Exiting in the age of iTunes

Whether you favour wholesale realisations or piecemeal sales, Fund I vintages are showing the merits of diversification, why being first matters and how everybody makes mistakes.

It’s a common complaint among music aficionados: in the ‘good old days’, the album – with all the craftsmanship and conceptualising that came with it – was king. These days, short attention-span consumers couldn’t care less about it, they just want to download the singles.

There was a whiff of that complaint in Martin Lennon’s recent comments on the realisation of Infracapital’s debut fund, which raised £908 million ($1.2 billion; €1 billion) in 2005 and was fully exited this year, generating a 2.1 times return on capital and an 11.4 percent IRR:

“When you’ve got a genuinely diversified portfolio and people start to analyse the assets individually, they can forget the portfolio value. A great lesson learnt was that it’s best to take those assets to [investors] that will want them, rather than trying to give them a portfolio that, if they don’t value that diversification, is not going to realise the best outcome.”

Call it exiting in the age of iTunes, if you will, but what Lennon discovered when he embarked on his LPA-mandated investigation on the feasibility of a portfolio continuation option was not dissimilar to what many a musician before him has found – that buyers these days are only looking for the bits that interest them, in spite of the care spent building a whole that’s larger than the sum of its parts.

Of course, a cynic might argue that, in this overheated market, you’d be crazy not to shop around asset by asset, but that doesn’t tell the whole story. The fact is, wholesale exits, or ‘rollovers’, or whatever you want to call them, can work well too. Just ask DIF, which in the summer sold its 2008-vintage Fund II’s portfolio, comprising 48 PPPs and renewable assets across Europe and the UK, to APG Asset Management, beating its 10 percent net IRR target as a result.

That doesn’t negate Lennon’s point, though, which is that, in Infracapital’s case, asset-by-asset exits ended up valuing Fund I’s portfolio diversification better than a wholesale realisation. More importantly, his comments highlight how crucial diversification – that old chestnut – actually is.

One reason for that, evident in many a Fund I vintage, is that everyone makes mistakes.

Infracapital got caught up in the Spanish retroactive renewables subsidy cuts debacle, as did Antin, another European fund manager well on its way to a successful Fund I exit, with the latter generating a 25 percent gross IRR and 2.6 times gross money multiple as of September. Even the mighty Global Infrastructure Partners was tripped up by its first fund’s investment in UK waste management company Biffa, derailed by the global financial crisis and low barriers to entry, though that vehicle is still beating its gross IRR target of 15-20 percent.

Compare that with the slightly panicky announcement put out earlier this month by UK-listed John Laing Infrastructure Fund, which said it would seek around £733 million in compensation if the opposition Labour party were to gain power and proceed with plans to nationalise all existing PFI contracts. That’s unsurprising, considering that £852 million of its £1.2 billion portfolio is made up of such assets.

So, not putting all your eggs in one basket definitely works, but putting some of your eggs in forward-looking baskets can work a treat too. Smart meters are fairly mainstream investments these days, but they weren’t when Infracapital bought smart-metering firm Calvin Capital in 2007. Being in early paid out handsomely when it sold the firm to KKR in late 2016, generating a 3.8 times cash-on-cash multiple. Antin can tell a similar story about telecoms exit FPS Towers, which it carved out from Bouygues in 2012.

Still, no amount of diversification will save you if you build a portfolio made up of duds. As the music industry learnt a long time ago, the surest way to keep your customers coming back, is to pack in the hits.