DIF on the opportunities in the North American mid-market

This article is sponsored by DIF Capital Partners

DIF Capital Partners, the Netherlands-headquartered infrastructure manager, has had a presence in North America since 2012, currently led by Marko Kremer, partner. Vincent Liu, managing director, has been focused on the firm’s energy/renewable energy and energy transition investments in North America. Last year the firm recruited Kanan Joshi as head of digital infrastructure North America and to establish a New York office.

Liu and Joshi characterise DIF’s approach as “generalist diversified fund with sector specialities”, including digital, energy transition, transportation and social infrastrucutre, across the global mid-market. They discuss the opportunities and challenges in the North American market, particularly in energy transition and digital infrastructure.

Kanan Joshi

How do you define the mid-market and what makes it attractive?

Kanan Joshi: DIF has two distinct strategies; the traditional DIF funds employ our core and build-to-core infrastructure strategy, while the CIF funds employ our core-plus strategy. The traditional DIF funds typically invest between $100 million and $400 million in transaction equity size and in the CIF funds the equity investment is in the range of $50 million to $200 million. Platform transactions, however, would typically grow over time, which offers co-investment opportunities for our investors.

Vincent Liu: We don’t intend to compete with the large-cap funds; that is not our strategy. We see the mid-market as the segment that offers opportunities with superior risk-adjusted returns for our investors. Smaller deal sizes allow us to build a more diversified portfolio for our investors and can be acquired at relatively attractive valuations that we grow into larger companies with our funding. Instead of the eight to 10 deals that are typical for the large-cap funds, the CIF funds aim to have a portfolio of around 15 investments, while the traditional DIF funds target 20-25 investments per fund. Both funds are comprised of many more underlying investments.

Vincent Liu

How do you source deals?

VL: One of our key differentiators is our large local office network with boots on the ground which allows us to leverage our global expertise in infrastructure locally. Our local knowledge and deep relationships enable us to source unique deals.

Our investment executives and operating partners/advisers have spent their entire careers in these local markets, building relationships across our target industries at the C-suite level. This ensures a more bilateral, proprietary deal pipeline for our funds.

KJ: Given our mid-market focus, we are often engaging with management teams where DIF is providing growth capital. Our target companies are typically founder-owned and we work closely with the teams to support them in formulating and achieving strategic goals, to help establish their growth plans and to help setting up an organisation that can scale, while at the same time implement institutional quality systems, audits and board reporting in our companies. A great example is our CIF II investment in Joink, a US fibre platform company, where we apply the full suite of value enhancement levers including add-ons, attracting financing and strengthening the organisation.

What are the dynamics in the North American renewables market?

VL: We are passionate about decarbonising the way we live, play and work. Investing in renewables and the transition to a clean, sustainable economy is the most urgent matter for humanity. The infrastructure funds we manage are making such investments as a priority and the decarbonisation push from governments and corporates has created a pipeline of opportunities for infrastructure investors.

We see energy transition as a three-tier cascade. Firstly, decarbonising the grid through renewable energy production, and increasing grid resiliency by investing in supporting infrastructure such as transmission and storage. Secondly, improving energy efficiency and reducing industrial and residential energy consumption.

Finally, the electrification of transportation and investing in requisite charging infrastructure that would allow this transition to take place. The Inflation Reduction Act passed by the US federal government is historic in this regard, providing America with tools needed to retain its leadership position in the renewable energy sector for years to come. It also has practical impacts, providing tax incentives that will make solar and wind much more competitive. For example, our investment in BluEarth Renewables is perfectly positioned to reap the benefits of this Act.

How will inflation affect renewable power generation?

VL: It is more expensive to build and operate renewable projects today. In particular, solar panels are much more expensive, especially with the sanctions the US has placed on Chinese solar panel manufacturers. The Inflation Reduction Act could help offset some pricing pressure as it supports local production.

The wind development pipeline remains robust, yet demand for tier-one turbines has given manufacturers more pricing power. We’re seeing a flight to quality from investors and lenders, a move towards quality projects that don’t have supply-chain risk.

