Make way for Blackstone

In early February, New York-based investment giant The Blackstone Group closed on $200 million in commitments for Blackstone Infrastructure Partners, its maiden infrastructure fund targeting up to $2 billion in total commitments.

Kohlberg Kravis Roberts has also been raising an infrastructure fund, targeting between $2 billion and $4 billion, as has CVC, which is seeking €2 billion for its fund. As of press time, only Blackstone had held a first close.

At $200 million, the news understandably left many wondering why Blackstone would hold a first close on such a small amount. After all, expectations are high, as evidenced by a 1 February Morgan Stanley research report on Blackstone that said “we are forecasting a $2.5 billion infrastructure fund in 2010”.

One reason why the “mini” first-close may not be such a bad idea is because it lets the market know loud and clear that the firm has found a big cornerstone investor – a key hurdle for any debut fund. Blackstone is said to have put $50 million toward the first close, with the remaining $150 million coming from a sovereign wealth fund.

Market sources say the sovereign wealth fund is likely to be China Investment Corporation (CIC),  the Chinese government investment arm, which invested $3 billion in Blackstone in 2007. Blackstone declined to comment.

If it is indeed CIC, the weight of a hefty $200 billion sovereign wealth fund, or at the very least the buzz that surrounds it, can only spell good things for the Blackstone team. It sends a clear message to the market that heavyweight investors are taking the fund seriously.

There are other details in the market that give potential investors an early indication of how Blackstone may play the infrastructure game. First, much as competitors like to criticise the firm for bringing private equity talent to infrastructure, the team that Blackstone is assembling is not foreign to investing in infrastructure assets. David Tolley, the Blackstone private equity partner who joined fellow in-house professionals Trent Vichie and Michael Dorrell to manage the fund, was in charge of selling Global Tower Partners to Macquarie-managed infrastructure funds. The company, a lessor of cellular phone tower space across the US, is said to be one of the better-performing companies within the Macquaire Infrastructure Partners II portfolio.

Secondly, some of the deals the Blackstone team has already looked at indicate that the firm is able to take an infrastructure approach to investing in the asset class. The recently announced purchase of $125 million of preferred shares in Crosstex Energy, a Texas pipeline operator, by GSO Capital Partners, the Blackstone credit investment unit, is a case in point.

Good upside

Market sources say the deal was sourced by Blackstone’s infrastructure team, which would have taken the bite had it already held its first close. The deal makes plenty of sense for an infrastructure portfolio. The preferred shares in Crosstex pay a minimum 10 percent coupon. So, to begin with, there’s limited exposure to downside. However, they can be converted at any time to common shares by Blackstone at a strike price of $8.50 per share. Given that the shares currently trade at a 30 percent premium to this price, there’s pretty good upside built into the deal from the start (though presumably Blackstone would only convert when it’s ready to exit the investment if it’s done as an infrastructure play).

If this structure sounds familiar, it’s not by accident. Global Infrastructure Partners (GIP) did a similar preferred share structure when it invested $700 million in El Paso Corporation’s Ruby Pipeline. GIP has a preferred interest that gives it downside protection and significant upside if it converts the shares to common equity. Prior to inking the deal with GIP, El Paso had a similar proposal on the table from a Blackstone Infrastructure Partners-led consortium that also included several Canadian pensions as direct investors, market sources say.

Strong downside protection with a sizeable opportunity for a larger return without taking on additional risk is a classic way to play the infrastructure game.  Blackstone won’t begin investing the fund until it gets to $500 million, with a second close likely in the first half of the year, according to market sources. 

Blackstone Infrastructure in brief 

Company: The Blackstone Group
Debut fund: Blackstone Infrastructure Partners I
Target: $2 billion
Focus: North America, private infrastructure
Professionals: 13, including three partners: Trent Vichie, Michael Dorrell and David Tolley
Source: Market research