‘No question there’s risk’ but LatAm opportunities are worth it

While the region continues to experience some volatility and uncertainty – elections, slower-than-expected economic recovery and the lingering after-effects of corruption – infrastructure investors tell Kalliope Gourntis all the reasons that keep them coming back.

“Latin America, particularly within the context of emerging markets, has always led the way in terms of integrating frameworks for private investment,” Michael Harrington, a partner at emerging markets specialist Actis, tells Infrastructure Investor in a recent interview.

While, like every other location in the world, countries in the region experience highs and lows, Latin America continues to offer infrastructure investors plenty of opportunities – primarily in the energy and transport sectors.

Asked whether the various markets are more similar than different, Harrington replies: “They don’t exactly repeat after each other but they rhyme.” With Actis having invested in 14 assets across Latin and Central America, Harrington is well-positioned to speak of their qualities.

“One of the things they have in common is long-term contracts,” he says, referring to the energy and power sectors specifically. “They’re buying the energy, they’re creating technology-specific auctions where you have renewables competing with renewables; and they’re setting an agenda,” Harrington remarks.

Another common element is the massive need for infrastructure.

“Stronger economic growth, combined with years of underinvestment, will increase infrastructure demand,” BlackRock predicts in its 2018 Global Real Assets Outlook.

According to the US-based fund manager, PPPs “will unlock sizeable investment opportunities in transportation and other sectors”.

Colombia joins the OECD club
Long a favoured target market for infrastructure investors, Colombia achieved a milestone earlier this year when it officially gained OECD status. What’s more, it has made great strides in improving its infrastructure as evidenced by its improved ranking in the World Economic Forum’s latest competitiveness report – moving up to 87th place from 117th in 2013-14.

Its progress is in great part due to the 4G infrastructure investment programme Colombia’s government launched in 2013, which aims to improve and expand the country’s road network.

“Colombia has made significant progress developing its transport infrastructure during the current administration,” S&P Global Ratings said in an April report.

According to the ratings agency, 30 projects out of 40 have been awarded concessions and 14 have reached financial close. Still, S&P points out that despite the significant progress made, Colombia continues to lag its regional peers.

However, the 4G programme should help the Colombian government – a new administration under the leadership of Ivan Duque took over on 7 August – formulate financial plans for previously announced initiatives, which include investment in the water/wastewater and social infrastructure sectors. These, however, will most likely not attract additional private capital as they fall under the jurisdiction of local governments which have weak credit quality.

“I think Colombia has a very interesting story to play out soon,” Actis’s Harrington tells us, referring to the country’s renewables sector. “Colombia has historically been a market really for local players. Local incumbent hydro-generators represent approximately 80 percent of renewables assets. “But that is about to change,” Harrington says.

What he’s referring to is a series of failures that have affected Hidroituango, a 2.4GW hydro project estimated to cost $2.8 billion that in April and May experienced a tunnel collapse, and multiple landslides. “It’s now going to be delayed for several years and will have cost overruns,” Harrington says. “The government is preparing contingency plans to address the issue.”

According to Norton Rose Fulbright, Colombia has a wealth of natural resources, which would allow it to diversify its energy mix and rely less on hydropower, which accounts for 65 percent of annual consumption. The country is planning to hold its first-ever renewables auction in the first half of 2019, which according to Fitch, “could accelerate the country’s plans to diversify its generation portfolio to include more non-conventional renewables in case Ituango suffers additional delays beyond 2022”.

“So that’s a market that can be very interesting in the near term,” he acknowledges. “But generally speaking, some of the markets that we’ve been in – due to their size and track record – will remain our target markets. You won’t see us leaving Mexico, for example.”

Mexico: politics, policy shift?
“I think a big step was taken by eliminating the uncertainty of the election outcome and the market has received the election outcome fairly well,” Ernesto Gonzalez, head of Macquarie Mexican Infrastructure Fund, says when asked whether a new administration under newly elected President Andres Manuel Lopez Obrador, the leftist candidate, is a concern for Macquarie Infrastructure and Real Assets.

“We look forward to continue to invest in Mexico and help close the infrastructure gap but it’s too early to tell what this administration will require of infrastructure investors,” he adds.

To date, MIRA has invested in five assets through MMIF, a vehicle it launched in 2009 targeting 15 billion pesos ($803.8 million; €686.9 million), although, according to Infrastructure Investor data, it only managed to raise 5.6 billion pesos. MIRA did not provide an update on the fund, but its website says it is now closed to investors.

The potential shift in public policy is a key issue to watch in the coming months, according to Fitch, until Lopez Obrador assumes office on 1 December. In its 2018 mid-year outlook, the agency rated the country’s transportation sector as ‘stable’, expecting volume growth to continue the solid trends witnessed in the first half of 2018.

However, it speaks of “heightened uncertainty” in the power sector – noting that its energy reform is progressing more slowly than expected.

Actis’s Harrington concedes that “on a macro basis, there are headwinds more generally for foreign direct investors until people see a continuity of policy, a policy that has encouraged people to come and invest. So, until he becomes more specific about what he’s planning on doing with the economy, I think people may hold off.”

Actis, however, despite the July election, did not hold off from making its largest single acquisition to date, when in April it bought a 2.2GW portfolio of six combined-cycle natural gas facilities and a stake in a 155MW wind project.

InterGen, which Actis has rebranded Saavi Energia, is co-owned by Ontario Teachers’ Pension Fund and the China Huaneng Group.

Saavi Energia is not the only asset Actis owns in Mexico. In 2014, the firm created Zuma Energia to develop renewables projects in the country and in 2016 it launched Atlas Renewable Energy to invest in the broader region.

