The £4bn loan supporting
Data from Thomson Financial shows there has been more than US$164bn of infrastructure deals done so far this year, while S&P has estimated that there is US$100bn to US$150bn of infrastructure fund money looking to be invested globally. And with lenders willing to fund these deals at debt to Ebitda figures in the mid-teens, valuations in the sector have increased exponentially.
Thames Water was sold at 1.3x the value of its regulatory asset base, while
The agency cautioned that “due diligence and robust credit analysis should be undertaken in the infrastructure sector to prevent similar mistakes occurring again”.
Michael Wilkins, managing director of European infrastructure finance at S&P and author of the report, adds that it is in part abundance of cheap debt that is feeding this boom: “Quite simply the high valuations in the infrastructure sector are being driven by excessive demand and limited targets. And these high valuations mean that more debt is required,” he said. “The business strength of infrastructure assets is typically better than those in the LBO market but that does not justify having debt to Ebitda figures that are double or indeed triple an average leveraged deal.”
The report comes as
Although, there has been some suggestion that the deal is over-leveraged, losing bidders have said that their bids were similarly aggressive. And despite press reports that the deal has struggled in syndication, the loan is set to close successfully on Tuesday.
The leads said that London City illustrated the diversity within the infrastructure sector. Not only does it have an above average margin, it sits on a hugely valuable property portfolio and has a unique market position. And compared with say a port, it has a low maintenance capex requirement, meaning most of the cash that flows through the business can service the debt. This, the leads said, meant the company’s credit metrics could support the leverage.
Infrastructure bankers remain extremely bullish about the sector and were unfazed by the S&P report. They argue that valuations look high partly because of historic undervaluation and that while debt multiples look high when compared with LBOs, this ignores several important facts.
Firstly, while the cost of debt has fallen, so has the cost of equity. A typical buyout fund will have an IRR target of between 25% and 30%, while the average infrastructure fund looks for an IRR in the mid teens.
Secondly, equity contributions are still high. For example, London City has an equity contribution of nearly 50%, while in the ports sector average contributions are well above 30%. This compares with 20% to 25% in the private equity sector.
Thirdly, they said that comparing LBO multiples with infrastructure multiples was misleading. Most traditional private equity targets can only sustain investment-grade status with a net debt to Ebitda ratio of around 3x, while assets such as airports or toll roads can remain investment grade often with leverage of more than 10x. Therefore, bulls argue that to claim infrastructure assets are over levered compared with private equity assets is simply wrongheaded.
Finally, they said concerns over interest rate movements ignored hedging requirements with a minimum of 75% of the debt hedged in these transactions.
“Debt and equity investors are aware of the impact of interest rates on their exposure, and often hedge more than the 75% minimum,” said one senior banker. “The tenor of such hedging tends to be very long-term in the UK in particular because of the inverted yield curve, thus almost totally nullifying refinancing and wider interest rate risk.”
However, even bulls agree there are some areas of concern. The popularity of these assets in the loan market means that the definition of what constitutes infrastructure has been stretched.
Generally, infrastructure investors require long-term stable cashflows in an asset that is typically in an oligopolistic or monopolistic position such as an airport, or with elements of risk that are state backed. However, infrastructure-style financings for sectors as diverse as car parks and motorway service stations have struggled in syndication.
There are also concerns that the line between infrastructure and private equity is becoming blurred. Sponsors are increasingly getting involved in the sector, with firms including Goldman Sachs, Credit Suisse and Terra Firma, all playing. And there are worries that cheap debt will increasingly be used to leverage growth rather than move the focus away from pure debt service metrics:
“There is an aggressive end to this market,” said one banker. “And the temptation is to use debt structures that seek to leverage growth rather than coverage models that focus on the bottom line annuity return.”