We often hear industry colleagues complaining about the headaches caused by the relentless returns compression. Alongside those complaints, “taking more greenfield risk” is a buzz-phrase we hear more and more. But is greenfield risk, like medicine, just a pill investors can decide to take to cure low-IRR syndrome?
The Asper team has worked on value-add greenfield energy investments for more than 12 years. We can look back at more than 10 different investment theses and reflect on how they unfolded over time and across cycles. One thing we almost never saw succeeding was partnering with developers at a very early stage. Teams of brilliant people with great ideas can far too easily end up crashing on the unforgiving rocks of execution. Even when successful, these ventures take too long to ignite value creation and sustain it over time. For investors in the energy transition, time is just too precious.
The opposite approach doesn’t work either: mature, large-scale developers rarely need a value-adding financial partner. They have the resources and knowledge to mobilise cheaper capital from banks, financial markets or even directly from large institutions. The investment scale they offer, and their reassuring track record, may be attractive to active managers, but we’ve seen most attempts to work with them fail on the grounds of risk, pricing or governance rights.
In our experience, an approach somewhere in between has often yielded the best results. This involves backing developers that are proven but not yet mature and providing them with the capital, strategic guidance and execution resources to accelerate the growth of their businesses and asset portfolios to industrial scale. We call this approach ‘infrastructure growth equity’, because it combines many features of classic growth equity together with typical elements of infrastructure investing.
Growth equity is a well-established subset of private equity that sits between venture capital and large buyouts. At its core is the idea of backing businesses that are still relatively young, but have gone through the venture stage. This allows investors to capture the upside from ‘roll-out’ growth, without the risks inherent in bringing a new product or technology to market. In short, it targets businesses at an important inflection point in their journey, when they need capital to scale an already proven product or business model. As intuition suggests and benchmarks from Cambridge Associates show, this strategy can offer investors a particularly attractive risk-return profile.
What is ‘infra growth equity’?
The analogies between growth equity and the success stories of the infrastructure development teams we have backed run deep.
For example, as in growth equity investments, these businesses are still owned by their original founders, their teams being unused to institutional funding. Instead, they value working with an active financial partner that can not only provide them with funding, but also roll up its sleeves, speak their language and help them run and expand their business.
Importantly, however, the teams already had experience of fully developing – and in most cases also building – projects of meaningful scale. They understood what it takes to execute, had developed a reflex for avoiding pitfalls and had gone through the ‘first-timer’ learning curve.
“Developers have enough scars to know what it takes to get a project all the way through planning, design, financing, construction and operation”
In the growth-equity analogy, this corresponds to only focusing on businesses after they have reached commercial stage. The core of our infra growth equity approach is backing the rollout of developers at this specific point in order to systematically capture the scale-up value while boxing out the binary risks of early ventures.
At this inflection point, developers have enough scars to know what it takes to get a project all the way through planning, design, financing, construction and operation. They have built up enough engineering skills to master technical details, and enough corporate substance to run a tidy shop. They also have a higher chance of avoiding design or planning mistakes that can easily be made early on and could lead to fundamental flaws later down the line.
This stage is often close to the point when developers start engaging with large-scale financial institutions, typically project finance lenders. In fact, we started working with some of our most successful developing partners just after they bank-financed their first projects (for example, in Ireland) or were preparing to do so (in the UK or in Sweden).
This first encounter with project financing is often a bumpy ride, not just because developers need to fund the equity portion of capex, but also because of the weighty documentation, the tight contractual terms and the heavy-duty due diligence that is required. Developers flying solo are often frustrated by these first financings because they easily take much longer than expected, often with painful transaction cost overruns.
Importantly, project financing does not solve one of developers’ key concerns: the funding of their own running expenses and substantial pre-financial close project costs. In a post-subsidy market, where development is ever-more competitive and professionalised, this often slows down entrepreneurs’ pipeline and growth prospects.
To these developers we offer a more appealing alternative. This includes a combination of equity capital to fund their business and support their projects before they are ready for financing; capital to finance the construction of projects, made up of both equity from the funds we manage and debt that we source, structure and execute; and strategic and organisational skills, experience and resources to guide and support their growth to industrial scale.
From our perspective, this means a very active investment style. As in the classic growth-equity approach, our investment teams work shoulder-to-shoulder with our development partners, complementing their organisations. This means financing the projects, of course, but also helping them grow their business and capture opportunities such as accretive acquisitions, liquidity windows or building new capabilities to internalise key elements of the value chain. The result of this teamwork is an acceleration of the developer’s growth trajectory, whereby its platform can reach industrial scale much faster than would be the case if it decided to pursue alternative sources of finance.
The ‘infrastructure’ part of our formula is equally important, since most of our capital is invested in physical assets through tried and tested project-financing structures. Investment discipline, experience with project contracts, and access to equipment suppliers and lenders have all been key parts of our contribution to the success of these platforms.
“Our investment teams work shoulder-to-shoulder with our development partners, complementing their organisations”
The risk-reward profile that results from this approach combines classic infrastructure value protection with tangible value creation from the private equity levers – greenfield development, business expansion, economies of scale and scarcity premiums. When good investment discipline and execution practice are applied to both sides of the equation, this translates into base-case returns in the high teens and low 20s, with capital protection and downside returns secured by fully contracted cashflows in the high single and low double digits – an attractive profile that we call ‘positive asymmetry’.
A holistic formula
The energy transition’s call to action is growing louder and louder, and correspondingly so is the scale of the opportunity for entrepreneur-developers of sustainable infrastructure. Although the phasing out of government subsidies is healthy, it is putting more stress on developers to outperform their peers and quickly scale up in order to be successful. Environmental constraints are tighter, planning is more technically complex and expensive, and offtake is harder to achieve and often requires capital at risk before financial close. To succeed, developers need access to specialist and high-calibre resources, stronger and more agile balance sheets, and deep and wide industry networks.
Excess competition for good infrastructure assets causes headaches to many investors, and we have sympathy for those reaching for the ‘development-risk pillbox’. In our experience, though, a more holistic approach has the potential to accelerate the trajectory of the most talented developers, while offering investors stronger risk mitigation and higher returns.
Luigi Pettinicchio is co-founder and CEO at Asper Investment Management.