When we interviewed London-based Infracapital co-founders Ed Clarke and Martin Lennon in December 2017, the pair had recently realised the firm’s maiden £908 million ($1.1 billion; €997.5 million) Infracapital Partners I fund.
What LPs should know
For an LP, navigating these processes can be a minefield. Rod James, of sister publication Secondaries Investor, offers a few pointers HERE.
The sale of Dutch telecoms firm Alticom had completed the process, but there was a tinge of sadness between the two, who compared the realisation of the fund to seeing one’s oldest child leave home for the first time.
The 2.1x capital returned to investors would have helped soothe the pain, but the point remained. However, fund managers are increasingly choosing not to say a full goodbye to their vehicles, or at least keeping them in the family in some way, shape or form. Fund continuations, rollovers and fund restructurings are increasingly part of a GP-led secondaries world that has found a new lease of life in the infrastructure market. With the relatively young asset class maturing, managers are looking beyond the traditional asset-by-asset sales process when it comes to realising funds.
In data released earlier this year by investment bank Greenhill, infrastructure formed the second-largest segment of GP-led transactions by strategy in 2018, at 17 percent.
More broadly in the secondaries world, purchases of infrastructure fund stakes grew 68 percent year-on-year to $3 billion, according to a separate report from advisory group Setter. And some 10 percent of the current Infrastructure Investor 50 – our ranking of the largest equity fundraisers over the last five years – have undertaken a fund continuation or GP-led secondaries deal.
Life at the end of the tunnel
Although such transactions are growing in frequency and scale, they are still very much in their infancy. As a result, each deal has its own idiosyncratic motivations. Still, if we were to try and sum up the underlying factor underpinning their growth, our assessment would be likely to echo that of James Wardlaw, vice-chairman of infrastructure at placement agent Campbell Lutyens, which has advised on the bulk of these deals to date.
“I think it stems from the fact that the natural life of a lot of infrastructure assets exceeds the natural life of an infrastructure fund,” he says. “There’s a natural issue of what you do with the assets when a fund comes to the end of its life. Often it’s with assets where there’s still runway left and there’s things a manager can do to add value.”
This was the case in both July and December 2017, when Dutch pension manager APG bought the whole portfolios of funds in which it was an LP from compatriot DIF Capital Partners and French manager Ardian, respectively.
“It requires a win-win-win. It’s got to work for the people that want to sell, the manager and the people that want to buy. If it doesn’t work for any of those parties, it will fall down”
The first of these deals saw it acquire the 2008-vintage DIF Infrastructure II portfolio, which was worth about €700 million and is now housed in a new 25-year vehicle. The second deal, for which it teamed up with AXA, saw the acquisition of the 2008-vintage AXA Infrastructure Fund II, raised by the Ardian team when it was still part of the French insurance group.
APG declined to comment for this piece. Its motivations, however, look obvious. After all, these were two cash-generating portfolios that APG knew well, with the Ardian portfolio delivering a 10 percent annual yield, the French manager told us at the time.
For the vendors, though, is it not better to capitalise on what’s often decried as a seller’s market and offload their assets piecemeal? “We offered the fund in parts; to acquire the euro-portfolio separately, the sterling-portfolio separately, or the whole portfolio, with or without the A63 toll road,” explains Allard Ruijs, partner at DIF Capital Partners. “There were four or five parts people could bid on. We also had institutions that could submit bids based on a certain discount-rate model devised with Campbell Lutyens.”
At Ardian, it was a little clearer which was the best way to realise the portfolio.
“Selling it altogether was a way to maximise value giving access to diversification to the buyers while also reaching buyers with lower cost of capital,” reasons managing director Marion Calcine.
On both occasions APG chose DIF and Ardian to continue managing the assets or perform advisory roles, thereby netting them fee income – albeit significantly less – from assets they know are reliable.
When Italian infrastructure fund manager F2i began raising its third vehicle in December 2017, it came up with a rather different solution to continue benefiting from the assets in its 2007-vintage maiden fund. The group merged Fund I’s remaining assets – comprised of gas distribution, airport, toll road and renewable energy companies – into its third fund. That allowed Fund III to hold a €3.1 billion first close comprised of €1.7 billion from Fund I investors and €1.4 billion from new LPs.
In a first for the asset class, F2i III thus became both a new fund and a continuation of its debut effort, which had been nearing its end. The first fund had been generating a 12.4 percent IRR and a money multiple of 1.8x when F2i pooled it with Fund III.
“The case for continuation was compelling for all parties,” says Lucien Cipollone, associate partner at Capstone Partners, which advised F2i on the process. “There were mature assets that made it easy for incoming investors to analyse performance and rapidly deploy capital. The fund was coming to the end of its life and contained assets that are the ‘crown jewels’ of Italian infrastructure. At the same time, there were opportunities to further enhance the value of the existing assets.
“We are very transparent with our LPs. They had the options on the table and were able to be part of the decision. We had different bids and we showed the LPs those bids. That’s how we go through such a process”
DIF Capital Partners
“It also suited the broad investor pool, some existing investors needing to rebalance their exposure to the asset class and some others requiring immediate liquidity. Furthermore, there were incoming investors who wanted exposure to Italian assets but couldn’t access them adequately. Finally, it was working out well for the manager to raise new blind pool capital as part of this operation.”
The F2i continuation perhaps reflects two of the most common motivations for undertaking such a move, with both the fund approaching the end of its life and the GP wanting to offer investors a liquidity option.
