A wall of pension fund capital is responding and owners of existing infrastructure assets can use this to their advantage, if they need to bolster their own balance sheets by making disposals. Peter Stonor, Managing Director Transport and Logistics, RBS, assesses the market and gives his view on how owners of infrastructure assets can take advantage.
UK Chancellor of the Exchequer George Osborne has placed infrastructure at the centre of his recent Autumn spending Review, with plans to encourage pension funds to invest GBP20 billion into a range of projects, from new roads to schools.
President Barack Obama is following a similar path in the US, committing USD10 billion of Government funds into an “infrastructure bank” to incentivise private investors to fund a USD100 - 200 billion programme of new infrastructure construction.
The rationale for this is confirmed by studies showing that, per pound or dollar of capital, the best way to stimulate an economy is by investing in infrastructure, particularly transport infrastructure. This creates jobs and, once the infrastructure is built, improves the efficiency and productivity of an economy.
The demand for new infrastructure is global, with huge requirements from emerging market countries. A recent report compiled by RBS in conjunction with Cambridge University* estimates that investment of USD1 trillion per year will be needed in the 40 most important emerging economies for the next 20 years.
A challenge for potential investors is that, historically, transport infrastructure has always been closely guarded by governments because of its strategic and symbolic importance.
Programmes such as the public / private partnership (PPP) programme in the UK have ensured that governments maintain an interest, even when they can no longer commit upfront investment to the projects themselves. Many European privately-owned infrastructure assets tend to be concentrated in the hands of a small number of large industrial conglomerates.
But all that is changing. Cash-strapped governments are being forced into privatisations that they would never have considered a few years ago, which will lead to attractive assets coming to the market. Similarly, many conglomerates or corporate owners are re-thinking their strategic priorities and assessing where they can secure the best returns for shareholders. At the same time, many emerging markets are still growing strongly and need outside expertise and investment to ensure their infrastructure network keeps pace with economic development.
The sudden abundance of new investment opportunities has led to infrastructure being labelled the new alternative investment class” by fund managers worldwide.
Pension funds globally are in the process of allocating huge amounts of capital to infrastructure investment, attracted by what are seen as strong, stable, inflation-linked returns at a time when there is great volatility in many other markets. More than USD150 billion has been raised by third party unlisted infrastructure funds alone in the last five years according to Preqin, with a further USD36 billion currently invested in infrastructure by the five largest Canadian pension funds (7 percent of their assets under management). The challenge for sellers of existing infrastructure is to structure transactions to attract some of this allocation of capital.
Infrastructure owners have to understand how to best access this new wave of money and secure the highest price for their assets. The first thing to note is that lumping all ‘infrastructure’ together as a single asset class is inappropriate.
There can be large variations in sales multiples and expected returns, depending on the type, maturity, size, location and credit characteristics of the assets in question.
A developed Western European motorway backed by government revenues under a PPP scheme would be considered a safer investment than a greenfield private port with customer concentration in a developing country subject to local competition. Investors would, correspondingly, expect very different risk-adjusted returns on their equity.
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| Source: Factset 12 Dec 2011 (Note: PPP Index comprises John Laing Infrastructure, HICL Infrastructure Company, 3i Infrastructure plc, International Public Partnerships Limited) |
With this in mind, it is critical that investors bid for the assets that suit their risk profile and provide the returns they desire, giving sellers the most achievable price for their assets. The aim is to structure portfolios of infrastructure assets with the appropriate risk profile for the pools of capital available. Rather than embark on a series of minor and time consuming disposals, sellers of a variety of smaller transport assets could consider setting up a special purpose vehicle (SPV) with an appropriate mix of investments. Key considerations in constructing a portfolio would include an appraisal of the location, subsector, size, stage of development, extent of control, concession life, volume risk, leverage, expected yield and general risk profile of each asset.
Such a portfolio could then be floated on a stock exchange via an initial public offering (IPO). There should be plenty of willing buyers for appropriately structured portfolios, particularly in the public markets, if the investors can rely on regular income streams from governments in developed countries. The London Stock Exchange currently has four identifiable listed infrastructure funds with a current combined market capitalisation of GBP2.7 billion, supported by a range of participating European, US and Asian investors. These defensive stocks have performed particularly strongly in recent months against a volatile equity market.
Those selling larger portfolios of economic infrastructure assets (e.g. airports) could pursue a dual-track option, looking to access trade buyers as well as considering a public market listing. The higher levels of risk in these assets may be appropriate for more active buyers, such as infrastructure funds.
Sovereign states still own a large majority of the largest and most valuable infrastructure assets in the developed world. In order to build new infrastructure, as leaders such as Osborne and Obama are planning, governments may need to raise money from the sale of existing assets, often through concession sales. Consortia of large infrastructure and direct pension fund investors are generally the only financial acquirers with the financial muscle to bid on the largest assets. Notable recent transport infrastructure privatisations include the sale of HS1 (the channel tunnel rail link) in the UK and the Queensland Government’s programme of asset disposals including ports, railways and roads. There is an active pipeline of privatisation opportunities in Europe, including the sale of Aena airport concessions in Spain and a toll road network concession in Turkey.
The publicity that global leaders are creating around the need for new infrastructure plays right into the hands of owners of established assets. Osborne and Obama are waking the sleeping giants in the pension fund industry, and directing their cautious gaze towards increased investment in infrastructure.
In the process, a significant amount of their capital is likely to be directed towards established assets, which can offer a reassuring track record of inflation-linked cash flows. The key for sellers is to put the right structure in place in order to attract appropriate capital and secure the best achievable valuation.
*The Roots of Growth | Projecting EM Infrastructure Demand to 2030
Published 29 Sept 2011 by Timothy Ash, Imran Zaheer Ahmad, David Petitcolin (www.rbsm.com)
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December 2011