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How has the market evolved since your first core infrastructure fund in 2015?
Nick Flynn: Infrastructure has certainly established itself as a distinct asset class and become a much more prominent part of pension fund and insurance portfolios. You see increased allocations from those investors because, in this low-interest rate environment, yields and returns have been good.
As a result, many original mid-market funds have stepped up in size, which has left a gap in the mid-market. We still see the lower mid-market as the most attractive area for pension funds and insurance clients to deploy capital.
Soti Calochristos: Infrastructure has really come into its own. There was a small dip in fundraising when the pandemic hit, but the industry responded very strongly and 2020 fundraising finished by matching the level of previous years.
How do investors view the opportunity now?
NF: Generally, investors see greater opportunity in lower mid-market infrastructure because there is more dealflow and less competition for large trophy assets. There is more opportunity to do bilateral deals, off-market deals or deals with family sellers. Entry multiples can also be lower.
But operating in the mid-market does not automatically mean higher returns. A lot depends on the risk profile and what you do with assets when you buy them. However, it is easier to take stable, smaller assets and develop them in the asset management phase, creating significant value.
One example is our Finnish gas distribution business Auris Kaasunjakelu, which we bought in 2015. We have been able to grow that business through 11 bolt-on transactions, funded predominantly through the company’s cashflows, taking it from €5 million in EBITDA to €18 million today.
Which investment strategies work best in the mid-market?
SC: Each investment must stand on its own two feet, but we also think about how to make it grow. That could be either bolt-on acquisitions or organic growth. For example, if we have a utilities business without any renewables, we can consider building a solar plant or wind farm alongside it to support the transition.
NF: Buy-and-build is an obvious way to create value in the lower mid-market, as is partnering with developers. In Poland, we have a solar platform that we have built up through nine subsequent investments, taking it from under 40MW to just under 400MW. The returns are better than in western Europe, where there is more competition, but you do need that local mid-market knowledge.
How is the mid-market infrastructure space broadening out?
NF: Infrastructure has traditionally been energy, utilities and transport – but we have always included telecoms, and have now added digital. We did our first fibre-to-the-home investment in December 2020. And data centres weren’t on the infrastructure agenda 10 years ago but are core today.
If there are long-term contracts and inflation linkage, it usually fits into the infrastructure bucket. You also need clear barriers to entry. There are lots of questions over EV charging, for example. How people use chargers and how that EV charging fleet develops over time are still not fully clear. So, we still see a lot more venture tech risk in that area.
Where do you see opportunities in energy transition?
NF: We have invested in bi-mode trains – which combine diesel and electric – through our exclusive partnership with Rock Rail in the UK. Over the longer term, we think battery trains will displace diesel.
Batteries today are very expensive and not very efficient, but over time the price will come down and performance will improve. We have also looked at green hydrogen trains in Germany, using green hydrogen routes with hydrogen infrastructure alongside them.
These are pilot projects that don’t show on the radar of larger infrastructure investors. You need to partner with experienced developers that can assess project viability and work with the right manufacturers to ensure
SC: You can do research, make smaller investments, and innovate in the mid-market space. For example, in Finland, we are looking at whether biogas can flow through our existing networks. That approach can give you knowledge to use in future investments.
In light of the energy crisis, is there a future for fossil fuels?
NF: We are still going to need certain fossil fuels – particularly gas – to get to net-zero. More EV sales will mean more demand for electricity.
We are simply not building enough wind farms and solar plants to meet that demand today, and when the wind is not blowing or the sun is not shining, you will need natural gas – which is the lowest of the CO2 emitters – for your baseload capacity.
When we think about transitioning away from the higher-emitting fuels, such as coal and oil, gas is a natural step.
In the medium-to-long term, we will still need gas. Even when you have enough renewable capacity, you can still have black swan events, like we saw in America – when wind farms freeze or it is too hot for solar, impacting production – so you will need baseload capacity from gas peaking plants.
SC: Energy transition is very important and it needs to happen. But we have seen that sometimes there is not enough wind in northern Europe, which means wind farms generate less electricity, and this can cause issues in the energy market, as can be seen in the current UK market. There needs to be substantial investment in technologies, such as battery storage and hydrogen, to facilitate the transition but we also need to be realistic about the transition.
So how can you invest in fossil fuel assets?
NF: Some fossil fuel assets could become very interesting buying opportunities as they become less attractive to other buyers. Investors will have concerns about them becoming stranded assets, but that is why it is essential to consider the transition.
We own German oil storage business Unitank, which is essential infrastructure for delivering fuel across the country. That business will allow you to close down refineries in the longer term and manage that reduction in demand accordingly.
But, ultimately, the need for those terminals will reduce, so we are looking at transitioning into other forms of storage, such as chemicals, liquefied natural gas and pilot projects like pyrolysis – creating liquid fuel from waste. We are using the company’s steady state cashflow to develop into new areas for the future.
SC: If you look at all the gas networks that have been built, do you just want to take them out of the ground? That could be detrimental to the environment and local communities. Perhaps you can repurpose them to transport biogas, hydrogen, or even to help lay fibre in a city? It becomes a question of repurposing existing infrastructure for the transition.
How do you construct a whole portfolio with that in mind?
SC: It is about finding the right mix. We definitely want renewables and assets that are further along the transition, but it is also important to have assets that we can help transition as well. In the current fund, we have Unitank, which we plan to transition to other forms of storage, and at the other end of the spectrum, the solar portfolio in Poland, which is already green, and we are building out. Then you have assets in the middle, such as our district heating businesses in Finland.
We have invested in a new boiler for Finnish energy supplier Loimua Oy, so that it can now run entirely on biomass, and this has helped facilitate the phase-out of peat as its heat source. At the portfolio level, it is like a jigsaw – it is about ensuring that each asset falls into place and complements the others.
NF: Energy transition is really a value creation lever for us. We develop and execute energy transition plans. And we make sure we have a story for the next investor to continue that plan. That is what creates value and maintains multiples as well.
How important is ESG going to be in the future?
SC: ESG is already a very high priority and that will not change. It is at the forefront of our minds when setting up a fund, sourcing opportunities and during the asset management process.
The beauty of the mid-market is that companies are looking for a path – whether that is through support, a clear focus or financing. We can work with municipalities or family-owned businesses to set that ESG agenda, put in strong governance and set achievable targets. We have worked with a number of municipalities in Finland in the district heating space to support their ESG goals and energy transition plans with our capital and expertise.
NF: We have signed up to Article 8 of the Sustainable Finance Disclosure Regulation and the EU taxonomy, and have developed new screening tools in line with that regime. That will bring reporting obligations for smaller businesses and means transition over time, which we help them with.
Often, we strengthen governance by building out management teams and boards with a more institutional mindset, which in turn adds value to companies. Each asset has its own value creation plan – that is how you really drive proper value and proper change over time.