The industrial investor

A modern, inconspicuous office building in a residential part of Essen, one of Germany’s great industrial cities, is where many Hochtief executives have their offices (the company’s 19th century headquarters is downtown). From here, they help steer the global operations of a corporation ranked fifth among the world’s largest construction companies.

Not that they are likely to spend much time back at base: Hochtief’s activities extend to the most far-flung corners of the world, and frequent travel must be a feature of many of the German managers’ job descriptions. Thankfully, Hochtief owned Düsseldorf International Airport is only a short drive away. For Essen’s taxi drivers, Hochtief must be a cherished source of income.

Design, build, finance, operate

One of the company’s frequent fliers is Bernward Kulle, a lawyer and economist by background who became an airport specialist in the 1990s before joining Hochtief in 2000. Kulle is CEO of Hochtief PPP Solutions and a member of the four-strong management team that runs Hochtief Concessions.  Incorporating both PPP Solutions and Hochtief AirPort, the concessions unit is Hochtief’s infrastructure platform and one of the group’s six main business divisions.

In terms of headcount, with just over 300 staff at the end of March 2009, Hochtief Concessions may seem barely noticeable in a corporation that has nearly 65,000 employees globally. But to understand the division’s significance, headcount is not the measure to look at: in 2008, Hochtief generated a pre-tax profit of €520 million on revenues of €29.1 billion; of the €520 million, more than 20 percent, or €110 million, came from Hochtief Concessions. The business clearly matters.

Hochtief Concessions GmbH was formally established 18 months ago, though its origins date back to some forward-looking decision-making at group level in the early 1990s. At that time, according to Kulle, Hochtief began to extend its business model from ‘design + build’ to ‘design + build + finance’ and eventually to ‘design + build + finance + operate’ in order to develop into what the company’s website now describes as “one of the leading international providers of construction-related services delivering integrated services covering the life cycle of infrastructure projects, real estate and facilities”.

In the mid 1990s, the group started to invest in airports. Around 2000, roads and social infrastructure assets became an area of focus also. Hochtief PPP Solutions was set up in 2005 and combined with Hochtief AirPort three years later to create Hochtief Concessions. Today, as Kulle puts it, the division operates as an “industrial investor and developer, which has the experience and capability to plan, design, develop, finance and operate infrastructure assets”.

Front-end integration

It’s a model that he says differs fundamentally from how a purely financial investor will approach projects: funds have generally leaner teams and are dependent upon outsourcing to consultants and advisors.

Kulle says there is an art” to doing what Hochtief does effectively, particularly on the PPP side where projects are usually greenfield – the art of being “an integrator at the front end”. When leading a project, Hochtief Concessions can draw on the resources embedded in the other divisions, and bring in a Hochtief construction team, financing specialists, or facility managers for example. Kulle argues that the Hochtief brand stands for trustworthiness, credibility and a solid track record in all these areas, and that the prospect of a “one-stop-shop solution from us” often appeals to public sector customers looking to choose reliable partners.

However, Kulle also stresses that all Hochtief business units operate as independent profit centres and strictly at arm’s length from one another:  “One very clear rule in the Hochtief family is that all divisions obey the rules of their market segments.” So to assemble a project syndicate, Kulle may bring in colleagues from other parts of the group – or he may choose not to. “Drawing on internal resources often adds value and allows us to manage risk more efficiently. But we are free to court the market and select external service providers if we think they can give us better quality or a better price – and we have done so in the past.”

What the division does is obviously capital-intensive work, but Kulle says the results are there:  “We are contributing very visibly to the group’s performance. The model is working – and progressing.”  

According to Hochtief’s Annual Report 2008, the value of the concessions portfolio amounts to almost €1.5 billion. Approximately 80 percent of it relates to airports. With stakes in Athens, Budapest, Düsseldorf, Hamburg, Sydney and Tirana airports, the portfolio has an annual throughput of some 90 million passengers.

On the PPP site, Hochtief Concessions has interests in more than 700 kilometres of roads in Germany, Austria, Greece and Chile, as well as a collection of schools, town halls and other public buildings in Germany, Ireland and the UK.  Finally there is a small exposure to the renewable energy segment, in the form of two geothermal power stations in Southern Germany.  “Renewables is our latest baby,” Kulle says fondly.

To have built up the portfolio over the past three years has been an achievement, he adds.  Among the highlights he points to is a 30 kilometre section of the Santiago de Chile beltway, a toll road the firm helped build and now operate, and which opened for traffic in 2006.  The division is also proud of its participation in two large highway construction projects in Greece, which in 2008 raised over €2 billion of senior debt between them, and where Hochtief, as syndicate leader and co-leader respectively, was able to bring to bear the fully integrated, total-package approach it considers its trademark.  

