Page 5 | Infrastructure Investor

From nascent to mainstream

2 September 2019

This article is sponsored by Antin Infrastructure Partners

Q What new sectors have you seen emerge in infrastructure over the past decade?

Mark Crosbie: A number of new sectors we have been involved in over the past 10 years have become mainstream. In the telecoms space, for example, we saw the advent of towers and fibre as infrastructure, and train stations would not have been considered infrastructure 10 years ago.

Then there are motorway service stations, crematoria and clinics. Even renewables have transformed completely over that period to become a firmly established part of the asset class.

Alain Rauscher: We do not fixate on particular sectors, but instead use the Antin Infrastructure Test to determine whether an asset provides essential services and has high barriers to entry, predictable and stable cashflows and downside protection. While we keep our minds very open, we are disciplined when it comes to the definition of infrastructure. We also look at the potential to create value. This approach allows us to think outside of the conventional boxes. We spend a lot of time encouraging our partners to be creative in their origination.

Q Have the Antin Infrastructure Test criteria stood the test of time?

MC: They have stood the test of time remarkably well and have allowed us to look at areas previously not thought of as infrastructure. It is worth highlighting that we also spend a lot of time at the investment committee focusing on disruption risk, so if we were devising the criteria today that is something we might consider adding. Disruption risk is everywhere and whether talking about decarbonisation, the digital revolution or changing consumer behaviour, we always have to consider not only if an asset meets our criteria today, but whether it will continue to do so in 20, 30 or 40 years’ time.

Q How do you view the electric car sector developing?

AR: We are taking some prudent steps in the electric car sector. I was recently driving on a baking hot day and passed a brand-new electric car with all its windows open. It was 38 degrees. The reason, I surmised, was that using the air conditioning would reduce the battery charge. The driver would have been terrified of running into a traffic jam and having to finish his journey on foot. The problem is that car batteries are big and heavy, take a long time to recharge, and can only take you a maximum of 150 miles, and this is reduced to something like 80 miles on a hot day with a little traffic. We have made a modest test investment in hydrogen-fuel cell cars through a portfolio company called Idex. That technology could allow car users to drive around 500 miles and recharge in two or three minutes, as opposed to several hours. But, as Mark says, there is a huge capex need and we are cautious to deploy capital only when we are comfortable about which technology will prevail.

Q What are the challenges associated with being a first mover in a sector?

AR: Our firm tends to think in terms of mega-trends or big societal themes that need addressing, such as the need for clean energy or mobility, rather than sectors. An enormous amount of capital is required to address these societal themes and we are in a position to provide it. But there are significant technology risks in being among the first to invest in these areas, hence the need for disciplined innovation. Take electric cars, for example, where there is some uncertainty about which technology will dominate in decades to come.

Q Talk us through the big societal themes you that expect to deliver new types of opportunity in the years ahead.

AR: I expect mobility will be a key theme. We do not break that down narrowly to cars, trains or planes. Rather, mobility is a broader discussion about the way people move around the world. Take car park operators, for instance. Some of them are facing reduced occupancy rates because of congestion and the availability of cheap alternatives to people driving their own cars, such as Uber or different forms of public transport. That means those car park operators are faced with the challenge of what to do with this surplus land. Many are working on deals with the likes of Amazon, for example, related to last-mile delivery. Even the most conventional forms of infrastructure assets are impacted by these wider societal trends.

MC: While we do see some emerging sectors, often the assets within them would not pass our Infrastructure Test today. Take electric charging. One way or another, that is going to become an important sector, but it is unclear exactly what direction it will take. Building the charging infrastructure is going to entail huge costs, not only in terms of the space to charge the car itself but also access to the grid. So, does electric charging offer stable and predictable cashflows or high barriers to entry? It may do in the future, but I do not think that is the case right now. Battery technology is not yet sufficiently developed. Another example is flexible power generation, which is still susceptible to a changing regulatory framework. We will watch those sectors with a great deal of interest, but today they are not stable enough to pass the Antin Infrastructure Test.

Q How do LPs tend to respond to new sectors?

MC: There is always an education process required and the onus is on us, as the manager, to explain why a particular asset should be considered as infrastructure and to take them through the Antin Infrastructure Test. We tend to find that by the time we come to sell, assets that initially attracted some scepticism have become entirely mainstream and many go on to be bought by core infrastructure players.

Q How do you maintain a competitive advantage in a sector once it has become mainstream?

MC: Sometimes we’re looking at a sector for four or five years before we invest. During that time, we establish relationships with a lot of potential target companies. Another infrastructure investor making the decision to move into fibre today, for example, would be a long way behind in terms of their understanding of the sector and knowledge of the key players.

And while creating alpha comes from sourcing and origination, it’s also very much about what you do with a business having acquired it. There is a very intensive asset management phase. In order to grow a business substantially, you not only have to come up with a differentiated business plan, you have to be able to deliver it. That requires expertise built up over a long time investing in people. We are not complacent about others moving into the sectors where we operate, but we’re confident we have a sustainable advantage.

Q What is the biggest lesson you have learned over the past decade that you will take with you as you prepare to tackle this massive global demand in the coming years?

AR: In one word, phronesis, an ancient Greek word meaning practical wisdom. That, for me, is what our job is all about. In an extremely fast-changing world, there are plenty of threats. We need to always be pragmatic and prudent. It’s important not to get carried away by the latest exciting technological development, but to stay focused on the big macro trends that underlie each investment.

Roadchef: Infrastructure or not?

Motorway services proved to be an attractive investment. When considering whether motorway service areas were infrastructure when it acquired Roadchef back in 2014, Antin turned to its Antin Infrastructure Test, which measures a target’s suitability in terms of the provision of essential services, stable and predictable cashflows, high barriers to entry and downside protection.

Motorway service areas are the only places to take a break on motorways in the UK and advertising off-motorway locations is not allowed. The UK network is effectively fully covered with service areas, which makes the introduction of new sites uneconomical. It is extremely difficult to get planning permission for new service areas, so barriers to entry are high. The areas have also proven remarkably resilient through multiple economic cycles, serving essential needs at a low average value per transaction. Traffic volumes have continued to grow, offering stable and predictable cashflows.

Antin also considers the potential to add value when acquiring an asset. The previous owners had underinvested in the Roadchef estate, so the company embarked on a refurbishment programme under Antin ownership and improved washrooms as well as energy and waste efficiency. Roadchef acquired the freeholds and extended the leaseholds of various sites, enabling several of the service areas to be expanded significantly. The company has also widened the commercial offering, with McDonald’s now at all sites. New brands, such as Cornish Bakery and healthy fast food chain Leon, with which Roadchef has partnered to open 12 stores over the next five years, have been added. It has opened 18 Costa Drive-Thru sites for customers in a hurry, along with nine Spar grocery locations. As a result, customer satisfaction with Roadchef has strongly improved and the firm’s Norton Canes site has been voted England’s best motorway service area.

Antin used its internal financing team to raise an infrastructure debt package, which replaced the securitised bond financing that had been in place since 1998, allowing investors to benefit from a strong dividend yield and improved terms.

“Despite a difficult environment on the high street, with a lot of headwind from everything from a rise in the minimum wage to business rates, we have been able to grow profitability substantially,” says Antin’s Mark Crosbie. “By the time we come to sell, we’ll have an asset that is in a far better shape than when we bought it, that has a stable, strong management team, and that is performing well financially. We had the investment thesis that was supported by the Antin Infrastructure Test. Now we have actually done the hard yards and completed the task we set ourselves.”

Alain Rauscher is chief executive and managing partner of Antin Infrastructure Partners and a member of both the executive and investment committees. He sits on the board of a number of Antin’s investments, including Idex

Mark Crosbie is managing partner and a member of both the executive and investment committees. He also sits on the board of a number of Antin’s investments including Kellas Midstream and Roadchef

The road less travelled

Guest Writer -

1 July 2019

0

This article is sponsored by Arcus Infrastructure Partners

Q: How is decarbonisation impacting investment opportunities in the road travel space?

Michael Allen: There has been a huge amount of investment in Europe’s road network over the past 10 years and there is a recognition that billions more is required. However, the increased focus on decarbonisation is influencing the nature of future investment.

