Careful who you exit to

Much is made of restrictions to foreign investment. Little, however, is heard about what happens when exits to certain types of investors create odd bedfellows.

If you’re following CK Infrastructure’s $9.8 billion bid for APA Group – Australia’s largest natural gas pipeline company – you will have noticed a familiar refrain: heavyweight Asian investor plonks down a large cheque for a critical infrastructure asset; a Greek chorus of pundits speculates about the likelihood of said bid making it through the various Australian watchdogs; local capital sources marshal together to try to provide a counter-bid – or at least be ready for the potential fallout.

That, or at least a similar pattern, is what you can reasonably expect will unfold in many OECD countries going forward each time a critical infrastructure asset finds itself in the crosshairs of a certain type of foreign investor. And by certain type, we mean sources of capital that are perceived to be – or are – directly controlled by foreign states, especially foreign states with which OECD countries are not aligned.

While CKI, one of the biggest overseas infrastructure investors in Australia, would argue it does not fall under that category, it has not escaped unscathed Down Under. We are of course referring to its 2016 bid for New South Wales electricity distributor Ausgrid, alongside China’s State Grid Corporation, which was knocked back by FIRB due to what treasurer Scott Morrison cited as “national security concerns” (IFM Investors and AustralianSuper snapped up the asset on the rebound).

What’s much less talked about is what happens when exits pair those cash-rich, state-backed sources of capital with partners that were, perhaps, not expecting to find themselves in that situation. In that respect, you could feel the anticipation in the market earlier this year when IFM Investors mooted the sale of a 20 percent stake in Germany’s 50Hertz to China State Grid, before fellow shareholder Elia ended up using its pre-emption rights to snap up the stake.

But late last year, for example, Brookfield sold its stake in Transelec, Chile’s biggest pure-play power transmission company, to China’s Southern Power Grid, another state-owned enterprise. That deal has received all the necessary regulatory approvals, which means the asset’s other shareholders – British Columbia Investment Management Corporation, Canada Pension Plan Investment Board and PSP Investments – now find themselves teamed with a very different type of investor.

In our just-published keynote, Scott Lawrence, CPPIB’s new head of infrastructure, had this to say: “We’re seeing that more traditional funds need to recycle capital and exit, which creates question marks and concerns, not only by investor bases but management teams and regulators”. Lawrence, however, subsequently stressed he was confident that CPPIB’s long-term investment horizon and willingness to deploy follow-up capital made the pension a good partner for all stakeholders.

When confronted with the same scenario, though, another long-term investor implied it now spends more time thinking about who its best partners are. The implication being that future partnerships will at least be partly dependent on how – and to whom – past partners exited in previous deals.

Alignment of interests is, of course, at the heart of these concerns, with both investors and managers wanting to make sure they couple with kindred spirits. When it comes to state-backed capital, that’s not always the case.

“Alignment is everything in a partnership,” Michael Harrington, a Mexico-based partner for Actis, told us previously, commenting on the suitability of partnering with Chinese SOEs in Latin America. “We will build up a business, get it to a certain scale and exit in five to seven years. I don’t think SOEs are buying to exit in five to seven years. They’re buying for the next hundred.”

In addition, state-backed capital often has lower return targets, sometimes being able to eschew immediate returns altogether for the sake of other, ‘strategic’ interests. All of which has the potential to leave a bad taste in the mouth of a newly minted private partner.

If you’re in the position of putting someone in that situation, our advice would be to think carefully about whom you exit to.