Fortunately, we are also seeing a willingness from corporates and utilities to revise power prices upwards. We have been in several conversations where off-takers were willing to increase their power prices to accommodate for higher costs of construction and operations.

Where do those second and third tiers – energy efficiency and transportation – come in?

VL: A good example of our investment in energy efficiency is our acquisition of Bernhard last year. The company offers energy-as-a-service solutions by installing high-efficiency HVAC solutions in large university campuses and hospitals. It significantly reduces customer carbon emissions and energy use while removing the customer’s burden of large upfront capex requirements.

For transportation, we see the electrification of vehicles and EV charging as a huge opportunity set. North America is a few years behind Europe, but we have reached a crucial inflection point with increased demand and changing regulations.

Charging networks must become more widespread and we are actively evaluating opportunities in the space: we look for true ‘critical infrastructure’ investments protected by contracts with credible counterparties, in particular in the B2B segment.

It sounds like there are plenty of opportunities in the energy transition space. What is the outlook for digital infrastructure?

KJ: We continue to be focused on fibre. Data growth continues to drive opportunities globally, especially with the increasing digitalisation of areas such as healthcare and education. There is huge disparity even within the developed countries in terms of broadband speeds and access to technologies.

So, there is still plenty of white space within digital infra offering many investment opportunities. For example, there are 140 million single-family homes in the US and as of 2021, the US had 45-50 million fibre-to-the-home (FTTH) passings or homes that have access to fibre; the number of FTTH passings is expected to reach 100 million homes by 2030.

VL: Data centres are another good example. We were an early mover, buying seven ‘mission critical’ data centres in North America and amassing a very attractive portfolio for CIF I.

KJ: We are in the process of putting together a new data centre platform. Our initial investment strategy has been in the form of triple-net leases – where we own the building but customers themselves manage the day-to-day operations. Today, we see more significant opportunities in owning and operating data centres and executing a
multi-tenant strategy ourselves.

What other opportunities do you see in digital?

KJ: The technology space that digital infrastructure supports is constantly evolving and there are new investment areas that emerge constantly. We recently invested in Airtower Networks, which is an in-building wireless connectivity provider for office, residential and commercial buildings.

Cellular connectivity in high-rise and large buildings is often very poor and Airtower builds cellular and other networks for a roster of blue chip customers.

This is a good example of backing a company with a strong management team with a track record where we are its first significant institutional investor funding capex for growth. In the US we have identified 10-plus cities that have massive potential for in-building connectivity solutions, and expect a high-growth trajectory for Airtower in these markets.

VL: Demand for data in North America is growing exponentially as digitalisation, smart city technology and the Internet of Things take hold. There is actually a sort of arms race right now between several large IT companies all offering their own smart ecosystems. With significant data collection, analytics and AI research, it means you are going to need more data infrastructure, and this gives us an opportunity to be owners of critical infrastructure.

KJ: I think we will see a lot of new digital applications emerging as the Internet of Things grows. But ultimately, they will continue to use the infrastructure we are creating now. These are long-lived assets that will be around not just for the next five years, but the next decades.

Which renewables sectors you are most interested in? And where does gas fit in the energy transition?

VL: We are focused on solar and onshore wind generation. For solar we are interested in developing utility scale projects and distributed generation. We focus on contracted opportunities with long-term power purchase agreements from high-quality customers.

However, as a natural evolution we also look beyond traditional renewable energy. For example, we are increasingly pursuing opportunities within the ‘energy-as-a-service’ segment, where companies help improve energy efficiency through long-dated concession style contracts. Energy storage, EV-charging and e-fuels are also a part of our strategy.

As for gas, the energy transition will require responsible investors to continue to invest in this sector. We have been involved in the 900MW Cascade Power project in Alberta, for example, where we are using gas to decommission coal from the Alberta grid. There is definitely still a role for gas as a transition fuel given its dispatchable characteristic and an increasing requirement by ISOs for grid resiliency. We would selectively consider such invstments in case of a clear decarbonisation angle.