In September, Henderson Equity Partners announced that it had raised US$1.05bn in the first close of its second infrastructure fund. Meanwhile, US buyout giant Carlyle is aiming to raise US$1bn for its own infrastructure fund. Other private equity houses active in infrastructure include 3i, Barclays Private Equity, Santander and Terra Firma.
In some cases, infrastructure funds are beating private equity bidders for assets. Last month, Thames Water, the UK’s biggest water company, was acquired in an £8bn (US$15.3bn) deal by Macquarie, the Australian bank that has pioneered infrastructure investment. It beat rivals such as private equity house Terra Firma.
UK water companies are popular targets currently because the regulatory framework means they offer institutional investors known rates of return over five-year periods. Anglian Water looks likely to be acquired in a £2.2bn (US$4.2bn) deal by Australian and Canadian funds backed by 3i, while two Australian funds are buying South East Water.
According to some estimates, more than two dozen infrastructure funds could be raised this year by investment banks, private equity houses and others. There has also been a significant increase in the size of the infrastructure funds currently being launched, compared with those launched in the past. Bahrain-based Gulf One is planning a US$10bn fund, while Goldman Sachs’s private equity group is targeting €3bn for its European infrastructure fund and ABN AMRO Capital is raising €1bn (US$1.3bn).
It is easy to understand the attraction for buyout houses of moving into infrastructure. First, institutional investors such as pension funds are looking for such stable investments. Second, there is massive demand globally for new infrastructure. Third, returns from mainstream private equity are likely to fall, due to increased competition for assets.
Cressida Hogg, senior partner in 3i’s infrastructure team, says infrastructure investment is regarded by pension funds as a separate asset class somewhere between private equity, property and fixed income. “It’s about investing for high yield and low risk,” she says, “and it can be important for institutional investors that returns from these assets are often inflation linked.”
But infrastructure is not an area that buyout houses should assume they can easily master, warns Thierry Baudon, managing partner at private equity house Mid Europa Partners.
“Infrastructure is a very different game to private equity,” Baudon says. “The latter is about betting on a capital gain, expanding the business, cost cutting and making the operation more efficient. Value creation comes from the way you run the company and develop it.”
Infrastructure, on the other hand, is often about the steady distribution of dividends and is more similar to fixed-income investment, he says. “It’s about fairly safe assets that have natural monopolies or are highly regulated, but which offer lower returns than those private equity is usually seeking,” Baudon says.
Mid Europa Partners, he adds, actually moved away from infrastructure and into buyouts several years ago.
“We decided that the regulatory conditions in Central and Eastern Europe made it very hard to do privately financed infrastructure deals, whereas buyouts were more attractive,” he says.
Despite the differences between infrastructure investment and private equity there are some similarities, according to Hogg.
“A lot of skills private equity people have are relevant to infrastructure, such as execution skills, origination and some of the asset management techniques buyout houses have developed,” she says.
But Hogg acknowledges that private equity houses are not usually familiar with the much longer investment periods that infrastructure may require, with deals sometimes running over 20 to 30 years.
She adds: “It’s also true that infrastructure financing is very different to traditional acquisition financing and a lot of the infrastructure deals are quite complex, especially PFI deals, so there may be quite a lot of learning for someone from a private equity background.”
3i invested £150m last year in an infrastructure fund established by Barclays Private Equity and SG Corporate and Investment Banking, to take it up to £450m (US$860m). The fund focuses on the UK’s private finance initiative and has invested in about 30 infrastructure projects in health, education, transport and defence.
One of the trends currently is that infrastructure funds are able to offer more for assets than mainstream private equity houses because they are offering their investors lower returns. That is thought to be one reason why Macquarie was able to outbid private equity participants for Thames Water.
Generally, private equity houses are not targeting buyout funds on infrastructure because the target companies generally offer lower returns and are not the kind of businesses private equity typically can add value to. There are some specialist PE houses, however, that are focusing on infrastructure more generally as part of their buyout strategy. Terra Firma, for example, has made a number of infrastructure-type acquisitions, the biggest being last year’s €7bn (US$8.9bn) acquisition of German private housing group Viterra.
