When the Organisation for Economic Growth and Development (OECD) more than doubled its forecast for economic growth across developed nations in November last year, one could almost hear the collective sigh of relief across Europe and North America. Europe could expect 0.9 percent GDP growth in 2010, instead of the previously estimated zero, and the US could look to 2.5 percent, rather than 0.9 percent.
Why the optimism? “China is leading the global recovery,” the OECD said, “helped by its limited direct exposure to the financial crisis and a massive stimulus pack- age.” At 10.2 percent, the country would see more than quadruple the growth rate of the US economy in 2010, the OECD predicted.
Against this backdrop, in January 2010 JPMorgan Asset Management held a final close on its Asian Infrastructure and Related Resources Opportunity Fund, or AIRRO for short. After two years in the market, the fund attracted $858.6 million in commitments. It was less than the fund’s initial pre-crisis target of $1.5 billion. But, to be fair, it is still one of the largest pan-Asian infrastructure funds ever raised.
“Matt Lim has a valid point,” says Philip Jackson, AIRRO’s chief executive, as he reflects on the close. “But I think it needs to be kept in perspective.”
The region is growing very rapidly. “But ultimately, good investment is about finding individual deals on sensible terms that you can execute.” AIRRO, he says, built an investment thesis “not on the macro Asia that’s growing” but instead “on sourcing investments that are manifestations of that growth” as evidenced by three deals the firm closed as it met with investors from all around the world.
Just like New Jersey Turnpike
Capitalising on Asia’s growth is nothing new in the world of infrastructure. EMP Global, the asset management firm formerly backed by AIG, raised two funds for Asian infrastructure in the mid-90s. The second of those, the $1.67 billion AIG Asian Infrastructure II Fund, became, with GIC’s backing, the largest pool of private equity ever raised for the region.
In 2007, when JPMorgan Asset Management assembled its team for AIRRO, it reached for two ex-AIG Asian Infrastructure team executives. Tony
Adams, a 10-year veteran of the fund, joined AIRRO as managing director in Hong Kong, while AIG’s Vijay Pattabhiraman joined as managing director in Singapore. Jackson, a veteran JPMorgan investment banker who had been in Asia since 1993, crossed over to JPMorgan’s Asset Management to head the fund out of Hong Kong.
AIG Infrastructure ended up investing in a wide variety of industrial sectors, from paper manufacturing to telecommunications and oil and gas. The core focus at AIRRO is going to be much more on the infrastructure value chain – “the same sort of infrastructure as existing in OECD funds,” says Jackson. “So it could be power stations, it could be transmission grids, it could be transportation assets like roads or ports, it could be social infrastructure like hospitals or it could be … telecommunications infrastructure.”
“It’s just that those entities and those assets are often earlier in their life in Asia than they would be in [OECD countries],” he adds. Or, to put it another way: “It’s like buying the New Jersey Turnpike 40 years ago”.
There’s a further dimension to this comparison. Put a dollar in to an asset like the New Jersey Turnpike today and, with steady but predictable traffic patterns, you might earn an eight to ten cent cash return, or an 8 to 10 percent dividend yield year-to-year. Put a dollar into the turnpike 40 years ago and, with rapid ramp-up in its use and fast traffic growth, your investment will likely grow at a much faster rate.
“Asian infrastructure is very much, in our view, about capital growth rather than dividend yield,” says Jackson. So rather than putting together a consortium of investors to buy out a large infrastructure asset and hold it to maturity, AIRRO will be looking to partner with local operators to provide them with the capital they need to achieve their goals and remain independent. That means investing forshorter periods than a perpetual OECD-focused infrastructure fund– AIRRO will typically target three to seven years – and investing with a view to eventually engineer an exit at some point during the fund’s ten-year life.
If all this sounds a bit like private equity, so will the fees. AIRRO employs a “conventional” fee structure of management fee plus carried interest, says Jackson. He declines to go into further detail, but adds that AIRRO targets “high-teens” returns, equating to about a 7 or 8 percent return spread over developed markets infrastructure, where lower perceived risks frequently translate to lower returns .
And, as a kicker, AIRRO will invest in a category of assets outside of infrastructure proper: related resources. Be it steel, cement or some other necessary inputs to the infrastructure that is being built around the region, these will be companies that stand to directly benefit from the urbanisation trends in China, India and Southeast Asia. Hence the “related resources” element of AIRRO’s name.
“We wanted the name of our fund accurately to reflect what we were going to do,” he says.
Need for cement
Related resources, Jackson cautions, will make up only a small portion of the fund. But he’s already got a head start. AIRRO’s maiden investment, Chinese cement maker Scitus Cement Holdings, provides an illustration of the related resources portion of the fund’s mandate. It is chaired by Tony Adams.
