When I arrive at M&G’s London offices to meet Infracapital co-founders Ed Clarke and Martin Lennon, it’s just weeks after the firm sold Dutch telecoms company Alticom, realising its debut £908 million ($1.2 billion; €1 billion) 2005-vintage fund and generating a 2.1 times capital return for investors. But despite the success, Lennon sees the process as a bitter-sweet pill.
“It’s a bit sad as well,” he says. “It’s a bit like experiencing a child leaving home when we say goodbye to these assets that we talked about pretty much every day for the best part of a dozen years.”
With that, the founders cast their minds back to simpler times, when Infracapital first began fundraising in the early 2000s. “Our original target was £750 million, but when we initially started out we thought that if we got to £450 million that would be great,” Lennon says.
“Infrastructure, because it’s an essential service, is always something that gets the attention of politicians and regulators and so that is the biggest risk”
That plain-sailing market wasn’t to last for long, though, with the global financial crisis hitting not long after and, according to Clarke, “really stress-testing the whole industry and our portfolio”.
“Could we have actually picked a more challenging period in which to manage any kind of investment portfolio?” asks Lennon. “But we’ve come out with a very satisfying result that we set out to deliver.” He adds that the whole fund was raised before the crisis – alongside five of the fund’s seven asset acquisitions – but after that “one had to take stock and be very cautious”.
The European infrastructure landscape has also changed broadly since Infracapital first began fundraising. A larger flow of capital, a shift in the types of assets targeted and a greater understanding of the asset class itself have all led to Infracapital altering its methods to ensure success.
“One of the biggest changes has been the emergence of much more direct investing by what have traditionally been fund investors,” Clarke notes. “We’ve seen a lot more capital come into the sector and therefore I think you’ve had to be a lot more innovative in terms of the way you approach it in order to keep finding value in that environment. We have adapted and continued to adapt strategies to try to take advantage of what we see as less competitive, less congested parts of the market.”
Lennon agrees and adds that Europe has since become Infracapital’s oyster. “When we started off, the opportunity set was overly weighted to the UK and one or two [other] countries,” he says. “Now, certainly across the European landscape, it’s [more] diverse geographically and sectorally. If you value portfolio diversification and construct portfolios very much with that in mind, your selection choice is as good as it’s ever been.”
Before Infracapital had divested the assets of its first fund, it had considered an entire rollover of the vehicle. It’s no surprise that method has been considered by other managers that launched funds around the same time as Infracapital Partners I, with DIF succeeding twice with a portfolio sale and Ardian also thought to have initiated such a process. However, Lennon says the returns offered by individual sales convinced Infracapital otherwise.
“In the fund, there was an obligation for us to consider whether a portfolio continuation was a feasible exit option,” he explains. “We did investigate that very rigorously, but ultimately the conclusion that we got to was that, in terms of delivering the best results to our clients, individual realisations would be the best outcome.”
While Infracapital eventually decided against the rollover, Lennon is pleased it was analysed.
“When you’ve got a genuinely diversified portfolio and people start to analyse the assets individually, they can forget the portfolio value,” he says. “A great lesson learnt was that it’s best to take those assets to [investors] that will want them, rather than trying to give them a portfolio that, if they don’t value that diversification, is not going to realise the best outcome. That was a surprise because there is clearly demand for the asset class, but it hadn’t evolved enough to give what we felt was the appropriate value to the benefits of a diverse portfolio.
“It was an interesting piece of work we did,” he adds. “Ultimately, our job was to invest the money and deliver the target returns for a defined period of time. That was our primary motivation and that’s what we did.”
They were certainly successful. In addition to the 2.1 times capital returned at exit, Fund I generated an 11.4 percent IRR, according to market sources, although Infracapital declines to confirm this. “Fund one got a nice pat on the back, taken away for a nice summer holiday by its parents and job well done,” was all Lennon would say.
“Could we have actually picked a more challenging period in which to manage any kind of investment portfolio?”
A particularly good exit was Infracapital’s sale of smart metering firm Calvin Capital to KKR in December 2016, revealed by Prudential at the end of Q1 2017, which netted the fund a 3.8 times cash-on-cash multiple. Prudential attributed this success to the growth driven by Infracapital in the smart meter market following its initial investment in 2007.
“[Calvin Capital] was a business which wasn’t on everyone’s radar when we bought into it and we developed it and turned it into a real success story,” Lennon says. “We then exited that once we built it as a proven successful platform.”