The more usual approach is for a buyout house to set up a separate, infrastructure fund, which it can then market to its institutional investors as offering a lower return than the mainstream buyout funds.
“Infrastructure investors are typically looking for high single digit or low teens returns, which is five to 10 percentage points lower than private equity,” says Thierry Baudon. He adds that institutional investors such as mature pension funds particularly like infrastructure because the income streams match more closely their liabilities.
Jane Welsh, senior investment consultant at Watson Wyatt, agrees that generally infrastructure companies do not offer the same potential for operational changes and value creation as a run-down manufacturing company.
But she adds that there are “shades of grey” and that there are some kinds of infrastructure interments that do offer potential. “Bidding for the opportunity to build a bridge or motorway offers more potential for private equity-type returns because there you have construction risk, demand risk and so on,” Welsh says.
She agrees with 3i’s Cressida Hogg that there is an overlap in skills between private equity and infrastructure, highlighting skills such as putting together a debt package, optimising the leverage, and analytical and financial skills. But she argues that originating deals may not be as valuable a skill in infrastructure as in private equity because it is often easier to hear about infrastructure transactions as they tend to be auctioned by large state agencies.
Georg Inderst, an infrastructure consultant, says that infrastructure is not a homogenous category, as it covers everything from a PFI hospital project in the north of England to a Spanish motorway or Australian airport.
“While these kind of projects do have things in common, there are also important differences, so buyout houses moving into infrastructure need to ask themselves which sectors they have expertise in already,” Inderst says.
He argues that private equity-style financial engineering is not necessarily well suited to many infrastructure projects, saying: “Many infrastructure assets attract political interest and pressure groups such as environmental organisations may be looking over your shoulder, which means aggressive financial engineering is difficult.”
Private equity houses looking at infrastructure need to be aware of some of the potential difficulties. One is the need for careful selection of country.
Italy is seen by some as a natural market for infrastructure funds going forward. Recently Giampio Bracchi, the president of Italy’s private equity association AIFI, said many of his members were considering expanding into infrastructure investment. But he did stress the need for stable legislation and taxes in Italy to ensure longer-term infrastructure investment was viable.
Davide Proverbio, a lawyer with DLA Piper in Milan, says the recent Italian budget reduces funds for infrastructure at local level, so there will be more demand for privately funded projects.
“The problem is that in Italy the legislative and regulatory framework is not very reliable and there have been cases where a change in the law has affected returns from big infrastructure projects like motorways,” Proverbio says.
He adds that in return for lower returns, private equity houses involved in infrastructure will want reliability of income over a longer period. “But at the moment that is potentially difficult in Italy, at least for infrastructure involving the state,” he says.
Another challenge is the temptation to move into industries that do not enjoy the stable cashflows or regulatory framework of mainstream infrastructure.
“I’m seeing a trend for infrastructure funds to bid for assets that do not match the traditional risk profile and don’t have quasi-monopolies, such as mobile phone companies,” says Baudon.
Another private equity director says that many buyout houses are now moving into infrastructure because of the success of the Macquarie model.
“Macquarie have been incredibly successful in infrastructure,” he says. “They manage to make fees all through the cycle, from developing a greenfield project, then syndicating the debt after completion risk is eliminated and then securitising the asset. The whole time they keep their exposure limited and make large fees on a limited amount of equity.”
For a number of buyout firms that have launched infrastructure funds, the strategy has been about brand extension.
“Especially for the large houses, they have established investors coming to them expressing an interest in infrastructure and so the buyout house sees it as a way of extending the brand,” says one director.
Thierry Baudon agrees. “The big houses, such as Carlyle or 3i, can run infrastructure funds because they have strong brands with a number of different funds in their portfolio,” he says. “An infrastructure fund is just one addition to their product suite and they can hire in the expertise they need. For smaller private equity houses it is much more challenging.”
Georg Inderst agrees that the performance of private equity houses in infrastructure will vary. “Some houses are well placed and it’s a good way for them to diversify their income, but others are going to find it very tough because they face a lot of competition from other infrastructure funds,” he says.