Based in the Southeastern province of Guizhou, Scitus operates in an area that has historically been very supply-constrained for cement, explains Jackson. The 1950s-era cement plants that do exist there are often not up to the government’s environmental standards and are scheduled to be closed. And the remaining ones simply can’t keep up with the demand since the Chinese government is looking to aggressively build out the province’s major roads and railways.
There is demand for Scitus’ cement in other provinces as well. Neighbouring Sichuan was struck by a powerful earthquake in May 2008 that killed nearly 70,000 and touched off a massive need for cement as the region rebuilt.
“We made our investment decision prior to the earthquake,” says Jackson. “But, clearly, demand for cement has only gone one way and you can’t really bring cement in. Even if you were in the US, you typically wouldn’t expect be able to move cement much more than a couple of hundred kilometres or a couple of hundred miles. The economics of it normally just don’t make sense.”
The result is an investment in a relatively protected market where, for the period of AIRRO’s investment in the firm, the AIRRO team can feel quite confident about growing cash flows. Since the company was founded in December 2007, AIRRO has dedicated growth capital to Scitus to fund additional cement plants and now owns just less than70 percent of the company.
“We are already comfortable with the way this is going,” he says.
But the investment climate in China isn’t always as agreeable as it was with Scitus. “The Chinese government’s approach to infrastructure is quite different than some other markets in the region,” says Jackson. As in India, the Chinese government tends to award long-term concessions to developers and investors in infrastructure assets. But unlike India, the annual tariffs on those concessions aren’t set to escalate at pre-agreed formulas. “So one of the questions each time is: how arbitrary is any tariff calculation going to be?” he says.
The AIRRO team, which includes several China specialists, kept the tariff questions foremost in their minds as they made their second Chinese investment. In December 2009, AIRRO took a controlling stake in Goldtrust Water Group, a Shenzhen-based company that operates 11 water treatment plants in Southeastern China.
“This is in a sector where there are longterm concessions that are awarded to build specific water and wastewater facilities that are then used by the municipal water authority or the regional water authority,” he says. And because Goldtrust owns and operates several plants under these types of concessions, AIRRO can minimise the rate risk that might exists if an authority contracting with any one plant abruptly decides to alter the tariffs. It can also capitalise on a steady stream of operating cash flows from Goldtrust’s active concessions.
AIRRO’s third investment was somewhat of a blend of the two Chinese deals. In October 2008, the fund invested in SevenHills, an Indian hospital operator which, like Scitus, had growth capital needs and, like Goldtrust, bankable operating cash flows.
In Visakhapatnam, a port city in the east coast state of Andhra Pradesh, SevenHills runs the only hospital within a 500-kilometre radius that offers comprehensive medical facilities, from diagnostic care to surgery and post-treatment care. The hospital is now in its 23rd year of operations.
But it was an unfinished hospital on the other side of the country that sparked AIRRO’s interest in SevenHills. In 2001, the Mumbai government started work on a 1,000-bed hospital in the country’s financial capital. But it ran out of money – “that’s the story of India”, says Jackson – and put the project out to bid to the private sector in 2003.
SevenHills won the bid and spent the next few years changing the design, acquiring adjacent land and petitioning the local planning authorities to let it expand the hospital to 1,500 beds.
“At that point, when planning permission was finally granted, they needed some additional equity to cover the incremental cost. So that’s where we came in,” says Jackson. Since the original investment in October 2008, AIRRO has gradually built a stake of just about 30 percent in SevenHills.
“The Mumbai hospital is a very good example of what we would and would not do,” says Jackson. Had it been just the hospital itself as a stand-alone greenfield or new development project in need of equity, his team would likely have passed on the opportunity.
“We just don’t think you need to take single asset greenfield risk to be able to invest profitably in infrastructure,” he says. But as the operating hospital in Visakhapatnam was already yielding cash flows and Mumbai stands ready to provide the first 300 beds as early as this year, the SevenHills deal made much more sense.
With these three deals inked, AIRRO has already committed almost 25 percent of the $858.6 million it raised for the fund. But even had Jackson committed the whole fund by now, it would hardly make a dent in the region’s burgeoning need for infrastructure, which he estimates at $250 billion annually.
Asia is still “psychologically a long way away” for many investors, he admits. But he also senses a growing desire among investors to allocate capital to the region, not least because of the growth story that everyone knows so well. And Asian infrastructure, he believes, will remain an integral underwriter of this story.
“It really is a strategy that is focusing on the massive urbanisation that is happening around the region, the growth of the middle classes that can now afford services which are often not available in a way that we take for granted in the West,” he says.
Jackson is taking nothing for granted – especially not the idea that this growth alone will deliver great returns. Only a well-trained eye for a good deal will achieve that – in Asia or anywhere else.