Infrastructure deals find home in private equity: Elected officials recognize that private funding can fill gaps created by municipal budget deficits

Some private equity groups are increasingly eyeing assets such as bridges and roads as many investors are perhaps sensing a contrarian opportunity about to emerge.

An investment in a bridge or a road is not sexy. Infrastructure generally covers what used to be, and still usually are, public works projects, encompassing investments in pipelines, airports, gas distribution networks, power generation facilities and of course toll roads and bridges.

But AIG Highstar Capital’s recent investment in North East Waste Services for an undisclosed price could soon be considered standard for the space. The company specializes in the transportation and disposal of non-hazardous municipal solid waste. It operates landfills, transfer stations and both long- and short-haul collection operations, all of which collectively handle roughly 10,000 tons of solid waste each day

Sexy it’s not, yet many first movers are running to gain exposure to these types of investments.

“There’s been a significant amount of involvement [in infrastructure] from the limited partners. They’re looking for a different return stream, one that has a lower variance,” says Erik Hirsch, chief investment officer at institutional advisor Hamilton Lane. “We’re also seeing a lot of interest in creating new [infrastructure] products from the GPs.”

Teachers’ Private Capital, the alternative investment arm of the Ontario Teachers’ Pension Plan, has been one the active players in infrastructure deals lately. The system, which makes direct infrastructure investments, started building its platform from scratch about four years ago. The pension fund, today, has plugged almost $5 billion into infrastructure deals.

Recent converts to infrastructure include Goldman Sachs, which is reportedly raising a multi-billion infrastructure fund, and JPMorgan Asset Management, which recruited Mark Weisdorf to head its new infrastructure program. The Carlyle Group has also rolled out ambitious plans. In March, the firm announced the formation of its new infrastructure arm and is also reported to be raising an accompanying $1 billion fund.

Teachers’ Private Capital Senior Vice President James Leech, speaking of the recent newcomers, says, “It’s become the taste of the day.”

The stimulus for the infrastructure blitz has come from multiple factors. On the GP side, first movers, such as Macquarie Bank and AIG Highstar Capital have proven the investment model out, while on the institutional side, LPs such as Baylor University’s endowment and the Ontario Teachers’ Pension Plan, among others, have set aside substantial allocations to the budding asset class.

Perhaps most important, though – at least in the United States – has been the recognition from elected officials that private funding can fill wide gaps created by municipal budget deficits.

If there has been a landmark infrastructure deal nationwide, the privatization of The Chicago Skyway, an elevated toll road that snakes from Southern Chicago into Indiana, would serve as the breakthrough transaction. Sydney-based Macquarie Bank and Cintra, a Spanish infrastructure investor, took over a 99-year lease of the highway, paying $1.8 billion for the right to run the road.

Chicago Mayor Richard Daley celebrated the deal as a coup for taxpayers, and since the Skyway sale, Indiana, New Jersey and Delaware have either privatized toll roads or debated doing so. Most recently, New York Gov. George Pataki proposed leasing out the Tappan Zee Bridge, which sits just miles north of its famed Brooklyn cousin.

It’s not just toll roads and river crossings. City, state and federal funding deficits are expected to turn to private sector funding for an expanding pot of public sector needs. It’s estimated that domestic infrastructure projects could run upwards of $1.6 trillion in the next five years, a number that some consider too low. Even if just a fraction of the anticipated projects receive private funding, it would represent a billowing pool of opportunity.

Moreover, many view the need for infrastructure improvements as urgent. Famed investment banker Felix Rohatyn, who chairs the Bi-partisan Commission on Public Infrastructure, told a crowd at New York’s 92nd Street Y: “Whatever you don’t do today, you’re going to have to spend 50% more to do it tomorrow.”

And this is just the opportunity set in this nation. Some domestic investment firms are looking at potential infrastructure deals worldwide in such emerging markets as Asia and Latin America.

Low Risk

Investor enthusiasm has been driven by the idea that infrastructure represents a lower risk strategy. There are inflation-protective characteristics that all investors like, and the monopolistic nature of the assets ensures that there is little threat of competition.

Moreover, infrastructure is more capital intensive than most PE investments and gives LPs a place to park capital for an extended period of time.

Management of infrastructure assets on the GP side is generally more cut and dry. There isn’t the risk of obsolescence that one might find in a typical technology or defense investment, and there’s no need to guess a bottom, as cyclicality is a non-issue.

“These are cash flow positive businesses,” says AIG Highstar Managing Director Jim Timmins. “And in many cases, the revenue streams associated with these assets have no correlation to commodity prices or to the other markets.”

As a result, Norwest Equity Partners has explored and cinched infrastructure deals that three years ago may have been overlooked. The firm, in April, paired off with strategic buyer The Broin Cos. to invest in two Iowa ethanol plants.

“These aren’t your traditional buyouts, but as we penciled through the math, we determined that the risk of entering into infrastructure can be offset by a potentially better payoff relative to today’s risk/reward of a typical buyout,” says Norwest Principal Dorian Faust.

Despite its billing as low risk, many GPs worry about a firm’s ability to successfully wade through the bureaucracy of government to close such a deal. In one AIG Highstar deal, for example, the firm had to gain regulatory clearance from 17 different states. Texas Pacific Group and Kohlberg Kravis Roberts & Co. were each unable to gain the necessary clearance for separate proposed buyouts of regulated utilities.

Though the transition can’t yet be described as a sea change, investor sentiment is clearly turning. “Ten years ago, infrastructure was kind of a dirty word in the institutional investor dictionary. The perception was that although these investments represented a lower risk profile they also had a corresponding lower return profile, and that didn’t sit well,” Timmins says.