Australia’s asset recycling produces ‘compelling’ results, but also poses risks

Now the initiative has ended, with most of the available assets in private hands, Daniel Kemp looks at the risks of taking such large businesses private.

The tragic collapse of the Morandi Bridge, in Genoa, Italy, this month, prompted a swathe of negative headlines centering around the private owners of a crucial piece of infrastructure. The causes of the collapse will take some time to determine, but one thing is clear: the incident highlighted some of the sensitivities around private ownership of critical assets.

The economic realities in many countries, though, mean private capital is necessary to fund the construction and maintenance of infrastructure. This is something the Australian federal government took on board several years ago, launching its Asset Recycling Initiative (ARI).

The biggest assets in New South Wales and Victoria have all now been privatised through this programme, as Marsh & McLennan Companies points out in a recent report titled Infrastructure Asset Recycling: Insights for Governments and Investors. The consultancy has been involved in some capacity in most of the major privatisations in Australia under the ARI and has taken stock of the lessons learnt.

In particular, MMC highlights three main risks for investors when participating in privatisations: ensuring the risk/reward balance is right; securing a successful transition of the business’s people and culture when taking it private; and factoring in potential regulatory risks.

How can investors deal with these risks? And what lessons do they provide for future privatisations?

Getting the balance right
One of the primary risks for investors that MMC identified was the need to get the risk/reward allocation right, particularly from an insurance point of view, as privatised assets generally do not have the same access to government indemnifications as publicly owned ones.

“The [governments] would try to pass on all liabilities – everything from pollution liabilities to directors’ and officers’ liabilities, and even workers’ compensation liabilities, which we weren’t really even sure was legal,” says Anthony Butcher, infrastructure practice leader at Marsh and a contributor to the MMC report. “We had to educate our clients, many of them international investors, as to the framework in Australia, and that you can’t just turn around to an insurance marketplace and say you’re taking on all these past liabilities.”
This meant there was sometimes negotiation required with state governments over what risks private investors should have to absorb, meaning that one of the main lessons from the process was knowing when to push back.

QIC was involved in the Port of Melbourne privatisation, leading a consortium alongside Future Fund, Global Infrastructure Partners and OMERS to operate the port on a 50-year lease. Ross Israel, QIC’s global head of infrastructure, says that Australian governments have tended not to want to retain too many liabilities and so ask buyers to price that.

“The Australian model has evolved to be very clear in terms of the risks that are being transferred and the risks that are inherent in the business,” he says. “You assess them and price them – and some of those risks that are specifically undetachable from the government’s ownership have typically been retained [by it], because the government takes the view that they want to maximise value.”

Brett Himbury, chief executive of IFM Investors, echoes this. IFM participated in the privatisation of New South Wales electricity distribution business Ausgrid, securing 50.4 percent of the enterprise on a 99-year lease, as part of a joint A$16.2 billion bid with AustralianSuper.

“The risks were all clearly understood when we went into the due-diligence process,” he says. “We were ultimately comfortable with the risk-return trade-off, clearly.”

Focusing on people
The second major risk identified by MCC is managing people and culture through privatisation. There are two main priorities: getting the organisation structure and executive team right; and developing a reward structure for employees that is more appropriate to a private-sector business.

“In government ownership, businesses have different objectives from private [businesses] with shareholders,” Israel says. He says there have “always” been objectives that receive lesser importance once an enterprise becomes privately owned.

Himbury says IFM looks to balance the need to move quickly when making changes alongside the necessity of doing it in a “sensible, empathetic and commercial manner”.

“You need to ensure that there are the [required] strategic and cultural disciplines in the new enterprise, and that there will be sustained earnings growth. It’s about balancing the long-term perspective with being empathetic to all of the stakeholders’ needs – which includes us as investors, but also the staff and the users of the asset,” he says.

On reward structure, Israel says the government has more constraints around how it can incentivise staff. “We focused a lot on reframing job descriptions and looking at an adjusted remuneration structure which might review short-term and long-term incentives,” he says.

Israel says there were “a lot of moving pieces” in the first 12 to 18 months following privatisation of the Port of Brisbane, which QIC carried out in 2010 as part of a consortium alongside Global Infrastructure Partners and IFM Investors.

“In the main, we probably kept a higher level of resource and augmented it with some further competencies, more at the senior-executive level than in the bowels of the business,” he says. “If some matters are going quickly you can’t compromise on the people side, so you’ve got to match your resource to the workflow and if that workflow’s accelerating then you live with it.”

Prepare for regulatory change

The third privatisation risk for investors comes in the form of understanding and negotiating the potential regulatory pitfalls associated with each asset. This is particularly topical now, with Australian energy policy in an uncertain position.

IFM Investors is aware of this risk, particularly when it comes to a business like Ausgrid.

“In some of our assets, like the regulated electricity assets, the federal energy policy continues to concern us,” Himbury says, highlighting the need for investors to monitor what is happening and react accordingly.

Israel says that QIC and its partners sought to engage heavily with the users of its port assets, building a better relationship that can help alleviate any potential concerns around sensitive issues such as pricing. He also points out that regulators are increasingly looking at industry structures – worth bearing in mind for investors who are looking to acquire complementary assets in sectors they already operate in (just look at the competition concerns that CKI’s bid for APA Group is facing, as well as the ACCC’s review of Transurban’s bid for WestConnex).

The lesson here is relatively simple – investors must devote more effort to understanding the potential regulatory pitfalls and be prepared to deal with them if they arise after privatisation is complete.

Lessons for the future
In Australia, most of the major assets in New South Wales and Victoria have gone through the privatisation process, with the Victoria land titles business currently subject to a bidding process.

But the other states, notably Western Australia and Queensland, are still holding out.
Himbury argues it is “virtually an imperative” for Queensland and WA to find alternative sources of funding for infrastructure and that asset recycling may eventually form a part of that, despite the current political realities.

“Both of those governments had an anti-privatisation agenda as part of their election narrative – I respect that politically as there are clearly cases where privatisation hasn’t been good for users,” he says. “But I continue to want to engage with those governments to reinforce that there are very different forms of privatisation. When pension funds own these assets, we look after them in a very different way from many other forms of private-sector capital,” he argues.

Adrian Dwyer, chief executive of Infrastructure Partnerships Australia, is forthright: “This stuff is easy to say, but hard to do. Resource states like WA and Queensland and other countries would be wise to read the NSW and Victorian playbook on asset recycling. The results are so compelling, and the opportunities are too big to ignore.”

Beyond Australia, there has been talk of other countries following the antipodean example and launching their own recycling initiatives – most notably the US.

“The need over there is just so huge,” Himbury says. “The policy prioritisation [by the Trump Adminsitration] of infrastructure is encouraging. We’re pragmatic about the focus on the midterms, but we’re confident that after that, there’s a strong likelihood there’ll be some action.”

He does add one caveat, though: it’s imperative that the first few privatisations are executed well.

“We hope the first case studies are really good ones, where the voters and users of the assets see it as a very good thing rather than being in any way concerned about it. If we do the first few well, it’s very likely those case studies will be looked at and emulated. But if that is not the case, and egregious private-sector capital gets in and upsets the users, it will put us back decades.”

Investors have obviously viewed Australia’s Asset Recycling Initiative as a positive policy. And, largely, so has the public, particularly as new infrastructure is announced and built Down Under.

Applying the lessons from the ARI will help ensure private capital is seen as a positive influence on infrastructure and society as a whole – as well as securing strong returns for investors.