Leman said: “Now racier opportunities are scarcer, private equity funds are having to look at service stations and domiciliary care businesses. They much prefer services and don’t want to be left holding the baby.”
Consultants also expect infrastructure funds to look around the world for opportunities, including in non-Organisation for Economic Co-operation and Development countries. CVC is examining sub-Saharan Africa for a new fund and the infrastructure joint venture between Macquarie and Renaissance Capital is understood to be launching a Russia and Commonwealth of Independent States fund this month.
• The volume of infrastructure financing this year is likely to continue at last year’s pace, says a report by rating agency Standard & Poor’s.
Last year was another bumper year for global infrastructure finance, fuelled by record levels of M&A activity driven by asset-hungry funds.
Infrastructure-related deals worldwide last year were worth $322bn (€216bn), just shy of the $342bn spent in 2006, according to S&P.
However, the agency warned infrastructure might not be a safe haven in a global recession. In a volatile market, bankers and investors might have expected infrastructure to remain a safe asset class and offer stable returns with little risk. But S&P said bank lenders and institutional investors had traded favourable debt terms against the management of credit risk during the infrastructure finance boom.
With the cycle turning in global credit markets, these loosely structured and highly leveraged acquisition loans are looking less attractive.
S&P estimated that up to $34bn of leveraged infrastructure loans could be left paralysed under present market conditions.
It highlighted the combination of project finance structuring techniques with the slacker covenants prevalent in leveraged finance. This new form of acquisition hybrid lending has allowed sponsors to acquire assets at record-breaking debt multiples but has dragged down credit quality in the infrastructure sector.
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