The steady risk-taker

I think it’s an example of conversational syncopation, or something like that. Werner von Guionneau, chief executive of London-headquartered fund manager InfraRed Capital Partners (InfraRed), is almost the embodiment of stability. A tall, imposing individual, he is given to measured, articulate responses to the questions that come his way. He pauses for thought and then plays them with a straight bat. He comes across as the proverbial steady hand on the tiller, which may help to explain why InfraRed’s third fund was able to close on an oversubscribed $1.2 billion in October last year. Investors, after all, like stability and steady hands in these volatile times. And yet, what’s this? Here is von Guionneau suddenly propounding the merits of risk.

And it’s then I’m reminded that – of course – InfraRed is a greenfield investor. “In primary infrastructure, it’s about constructing and commissioning new assets,” says von Guionneau. “This involves the de-risking of a business idea, taking it from paper and turning it into reality. The value creation is very tangible. In secondary infrastructure, you take an existing asset and manage it well. That’s less labour-intensive but involves a continuous drive for efficiency and managing operational assets for the long term to a high standard.”

BOLD ENDEAVOURS

I venture that greenfield is a risk/reward profile out of tune with the times (conveniently ignoring the oversubscribed fund for a moment). Isn’t careful custodianship of mature assets more in keeping with the zeitgeist than embarking on grand projects? My prejudice is that, the grander the project, the longer the list of things that can potentially go wrong. I suppose an example of such bold endeavours might be Singapore’s visionary Sports Hub, in which HSBC Specialist Investments – the forerunner of InfraRed – was confirmed as lead equity investor when the project reached financial close in August 2010.

To those unfamiliar with the €770 million project, which is currently under construction, it comprises (deep breath): a 55,000-capacity national stadium; an aquatic centre; a multi-purpose indoor arena; a water sports centre; 41,000 square metres of commercial space for leisure, shopping and dining; a sports information and resource centre, comprising a library, museum and exhibition centre; a sports promenade and community facilities; and the provision of entertainment at an existing 12,000-capacity indoor stadium (breathe out). It is, in sum, the world’s largest sports public-private partnership (PPP) – and  it all sounds a little bit complex, doesn’t it? As an investor, should I be worried that I may not see a return on my money? Wouldn’t I be better off investing in regulated utilities?

“Risk is in the eye of the beholder,” asserts von Guionneau. “If it’s a strong management team that can manage risk, you [as an investor] are likely to get comfortable with taking risk. You need to understand how a team mitigates investment risks. At the same time, you are entitled to expect a higher reward.”

Von Guionneau is clearly very proud of the landmark Singapore deal [Sports Hub] as, in his view, it enabled his organisation to bring many of its strengths to the table. “It was a hybrid PPP which drew on our skill sets in PPPs and in real estate development [the firm is active in Asian and European real estate as well as infrastructure]. It drew on all our resources due to its scale and complexity. It was challenging and interesting in every respect and there was a lot of knowledge needed to make it happen.”

When von Guionneau talks of investors only being comfortable with risk when they trust the management, it’s no glib assertion (as it might be coming from others). His point is: examine the history of InfraRed and you will find deep roots in the infrastructure asset class combined with loyalty on the part of team members that saw them stick together through a period of profound transition for the business (of which more later). Such traits cannot be easily dismissed in an asset class that is still as youthful as infrastructure.

BANK IN TRANSITION

In fact, the original iteration of what subsequently became InfraRed was only the third team focused on making equity investments in UK infrastructure. It was back in 1997 that it made its first investment in a UK Private Finance Initiative (PFI) project. At the time, it was part of Charterhouse Bank and was investing off the bank’s balance sheet. Von Guionneau had joined Charterhouse as joint chief executive in 1995.

It was a bank in transition – its traditional merchant banking activities were, by von Guionneau’s admission, running out of steam, and it was looking to develop leading positions in markets that were nascent and demanded limited resource. The bank had already advised the UK government on some of the country’s first PFI projects and decided it would not be a big step to move into investing. It did so around a year after Innisfree and six months after Barclays.

It was in April 2000 that the next historic landmark occurred when UK bank HSBC acquired Credit Commercial de France, the French parent of Charterhouse, in an €11 billion deal. HSBC subsequently reorganised the business and divested some parts of it – securities business Charterhouse Tilney was sold to ING Baring, while the management team led a buyout at private equity shop Charterhouse Development Capital. “Our business considered a buyout, but we had talks with HSBC and they understood our strategy and they liked it because it was differentiated,” recalls von Guionneau. “So they decided to keep it in the group.”