By the time it had exited Calvin Capital, Infracapital had financed the installation of 2 million smart meters and had secured contracts for more than 8 million smart meters in total. This came despite some UK energy suppliers being fined by the regulator Ofgem for their failure to install the meters quickly enough. Calvin Capital had also been partly backed by Infracapital’s second £1 billion fund after the first vehicle had reached the maximum it could invest.
“The two sat alongside each other,” Clarke explains. “We’d really given it the bedrock of a strong group of contracts with some of the big utility groups which provided a perfect platform for someone to take that business on and develop it further and overseas as well.”
Clarke is also sympathetic to the problems suffered by the smart meter scheme. “Making such a big change always takes a bit longer than people hope. On that side, Calvin played a huge part in facilitating that rollout because post-financial crisis, the utilities’ balance sheets were not what they used to be. I think it was a godsend to them to have an entity like Calvin where they could outsource that capex and still get the investment being made on an accelerated basis.”
Still, there were bumps in the road. As any parent would know, a child might start to cause a few grey hairs during its adolescence and Infracapital’s oldest child is no exception to the rule. The firm’s 2011 investment in a 23MW Spanish solar portfolio was soon hit by the government’s cuts to the sector’s subsidies and some important parenting lessons were learnt.
“The reality is, infrastructure, because it’s an essential service, is always something that gets the attention of politicians and regulators and so that is the biggest risk,” Clarke maintains. “What we take away from that experience is, if an investment is based around a subsidy regime of some sort, then we’re much more focused on the underlying economics of the country involved, making sure that there is a viable long-term story there.”
While the decision remains under arbitration, Clarke emphasises that the fund’s strongest defence in this case was its portfolio diversification and that it wasn’t overexposed to one country. It’s a salient point, particularly with Brexit on the horizon and Infracapital being a firm raising funds in sterling and investing across Europe.
“I think from a business point of view, Brexit is not a big deal for us,” Lennon believes. “We are structured as a European fund manager. It worked before Brexit and it works after Brexit. In terms of the deals that we target, because of the essentiality of them, Brexit is not going to impact us to a large extent. What’s important to us is that we tick all of the regulatory boxes. We’re able to transact in all the countries we want to and all the sectors we want to. The UK is important to us but not uniquely so.”
Lennon does concede that some UK assets have recently become significantly pricey and says Infracapital’s strategy has been to look down the less-trodden paths across Europe, particularly in the mid-market sector, an approach that “has borne fruit for us so far”, he says.
One of those off-the-beaten-track approaches has been the manager’s greenfield strategy, formed in 2015 and followed by a £1 billion fund launched in 2016, which reached its £1.25 billion hard-cap in November. The firm’s push for greenfield is in contrast to many of its peers. In a sign that greenfield hasn’t quite hit the mainstream of investment, one LP declined to place it in its infrastructure bucket, instead classifying it under a new pool containing “more out-of-the-ordinary assets”.
Clarke, however, views things slightly differently. “We’ve always felt that the perception of construction risk has been slightly out of kilter in terms of what it should be. If you look at the Juncker Plan, governments getting behind investment in infrastructure as being a key driver for economic recovery, and a lot of big corporates being more open to partnership, that combination of factors means that [greenfield] is an opportunity that’s really emerging and is a thing of the now.”
Lennon echoes these sentiments and, while he maintains the benefits of the broader operational market, he sees the greenfield strategy as a great addition.
“We couldn’t have done it five years ago because we wouldn’t have had the confidence that the pipeline was there,” he says. “With renewable energy and greenfield PPPs, loads has been done in those areas. But utilities, energy and transport – to actually have sufficient pipelines to enjoy the de-risking effects of putting that together as a portfolio wasn’t there five years ago. It is still smaller than the brownfield world, but sufficient for somebody with the right skills, expertise and capital to address.”
As with Infracapital Partners I, II and III – which is about to be raised, targeting £1.5 billion – the greenfield fund is a close-ended vehicle, albeit with a longer 25-year term. Lennon and Clarke hail the impact a closed-ended fund has on the management of an asset, with one eye always kept on the realisation aspect.
“The exam question is different [with a closed-ended fund],” says Lennon. “You have to graduate at the end of your fund and knowing you’ve got that big test means you can’t afford to be complacent.”
If Fund I is anything to go by, complacency is not a problem for Infracapital.