Brazil’s uncertainty
Another presidential election slated for October is also causing uncertainty further south, but in the case of Brazil, it is not the only cause of apprehension.

“The pace at which project developments and approvals take place, is pretty uncertain, mainly because of the political dynamic and the issues with corruption, which still linger and that remains a problem,” explains Cherian George, Fitch Ratings’ head of infrastructure for the Americas.

The country has yet to completely resolve the corruption scandal known as Operation Car Wash, that unfolded with an investigation that started in 2014 and led to the impeachment of then president Dilma Rousseff two years later. What’s more, her successor and current President Michel Temer has also been dogged by corruption allegations both as vice president and in his current role.

And then there is economic uncertainty.

“Once you’ve had a large recession, you expect a strong recovery but we’re not quite seeing that,” George comments. “None of us doubt that the recovery will be there but it’s a function of political decisions and other things that strengthen the underlying confidence in the political system and the economy, which is hard to predict,” he continues.

“But, do we have confidence that Brazil has an underlying set of demand and there’s a floor of demand that will support toll roads? We absolutely do,” he says.

The question is, when? For the time being, Fitch’s outlook for the country’s transportation sector remains negative, “despite some signals indicating traffic volumes might have touched bottom”.

“Continued traffic underperformance has not only pressured credit metrics but also increased concessionaires’ exposure to refinancing risk, as approaching maturities have often been rolled over with short-term debt,” Fitch wrote in its 2018 Latin American Infrastructure Outlook.

However, the ratings agency expects Brazilian toll roads to stabilise and was more positive on the country’s power sector, expecting $7.3 billion in transmission line investments due to auctions in 2017 and the first half of 2018. “Rising investor comfort should increase issuance tenors to unprecedented levels, allowing for stronger and/or higher leveraged transactions,” Fitch noted.

Despite the challenges the country faces, there are those investors who will not shy away from this market. Brookfield Infrastructure is a case in point.

“While the region was being weighed down by a severe recession in Brazil and the impact of lower commodity prices, we acquired a number of high-quality, irreplaceable assets at attractive entry points, including a large-scale regulated natural gas pipeline system in Brazil,” Brookfield Infrastructure chief executive Sam Pollock says, referring to Nova Transportadora do Sudeste.

The Canadian fund manager acquired 90 percent of NTS, in a $4.23 billion deal in April 2017 from Petrobras, the oil company that found itself at the centre of what has turned out to be the largest corruption scandal in the country.

Brookfield is generally known to take a contrarian approach to investing. As Pollock explains: “We were early investors in Chile, acquiring the largest electricity transmission system in the country in 2006, at a time when it was perceived as an emerging market and capital was scarce.

“Our view was that the fundamental need for the country to grow its electricity infrastructure would drive attractive opportunities over time and that we could apply our operating expertise to improve asset performance, margins and reduce the cost of capital over time,” Pollock says.

In the meantime, Chile achieved an investment-grade rating and OECD status, and the asset Pollock refers to, Transelec, generated a compound IRR of approximately 18 percent over 11 years and a capital multiple of 3 times, when Brookfield sold a 28 percent stake in the company in March to China Southern Power Grid International for $1.3 billion.

The safety of Chile
Chile has long attracted foreign investment due to its political and economic stability.

“Chile is the most developed market in Latin America in terms of the legal framework, the experience and the way they allocate risk for infrastructure projects,” Juan Angoitia, a managing partner at French fund manager Ardian says.

They’re also one of the most developed in terms of GDP per capita and “one of the safest in terms of macroeconomic and political stability”, he adds.

Perhaps those are the reasons Ardian, which recently closed its first Americas-focused fund on $800 million, chose Santiago for its Latin American outpost that it opened in June.
Ardian, which through Ardian Americas Infrastructure Fund IV will concentrate on the US, Chile, Canada and Mexico, sees opportunities in both energy and transportation, the two sectors it targets through all its funds.

The French firm has already invested in the region, acquiring an 81 percent stake in four solar projects from Spanish developer Solarpack. The portfolio, which Ardian acquired in September 2016 for $31 million, comprises three plants in the north of Chile and one in the south of Peru. Under the terms of the agreement, Ardian also acquired a minority stake in Solarpack and a seat on the company’s board.

In addition to its excellent solar resource – the Atacama Desert located in the north has one of the highest rates of solar irradiance in the world – Chile also possesses geothermal resources and “the greatest potential in the world for the development of wave energy,” thanks to its long coastline which exceeds 4,000 kilometres, Norton Rose Fulbright states in a February 2017 report, citing a study conducted by the British embassy in Chile.

According to the law firm, the increasing development of renewables is a ‘game changer’, with Chile slated to become an exporter of electricity in the near future.

In addition, the country expects to interconnect its National Transmission System with Peru, Ecuador and Colombia by 2021, according to Norton Rose Fulbright.

‘No question there’s risk’
Perhaps it’s no coincidence then that a recent study by the International Forum of Sovereign Wealth Funds found that while in 2017, sovereign funds were scaling back their infrastructure investments in developed markets they were deploying capital in Asia and Latin America.

“Although this is not a new trend, it has intensified over the last year,” IFSWF wrote in its report. “While it might, on the face of it, appear to be a higher-risk strategy, emerging markets can carry lower potential political risks as there are fewer concerns about foreign investment in infrastructure and SWFs can pair with a domestic promotor.”

George of Fitch Ratings doesn’t fully agree. “It depends on your understanding of risk. It depends on what your definition of higher risk is.

“It is higher risk,” he asserts, “but if you have an understanding of the risk and you’re able to make judgments about how to mitigate it, you may be better prepared to take on that risk. But, there is risk. There’s no question there’s risk. The important thing is to be educated about the market in which you’re investing.”