No bid for Midway

Geographically, there are many new markets for Hochtief Concessions to move into. North America and Eastern Europe sit at the top of the expansion plan, and Kulle also sees potential for the business in the growth markets of Brazil and India.

Right now the priority is to get traction in North America, where Kulle believes current and medium-term opportunities are more attractive than anywhere else.  He says the firm expects not to invest in market development on the continent, but pursue low-hanging fruit instead. A team of infrastructure professionals was formed last year and is now operating from offices in New York and Toronto, with a satellite presence in Vancouver.  Kulle himself is visiting North America about once a month. He says Canada is “quite a mature infrastructure market and offering a sustainable value-for-money opportunity – it’s our No 1 at the moment. The US isn’t as well developed, but given their enormous backlog of projects and the budgetary constraints, they may likely have no choice but to embrace PPP  – whether they believe in it or not.”

Hochtief Concessions has not done a deal in the US, but it already has some first-hand experience of the PPP bidding process in the country.  It was part of the syndicate that came second in the race to win the ground-breaking concession lease of the Chicago Skyway. More recently it partnered with Goldman Sachs and Global Infrastructure Partners to prepare a bid for Chicago’s Midway Airport, though ultimately it decided to pull out after deciding the proposition to bidders was unattractive. 

The Midway auction, with the winning bid from a Citi-led consortium turning out to be unfundable, is now infamous. Kulle won’t comment on the outcome, but is happy to explain why Hochtief chose not to make an offer for the asset: “We concluded that the proposed contracts were not well balanced; there were clusters of risk in certain areas where we would have been dependent on the airlines without them being dependent on us. This is something we don’t like, and the broader point is that public sector authorities going into a privatisation process have to learn that there can only be a good outcome if they design balanced contracts.” Kulle says the City of Chicago understood Hochtief’s reasoning.   

Precisely what constitutes a ‘balanced’ contract can of course be hard to determine, and Kulle accepts that “sometime you will only be clear on this years into the project – that’s the difficulty in infrastructure.”

Because of this difficulty, Kulle has a second message for public sector owners looking to privatise assets: “You will have a better deal if it is well-balanced over the long term, and not just at the beginning of the contract. Vendors need to have a long-term vision as to how the asset should be developed. Whether they do is one of the filters we use to select opportunities; if they don’t the opportunity is probably not for us –
because our strategy is to realise long-term potentials.”

By the same token, projects need to be cash flow generative early on in their life cycle if Hochtief is going to be interested. “We’ll only do a deal if it delivers good bottom line early on. We won’t bet on the last 10 years of a contract.”

Clearly, selectivity will be important as Hochtief Concessions continues to add to the portfolio. “We’re set for controlled growth, and the good news is the pipeline is in good shape,” says Kulle. Also helpful is the fact that Hochtief is in reasonably good health despite the global slowdown: with a backlog worth over €30 billion, according to the Q1 earnings report, the company’s order book is full, and chairman of the executive board Herbert Lütkestratkötter recently confirmed the group’s profit forecast for the year.

Models for the future

“The capital intensity of our business could be a challenge, but it’s not a constraint,” Kulle says. For the time being, the Hochtief balance sheet is likely to remain the main source of funding for the business, although in August, after we met with Kulle, the group said it was pondering a potential IPO of shares in Hochtief Concessions. Such a move, alongside other benefits, could open up new sources of capital for the division. In any event, Hochtief Concessions has already taken some steps towards opening up the platform to third party investors.  For example, the concessions group advises Hochtief AirPort Capital, an investment partnership backed by Australia’s Hastings Funds Management, Caisse de dépôt et placement du Québec and German development bank KfW IPEX, which has co-invested in the firm’s airport projects. In addition, the division is the majority shareholder in Hochtief PPP Schools Capital, a joint venture with Barclays to invest in school projects in the UK.

It’s a model that other investors who are currently trying to find a suitable way for them to participate in infrastructure investment might find interesting to study.

At a time when the applicability of the private equity fund model to infrastructure is being questioned (see page 32), and the once dominant listed funds are in retreat, incumbent practitioners like Kulle are paying close attention to the rapid evolution of the asset class. He speaks of an ongoing “changing of the guard”and also points to the foray of private equity groups into infrastructure with dedicated pools of capital as an interesting and stimulating development. Amid all the flux, he also exudes confidence about Hochtief’s own approach, and says he is looking forward to what’s coming. Peers and rivals had better take notice: this industrial investor has only just started.