Governments are especially focused on heavy-goods vehicles, which represent 3 percent of road use but 25 percent of CO2 emissions.

The European Union has passed legislation to reduce heavy-goods emissions by 15 percent by 2025 and by 40 percent by 2030. One of our investee companies, Brisa, represents just over half of the Portuguese motorway network. It is a member of the Transportation Decarbonisation Alliance – a French-Portuguese government initiative targeting the elimination of mobility-related emissions by 2050.

Another priority is the patchwork of different rules and regulations regarding tolling across Europe. In particular, there is a policy debate around charging heavy-goods vehicles on a per-kilometre or CO2-based pricing model.

That has the potential to create a lot of opportunities in the toll collection and road infrastructure area.

Q: What about demographic shifts and technological advances? How are they creating road infrastructure opportunities?

MA: Greater urbanisation in Europe is increasing the burden on transport infrastructure in cities. There are also questions about the transport needs of a growing elderly population and, in certain geographies, you see a younger generation that doesn’t view car ownership as desirable or necessary. All of that is impacting the infrastructure needs of the future.

In terms of technology, there is a huge amount happening. In addition to increased electric vehicle penetration and the inherent need for charging infrastructure, we believe there is a future with autonomous vehicles.

Those advances impact not only road infrastructure but ancillary infrastructure around roads, such as motorway services and car parks.

Q: What changes are you seeing in the rail industry?

Nicola Palmer: The drive to reduce emissions means the EU is directing regulation to encourage a modal shift away from roads and towards both rail and maritime. The overall performance of rail in the last 10 years has been sluggish. But that isn’t the full story.

There has been a structural decline in the transport of coal and iron ore as a result of decarbonisation. By contrast, other parts of the market, and in particular intermodal transport, have been growing quickly. Technology has an important role to play in driving that. Historically, there have been capacity constraints. But the development of the European Train Control System’s signalling systems is enabling more rail freight on to the network.

Intermodal goods are also time-sensitive and therefore need to be pulled by locomotives that are reliable, which has really benefited one of our portfolio companies, Alpha Trains. Alpha has a far younger fleet than the majority of those in Europe, having the reliability required for intermodal freight.

Overall, we are forecasting that rail will start to erode road’s modal share, particularly as European ports develop strong rail and inland waterway networks, creating real competition for road freight. Around 47 percent of goods now leave the Port of Hamburg by rail.

Q: Is maritime also benefiting from these shifts?

NP: Yes, maritime is another sub-sector that is likely to be a winner as a result of decarbonisation and changing technology, taking modal share away from road. The International Maritime Organization has adopted a climate change strategy that aims to see international shipping cut emissions by at least 50 percent by 2050. In addition, new IMO regulations requires all global shipping to use low sulphur fuel by 2020. One of the implications of the regulation will be around $15 billion of additional costs globally. But, on the positive side, it will stimulate companies to look at alternative fuels.

“The drive to reduce emissions means the EU is directing regulation to encourage a modal
shift away from roads and towards both rail and maritime”

Nicola Palmer
Arcus Infrastructure Partners

That shift towards alternative fuels is being encouraged by subsidy programmes and is likely to result in the early scrapping of dirty vessels and a complete refresh of the infrastructure around the maritime sector, particularly in Europe.

Blockchain and the internet of things, meanwhile, are also enabling traceability of goods. That allows you to reduce changeover times at intermodal facilities and improve the efficiency of both maritime and rail. In addition, we are seeing the increased automation of European ports such as Rotterdam and Hamburg. We think that will gradually spread to smaller ports and has the ability to improve efficiencies as well.

Q: How is regulation impacting the transport sector beyond emissions reduction?

NP: There are a lot of positive subsidies available. There are subsidies for intermodal terminals, for example, trying to encourage a modal shift from road to rail or sea.

Regulation is also encouraging research into new technologies such as LNG, electric hybrid vessels or hydrogen. These technologies are being tested in sea ferries and the locomotive market, and manufacturers and operators are able to access European subsidies to bring the costs of those technologies down. Many countries also have subsidies for individuals buying electric vehicles, as well as offering access to free parking or the ability to avoid congestion charges.

The rail industry, meanwhile, has really been strengthened by the Fourth Railway Package. There are two main pillars to this regulation: market liberalisation and technology, both designed to allow transport to move across Europe freely. In terms of the road sector, the EU has introduced a directive relating to toll systems. That is intended to help traffic move freely without encountering multiple tolling technologies along the way.

Q: What challenges do you associate with investment in the transport sector?

NP: We recognise that the vast majority of transport infrastructure revenues are either GDP- or volume-linked. We are one of the few investors in the market that has owned transport infrastructure through the economic cycle. What we see at the moment in the market are premium prices being paid for selected types of transport. I question whether the investors paying those prices recognise that transport assets require active asset management – particularly during downturns, but also in order to take advantage of economic growth.

Q: To what extent do opportunities vary by geography across Europe?

NP: Opportunities do vary. If you look at the rail industry, we’ve seen particular growth in Germany and Central and Eastern Europe.

Those are the markets that have seen the biggest growth in intermodal. Eighty percent of all rail transport has to pass through Germany, and so the German authorities have been very supportive about investing in infrastructure, either directly or through government-owned corporates such as Deutsche Bahn or the Port of Hamburg. This then creates ancillary infrastructure investment opportunities, for example in rolling stock.

The One Belt, One Road initiative is also an important driver, trying to encourage freight travel from China all the way through to Europe. Over the past few years, freight travel time has reduced from 45 days to 16 days, which allows it to compete head on with road and sea for high-value goods.

Q: How would you describe LP appetite for the sector and is it changing?

MA: I would say transportation has been one of the more difficult sub-sectors for LPs to get exposure to.

Transport has represented a little over 20 percent of infrastructure deals over the past three years and recently that percentage has been falling. I think LPs were initially concerned that many transport assets carried volume risk or didn’t have very long-term contracts and that they require a lot of active asset management.

Not many investors are resourced to undertake that. Most LPs have focused on regulated assets and utilities and, as a result, many are overexposed in that area. That means they are very much looking to increase their exposure to transportation. This is further underpinned by continued economic growth in Europe which means transport assets should provide good returns.

Q: How have competitive dynamics evolved?

MA: Because of the weight of investment that has gone into the regulated sector, we are now seeing a huge wall of money trying to get into the transportation space. We see fierce competition, particularly at the larger end, from GPs, pension funds, sovereign wealth funds and strategic players. There is significant competition for smaller deals too. We have seen some very high valuations paid recently, whether that’s for UK ports, airports or indeed in the road space.

However, the breadth of opportunity in the transport sector means we remain confident we can source good investment opportunities.

Q: You are continually making bets on the medium-term future of the sector. But what do you think the long-term future holds for European transport?

MA: Crystal-ball gazing is always difficult. But we are cognisant of how long-term trends will impact the investments we are making, not least because at some point we will be looking to exit some of our investments and those trends may have become more apparent. If you look at the road sector, there are clear long-term trends towards shared mobility, electric vehicles and indeed fully autonomous vehicles. That offers opportunity but also, if not properly managed, a threat.

I think most commentators believe the advent of autonomous vehicles will be a net positive for road infrastructure. Brisa, for example, has run a successful trial to collect tolls from autonomous vehicles on one of our motorways. Brisa has also launched mobility-as-a-service through a car-sharing joint venture with Drive Now. And when it comes to heavy goods, I think we will see not only automated vehicles but platooning, reducing fuel consumption significantly.

There will be implications for infrastructure but, on balance, I think these developments will create interesting opportunities for the sector.

Brexit and the transport sector: The Arcus perspective

The spectre of a no-deal Brexit is looming and is making investors pause when considering transport investments in the UK. A no-deal Brexit would negatively impact GDP.

The hope, for the industry, is that parliament prevails and that, even if a Tory Brexiteer takes control of the party leadership, this option is blocked. Even if a deal is reached, however, it is likely to impact transport flow. If the UK is not part of the customs union then we would expect to see a shift from European trade towards trade with Asia and the Americas. We would also expect to see road and sea freight costs go up because of additional customs requirements.

