Infrastructure investment: new frontiers or blurred boundaries?

Asset shortages and rapid technological change are forcing many to rethink what “infrastructure” really means

From airports to power grids, infrastructure assets are increasingly sought by investors worldwide. The asset class offers attractive returns, reduced volatility, stable cash flows, inflation-linked revenues and diversification advantages.

So it is not surprising that infrastructure fundraising has continued more or less unabated. According to data from Infradeals, global unlisted closed-end fundraising for infrastructure totalled US$54.3 billion in 2017. This marks the second-highest annual value on record following a record-breaking 2016, and the second consecutive year in which the final close value has exceeded US$50 billion.

However, global infrastructure investment is in something of a state of flux, and targets are in short supply. Transactions involving assets such as greenfield public-private partnerships (PPPs) and brownfield privatizations experienced significant contractions in 2017. Greenfield PPP transactions globally in 2017 fell to their lowest level in more than a decade with a total value of US$44.5 billion, while privatizations’ value slid more than 46 percent compared with 2016.

This has led to an intensifying of the competition among investors for infrastructure assets, as stockpiles of dry powder reached record levels. According to Preqin’s latest report, the high value of capital secured by infrastructure funds globally has caused dry powder to reach US$149 billion.

Redefining infrastructure

Defining exactly what constitutes an infrastructure asset is a question increasingly under debate. The term traditionally embraces “core” long-term assets on which people and businesses depend, such as railways, ports and roads.

But increasingly, the label applies to “non-core” infrastructure, including digital infrastructure such as phone masts, data centers and smart metering, as well as energy services and car parks. Social infrastructure, including healthcare and medical diagnostics, is also part of the non-core mix.

Unlike core infrastructure assets—which often benefit from monopoly positions and revenue guarantees—non-core assets typically are exposed to higher levels of competitive pressure and lower levels of market regulation. The risk for long-term investors is therefore greater.

And with core infrastructure priced at a premium and in short supply, non-core assets with infrastructure-like qualities are going to be in demand. A 2017 survey from White & Case, Infrastructure M&A: Journey to the non-core, noted that investment in European non-core infrastructure had more than tripled in recent years, from €4.23 billion in 2010 to €14.46 billion in 2016.

Compounding this is the growing competition from dedicated infrastructure funds, which have more than tripled in number since 2009, from 10 to 35. Fund managers are under pressure to populate portfolios with credible assets in the face of growing competition from rivals.

There is a good case for broadening the infrastructure definition. Digital technologies, for example, are integral to the operation of core infrastructure from railways to power grids. They also provide the primary bridgehead between infrastructure providers and consumers—everything from smart meters to trip-planning apps. The purchase of data center company Cologix by private equity firm Stonepeak Infrastructure Partners for US$1.3 billion underlines this trend. The acquisition adds to a portfolio that includes assets from energy to transportation.

The definition increasingly embraces the businesses that enable infrastructure roll-out. The acquisition by private equity firm KKR of Calvin Capital—which finances smart meter installations on behalf of energy suppliers—highlights this tendency. With government-mandated smart meter roll out in the UK worth an estimated US$14 billion, the market has clear attractions.

Social infrastructure also forms an increasingly important part of portfolios. Investment manager AMP Capital recently entered the UK specialist care market through its acquisition of The Regard Group on behalf of investors in its global infrastructure equity strategy.

Shifting strategies

Another factor shaping the infrastructure landscape is convergence in the strategies adopted by private equity firms and institutional investors. The latter have a reputation for taking a long-term view on the assets they hold. Private equity firms are more closely associated with purchasing and selling assets quickly—typically within three to five years.

But in the battle to secure returns, the distinction between private equity firms and institutional investors continues to blur. Private equity firms are increasingly prepared to look beyond the horizon, with players such as Blackstone, Carlyle and CVC now offering dedicated long-term vehicles.

Meanwhile, institutional investors are increasingly competing for riskier non-core assets—such as parking lots—normally sought by private equity firms. Institutional investors can afford to outbid private equity competitors because they target lower returns over a longer hold period, a factor contributing to the upward spiral in asset prices.

There are also signs that institutional investors are increasingly interested in going it alone and investing in infrastructure directly—potentially generating even greater competition for assets.

The attraction of direct investment is that it allows institutional investors to avoid the high cost of using external fund managers. The downside is that direct investment means coping with new layers of contractual complexity. To solve this problem, institutional investors are increasingly teaming up with industry peers to pool expertise and mitigate risks.

Infrastructure is an asset class on the rise. The clamor for high-quality assets by both institutional and PE investors continues to grow. And with the Trump administration looking to private funding to support its US$1.5 trillion US infrastructure plan, the momentum to deploy dry powder in illiquid assets is unlikely to abate any time soon.

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