Infrastructure boom

Recent deals in the infrastructure sector include the €1.94bn facility backing the acquisition of Saur, a French water, energy and waste management business; the £3.4bn in loans behind Macquarie’s acquisition of National Grid Wireless, and the circa €1bn in financing that will back the purchase of the Scandlines ferry business. Banks are also busy working on financing structures around the acquisition of Southern Water and the sale of the electricity assets of United Utilities, with the bid by Suez and La Caixa for Aguas de Barcelona also a potential trigger for a deal.

As this list suggests, loans to the sector are big, M&A driven and increasingly common. But why has the market taken off now?

“The strong deal flow in infrastructure is the natural evolution of an asset class that has been growing over the past 12 months,” said Rebecca Manuel, managing director and head of corporate and structured loan syndicate at RBS.

“Jumbo deals have focused the attention of equity investors on the long-term attractiveness of infrastructure, and the knowledge of debt investors has grown as more deals have gone through.”

And the deals are expected to keep coming. Planned European regulations, such as the water framework directive and rulings on urban waste water treatment – together with the need of new EU members to upgrade infrastructure – mean that financing requirements are not likely to be sated any time soon.

“Water companies in Western Europe and Central and Eastern Europe will have 20–30 years of fairly intense spending requirements,” said David Lloyd Owen, founder and managing director of water consultancy Envisager. Owen points to population changes, increasing affluence and climate change as drivers for investment by water companies in particular, though he cautions that water can be unpopular when it comes to financing.

“There is always political opposition to paying for water,” said Owen. “Electricity assets are further up the pecking order.”

For debt investors, what makes infrastructure assets appealing is the comfort they bring. An infrastructure asset is generally a business that has stable cashflows, long-term sustainable, if unspectacular, growth and limited business risk, together with high visibility.

Risk can be limited by the company being in a regulated industry, such as water provision, where the regulator will set tariffs that enable the company to keep investors happy, or by being in a segment where a licence or a concession is required, such as toll roads.

Such steady assets have obvious advantages, which is why groups such as Australia’s Macquarie have specialist funds focused on the infrastructure segment. Macquarie currently manages around €20bn in infrastructure assets, including some, such as telecommunications holdings, that arguably fall outside the traditional definition of the safely ring-fenced cash generator.

Such widening of the definition of an infrastructure asset is, bankers say, part of a general move in the market towards financing what are perceived as essential services.

“Traditionally, core infrastructure assets – utilities, ports, roads and airports – have been popular with investors, but there is growing demand for broader categories – ferry companies, motorway service stations, telecom towers and waste management businesses,” said David Higgs, a director in the global loans syndicate at Barclays.

This loosening of the definition is not the only change that the increased appetite for infrastructure investment has brought about.

“Until a year ago, the junior debt in infrastructure deals was relatively limited in quantum and sold mainly to the same banks that were buying the senior tranches to boost their overall transactional yields,” said Higgs.

He points out that they are now increasingly able to cross-sell infrastructure paper to traditional second-lien investors in the institutional world who value the diversification junior infrastructure assets bring to portfolios.

“Particularly as they’ve seen compression on second-lien spreads over that time,” added Higgs.

The yield on the junior tranche of infrastructure deals used to be 100bp or so lower than the typical yield on traditional second-lien but spreads have largely converged over the last 12 months, he argued.

Another advantage of infrastructure assets in a highly liquid market is that they can shoulder leverage rates that more cyclical companies cannot bear.

“Regulated infrastructure assets, like water companies, lever up on a debt to regulated asset base (RAB) ratio,” said Robert Pugvogel, a director in the infrastructure finance group at Dresdner Kleinwort.

“Given that the stock of water companies trades at a premium of 20%–30% to the RAB, investors have the comfort of a significant equity cushion and leverage can easily be 95% of RAB, as was the case with Thames Water.”

Prices are also designed to keep investors on board for the longer term. “For many deals there is an expectation of a refinancing in the capital markets. This is why the loans typically have margin step-ups and cash sweeps toward the end of their tenor,” said RBS‘s Manuel.

Although the infrastructure market looks set to boom, investors still look for strong comfort. This means that investment in infrastructure in emerging markets, such as Russia’s current mandate for a Rbs13bn loan to its Federal Electricity Grid, would not be to everyone’s taste.

Emerging markets, with their need for new infrastructure and growing populations are, however, certainly on the financing radar.

“As private equity funds cast their net further in search of value, emerging market destinations are increasingly on the agenda,” said Simon Meldrum, head of emerging markets at Dresdner Kleinwort.

He points out that many deals in Central European countries are still small and can be financed by local banks. What may be more of a spur to the market is the arrival of Middle Eastern investors in Western Europe.