Despite being the common causes of deals today, neither end-of-life nor liquidity considerations were behind one of the earliest continuation vehicles. In 2012, London-based InfraRed Capital Partners raised £500 million for the InfraRed Infrastructure Yield Fund, which, like the DIF II portfolio, housed a number of PPPs and renewable energy assets.
“The assets had come through the development phase and we created a continuation fund for the remaining life of those assets, which appealed to a different type of investor with a lower cost of capital,” outlines Wardlaw.
“We felt this would give new investors something unique while creating best value for existing investors,” notes Harry Seekings, co-head of infrastructure at InfraRed.
With the prevalence of GP-led secondaries, and fund continuations increasing in popularity, the challenge remains in ensuring the original LPs are offered a fair deal and have enough time and resources to review their options.
“It requires a win-win-win,” declares Wardlaw. “It’s got to work for the people that want to sell, the manager and the people that want to buy. If it doesn’t work for any of those parties, it will fall down.”
Ruijs is equally clear that this could not have worked for DIF without such an equal outcome. “We are very transparent with our LPs,” he says. “We had different bids and we showed the LPs those bids. We discussed with them the options on the table. That’s how we go through such a process.”
However, the world of everyone being a winner is a very small one, and Cipollone points out that many attempted continuation funds will fail to get past the first hurdle.
“To justify these transactions, it’s very important to have a specific reason … It’s very important to have third-party offers, so you can show LPs you have really done what is in their best interests”
“We come across an opportunity about once a month across all private markets, but many of them do not satisfy the objectives of all stakeholders so we excuse ourselves early on,” he says. “Some are inherently imbalanced so in all likelihood will be difficult to complete. Often there is an unbalanced trade, either for the existing or incoming investor base. [F2i] suited all the stakeholders involved and was executed within a transparent and structured process.”
In the aforementioned Infracapital interview, Lennon said that not only did the fund LPA oblige Infracapital to explore a rollover, but that the firm had investigated such a prospect “very rigorously” before deciding against it.
“[Demand for infrastructure] hadn’t evolved enough to give what we felt was the appropriate value to a diverse portfolio,” he said. “Ultimately, our job was to deliver the targeted return for a defined period of time. That was our primary motivation and that’s what we did.”
So, when a ‘win-win-win’ has been achieved, how have managers and advisors carried this out?
“Existing investors could either sell completely or they could rollover and maintain their stakes,” recalls Cipollone. “There was a full menu of options for investors. The net position was there was about €300 million of redemptions.”
Seekings says that InfraRed kept something of a distance between the buyside and sellside investors, to ensure a fair outcome.
“It was a book-build process – where the market sets the transaction price – which gives investors confidence in the pricing,” he explains. “It was important for both buy and sell sides to feel confident that InfraRed was not determining the price, that they were trading at a market price.”
However, in the case of Ardian selling to one of its existing LPs, this process needed to be managed with even more sensitivity.
“To justify these transactions, it’s very important to have a specific reason to do them,” says Calcine. “It’s very important to have third-party offers, so you can show LPs you have really done what is in their best interests.”
Continuing fund continuations?
Since deals to date largely involve mid-2000s vintages, the question remains as to how replicable a model this is. Will asset-by-asset sales remain the norm, or will fund continuations see more of a role? For Wardlaw, the latter is true, although we may have to wait a little.
“In the past, I would have said this would have tailed off because the number of funds issued between 2008 and 2010 was pretty limited,” he says. Indeed, Infrastructure Investor data show the number of funds raised between 2008 and 2010 was 172. Between 2011 and 2015, however, 448 funds were raised, which gives Wardlaw confidence continuation vehicles will continue to play a significant role.
Cipollone is also confident these structures will see more exposure but sounds a note of caution. “If the fundamentals are there and it suits all the stakeholders – existing and incoming investors, as well as the GP – and there is a path to making the fund assets more valuable in the future, then there is a merit to the continuation,” he believes. “But if you’ve got a GP that’s being quite opportunistic because the assets are underperforming and/or they are not in position to raise a new blind pool fund, or they only want to crystallise some carry early, or if it’s a transaction that benefits one side to the detriment of the others – those sorts of deals are not going to be as successful.”
This warning is also echoed by Seekings, who is open to replicating the model providing the portfolios are homogeneous enough.
“For a manager, from the outside looking in, there’s a conflict there,” he says. “That has to be managed to the satisfaction of both sets of investors: that’s what we as a manager needed to do and successfully achieved.”
His point about portfolio homogeneity is particularly pertinent for today’s portfolios. The DIF and InfraRed portfolios were largely made up of PPP assets, which also featured somewhat in the Ardian and F2i portfolios. All of them carried a degree of similarity, though, which is less common in more recent funds.
“If you have a €2 billion portfolio, that may be too big,” says Ruijs. “You would need to work with so many LPs, it may be too complex a process to bring together. It would not be as homogeneous as our portfolio was – it may be more global, for example, and have many different asset types. A smaller LP universe is likely to be interested, given different investment mandates and increasing complexity.”
It’s a pertinent observation. Our H1 figures show average fund size now stands at $1.9 billion, up from $490 million in 2012. The number of funds raised is also steadily decreasing, from a high of 112 closed in 2015 to 71 last year. So, the larger portfolios Ruijs alludes to are becoming the norm, as fewer, larger funds get raised.
Those challenges needn’t be existential – but they will certainly test the nascent market’s creativity, and its limits, in the years to come.