Don’t sour on private equity

The news of the spinout of The Blackstone Group’s infrastructure team had attendees buzzing at this year’s Infrastructure Investor: Europe forum in Berlin. The obvious question, of course, was what the spinout of such a high-profile infrastructure team means for the rest of the market? Does it spell doom for private-equity owned infrastructure funds? Are there more spinouts on the way? Is the world ending?

The knee-jerk reaction may be to panic and say “yes” to all four of the above. But a more nuanced – and appropriate – view may be that the market shouldn’t sour on an infrastructure fund just because it is managed by a private equity firm. 
 

Cezary Podkul

To do so, in the first instance, would be to throw out the proverbial baby with the bathwater. Just as infrastructure is a multi-faceted asset class with many different investment strategies and outcomes, the private equity world has many different managers capable of leveraging different strengths to cater to those strategies and outcomes. At the very least, limited partners should take a view on the individual manager, not the very concept of private equity sponsorship of an infrastructure fund.

More importantly, limited partners should not overlook the synergies that come from managing a stable of different funds under the same banner. One often hears that if a manager earns carried interest from various different funds it could lead to conflicts of interest. Say you find a choice infrastructure asset capable of delivering a solid return, such as an airport with lots of room for operational improvement. Why put it in a lower-fee earning infrastructure fund if you could stick it in a private equity fund and earn higher fees? Fair enough. But one should not overlook the fact that having a stable of different funds and teams also has some significant benefits.

Chief among these is the ability to cross-source deal opportunities. Take, for instance, private equity firm CVC’s buy-in to infrastructure developer Abertis. CVC inked the deal with one of its private equity funds. But that may well give rise to opportunities for the firm’s infrastructure fund down the road such as acquiring one of Abertis’ subsidiary companies or partnering with the developer on a big project. At the end of the day, infrastructure deal-making boils down to deal opportunities and having the relationships necessary to execute on those opportunities. A private equity-managed infrastructure fund can clearly gain access to both.

And, just as the management of multiple funds can give rise to potential conflicts, it can also prompt the manager to act in the limited partners’ best interest. Take the same airport example referenced above. Let’s say, after examining the risk-return profile of the airport, the upside is so dependent on retail opportunities that it’s not really an asset with predictable, infrastructure-like revenues streams. If you have a buyout fund you can pass the deal to, you don’t have any pressure to stick the airport in your infrastructure fund just for the sake of showing your limited partners you can do a deal.  That is, with many different pools of capital to invest with, you can better match appropriate assets with the most appropriate pools of capital.

Still, private equity firms should realise that the concerns limited partners have raised around conflicts of interest are very real and should work to mitigate them appropriately. One easy fix could be to eliminate the payment of internal fees to different parts of the organisation in exchange for working with the infrastructure fund. Sure, it sounds great if you have a world-class asset management arm that can bring operational expertise to an asset bought by the infrastructure fund. But once limited partners find out there’s internal fees involved for that, the looks on their face rightfully sour.

Stronger key-man provisions for a private equity firm’s infrastructure fund can also help assuage limited partners. If it’s the infrastructure team that’s providing the value add for the fund, it makes sense to focus the key man provisions on the fund, not the private equity firm’s overall management.

But these are tweaks to the business model – not major brain surgery. Notwithstanding the Blackstone spinout, private equity firms have a role to play in the asset class and, provided they adapt their business model accordingly, will continue to do so in the future.