The KKR template

Institutional in vestors and competitors interested in learning more about private equity firm Kohlberg Kravis Roberts’s approach to infrastructure got plenty of hints in 2010.

Early in the year, the firm’s name showed up on the lists of qualified bidders for the US’ three largest parking deals: Los Angeles, Pittsburgh and Indianapolis. Then, in October, KKR closed a $1.1 billion deal to purchase a 23.4 percent interest in Colonial Pipeline, a major carrier of refined petroleum products on the US’ East Coast. And by year’s end, KKR had collected $515 million for its debut infrastructure fund, according to the private equity firm’s annual earnings report. 

Now that KKR’s infrastructure team is up and running, Infrastructure Investor caught up with Raj Agrawal, a director on the team, to reflect on the deals it did and did not do in 2010 and get a preview of what lies ahead. For Agrawal, a former Warburg Pincus executive who joined the private equity firm in 2006 and switched to its infrastructure team in 2008, infrastructure could be in line for a private equity-like growth streak.

“We think that infrastructure is probably one of the highest-potential growth businesses that we have,” Agrawal says.

Dual focus

For KKR, infrastructure is part of a two-sided investment strategy that also includes the energy sector. For example, in 2010, as Agrawal focused on pursuing infrastructure deals with Marc Lipschultz, KKR’s global energy and infrastructure head, others in the group focused on private equity deal opportunities in the energy sector. In December, KKR inked a $625 million joint venture with natural gas giant El Paso Corporation to buy some of its assets in Utah and invest together in further opportunities in the sector.

Some of KKR’s competitors have criticised the joint energy and infrastructure focus as an unwise strategy because it might tempt Lipschultz’s team to pursue higher-earning energy private equity deals than the relatively lower-risk, lower-return infrastructure deals.

“It’s actually quite the opposite,” Agrawal says. “Our model is to use an extremely disciplined and rigorous approach. We have a set definition of infrastructure and a set of characteristics that must be present in order for something to meet the threshold for consideration. He points to the recently agreed El Paso joint venture as an example.

“There are a lot of people who would say, ‘well, it’s energy midstream, so that’s infrastructure, right?’ We went in with an open mind. When we looked at the underlying risk characteristics . . . we were able to say, ‘ok, not appropriate for infrastructure, it doesn’t meet our criteria,’” he says, citing investment characteristics like commodity risk, lack of long-term contracts and competition on some of El Paso’s midstream assets.

He added: “These are all very acceptable and manageable risks from a private equity perspective but do not belong in a very low-risk asset class like infrastructure. El Paso is a terrific business; the emergence of unconventional resources is driving a need for significant investment in this sector in the US and the El Paso joint venture is perfectly positioned to deliver win-win solutions to producers.”

“We are rather insistent on the disciplined approach,” he adds. “It’s methodical and somewhat formulaic, but it’s the backbone of our business model. Deviating from it would be counterproductive.”

No ‘existential crisis’

In 2010, Agrawal was busy focusing on investments with defensive characteristics and, so far, the flagship example has been the firm’s purchase of its 23.4 percent interest in Colonial Pipeline, which KKR did as part of a separately managed account with the National Pension Service (NPS) of Korea, a long-time limited partner in KKR’s private equity funds.

“The Colonial transaction is a great example of why we’re so excited about this asset class and our ability both to make good investments and be a good partner to our investors,” Agrawal says. On an average day the 5,500-mile long Colonial pipeline network delivers 100 million gallons of gasoline, kerosene, diesel fuel, home heating oil and aviation fuels to customers on the US’ Eastern Seaboard, according to Chevron, the seller, when it announced the deal with KKR.

“In Colonial, you have a pipeline that, as the low-cost carrier, delivers much of the East Coast’s fuel consumption . . . it’s an absolutely critical part of this country’s infrastructure,” Agrawal says. “It’s durable, predictable nature, coupled with attractive inflation-hedged cash yield, made it exactly the type of defensive asset we seek in infrastructure.”

But this prompts an existential question that’s been bugging many infrastructure managers in recent years. If large, sophisticated institutional investors like Korea’s NPS value these assets so much, why do they need investment managers like KKR to do the deals with them? That is, why don’t they just invest directly themselves?

“Honestly, in 90 percent of the opportunities that we look at, we’re not competing against anybody that’s going direct,” Agrawal says, adding: “We’ve never felt an existential crisis. Even in an auctioned deal like Colonial, our partner sought us out because they found it valuable to team up with an investment manager to do the deal.”

“They could have attempted this directly but they wanted the operational value add and the decades of energy and infrastructure experience that we can bring to bear in diligence and as a partner in the deal,” Agrawal says. KKR, he adds, not only led the due diligence but, now that the deal is done, provides active governance through Agrawal’s representation on the board.

Careful with parking

Turning to deals it didn’t do, KKR can be excused for being glad it didn’t end up putting in a bid for Pittsburgh’s parking auction.

In October, after nearly two years of deliberation, due diligence, qualifying investors and pursuing a bidding process that resulted in a $452 million bid from JPMorgan Asset Management, the Pittsburgh City Council rejected the deal and opted instead to use a parking tax to help them plug a hole in the city’s woefully underfunded pension plan.

“We have, over the years, worked with many public and heavily regulated entities – as business partners. We recognise that active stakeholder engagement that is sensitive to the needs of citizens, governments, local businesses, unions and others is a critical element of successful infrastructure investing,” Agrawal says. He declined to discuss specific reasons why KKR opted not to submit a bid, but summarized them as “concern that there would not be a win-win” for both the city’s stakeholders and investors interested in the deal.

“We very much believe there is a need for private capital in infrastructure and we want to be a partner with communities in pursuing such investment. But in our view, any privatisation should be a win-win for all parties involved,” Agrawal says, pointing to another recent parking auction in Indianapolis as an example.

There, the city council approved a deal that involved not only an upfront payment but also an ongoing revenue share with the private operator, Xerox-owned Affiliated Computer Systems, which ultimately triumphed over KKR in a final two-way bid between the teams. Agrawal declined to discuss any specifics of KKR’s bid.

Eyeing private deals

Despite the outcomes in Pittsburgh and Indianapolis, KKR hasn’t lost interest in parking, or in public-private partnerships overall. The New Jersey Transit Authority recently disclosed the firm was one of seven potential bidders to express interest in a long-term concession for its parking lots.

But Agrawal admits such deals are not the core focus for KKR’s infrastructure team. “We’re not excluding those from the deals that we do, but we are some time off from their becoming an attractive source of deal flow.” He adds that he and his team are busy currently identifying proprietary opportunities with private owners of infrastructure. “In the next three to five years, private-to-private will be where the majority of deals [will] happen,” he says, adding: “That’s certainly where the majority of our focus is today.”