Crackers and infrastructure

A MEMORABLE PASSAGE from Barbarians at the Gate, the book chronicling arguably Kohlberg
Kravis Roberts’ (KKR) most famous deal – the $31.4 billion LBO of food and tobacco conglomerate RJR Nabisco – shows how history has a funny way of repeating itself.

“‘So this is what it’s come to,’ he thought. ‘Every investment banker with an extra nickel in his pocket thinks he ought to go into LBOs’. After five years of steadily mounting competition, Kravis was sick of it.”

Twenty years on, as private equity firms the world over set their sights on infrastructure, the newest asset class to capture the imagination of institutional investors, one is apt to hear a similar sentiment being expressed.

Except this time it is likely to come from managers which have been staking out the space for the better part of the last decade, wondering why now every private equity firm with a nickel in its pocket is wanting to get into infrastructure.

InfrastructureInvestor pondered the same on the way to meet Marc Lipschultz and, via remote satellite TV, Raj Agrawal, leaders of the firm’s new infrastructure investment team, in KKR’s lofty New York headquarters overlooking Central Park.

It didn’t take long to find out.

“There’s going to have to be a version 2.0 [of infrastructure investing],” says Lipschultz, and the 33 year-old private equity firm, he believes, is poised to lead the way.

Broach the idea of investing in infrastructure with Lipschultz, and the first thing the 15-year KKR veteran is likely to say is that this is not a new area of expertise for KKR.

“For the last ten years, we’ve done a lot of investing in infrastructure and infrastructurerelated businesses,” he says, pointing to KKR’s nine infrastructure-related investments consummated
over the last decade, including an investment in electric transmission operator ITC in 2003 in a $610 million deal.

But unlike ITC, 80 percent to 90 percent of investment opportunities KKR found, while attractive as infrastructure investments on their own, didn’t have “an appropriate home” within KKR. “And, of course, that’s a tremendous loss of opportunity,” says Lipschultz.

There was something else, though, that was bothering Lipschultz as he watched the market for infrastructure evolve over the last decade. Existing managers, focused on transactions more so than on returns, invested in the sector without “the toolkit it would take to ultimately deliver an attractive result for investors,” he says.

Consequently, early investors over-promised and under-delivered. “The infrastructure market was talking about, ‘what we’re doing is buying very long-duration, no-risk, high return assets. And they’re passive,’” meaning that they do not have to be actively managed because of their inherent stability.

“It doesn’t work that way. I mean, there’s always the one-off that’s going to exist in the world but systematically, it should be obvious, that that’s unachievable. And yet, it was implicitly what people hoped they were getting themselves into in version 1.0 of infrastructure,” he adds.

And now, he says, the infrastructure market is at “a pivotal moment” when everyone is asking, “what’s next?” Of this much Lipschultz says he is absolutely certain: “Simply repeating version 1.0 with the same strategies and the same managers is likely to yield the same result.”

And so, on 16 May 2008, in a calm and collected press release, KKR announced to he world “plans for investments in global nfrastructure assets,” to be led globally by former Lazard energy banker and TXU advisor George Bilicic.

The effort was not without its fits-andstarts; less than six months after the announcement, Bilicic rejoined his old shop (the word at the time was that he missed doing advisory work).

Despite the setback, Lipschultz didn’t waste much time. He’s spent the better part of the last 18 months building up his team, which is comprised of three core groups of professionals: investors, operations experts and stakeholder management experts.

He calls them the “three critical capabilities” needed “to make this business work”.

Around KKR’s offices, they’re also known as “infrastructure 2.0.”

On the investment side, Lipschultz says he’s assembled a team that will apply a different kind of lens to the infrastructure asset class.

“I don’t think it’s been very well defined in the past and I think it’s one of the failings, candidly, of the sector,” he says.

KKR’s infrastructure team views infrastructure as a “special set of assets” with a “very distinct” collection of six characteristics, he says.

They must be physical, tangible assets; provide a necessary good or service that is core to the functioning of the economy; have very high barriers to entry; provide inflation protection; have limited sensitivity to the economy; and have predictable cashflows over a long time horizon.

In addition to seeking to minimise risk through careful selection, making businesses more efficient and profitable will be a key focus for KKR.

“Part of what I think is important about version 2.0 is to recognise that infrastructure businesses are still businesses,” he says.

As part of that recognition, he plans on complementing his team with professionals from KKR Capstone, a team of 50 executives with various types of operational expertise that they bring to KKR portfolio companies.