We will probably see freight flow from continental Europe, via the UK, to Ireland being impacted as well. Around 60 percent of Ireland’s import and export trade currently goes via the UK, either on truck or via UK ports. There will be changes, too, to the cabotage rules that allow European truck drivers to work in the UK. That will materially impact road transport costs. Around 65 percent of domestic goods currently go by road and labour represents around 40 to 50 percent of total costs. From a positive perspective, however, this will again encourage that modal shift from road to rail.

Investing for tomorrow’s needs, today

Guest Writer -

30 April 2019

0

This article is sponsored by AMP Capital.

A digital transformation has revolutionised how the world communicates and how information is accessed, processed and stored. From interfaces that allow companies to operate seamlessly around the world to connecting friends and family, technological advances have made instant interactions and content access reliably routine.

Creating, storing and accessing reports, media content and other data can be done with a click and sent worldwide in seconds. But this is revolution, not evolution. Underpinning the trillions of daily communications and masses of newly created data is a vast network of infrastructure that needs constant innovation and development.

Expansion and scope of the digital network

From the first electronically delivered message to the prototype portable telephone, the development of the communications sector has exploded over the past 50 years. There are now trillions of messages sent every day using billions of laptops and smartphones that are more powerful than NASA’s computers that put a man on the moon.

Evans: “The race to control data, often dubbed ‘the new oil’ is a key value driver”

Through these new communication methods travel quantities of data that were unimaginable just a few decades ago. Instead of recounting a story or episode using a single, vocal medium, pictures, music and videos are regularly used to communicate with friends, colleagues and the wider world. This all adds up to an ever-expanding data mountain, which is sent through a mixture of mobile and fibre networks to be hosted in the rapidly expanding cloud, powered by servers that are integral to corporate and international security.

But the growth story is not over: the advent of the Internet of Things will connect autonomous cars; people will demand more content such as 4K Netflix; and businesses will process and store more data – indeed the race to control data, often dubbed ‘the new oil’ is a key value driver for FAANGs (Facebook, Amazon, Apple, Netflix and Google) the market capitalisation of which is greater than the UK economy.

While back in the first stages of development, consumers were happy to wait for existing, analogue systems to respond, they have become less patient. Messages must now be delivered immediately, and data uploaded or accessed accurately and without delay – and, most importantly, the whole process must be secure.

The technology that supports this innovation is developing all the time and provides a wide range of investment opportunities. Fibre optic cables are replacing copper lines and new data centres are coming online to support the weight of the expanding cloud services being launched around the world. As mobile telecommunications grow alongside fixed-line networks, there is a continuing push to maximise spectrum efficiency whilst building and repurposing masts and towers to transmit increasing volumes of radio waves.

‘The four Vs of big data’

An explosion in data demand is the fundamental driving force behind growth across the telecommunications sector – this phenomenon is summarised by the ‘four Vs of big data’.

Volume: The ability to process and store the huge amounts of data that are being created at a previously unseen speed. The 24 exabytes – or 24 quintillion bytes – of monthly data traffic around the world in 2019 is set to more than double by 2021.

Variety: Some 90 percent of data is unstructured, which means it is made up of personal photos, audio and video clips that cannot be filed and archived in a methodical fashion like a database. Despite this, users demand the ability to access the files they want quickly, putting pressure on the effectiveness and efficiency of those hosting it.

Velocity: Latest estimates show more than 70 hours of video is uploaded to YouTube each and every minute. With users refusing to wait for attention, acceptance of buffering and dropping connections is a thing of the past. Users expect networks to be instantaneous and reliable.

Veracity: The most important thing for users is that they trust the data they are accessing. One in three business leaders in the US do not do so, and more than $3.1 trillion is lost in the country each year to decisions made on poor data. Not only does data have to be available, accessible and quick, it must be accurate too.

The basis for development in a burgeoning sector

In addition to rapidly growing demands on digital networks, emerging themes are creating sectoral shifts.

For instance, analogue radio transmission revolutionised communications over the last century, but the spectrum over which radio is transmitted is finite. Trying to match ever-growing mobile data demand with available spectrum has resulted in record prices paid across Europe by operators. We are seeing governments repurposing spectrum to maximise capacity, whilst supporting the growth of fixed-line networks (fibre is essentially unlimited) which increasingly connect homes, businesses and towers.

We are seeing enterprises the world over increasingly outsourcing their IT infrastructure, with rapidly increasing demand for co-location data centres and fully integrated cloud services including Infrastructure as a Service (IaaS). Outsourcing can be cheaper, more scalable and push highly critical work to independent expert providers. But this revolution again needs network investment to build and connect the data centres that power our businesses and deliver the media content we demand.

The amount of data we send, compute and store is rising exponentially – whether it be streaming 4K Netflix at home, autonomous cars and other IoT devices communicating or searching email archives on Office365 at work. To maximise network efficiency, much more infrastructure needs to be deployed at the edge of the network – right where we use it. This means greater fibre deployment (FTTx) and more small-scale ‘edge’ datacentres.

Small cell networks and the advent of 5G will have a significant part to play in delivering this too. But this will take time due to the cost mobile operators face in rolling out new equipment (and the fibre that connects it) against a backdrop of stagnating revenues and no clear path to increase them sustainably with a 5G offering.

These themes are the corners of a framework that are essential when considering where the sector is set to expand next. While a company or venture does not have to provide solutions to all these themes to be considered for investment, it must at least acknowledge their direction of travel as the sector gains momentum.

We are not yet at the end point of the transition out of our analogue history. We believe the world is between a third and half of the way through its conversion to a digital network. As even more of the processes that affect our daily lives begin to move online, the need for data centres, fibre connections and reliable connectivity will only increase.

Not only corporations of all sizes, but government and regulators are increasingly dependent on digital outreach to stay up-to-date with the public they serve.

Case study: Turning dark into light

A new joint venture between an AMP Capital portfolio company and Spain’s national gas network is set to deliver additional fibre connectivity to the Spanish market

In 2016, AMP Capital acquired Spanish telecoms infrastructure business Axión with a plan to grow and evolve its business. At the time of the acquisition, Axión’s primary focus was media broadcasting, but managers envisaged how it could be developed to have a broader emphasis on telecommunications, keeping pace with society’s growing demand for data connectivity.

Through a partnership with Spain’s gas network owner and operator Enagás, Axión, led by AMP Capital, created Axent – a new fibre business.

By bringing the capabilities and assets of these two companies together, Axent can utilise 4,600km of optical fibre owned by Enagás and more than 300 radio links operated by Axión.

Axent holds around 5 percent of the dark fibre currently available in Spain.

The integration of fibre and radio technologies is an advantage for customers, including mobile operators, content and so-called Over-The-Top service providers, who are increasingly demanding efficiency, greater capacity, flexibility and durability. Infrastructure providers are expected to offer robust and competitively priced solutions, which Axent’s scale and diversified networks can supply.

Communications infrastructure businesses need to keep moving to keep up with demand, both for increased capacity and speed, and quality of service.

As the joint venture primarily makes use of existing fibre networks that were originally laid by Enagás for its own needs, something many utilities companies have done historically, Axent expects to be more efficient and cost-effective than if it were to put in place new fibre and related infrastructure as it expands with further connections. It plans to roll out a further 1,000km of fibre to broaden its network reach, enhance connectivity and develop redundancy (back-up). Eventually, Axent hopes to connect 25 Spanish cities using both fibre and radio networks.
By marrying the two companies’ experience – Axión as an operator of wireless telecommunications infrastructures and Enagás’s technical knowledge related to fibre deployment and maintenance – the joint venture has been able to innovate and capitalise on where the technological revolution is heading next.

Turning today’s tech into growth

Regeneration of old technology is a key theme in communications and data infrastructure. The mantra of ‘reuse and recycle’ is applicable to the apparatus these sectors rely on to function, and it enables the owners of these assets to tap into future growth.

By establishing where and how the communications and data sector is set to move next, we can look at existing infrastructure and work out how it can be used in the future, while keeping it operational today. While there has been a sensational lunge towards new technology in the previous couple of decades, it has not yet taken over completely. Traditional forms of communication still have a part to play and, at least for the time being, the world does not rely entirely on the cloud for storage.

For example, some international governments still rely on an analogue broadcasting system through which they can communicate with the public in the case of an emergency. While there is little development needed to maintain that service, by taking control of the assets that provide it and updating them, an investor can be ready for when the next step in the journey is taken.