This brings us, in von Guionneau’s view, to one of the key ingredients of the trust investors now have in InfraRed: for the 11-year period that it was part of HSBC, it was – while a separate legal entity – subject to the bank’s risk and governance strictures. “It was a specialist investment business that was comfortable with tight controls,” says von Guionneau. A business, in other words, that can take risk because it understands it.

Having initially invested from HSBC’s balance sheet, HSBC Specialist Investments (HSBC SI) closed its first fund – HSBC Infrastructure Fund I – in 2001. The fund raised £125 million (€150 million; $199 million) from institutional investors for investments in PFI and public-private partnership (PPP) projects in Western Europe. The fund was primarily focused on UK assets in sectors such as hospitals, government offices and schools. But it was also responsible for the firm’s first investment outside the UK when it backed the HSL-Zuid PPP in the Netherlands, involving the construction of a high-speed rail link between Amsterdam and the Belgian border.

THE ADVANCE OF THE PPP

It was at this time that PPPs, which had begun in the UK, were gradually spreading to other countries. For reasons outlined later, InfraRed is now almost exlusively focused on markets outside the UK for new deals. Back in 2001, the evolution to an international PPP market was taking its first tentative steps. “We were comfortable working in the Netherlands on HSL-Zuid as it applied the UK PPP standard in all material respects,” recalls von Guionneau. “We worked [on the deal] with some of the same business partners we had worked with in the UK such as Siemens and Fluor. The major difference was that the documents were drawn up under Dutch law.”

The firm was coming to appreciate that, as long as certain ingredients were present, there was nothing to stop the international spread of PPPs. “It is critical to have the right regulatory frameworks and the separation of state and judiciary, as well as financial stability,” says von Guionneau. “This combination dictates when you are able to apply PPPs.” Today, he says, he finds this combination present in the UK and most of Europe, Canada, the US, Chile, Australia, Singapore and “a few others”

By the time HSBC SI had closed its second fund on £300 million in 2004, it was turning its thoughts to how it could effect exits from its deals. A solution arrived in 2006, when the firm listed secondary fund HICL Infrastructure Company (HICL) on the London Stock Exchange. The fund, which subsequently acquired all the assets from HSBC SI’s first fund, was the first-ever London-listed investment company set up to invest in yielding infrastructure projects. HSBC SI was appointed the investment adviser to the fund with responsibility for its day-to-day management.

“We knew how to manage the assets well, which made it a stable business,” says von Guionneau of HICL. “And by now these were operational assets, so the construction and commissioning risks had been taken out. They were strong, good assets that we wanted a long-term affiliation with.” He concedes, however, that “it was challenging at the time as it was the first one [of its kind] and there was a lot of convincing to be done in the investment community”. He returns to that crucial theme mentioned earlier – a key part of HICL’s ultimately successful adoption by the market, he insists, was its “very high threshold for governance and transparency”

Today, HICL is over £700 million in size according to InfraRed’s website. “It’s now six years since the flotation and, although the fund is listed equity, it has strong fixed income characteristics,” von Guionneau notes. “The volatility of the stock has been very low, in spite of there being exceptional equity market conditions, making it essentially uncorrelated with the equity market.”

SPINOUT

The next big turning point for the business came when it span out of HSBC in 2010 to form the independent InfraRed. The spinout had been 18 months in the making by the time it happened. “The seeds were laid when it became clear that what we did impacted the wholesale bank’s balance sheet due to increased capital weighting for our investments at a time when that balance sheet was focused  on serving its core business activities [following the global economic crisis]. Moreover, the regulatory framework, particularly the Dodd Frank act in the US, made it less tenable for global banking operations to retain private equity activities.”

Von Guionneau said HSBC SI needed a “solution that would serve the investor base and be a strong business with good governance and systems, so that HSBC could be taken out [of the equation] without adversely affecting stakeholders”. He reiterates the point that, although controls were imposed on the business by HSBC, it was effectively a standalone entity. “It would have been difficult if we had not been operationally separate,” he insists.

Although he was concerned about the investor reaction, von Guionneau makes it clear he was at least as concerned with how any spinout proposal would be received by the members of his own team. He says: “The biggest reward for me was that all the staff came with the new business. All 28 partners took the invitation. It’s very difficult to get everyone in the same tent, and lots of buyouts don’t happen for that reason. But it was hard work. It always takes three times as long as you think it will and you end up with many [more] grey hairs. But we created a strong business.”

