Out of private equity’s shadow

As if he were not already persuaded, the benefits of long-term investment in infrastructure have come into even sharper focus for Thierry Déau, founding partner and chief executive of Meridiam Infrastructure, on this September morning in London. After all, he was earlier forced to watch around four packed underground trains depart his Victoria line platform before he was finally able to board one. As the city’s commuters know well, London’s tube lines have suffered notorious under-investment over the years.

Paris-based Meridiam, which has a strong presence in North America as well as Europe, is one of the firms providing the private capital that is sorely needed for infrastructure development in a world of cash-strapped governments. The firm has been busily investing a €600 million fund, which it closed in 2008, in notable projects such as the €7.8 billion Tours-Bordeaux high-speed rail line in France and the C$585 million (€419 million; $568 million) Montreal University Hospital Research Centre in Canada. Two further funds – one focused on Europe and one on North America – are currently being raised.

Road to recognition

Sipping a reviving coffee in the lounge area of the Goring Hotel near Buckingham Palace, Déau reflects on the history of private capital involvement in infrastructure. The journey to recognition as an asset class in its own right has been a relatively brief one, he explains, but with a number of twists and turns.

“In the late 1990s, the Private Finance Initiative (PFI) was launched in the UK and in Australia some notable infrastructure transactions were coming to completion. [Australian investment bank] Macquarie was a pioneer in making the asset class visible and various Australian infrastructure funds were springing up. In the UK, the likes of HSBC and Barclays were also looking to raise funds.”

It’s sometimes thought that private equity funds were the pioneers of private investment in infrastructure. In fact, not only investment banks but also pension funds investing directly got there first. In regard to the latter, Déau points to the 1999 privatisation of the 407-ETR toll road in Canada, which saw Caisse de Depot et Placement du Quebec take a 16 percent equity stake in a deal led by developers Cintra and SNC-Lavalin.

In was not until after 2000 that infrastructure began to obtain more of a private equity flavour. Initially, says Déau, the focus was on operational PFI concessions before expanding to all types of infrastructure. Around 2005, came “a huge phase of big projects and company acquisitions dominated by the private equity model”. “Suddenly, everyone wanted to do infrastructure,” notes  Déau. At this point, one of his trademark mischievous smiles provides a hint that he probably doesn’t think of this as a good thing.

Anomaly

Until the global economic and financial crisis came along, infrastructure investing had certain characteristics in common with leveraged buyout investing – among which were the use of large amounts of cheap debt and a focus on the short term. In retrospect, this can be seen for the anomaly that it was.

“One of the main reasons I created Meridiam was the over-use of leverage, which meant that I knew things wouldn’t end well,” reflects Déau. “The way that infrastructure had been sold to investors was not what they ended up getting. It prevented investors from having access to infrastructure’s most attractive features such as long-term cash flows and liability matching.”

Déau says that fundraising for Meridiam’s debut fund was a “hard pitch” all the while investors were drawing false suppositions about infrastructure’s risk/return profile which, in his view, had been distorted by private equity-type strategies. “I had a hard time explaining to investors that aiming for a 12 to 13 percent return did not make me a big loser compared with those who said they could get at least 15 percent. What was being offered were two different things.”

The crisis has had a cleansing effect, in Déau’s view, since investors are now better able to understand the asset class. “The crisis took away the leverage,” he says. “It became much clearer what was robust and what was not, and made apparent the nuances of infrastructure.”

He points out that it became easier to identify assets that had, for example,  a strong correlation to economic performance, sensitivity to leverage or a strong susceptibiity to changes in regulation. Investors also realised “that management of assets is important and that the public-private partnership (PPP) side is rather uncorrelated [to the rest of the asset class]”.

Own fund model

As understanding of these nuances deepens, so investors are increasingly sympathetic to the idea that infrastructure may need its own fund model (or models) rather than the off-the-shelf private equity version that had become dominant.

One difference that’s emerging is the length of fund lives, with Meridiam’s own fund having a 25-year time horizon in comparison with the 10 years typical of private equity funds. “The model had to evolve to a longer term,” insists Déau. “That has been a major change in trend, and even some of the remaining private equity-type infrastructure funds are now stretching to 15 years.”

As part of infrastructure’s evolution, Déau also notes increasing fund specialisation: ranging from the world-spanning mega-funds such as Global Infrastructure Partners (GIP) through mid-market funds to those with more of a greenfield (new development) focus, such as Meridiam or InfraRed Capital Partners.

The ‘new era’ of infrastructure investing involves listening closely to what investors want and responding accordingly. This is clearly illustrated by the momentum behind co-investment. “One new feature is that investors absolutely want co-investment,” says Déau. “There is no fundraising today without a commitment to co-investment. Investors are more educated. They want a different partnership between investors and fund managers which is more long-term relationship based.”

Déau doesn’t need the evidence of his unfortunate experience on the London underground to persuade him of the potential for infrastructure investment in developed markets. He notes the stimulus packages, such as President Obama’s famous jobs plan, and thinks that efforts to promote economic growth will increasingly revolve around PPPs – even in wealthy countries.

“Even Norway, which is rich, uses PPPs for efficiency reasons,” he says.

In emerging markets, meanwhile, the need for infrastructure investment is obviously enormous, although more akin to private equity investment at this point in time due to these markets’ typically rapid growth trajectories.

More products

Déau believes that more infrastructure investment products will continue to be introduced (debt funds would be one recent example) to cater to investors’ needs.

“Infrastructure has gone from a private equity game to having a broader scope with well-identified features, and now a spread of products is developing. Just by expanding the number of products – all the way from those with private equity features to fixed income characteristics – you could triple the size of the asset class.”

Déau smiles again, before draining his coffee cup. Pondering the tripling in size of the asset class has no doubt put him in a more positive frame of mind than standing on a cold underground platform as London’s transort deficiencies materialise in front of him.