“Opportunities to update and innovate lie everywhere … it is the expertise of investors and managers to develop and shape the future that is key”

Data centres, too, rather than continuing to grow in number, will need to start boosting their capacity to process and store information more quickly and securely. Upgrading assets while maintaining current service is a key aspect of infrastructure investing.

Opportunities to update and innovate lie everywhere, and while there is no lack of capital to fund and facilitate transformations of existing assets, it is the expertise of investors and managers to develop and shape the future that is key – and increasingly scarce.

Innovation and expert knowledge of the sector is crucial to coming up with new, practical ideas that can transform an existing structure into something fit for the digital age. Adapting something to a new environment unleashes its potential, while enabling it to continue to carry out its original function.

In looking at infrastructure assets this way, it is clear they do not have to behave like bonds or other fixed-income instruments. The returns on fixed-income securities rely on something that has already been created and pay out regardless of any improvement to the underlying company – this is not the aim of transforming existing infrastructure assets.

In classing infrastructure as a bond-like asset, an investor risks being unable to create upside to a project but is susceptible to any downside slip that is out of their hands. Disruption, as we have seen, can come when a sector least expects it, leaving assets that have no ability for flex and change becoming rapidly outdated.

When this happens, any perceived predictable and dependable income stream could dry up and the asset rapidly fall in value.

Instead, infrastructure investments can be managed like growth assets to be improved and reconfigured towards changes and advancements in society.

The mammoth investment in communications infrastructure to meet the needs of tomorrow will also depend on new and emerging business models. For example, mobile operators may not be best placed for the huge capital investment required for 5G (and whatever succeeds it in the future) – especially as they consider record levels of leverage. We expect to see new business models and partnerships to invest in the likes of spectrum, communications equipment and infrastructure – with expert investors offering deep sector knowledge and strong relationships best placed to benefit from these shifts.

A great capacity to build

Guest Writer -

30 April 2019

0

This article is sponsored by DIF.

Q: What is driving demand for digital infrastructure?

WJ: The key driver behind escalating demand for digital infrastructure – be that fibre, towers or data centres – is changing consumer behaviour.

We are all doing much more on our smartphones and data volumes are exploding – growth rates average typically 60 percent per annum – which is driving the growth of storage in data centres. Traditional copper networks are struggling to keep up and will require replacement. The rollout of 5G will only intensify those trends.

Q: What areas of the market are most attractive?

WJ: The digital space is one of the most active and interesting parts of the infrastructure landscape. At DIF, we focus on the smaller and mid-cap end of the market and are investing through our DIF Core Infrastructure Fund. We are not looking at very large or trophy assets.

We target regional data centres and fibre networks where we can buy up smaller projects, build them out via expansions and build a large-scale portfolio through add-on acquisitions. The digital infrastructure market offers great contracted infrastructure projects that offer stable cashflows but also significant upside potential.

Q: Does the investment proposition differ from region to region?

WJ: It is very much a local market. A fibre network in Germany will be completely different to a fibre network in France, the UK or US. You really need to look at local circumstances, local demographics, local levels of business activity and local levels of infrastructure – if there is any. Our broad network of local teams is a major differentiator in this approach.

Q: Which regions offer the best opportunities?

WJ: Fibre markets offer great opportunities, although some European markets are already quite well built out. The Benelux and Nordic regions, for example, are competitive and fibre penetration is high. Other countries, such as the UK, France, Germany and Italy, are still a fair way behind. Parts of southern and eastern Europe also offer attractive investment opportunities, as does the US.

Europe is behind the US when it comes to data centres. There is still a lot of capacity to be built, both in the hyper-scale segment and the more regional segment.

“If platform companies are well built out, refinanced and de-risked from a contractual perspective, there is a high degree of appetite, especially from the large global investors’’

Q: How are competitive dynamics and are they changing?

WJ: Digital is probably the most dynamic and fast-changing infrastructure sector. The strategic players are very active at the larger end of the market. We see a lot of the big American data centre players being very active, as well as the big tower companies in both Europe and the US.

An increasing number of infrastructure funds are also looking at this sector but, particularly in the greenfield segment, there are still many interesting projects to be done. Valuations on the greenfield side are pretty healthy, while at the plain vanilla brownfield end of the spectrum pricing is getting rich.

At DIF we always look at opportunities in terms of what we can do with an investment, once we have done a deal. Get that strategy right and the returns can be very attractive, while downside cases are protected through contractual structures.

Q: Do you primarily back greenfield opportunities?

WJ: We invest both in greenfield and brownfield. Especially in fibre we look at many pure greenfield opportunities. In other areas we will look to find a good nucleus and then build those out. Across all sectors, our strategy is to start small and build scale through acquisitions and greenfield rollout. That way, once we bring a portfolio or company to a certain size, we can sell it to larger investors at attractive valuations and realise a premium for creating an enhanced portfolio. In this way, with limited risk we can deliver value-add returns.

Q: What is that exit environment like right now?

WJ: If platform companies are well built out, refinanced and de-risked from a contractual perspective, there is a high degree of appetite, especially from the large global investors. The market is very active and good quality investments are in high demand.

Q: How do deal structures differ in the digital space to other areas of infrastructure?

WJ: Digital infrastructure tends to have far less project finance than other areas such as PPPs or renewables, with the possible exception of French telecoms.

With the smaller scale investments in data centres and fibre that we look at, you see more acquisition finance or real estate-style financing structures, particularly in early-stage projects. You want that flexible financing at that point in a company’s development.

When the portfolios have been built out you can refinance with a more traditional structure to obtain more attractive financing terms and increase the returns.

Increased risk should result in an increased return, but we come across transactions where we struggle to understand how other parties are separating the services from the infrastructure and how they are valuing those components.

Q: How much of a challenge is technology risk? How do you mitigate it?

WJ: In digital infrastructure, it can be complicated to differentiate the services and technology component from the pure infrastructure component of a deal. A lot of other funds are moving increasingly into telecoms services and, in our view, that means taking on more technology risk and more business risk.

Beauty is in the eye of the beholder, but at DIF we are pretty conservative. We like to focus on the asset-heavy, lower tech risk deals, and on pure infrastructure with good contracts and decent counterparties. With the deals we have done, the technology risk is with the contracted counterparty and not with the project.

France, once lagging in respect of fibre penetration, will be one of the leading fibre countries in the world in five years. Regulatory intervention, particularly in rural areas, is critical and France has set up a very healthy model which some other countries could do well to follow.

Q: What about policy risk? Isn’t digital infrastructure highly reliant on governments and regulators?

WJ: Regulators have always played an important role in digital infrastructure. The way the French regulators have created the rural broadband concessions and tendered those out has led to a massive round of investment in French rural broadband that is unlikely to have happened without regulatory involvement.

We also see in other countries commercial developments happening without any government support, but it always requires efficient permitting procedures in order to make it all happen. This is, happily, largely clear on most local governments’ agendas.

Q: How would you describe underlying LP appetite for this sector?

WJ: LPs generally like digital infrastructure. The returns are usually good and there are positive benefits for society in terms of keeping up economic growth, job creation, and also energy efficiency gains, which are all viewed very positively. At the same time LPs are also cautious, while it is a new sector that not everybody fully understands yet, and every infrastructure fund has its own approach.

Where we approach the sector more through contracted projects, others may take more development and technology risk. In order to further mitigate market risks we mix digital infrastructure in a broader fund strategy that also targets the energy and transportation sectors. I think investors appreciate this diversification.

Q: What does the future hold for digital infrastructure and the role of infrastructure funds?

WJ: Digital infrastructure will continue to be a very high growth area in Europe and North America. There is still a lot of catching up investment to be done compared with, for example, Japan or South Korea. But it is important to remember that the pace of change in the telecoms industry is far higher than in other infrastructure segments. It is vital to have specialist knowledge inside the deal teams and to be working with the right operators.

You need to understand these assets well or deals could go wrong. Through its network of local offices and specialist knowledge, DIF is well placed to source the right opportunities in underserved telecom infrastructure markets and enhance these during its ownership.

Bridging the digital divide

Guest Writer -

29 April 2019

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This article was sponsored by Cube Infrastructure Managers.

Q: What are the origins of the Connecting Europe Broadband Fund?