“Cohesion in the investment team” is one of the reasons cited by von Guionneau for the closing of InfraRed Infrastructure Fund III, a primary fund taking construction and commissioning risks on an oversubscribed $1.2 billion in October last year (the fund had been aiming for at least $1 billion). The firm had raised almost half of this amount at a $580 million first close before the spinout from existing investors who, in von Guionneau’s words, were “just as happy to invest whether the buyout happened or not”

Interestingly, the second half of the total amount came from investors that previously would not have been likely to give the firm much consideration. “We had to stop fundraising for six months,” says von Guionneau. “Then, once we had articulated the buyout, we broadened it to investors who would not invest with captives. And we drew in a strong list of blue-chip investors.” What InfraRed ended up with was the world’s largest greenfield infrastructure fund to date.

In a geographic context, the fund represents the continuing evolution of the PPP market. As mentioned earlier, the first HSBC SI fund was focused mainly on UK assets although it dipped its toe in the water in the Netherlands. By the time of the final close of InfraRed Fund III, it had put $400 million to work – but not a single dollar of this had been invested in the UK.

BEREFT IN BRITAIN

Moreover, it’s no coincidence that the fund is denominated in US dollars where the previous two infrastructure development funds were sterling-denominated [the first non-sterling fund, incidentally, was the €235 million Environmental Infrastructure Fund, which it closed in 2009]. While Europe is still a target region, the new fund is also pinpointing opportunities in North America, Singapore, Hong Kong and Australia. The firm itself now has offices in Paris, New York and Hong Kong as well as London.

Von Guionneau says the drying up of long-term bank finance explains the diminishing importance of the UK for new deals. “The UK needs to find a solution for debt funding and PPPs will not take off again in a material volume until that changes,” he says. “The UK is not a core market at the current time [for primary deals]. The secondary market is healthy at the moment but it follows the primary market by about five to seven years, so eventually it will also dry up if no new assets are being built.”

Von Guionneau’s view is that the UK needs to overcome “structural issues” such as the reduced appetite of banks for long-term lending in light of the increased capital weighting under the Basle III regulations, and also the near-disappearance of the monoline insurers which means investors “have no way to get into the long-term funding market in the way that they used to. There are currently no market participants undertaking proper risk assessment for PPP debt which have interest alignment with long-term institutional investors ”

In Canada and Australia, he says, things are rather different. “You have a private placement market in Canada that works well. In Australia, you have shorter-tenor capital markets so projects get funded with refinancing risk. The Australian market has accepted that this changes the risk profile of transactions, but we’re not used to it in the UK.”

RICH POTENTIAL

His observations on the UK greenfield market should not be confused with a pessimistic outlook, however. Far from it. Not only does von Guionneau see rich potential in other [geographic] markets, he also believes that the future of the infrastructure asset class as a whole is a bright one. “Growth potential is favourable because it [the asset class] meets investor requirements. It’s starting to become more of a mainstream fund management activity with management fees reducing, particularly for secondary funds investing in economic infrastructure. As the secondary markets have matured during the past years the sector has developed more scale, which in turn opens up the market and enables further growth. The initial [fee] excesses have drained from the system.”

Arguably, the maturity of the asset class is apparent in InfraRed’s success in persuading the investment community that stability and risk can indeed be reconciled. Von Guionneau is himself pondering issues of stability and risk as a I prepare to depart. Stability is offered by the prospect of an annual family trip later in the year to the tranquil shores of Lake Michigan in the US – a much-needed break from the hurly burly of running an international investment business. The risk is in telling me that he has discovered there the best location for best salmon fishing in the world, since he doesn’t want anyone else to know. Oops.

“The seeds were laid when it became clear that what we did impacted the wholesale bank’s balance sheet due to increased capital weighting for our investments”

“There are currently no market participants undertaking proper risk assessment for PPP debt which have interest alignment with long-term institutional investors ”

INFRARED CAPITAL PARTNERS AT A GLANCE:

1990: established as principal real estate investor within Charterhouse Bank (first infrastructure investment in 1997)

1998: Opens to third-party investors

2000: Acquired by HSBC and named HSBC Specialist Investments

2006: Launches London Stock Exchange-listed HICL Infrastructure Company

2007: Opens Hong Kong office

2008: Opens New York and Paris offices

2011: Acquired by management team and renamed InfraRed Capital Partners

Business areas

Infrastructure development; secondary infrastructure; environmental infrastructure; Asian real estate; European real estate

Infrastructure funds

HSBC Infrastructure Fund I (2001, £125m); InfraRed Infrastructure Fund II (2004, £300m); HICL Infrastructure Company (2006, over £700m); InfraRed Environmental Infrastructure Fund (2009, €235m); InfraRed Infrastructure Fund III (2010, $1.2bn)
Size of team: 80, including 28 partners

(Source: www.ircp.com)