“A rising tide lifts all boats”. It was a phrase that became something of a cliché during the pre-Crisis private equity boom, and was frequently used in a disparaging context: namely, that certain private equity funds were able to look good only because of buoyant market conditions.
Because of this negative connotation, it was somewhat alarming to see the “rising tide” reference being used in the infrastructure section of Partners Group’s latest “Navigator” report, which assesses the current state of private markets. Here, the context was valuations and drew attention to the lofty prices being paid for core infrastructure assets.
The report claimed that high valuations were sometimes being underpinned by “optimistic” assumptions about growth and regulatory support. It gave two examples: the A$7 billion (€5.0 billion; $6.5 billion) paid for Australian road network Queensland Motorways at a valuation of approximately 27 times EBITDA; and the purchase of Fortum’s Finnish electricity networks at 17 times EBITDA and representing an 80 percent premium to the regulator’s valuation of the asset.
Interestingly, the report challenges an oft-used counter-argument which relates to relative out-performance versus exceptionally low government bond yields. It is frequently said that if high valuations of core assets mean accepting returns of 8 percent or less, then so be it: relatively speaking, this is still a decent number. But the report contends that returns at that level “do not adequately compensate investors for inherent business, regulatory or macro risks”.
It goes on to point out the follies of seeing core infrastructure as a straightforward fixed-income substitute. In fact, significant differentiating factors need to be taken into account such as the need for active management, the requirement to address specific asset risks, plus the possibility of real rates reverting to mean levels and of adverse regulatory changes.
The report says that infrastructure managers currently have an estimated $100 billion of dry powder, which represents an “all-time high”. Amazingly, 80 percent of this capital is targeted at core markets in the US and Europe.
For Partners Group, future success in infrastructure investment depends on “having the flexibility to assess infrastructure opportunities globally”. It has to be said this is an argument that suits the firm, as it is keen to point to its recent investments in the likes of Japanese solar and Mexican natural gas – investments which are, to borrow from its own wording, “away from crowded waters”.
Of course, if investing in ‘lower-profile’ infrastructure markets were easy, there would be more people doing it – and the gap in allocations between Europe/US and the rest would narrow. But in many places – for all sorts of reasons – we know that it’s extremely difficult.
There has to come a point, however, at which projected returns fall to the point where persisting with the same strategy becomes hard to justify. The Partners report prompts consideration of whether that point has been reached – and, if so, whether some strategic realignments will follow.