IG: The genesis of the Connecting Europe Broadband Fund (CEBF) was the European Commission’s vision of eradicating the digital divide that affects rural and semi-densely populated areas throughout the European Union. This is not the first time that the Commission, along with some of the other public institutions that are part of our investor base, has attempted to tackle this problem. But, this time, it has taken a different approach. The governance of CEBF is akin to any private equity vehicle and we are bringing private investors on board as LPs.

HP: CEBF has been created to foster the emergence of alternative open-access networks sponsored by local entrepreneurs. Traditional telcos have their role to play in deploying fibre networks, but they are usually reluctant to open their networks to competitors.

As a consequence, we usually see overbuild in dense areas and no network in rural areas. A shared network is the answer. Such an initiative can become an attractive platform for investors to finance the deployment of new fibre networks to provide third-party access services to all interested telcos.

Q: What makes fibre rollout such an exciting investment proposition for these private investors?

HP: We are trying to promote the concept of an independent open-access network. That means the operators, our portfolio companies, will own the network, but their subscribers won’t be the end users. Those will be the telecoms operators such as Deutsche Telekom, Vodafone and Orange. These telcos will buy access from our network and then sell it to their retail customers.

IG: That is exciting because this is very much an untapped market. In many European countries, there is still a huge amount of progress required in fibre rollout, in general. On top of that, we are not looking at downtown Paris, for example; we are looking at rural and semi-dense areas. The first players who come to market with a fibre network in these regions will be creating a virtual monopoly. No-one is going to waste money building a redundant second network.

The financial model is very simple: telcos that want access can either lease our space or build their own network. Leasing is always going to be cheaper. This is why European fibre rollout is an exciting proposition for investors.

Q: Are other infrastructure funds or independent network operators looking to access this opportunity as well?

IG: Rolling out broadband networks in rural areas requires a detailed understanding of technological advancement and is not cheap. The J-curve can be very steep. No traditional infrastructure fund is going to be interested in getting involved right at the start as early-stage permitting requires the support of local public authorities.

Usually, a traditional infra fund cannot wait that long for a network to start throwing off cash. Independent network operators such as Gigaclear or Deutsche Glasfaser are going to concentrate on the more densely populated areas, where it is less expensive to deploy a network.

With so much still to do, particularly in a country like Germany, for them that is always going to make sense.

Q: How does CEBF fit with the existing Cube strategy, which also encompasses telecoms ?

HP: Cube Infrastructure Fund II, our brownfield infrastructure fund, invests in brownfield transport, energy and telecoms, while CEBF is investing in early-stage greenfield broadband projects.

CEBF gets involved at the beginning and aims to bring a project to the point where a brownfield fund can come in to grow it to the next stage. CEBF’s investments are managed by an investment team led by Izzet which is 100 percent dedicated to CEBF. As a result, CEBF and Cube II are able to address all parts of the European telecom fibre market.

Q: What are the biggest challenges you face in this market?

HP: The biggest challenge is identifying teams which have the necessary experience. We are really looking for teams that have already managed to raise early-stage capital in order to create a proof of concept.

We frequently get requests from what I euphemistically call “two persons and
a book”.

The concept might look great but if no technology has been put in the ground, it becomes almost a pre-seed venture capital play. That is far too risky and not what we are looking for.

If you look at our recent investment in Croatia, the team already had a proof of concept. They had done it before. While it is an early-stage investment, that made us a lot more comfortable.

Q: You have had private investors come on board alongside your public cornerstones. How would you describe LP appetite for this sector?

IG: The level of appetite has pleasantly surprised us, given that this is all so new. For most investors in infrastructure, telecoms is all about one thing – towers. Over the past 10 or 15 years, the incumbents that owned those towers have realised that it is more cost-effective for someone else to take ownership and lease that space.

What we do is explain to investors that that same paradigm shift is now taking place with the open-access fibre networks we are putting together.

We can point to the success stories of Gigaclear and CityFibre, for example, which are not only accessing private equity, but also the debt markets, as banks get increasingly familiar.

This sector is still in its infancy but by making that comparison with towers, more and more investors are able to get comfortable with the concept.

Q: What does the future hold for this part of the digital infrastructure landscape?

IG: When it comes to telecoms, I always believe you need to look to Asia-Pacific for what comes next. Take 5G in Europe. Operators still need to spend millions – or billions – to build networks. And then they need to provision the networks, so people sign up.

We are many years away from having a fully fledged 5G industry. Go to Asia-Pacific and it’s already up and running. A country like Singapore provides us with a model of how open-access networks can work. We believe those networks are the future and that is why, with CEBF, we are trying to get there – as soon as possible.

Geographies across Europe differ in the maturity of their fibre broadband networks and the way their governments are approaching the digital divide.

HP: Every country has its own national broadband plan, targeting a specific percentage of the population that will have access to high-speed broadband by a certain date. Each country has also approached tackling these targets differently.

In France, the government has taken a concession-driven approach. It has divided the country into areas where there may be private sector appetite, providing there is a concession in place which gives a de facto monopoly for a number of decades; areas where there is very little interest and subsidies may be required; and then areas – towns and cities, for example – where the government believes competition will do its job.

Germany, meanwhile, is a free-for-all. And in Italy, where there is a large digital divide, the government has taken a highly interventionist approach. State entity Cassa Depositi e Prestiti – one of our LPs and a shareholder in both Telecom Italia and Italian network company Open Fiber – has been tasked with doing everything within its power to tackle this divide.

There are other countries still – in the Baltics, for example – which are already well-fibred and where there is very little required at all.

Hydro’s role in Europe’s energy transition

Guest Writer -

1 April 2019

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This story is sponsored by Aquila Capital

Solar power, both photovoltaic and solar thermal, and wind farms, both onshore or offshore, are mainstays in the discussion of renewable energies. Both are profiting hugely from recent advances in technology that have made them more efficient as well as cheaper. However, investors need to look beyond the headlines and remember that there are much older renewable technologies that will play at least as great a role in the energy transition.

Hydroelectric power has been used for more than a century in Europe – since 1878, in fact, when William Armstrong used it to power a single arc lamp. Larger-scale hydroelectricity started 100 years ago in Norway, which still derives more than 95 percent of its energy from this source. This technology is not only tried and tested, but will play a pivotal role in the future of power generation.

For many people, the term hydroelectricity still conjures images of huge reservoirs and large-scale projects, as epitomised by China’s Three Gorges Dam. However, besides such stored or single-reservoir plants, there are two other forms of hydropower generation: pumped-storage and run-of-river. The latter allows the construction of many smaller-scale, decentralised plants. Although this type of power depends on a river’s flow and is thus susceptible to seasonal changes, it minimises the impact on both the environment and nearby communities. Run-of-river generation is also much less volatile than solar or wind power. Seasons and even average amounts of rainfall are more predictable in the long run than the local weather. And there is very little correlation between, on the one hand, the seasons and rainfall levels and, on the other, the output from run-of-river power plants.

Pumped-storage hydroelectricity uses two reservoirs to profit from price fluctuations on the electricity market. In times of low demand or high production, when power is cheap, water is pumped into the higher reservoir. During times of peak demand the water flows back down through the turbines, generating power that is then sold at peak prices.

COMPLEMENTARY REMEDY
All three types of hydroelectricity have attractive risk-return profiles. Although large-scale projects demand a relatively high initial expenditure, their low operating costs and longevity make them competitive sources of renewable energy, especially over the long term.

However, storage and pumped-storage hydroelectric plants will play an even more crucial role in the transition than just as additional sources of energy. They are the perfect complement for intermittent renewable sources such as solar or wind power. A simple look at an average day in a first-world, service-driven economy makes this obvious. Although wind may blow, or not blow, at any time and the sun delivers most of its energy around midday, demand for electricity surges in the morning, when people get up, switch on their lights, and use transport to get to school or work. Demand then peaks in the evenings, when commuters use transport to return home, electric lights replace daylight, dinners are cooked, and televisions and other electrical devices are switched on.

This means there will be times when demand far exceeds the availability of solar and wind power, as well as times when these volatile sources of energy generate more electricity than is needed. This discrepancy needs to be urgently addressed. Excess energy during peak production has to be stored, and excess demand during calm nights and windless, cloudy days somehow has to be met.

