European Infrastructure Investors: Back To The Classics

Back to the classics: key themes from the London Infra-News infrastructure investors forum on 26 February 2009

The sombre mood of the financial markets and wider economy is affecting infrastructure but, as an asset class, it is holding up relatively well. In fact, the global financial crisis is showing the resilience of the asset class and demonstrating that the key fundamentals for infrastructure investment remain.

Over 190 representatives from banks, infrastructure funds, financial advisers, the public sector, technical advisers, accountants and lawyers attended the Infra-News executive briefing 'Assessing the future for infrastructure investors in the new economic climate', co-sponsored by our firm on 26 February 2009.

The seven panel discussions focused mainly on the effects of the global financial crisis; in particular, the consequences of the lack of liquidity available for investment in infrastructure assets; the focus on the management and operation of assets; the flight to quality and 'pure' infrastructure assets; and the future of the infrastructure fund model.

Liquidity constraint concerns

Lack of bank debt was, unsurprisingly, the overriding concern of the forum participants. To the extent that bank debt is available, it is also expensive, while banks ration and manage debt across all lending activities and review their relationships across all borrowers. Thus, infrastructure investors are competing for bank debt in a very constrained market.

Further, banks are repatriating capital while nation states support banks, and it is feared that the rise of economic nationalism will force many banks to focus on their domestic markets.

Because banks are no longer underwriting deals, infrastructure investors are having to look to clubs of banks. Alternative sources of debt were mooted, particularly private bond placements, but this is a market that has yet to open up to any significant degree. Clearly, the ability to access the public capital markets, formerly provided via the monolines, is a critical missing link and participants await a substitute intermediation route to the capital markets and/or the revival of the monoline model in some form.

Banks themselves are stretching their take-and-hold levels and using their best endeavours to sell down debt as opposed to underwriting deals.

Participants felt that Gatwick Airport is likely to be the biggest deal in 2009 and will push the envelope in terms of bank capacity.

Management and operation of assets

Investors are reviewing their portfolios and focusing on the management and operation of their assets.

This is happening in light of the difficulties of originating acquisitions, and of evidence of increasing demand risk across many asset sectors, such as airports, toll roads and even utilities, as the recessionary climate manifests itself. As a consequence, investors are focused on closely monitoring the performance of their existing assets, anticipating and, hopefully, avoiding financial covenant pitfalls and looking at ways to improve the operational performance of assets.

The panel discussion on operation and management focused on the importance of engagement and management of stakeholders; the need for investor groups and management to have aligned interests; and the importance of planning strategic objectives and working towards a common and agreed business plan with a long-term perspective.

A long-term approach to asset management is particularly important because it is invariably difficult to implement dramatic operational changes to the costs or other operational features of infrastructure over a short period of time. A long-term approach is necessary to see the benefit of small but incremental improvements to the manner and cost of operation.

Quality is king in a target rich environment

The start of 2009 has seen a return to quality 'core' infrastructure assets in traditional jurisdictions. Unlike 2006 and 2007, which saw a large number of new infrastructure investors (such as hedge funds and infrastructure funds) fighting for quality assets at auction and pursuing hybrid assets, deals in the last 12 months have seen a return to the classic infrastructure assets – airports, toll roads, rail, public-private partnerships (PPPs) and private finance initiatives (PFIs).

Investors and lenders have little appetite for greenfield assets and assets in emerging markets. Emerging markets will find it difficult to attract investment in 2009 because investors are increasingly concerned about currency, political and other macroeconomic and geopolitical risks during a period of global economic distress. Further, high-quality infrastructure assets are and will become increasingly available in more developed and stable jurisdictions where the environment – legal, economic, social, political – for owning and operating infrastructure is fully understood.

Developed infrastructure jurisdictions, such as the UK and western Europe, will benefit from the return of capital from other jurisdictions and an increase in the number of 'classic' infrastructure assets that will become available.

Investors believe that vendor price expectations have still not adjusted downwards to match prevailing market conditions. However, it is anticipated that there will be a number of categories of 'distressed' sellers in 2009/2010 who will need to be more realistic in valuation terms.

The first category will be the traditional distressed seller – corporates and funds that have overburdened infrastructure assets with excessive leverage. Other categories will include investors who have been forced by regulatory requirements to sell assets, such as BAA and its current sale of Gatwick Airport. Governments are also likely to be forced to sell assets to raise additional cash.

The future of the infrastructure fund model

The last three to five years have seen a dramatic increase in the number and classes of infrastructure investors. The majority of funds raised in this period (about 55 per cent) were bank-sponsored funds, followed by 'funds of funds', private equity funds and independent or other funds.

Although pension funds are still very interested in investing in infrastructure assets with their stable, long-term economic performance, it was felt that certain funds may limit further exposure to infrastructure assets because the value of other asset classes in their portfolios have plummeted, resulting in a disproportionate investment in infrastructure.

Listed funds, while providing investors with liquidity, access and asset diversification, have encountered market and share price volatility in the wake of the global financial crisis and are in a position where their share price does not match directors' valuations. However, the advantages of listed funds should ensure that the model continues to be attractive to certain types of investors in the medium to long term.

Investors in listed and unlisted funds, in particular pension funds, are increasingly focused on management fee levels, leverage levels and are looking for transparency and clarity in fund governance.

These concerns may be compounded by the relative lack of experience on the part of infrastructure fund managers when compared to managers of other asset classes: more than 75 per cent of infrastructure fund managers have less than three years fund management experience.

So what are the future opportunities?

Headline large infrastructure deals are being replaced by small, simple and straightforward transactions – and, save for certain specialist funds, principally in operational (brownfield) assets where risk profile matches infra-funds' conservative appetite for risk.

There will be significant opportunities as the recession (or depression) bites harder: reductions in demand will expose over-geared assets to breaching financial covenants and more and more distressed vendors will enter the market. However, infrastructure investors will have to work hard to justify the capital required to make acquisitions – bank debt remains expensive and capacity is tight. All-equity deals may be possible but carry an inherent refinancing risk that, in the current market, is a step too far for the majority of infrastructure investors.

Infrastructure will continue to consolidate its growth and recognition as an established asset class while investors realise how resilient it is to fluctuations in economic conditions – an asset that provides long term stable cash flows, particularly in distressed times, is very attractive. There is clearly a movement back to the fundamentals of classic infrastructure investment.

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