In focus

Build, build, build: the road to recovery and returns?

As countries around the world begin to look beyond the Covid-19 lockdowns, attention is turning to mitigating the dramatic economic fallout of the pandemic. Infrastructure is set to play a major role in this, especially in Europe.

Indeed, UK prime minister Boris Johnson recently called for an “infrastructure revolution” to help revive the economy. “We will build, build, build. Build back better, build back greener, build back faster,” he said.

Across Europe, we believe that the stimulus packages being considered will provide a number of new infrastructure investment opportunities.

Before the coronavirus crisis, European countries faced large funding shortfalls. These posed challenges in developing, maintaining and upgrading key infrastructure: governments are often cash-strapped and banks are constrained by regulation.

This could be about to change should these stimulus packages become reality. Infrastructure is the backbone of most economies. Its modernisation, the development of renewable energies and support for the digital revolution should rapidly feed the infrastructure investment pipeline.

From an investment perspective, the infrastructure market is still relatively young, only really emerging in the past 15 years, comprising both debt and equity. Of the two key pillars, infrastructure equity offers higher return potential than debt, and is the larger portion of the market (at around two-thirds). However, investing in infrastructure equity requires specialist expertise and much higher levels of engagement. Newer investors will need support to get the most of it.

Why infrastructure equity?

Infrastructure as an overall asset type generally offers high levels of visibility and low volatility because of the essential nature of the financed projects. The need for energy utilities, water and waste management or telecom infrastructure networks  doesn’t disappear because of a short-term economic slowdown.

When an infrastructure debt investor approaches a new opportunity, most of the work is done upfront. The investors would undertake their review of credit/funding risks, but then may have little interaction with the investment until termination (or sale).

When it comes to infrastructure equity there are a few more avenues to pursue in terms of value creation. When we draft a value creation plan - providing a sort of “road map” to expected returns - we might be focusing on maximising operational efficiency, refinancing the asset, enhancing organic growth or “bolt-on” expansion through acquisition.

Where it differs from conventional private equity is in the nature of returns, and often the counterparty relationship. With private equity, return expectations are generally based on the capital gain made at exit or disposal. In infrastructure equity, returns are in the form of consistent cash flows. Holding periods in infrastructure equity are also long - generally around a decade or more, needed to implement the value creation plans. Finally, infrastructure stakeholders tend to be public bodies or municipalities, as opposed to corporate entities, which adds a political element to execution. This also necessitates a long-term approach.

The best hunting ground

We see compelling opportunities in infrastructure across Europe, but particularly in France, which is the largest and most truly diverse infrastructure market in the region.

The diversity of the French market means we can access more of the major long-term themes that we expect to drive structural growth; things like the energy transition and digital transformation.

France also benefits from a very strong regulatory framework and a long history of delegating public services to private operators. This is what generates opportunities for infrastructure investors.

Buy well, manage well and sell well

Where we do believe investors should be a little more picky is in deal size. In its fairly short lifetime, the infrastructure investment industry has grown significantly. Given the economics of asset management – specifically the fairly fixed cost base - we have seen demand for larger deals grow. The time required to transact a deal is not materially influenced by size; small and large deals take similar amounts of time. As a consequence, those firms that have grown to large scale have all but abandoned the small and mid-size portion of the market.

This decline in competition means that our recently completed deals have been made on a bilateral basis. This has at least two advantages: better acquisition terms and conditions, as well as less transaction cost at risk.

Finally, the make up of the team is very important in infrastructure. The need to be close to the field is non-negotiable. The likelihood of success in winning an opportunity rises significantly as a domestic player. In France, where we are based, it may rise further as European governments deal with the economic fallout from coronavirus and grow increasingly protectionist.

While we expect infrastructure investment to benefit from rising government investment, it remains the case that where and how you invest, and who with, will determine success.