For Aquila Capital, this is where stored hydro comes into the picture. It still is the most cost-efficient method of storing large amounts of energy. Conventional and pumped-storage hydro plants are thus poised to become the central balancing element in a renewable energy mix, because they provide one huge advantage: control.

Hydroelectric power is also one of the most flexible sources of energy. The output of both storage and pumped hydroelectric plants can be varied rapidly to meet changing demands. As long as there is enough water in the reservoir, power generation can be turned up within minutes if necessary. Pumped-storage plants can absorb large amounts of excess electricity, thereby reducing the stress on electricity grids and preventing energy from being wasted. They are therefore the ideal complement not only to high-output, high-volatility renewables such as wind and solar, but also to short-term storage methods such as batteries. These are faster – with reaction times in the milliseconds – and thus perfect for balancing sudden peaks in consumption or production.

Notwithstanding the fall over recent years in the cost of producing batteries, their material cost and shorter lifespans will make them more expensive than amortised hydro plants. This means it will not be viable to store large amounts of power in batteries. The ideal solution will again comprise a combination of technologies: batteries to balance short-term surges and hydro to store energy for long stretches.

NEW REVENUE STREAMS
For investors, hydroelectric power offers new revenue models. In total, we can identify four potential revenue streams: standby services, grid balancing services, capacity revenues and energy revenues. The last of these is the most traditional: hydropower will still be fed into existing power grids at market price. The other three derive from the load-shifting capabilities of storage and pumped-storage hydro.

In modern energy markets, however, output is not the only important figure. Investors should also consider the crucial capture rate. This describes the relationship between the average market price of energy in a given timeframe and the revenue actually achieved by an energy supplier. For example, a traditional baseload supply – such as that provided by coal or nuclear plants, which feeds a constant amount of energy into the grid throughout the day – will be paid more during peak demand and less during other periods.

Assuming its energy output has continually been below total demand, its capture rate will be exactly 100 percent. Run-of-river plants usually achieve a capture rate of about 95-99 percent. Solar plants currently range slightly above 100 percent, but are expected to see deteriorating capture rates as a lot more solar enters the grid. Wind power is dependent on the whims of the weather and is usually unable to achieve 100 percent. In markets where there is a large amount of wind energy capacity being built out, deteriorating capture rates are also expected. The infamous California ‘duck curve’ is a good example. Although solar and wind energy output are highest during the middle of the day, energy demand is usually at its lowest, making huge energy storage capacity indispensable. By contrast, storage and pumped hydro can retain energy for substantial amounts of time and release it specifically during peak price periods.

According to projections from Thema Consulting Group, hydroelectric plans will be able to achieve capture rates of up to 125 percent and therefore profit immensely from market fluctuations. Projecting a future in which societies will be largely dependent upon renewable energy, a portfolio that combined solar, wind and hydropower would be able to sustainably reach and at times exceed a 100 percent capture rate.

During times of peak production and low demand, there is also a need to balance the grid and prevent power surges. Of course, one way to prevent the grid from exceeding its capacity is to take some energy generators offline. This is the current modus operandi for many wind power stations in Germany, where grid infrastructure has not caught up with the maximum output of renewable energy during stormy days (and nights, when demand is low). This is more difficult with solar plants and, even where it works, is a waste of energy. Grid balancing will thus become an important service in the near future, and one that service pumped or storage hydro plants will be able to perform efficiently and at competitive prices.

HIGH ENERGY
Power-purchase agreements are a comparably recent revenue stream to which hydro is ideally suited. Energy-intensive companies, such as those active in the digital economy, are already willing to pay not only for the energy generated and delivered but also for capacity. These companies depend on reliable energy supplies, without surges or scarcity to deliver their services. PPAs guarantee that a certain amount of energy will be available at a moment’s notice whenever needed. In the case of hydro, this means water stored in reservoirs. If cloudy and calm weather prevents solar and wind plants from producing sufficient energy, PPA customers will be able to fall back on stored hydroelectric power.

GET CONNECTED
Hydro, like any other kind of renewable, is dependent on suitable locations. Run-of-river plants need fast-flowing rivers, preferably with rapids or waterfalls. Conventional dams need large river valleys and have a significant environmental impact, while pumped-storage plants need both large geographical height and ready water supplies.

A sustainable future for European renewable energy will therefore require interconnections between local and national power grids in order to combine different sources in different locations and thereby offer reliable electricity supplies to all customers. The fewer interconnectors a country has, the greater storage capacity it will need. Governments are still struggling to meet the demand for flexible, decentralised and crossborder energy grids. Scandinavia and the Iberian peninsula are trailblazers in this regard, and are connecting more and more with the rest of the continent.

Yet this process is much slower than the transition to renewable energy production. And even if Europe were connected in one large grid, storage capacity will always be needed in a renewable energy future. Investors should aim to have a balanced energy portfolio that is diversified accordingly: with solar and wind power stations to reap peak production, in combination with batteries for short-term and hydropower for long-term balancing.
In the future, our energy supplies will be diverse and complementary. Long-term, sustainable investments in the sector should be so too.

Tech companies ‘boost demand for renewables’

Guest Writer -

28 November 2018

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This article is sponsored by Starwood Energy Group and first appeared in Infrastructure Investor’s North America Report.

Q: How have falling energy prices affected investment opportunities for infrastructure investors in North America?

HS: The shale gas revolution has created a great deal of disruption over the past 10 years. I remember the take-private transaction of TXU in 2007, the largest deal in the industry’s history. The sponsors were forecasting gas prices of between $6 and $8 for the foreseeable future. Now, the forward price is in the $2 to $3 range. That is a phenomenal shift and a reflection of all the technological evolutions in the oil and gas space, whether that’s fracking, or even newer technologies being implemented to increase the efficiency of existing wells.

With gas prices low, and expected to remain low, the profitability of power generation assets has changed. We have around 1,000GW of installed power generation in the US. A little over half of that is coal and nuclear. Before the shale gas revolution, these assets were highly profitable. But with the price of gas so low, there has been a shift on the marginal unit – effectively the last asset that has to run to meet the power demand at any point in the grid. That marginal unit has, generally speaking, become natural gas, so gas is now setting the price of power. In most markets in the US, that price of power is now in the $20 to $30 per megawatt-hour range.

At those prices, coal and nuclear plants are often no longer profitable and we are continuing to see economic retirement of nuclear and coal assets. This decarbonisation is not being driven by politics or regulatory issues. It is basic economics. The old technologies for generating power are no longer the technologies of the future. Coal and nuclear plants are being retired and gas-fired plants and renewables are being built in their place.

Q: But the energy sector is still facing decreased demand. What does that mean for the future?

HS: Over the past 10 years, there has been a big increase in the efficiency with which energy is used. That has led to flat or even decreased demand, despite population growth and despite strong economic growth. We are doing more with less energy.

Flat demand does create significant challenges for some assets, but I think that the demand pattern is set to change. Look at all the data centres being built as tech companies like Facebook try to keep pace with demand. These data centres are massive users of energy. Also consider the amount of energy it would take to mine bitcoins, if projected growth ever becomes a reality.

Electric vehicles are another piece of the puzzle. There are forecasts that envisage hundreds of billions of dollars of infrastructure being built to support electric vehicles going forward.

Q: Given these macro trends, where is Starwood placing its bets?

HS: We focus on two key verticals: greenfield and brownfield. We look at building greenfield gas-fired power plants; renewable assets including wind, solar and biomass; transmission assets; midstream assets; battery generation and battery storage assets. We tend to get involved during the mid- to late-stages of development when it is not necessarily about deploying a lot of development capital but of adding value during critical phases of the development lifecycle. We have relationships with all the OEMs, with financing counterparties; we know how to negotiate a construction contract and how to find a long-term customer for the capacity and energy we are selling.

Every asset we develop has pre-identified customers, whether it is a state, utility, city or a corporate that is willing to give us a long-term contract. It is a really important risk management tool for us.

So, essentially, we do a lot of cooking to produce high quality infrastructure assets Decarbonisation is not being driven by politics or regulatory issues. It is basic economics and that cooking is how we create value for our investors. We have built six wind farms now, with combined capacity of more than 1.2GW. We have built large solar photovoltaic projects in Ontario and the largest biomass project in the country down in Florida.

