A decade of price increases characterised the post-financial-crisis era in the unlisted infrastructure market. It was sometimes feared to be an ‘infrastructure bubble’ driven by a wall of capital chasing too few assets. New research by EDHECinfra finds that, on the contrary, this was a period of price discovery for a nascent asset class.
Infrastructure equity prices do not exist in a vacuum. Analysing hundreds of transactions over the past 15 years, we found that they are driven by systematic risk factors, which can be found across asset classes. In other words, markets did process information rationally and average prices did reflect buyers’ and sellers’ views and preferences for taking risk.
These risk factors – size, leverage, profit, term spread or value – are commonplace for stock-market investors. After all, unlisted infrastructure equity is still ‘equity’. As a result, unlisted infrastructure prices have been partly correlated with public markets over the past 15 years.
However, the price formation process happened almost in slow motion because of the illiquid nature of the unlisted infrastructure market.
Looking at the raw data, we see that unlisted infrastructure companies – including merchant infrastructure companies like ports, airports or merchant power – experienced a sharp drop in revenue in 2009. But unlike stocks, the effect on valuations was not immediate because few transactions took place at the time. This shock on revenues and earnings only impacted transaction prices later on.
Then in 2011, despite revenue growth being either stable or still declining, average infrastructure valuations began rising rapidly and continued doing so until 2016. Not all sectors peaked at the same time. The power sector, for instance, started a new price decline in 2015. Conversely, airports saw highest average valuations increase in that period. By 2017, despite the return of revenue growth, average prices had plateaued. This was mostly due to the impact of the leverage factor (an increase in the price of credit risk) and of rising interest rates.
In the end, this decade of price increases can be considered a normal process of price discovery. Prices increased rapidly as more investors entered the market and buyers and sellers discovered how much they were willing to pay for infrastructure assets. In this period, the risk preferences of the average buyer of private infrastructure companies also evolved, leading to lower required returns for infrastructure investments.
Today, a price consensus may have been reached and ‘peak infra’ may even have occurred two years ago as valuations followed a steadier path.
Of course, there are always exceptions. VINCI’s recent acquisition of a majority stake in Gatwick Airport valued the London facility at eight times revenues, while the data suggests that an average airport should sell for 2.5-3 times revenues. But the price paid for Gatwick may not be considered ‘fair’ value by everyone.
We are on the cusp of a new era for infrastructure valuations. These businesses are expected to deliver steady and predictable cashflows and, to the extent that this is the case, they should be expensive. Prices will continue to evolve more rationally as more informed buyers and sellers engage in a steady stream of transactions in the most active markets.
This is good news for investors who have been looking to infrastructure for stable, long-term investments. Unlisted infrastructure may be driven by common equity factors, but it remains partly de-correlated from public markets and has a visible track record of steady and significant dividend payouts. The infrastructure investment narrative still holds.
With the period of easy returns driven by ever-increasing valuations coming to an end, a new era of risk management can begin for infrastructure investors. Such an era will require better measures of risk and the contributions made by infrastructure assets to the total portfolio.