We have developed two large transmission projects, Neptune and Hudson, and are now developing our third, the Ten West Link, connecting Arizona and California.

The other half of the business is buying existing assets with an eye towards adding value by making those assets run better, upgrading the capacity on the gas turbines or connecting the gas power plants to better pipelines. It is all about adding value. A lot of us are engineers by training and love getting involved with the assets.

Q: You acquired a portfolio of coal assets from Ares last year. How does that brownfield deal fit in with the decarbonisation trends you were describing?

HS: We don’t generally invest in coal, but this was a unique opportunity to buy a portfolio of four contracted assets – it was more about the contracts than about the coal. In time, these plants will be replaced with gas-fired plants or with battery storage assets.

Any time we are investing in an operating asset we are thinking about what we can do with it. We are selectively buying, selectively building and selectively switching between different technology types as windows of opportunity open and close.

Q: You are a mid-market player in an industry dominated by mega funds. How does that affect the way you operate?

HS: There are firms out there raising $20 billion funds right now and we see a lot of competition for deals involving equity cheques of between $500 million and $1 billion. These mega funds are far less likely to pursue single asset opportunities – a wind farm in Ohio, for example, that is still three years from commercialisation.

Mid-market deals, which I would describe as those involving equity cheques of between $50 million and perhaps $400 million at the top end, attract a lot less competition and can ultimately be more profitable.

Q: How do you see the renewables industry evolving within the broader energy sector over the next decade?

HS: The renewables industry is here to stay. I read a report recently that said there is around 90GW of installed wind in the US, which is around 9 per cent of installed generation capacity. Most of that has been built over the past 10 years. I would expect that to grow by the same amount, if not more, over the next 10 years.

People ask whether renewables would have done so well without subsidies. Look at what is happening in Alberta, where they don’t have subsidies, or in Mexico. Wind is being priced in the high teens and low twenties. It is clear that wind can be competitive on an unsubsidised basis.

The other interesting point here is that demand for renewables is being driven by customers. Amazon, Google, Yahoo, Microsoft, Facebook – these tech companies are some of the largest buyers of renewable energy in recent history. They are not buying because they are obligated to. They are making an economic decision to buy this energy based on the ability to lock in favourable pricing and the ability to be sustainable.

Facebook wants every new data centre it launches to be 100 per cent powered by renewables. That is what its users demand.

And it’s not just tech companies. Numerous non-tech names such as General Motors, Johnson & Johnson, Procter & Gamble – these businesses are looking, in many cases, to be 100 per cent green in their procurement.

This huge buyer pressure means that renewable assets will continue to be built even if subsidies expire.

Q: Nonetheless, regulatory and political risk is prevalent in the energy sector. How do you manage that risk?

HS: We do consider regulatory risk carefully. In many cases we will try and pass on some of that change of law risk to our customers, in our contracts, or manage it through insurance products. But the regulatory environment in the US is really, very stable. In other markets, such as Spain, where subsidies were given and then withdrawn, that hurt a lot of investors. We haven’t seen that in the US. That is why the US is one of the most constructive regulatory markets for operating assets in the world.

The US infra landscape is shifting for foreign investors

Guest Writer -

24 September 2018

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On August 13, 2018, President Trump signed the Foreign Investment Risk Review Modernization Act into law as part of the National Defense Authorization Act of 2019.

FIRRMA strengthens and modernises the process by which the Committee on Foreign Investment in the US reviews foreign investment in the country’s businesses to assess the impacts of such investments on US national security. While many key provisions of FIRRMA remain subject to clarifications and further refinement in regulations, the legislation broadly expands the authority and resources of CFIUS and is poised to have outsized impacts on deal timing, certainty, feasibility and costs across diverse sectors, including, especially, infrastructure.

Background
Established in 1975, CFIUS is an interagency regulatory body of the US government authorised to review “control” transactions involving a foreign person and any business engaged in the interstate commerce of the US in order to assess the impact of such transactions on the national security of the country.

CFIUS has long interpreted control very broadly, such that a foreign investor’s possession of a single board seat typically confers control even if the position does not enable the investor to “out-vote” other representatives or otherwise control, in a traditional sense, the decisions of the board.

Over the past several years, members of Congress and other US government policy and political stakeholders have raised alarms that CFIUS did not have sufficient legal tools and financial resources to address new and different national security risks arising from, among other things, complex co-invest and other transaction structures and minority, non-controlling investments in US companies.

In parallel, the scope of CFIUS’s national security analysis has become increasingly far-reaching. CFIUS has raised questions about industry sectors and transactions that historically have not been considered to have national security implications, and several high-profile public transactions have been blocked, abandoned, or delayed due to CFIUS concerns.

In November 2017, a bipartisan group of members of congress proposed new legislation to address perceived inadequacies in CFIUS’s ability to tackle foreign investment risks. Following seven public hearings on the CFIUS process and several turns of draft legislation, the final text of FIRRMA was agreed in late July, and subsequently included in the NDAA for President Trump’s signature. Most provisions of the Act have delayed applicability, pending the adoption of new regulations.

We discuss below three key impacts that FIRRMA will have on infrastructure investment and offer related takeaways.

1. FIRRMA makes many minority infrastructure investments by foreign investors newly subject to CFIUS’s jurisdiction.

CFIUS’s legal jurisdiction has historically been limited to transactions that result in a foreign person acquiring “control” of a US business. FIRRMA shifts CFIUS’s jurisdictional focus to make “critical infrastructure” investments that are “non-passive” reviewable by CFIUS, lowering the threshold of rights or influence that a foreign investor could possess without triggering CFIUS’s jurisdiction. Indicia of non-passivity include, but are not limited to, board observer rights and certain information rights, and can attach to an investment of any size.

Importantly, “critical infrastructure” is broadly construed: the term may include many US companies operating in the energy, transportation, communications, utilities, and water and wastewater systems sectors. And, the target company in question may be positioned at any point in the value chain as an owner, operator, manufacturer, supplier, or service provider to critical infrastructure.

In practice, CFIUS has been keenly interested in formally reviewing a wide variety of infrastructure investments (e.g. oil and gas pipelines, data centres, water treatment plants, telecom assets, power grid assets, mining companies) given the potentially sweeping adverse impacts that sabotage or disruption of such assets could have.

Following the implementation of FIRRMA’s regulations, the advisability or necessity of notifying CFIUS will be a question for most, if not all, foreign investments in US infrastructure, regardless of the size of a foreign investor’s equity check.

2. FIRRMA authorises CFIUS to review “greenfield” transactions involving the purchase of vacant real estate.

FIRRMA provides that the purchase, lease, or concession by or to a foreign person of real estate in close proximity to US military or other installations or facilities that are sensitive for national security reasons will be subject to CFIUS’s jurisdiction.

In assessing whether such a transaction will be subject to its jurisdiction, CFIUS will look at the extent to which the transaction could expose “national security activities” conducted at the site in question as well as whether the foreign investor could gather information on any activities at the site (i.e. not only those activities relating to national security).

The inclusion of greenfield investments in CFIUS’s jurisdiction follows concerns that its member agencies did not have a streamlined and consistent process to evaluate the potential national security risks of an asset’s proximity to sensitive sites.

As the Trump administration has advocated for greenfield foreign investments in US infrastructure as a key component of its domestic economic policy package, the expansion of CFIUS’s jurisdiction relating to real estate will make it highly relevant for foreign investors considering new US infrastructure opportunities.

Foreign investors considering new infrastructure projects should undertake a rigorous “co-location” assessment of the land to be used for the project to determine its proximity to potentially sensitive sites. Because the most sensitive US government sites are not widely known, early assistance from experienced CFIUS counsel is critical to ensure appropriate identification and mitigation of potential risks.

3. Certain infrastructure investments will trigger mandatory notifications to CFIUS.

The CFIUS review process has historically been initiated voluntarily by parties to a transaction, absent an agency request to file on a non-notified transaction. FIRRMA makes certain infrastructure investments subject to mandatory notification requirements. Specifically, FIRRMA will require transaction parties to submit “light” notifications (“declarations”) of transactions that will result in the acquisition of a “substantial interest” in US “critical infrastructure” companies by a foreign person in which a foreign government holds a “substantial interest.”

Declarations must be submitted at least 30 days in advance of the closing of a transaction, which may effectively prevent transaction parties from structuring their deal as a simultaneous sign-and-close if regulations do not permit parties to file a declaration without a signed agreement.

The requirement to file declarations remains subject to important clarifications in FIRRMA’s implementing regulations, including with respect to potential exemptions for investors from US allies. However, it may have an outsized impact on public pension funds, sovereign wealth funds, and other investment vehicles affiliated – formally or informally – with foreign governments.

Mandatory notification requirements will affect both the competitive positions of foreign investors subject to the requirements as well as timing and certainty considerations for sellers. All other things being equal, investors required to submit declarations for infrastructure investments may be at a comparative disadvantage in competitive contexts. Sellers will likewise need to ensure their due diligence appropriately surfaces potential declaration requirements early in the deal process.

Planning for the future
While the ultimate impacts of FIRRMA will not be clear until after regulations are implemented, investors and companies should ensure that CFIUS considerations are considered in the early stages of transaction planning.

Private equity sponsors must assess how capital raised in the near term could be subject to FIRRMA’s provisions upon deployment. Moreover, sellers should carefully evaluate the relevance of CFIUS to potential exits, including how FIRRMA may affect the universe of suitable and realistic buyers for a company.

Kirkland & Ellis partner Mario Mancuso leads the firm’s International Trade & National Security (ITNS) practice. Mario is a former US under secretary of commerce for industry and security and senior Defense Department official, and the author of A Dealmaker’s Guide to CFIUS. He regularly represents companies, private equity sponsors and financial institutions on CFIUS and other international risk matters.

H. Boyd Greene is a partner in Kirkland’s ITNS practice, concentrating on government contracts, grants and co-operative agreements with defence, intelligence, and civilian agencies. Boyd regularly represents clients before the Defense Security Service on matters involving facility security clearances, including in connection with concurrent CFIUS-DSS reviews.

Luci Hague is an associate in Kirkland’s ITNS practice. Luci counsels US and foreign clients on CFIUS and international risk matters across transaction scenarios, including fundraising, M&A, lending transactions, and minority investments.

Mirova: Contributing to Europe’s energy transition

Guest Writer -

29 May 2018

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Energy transition report

Beyond renewables

Power to the corporates

Roundtable: Inflection point

Wrong policy, right time?

It’s all in the service agreement

The importance of pro-active management

Q: How has Mirova’s strategy evolved in recent years with regards to energy transition and renewables?

RL: Our strategy has remained consistent over the years. We have continued to invest mostly in greenfield assets and mature technologies – primarily onshore wind and solar PV – alongside our partners, which include developers and utilities. That has remained unchanged.

We believe in the alignment of interest between ourselves and our partners, and we want to contribute to the energy transition by investing in new capacity as opposed to monetising existing operating assets.

So, from that standpoint, the core of our strategy has remained constant. Obviously, we’ve had to adjust to the evolution of the market, moving away from mostly feed-in-tariff schemes in a lot of countries to more market-driven opportunities with the emergence of private PPAs. That has been the case in Spain and Portugal, where we closed our latest deals, but also in France, where you now have to go through an aggregator with whom you need to sign an aggregation contract.

Q: You tend to focus roughly half of your funds on France. Where are the best opportunities in France for managers like yourselves?

RL: France has very ambitious targets in onshore wind and solar. Last year, we had a record year with more than 1.5GW of new wind capacity installed. It remains an atomised market, however, with a lot of small- to medium-sized projects. It’s not like Sweden or Spain, where you have very large wind farms.

In France, we are constrained by our environment. The population is scattered so we have to build small- to medium-sized projects, which present pretty good opportunities for regional developers who continue to be active and seek financial partners.

We have also seen very interesting opportunities in the solar sector associated with storage – an area we are exploring with one of our partners in Corsica, for example.

Then there is the emergence of biogas plants, where we have also made investments alongside one of our developer partners. France aims to increase the penetration of green gas on the grid, and that creates a very interesting opportunity. Overall, the renewables market remains very dynamic, with the advantage of benefiting from very satisfactory tariff mechanisms, such as 20-year contracts on both solar and wind. CfD’s [contract for difference], which have replaced FiTs, are fairly stable and predictable, which, combined with the planned growth of installed capacity, makes it a very attractive market.

“From a risk standpoint, it’s much better to have assets that are profitable at market prices without subsidies”

Q: In January, you closed a subsidy-free deal in Spain, acquiring nine wind farms. Do you welcome the end of subsidies in Europe and how does this affect your strategy?

RL: I believe, from a risk standpoint, it’s much better to have assets that are profitable at market prices without subsidies. It means the technology is mature and is now in a position to continue to grow. On the other hand, market-driven schemes also generate more complexity in the deal structuring. For us, being a very specialised fund in renewables with a dedicated team of experts, that should create a hedge.

I would say the more complex the transaction becomes, the more favorable it is for us because we can leverage our expertise and know-how. For example, structuring PPAs is a complex process. There are long discussions, and it is fairly technical, so it means being able to understand the electricity market well and the risks involved. But we are well positioned to do that.

Q: You talked about the newer sectors you’ve entered recently. Do you see yourselves ever expanding into something like offshore wind?

RL: We’ve decided not to expand into offshore wind because, first of all, it involves large transactions. For those, it would make sense to have bigger funds to deliver larger tickets. But we have decided to remain in the mid-market and invest in small-ticket deals – that’s where we can create more value. If you look at the latest offshore transactions, there is a lot of liquidity in that market and the returns are already quite tense, while the risk is higher. In my view, the risk should be more rewarding than it is in offshore wind.

But what we have been looking at for a few years now and continue to look at, is storage. We think there are good opportunities given the reduction in cost and improved battery performance. We’re also very interested in looking at electrical vehicle charging infrastructure, but only to a certain extent, because the models are not completely project finance-like. We intend to try to understand this market and we are in contact with most stakeholders to help create bankable structures, so that the enormous capital required for its development is addressable by private investors.

“If you look at the latest offshore transactions, there is a lot of liquidity in that market and the returns are already quite tense, while the risk is higher”

Q: Is the electrical mobility sector ripe for infrastructure investors like yourselves? Are there opportunities that you’ve identified?

RL: Yes, we’ve identified a few. We are working on specific projects but they’re confidential, so I cannot go into details. But they are models in which you have a captive fleet and, say, a private industrial player that gives you some capacity payments. That means you’re not fully exposed to obsolescence risk or traffic risk, which are two key risks that we consider difficult to ‘swallow’ today, given the pace of the deployment of electrical vehicles as well as the evolution of the technology.

Q: Fund managers haven’t really entered the space. Do you expect this to change?

RL: I think the opportunity is huge because of the capital required to meet European or country objectives. Technology is catching up, and the anticipated car shift is important, so we really believe there is great potential. There is a strong willingness amongst municipalities to accelerate deployment of electrical vehicles because of pollution issues.

We have been in discussion with various players – municipalities, utilities, international bodies and other stakeholders – for a year now, and a lot of companies are thinking about the kind of business model they can deploy. We’re seeing the first projects coming out with a decent risk profile for a long-term investor like us.

Q: What about storage – do you expect to invest in that market in the foreseeable future?

RL: In recent years, storage has become more and more competitive. We remain sceptical about making investments in storage capacity that need long-term cashflow to be paid back where you have short-term contracts in front of you. If you are exposed to that, we’re afraid that the capacity you build today is going to be left competing against the capacity built tomorrow. We clearly see the curve of a big improvement in cost and therefore if you’re not secured with long-term cashflow, you are outdated and then your capacity isn’t well-placed in the merit order.

Q: Are there any European markets, in terms of sectors and geographies, that you would consider relatively untapped?

RL: Untapped? No, not really. But there are markets that are booming and that we think are interesting. For example, Spain and Portugal are really back on and we’re very happy to have done the first new generation wind park in Spain, because it gives us an opportunity to understand the market early and to be prepared for the next transactions.

There are also opportunities in the Nordics, which have these ambitious growth targets in renewables. The economics in the Nordics have been difficult because of the low electricity and green certificate prices. But, there is a rebound, so maybe it’s the right time to secure long-term contracts and make a decent return.

This story is sponsored by Mirova.

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