Here comes the wave

It’s a crisp but sunny morning in Sydney as seven of Australia’s leading infrastructure investment professionals gather to discuss key market themes. The location is the Shangri-La hotel in the historic Rocks precinct, where the original European settlers first put down roots in the late 1700s. Ironic in a way, then, that we come together at a time when European banks – hampered by the Eurozone crisis – have been fleeing the Australian infrastructure market. At least their mode of travel will have been more comfortable than those who journeyed in the opposite direction more than 200 years ago.

The absence of European lenders is one of the talking points that crops up during the exchange of views between those present: David Roberts (ANZ Banking Group); Danny Latham (Colonial First State Global Asset Management); Raphael Arndt (Future Fund); Richard Hoskins (Hastings Funds Management); Michael Hanna (Industry Funds Management); Greg Boyer (Infralink); and Duncan Taylor (Lend Lease Investment Management). But, while financing is an important issue – and one that will be returned to later in this article – the mood in the room is a positive one, and that’s because Australia is contemplating an upsurge in privatisation-led deal flow that has not been seen for the last 10 years.

Revival in full swing

The last strong wave of privatisation in Australia came in the 1990s, led by the state of Victoria’s sale of $30 billion worth of public assets ranging from prisons to toll roads and hospitals. Since then, things have been relatively quiet. But a privatisation revival has been underway in Queensland, where a $15 billion sell-off was announced in 2009. This programme is now in full swing, with examples including a 99-year lease of Port of Brisbane to a Global Infrastructure Partners-led consortium in November 2010 in a A$2.1 billion (€1.5 billion; $2.1 billion) deal and another 99-year lease being sold to India’s Adani Enterprises for the Abbot Point Coal Terminal in May 2011 for A$1.8 billion.

“There had not been any privatisations for quite a while and when Queensland did theirs it attracted interest outside PPP [public-private partnership]-type investors,” reflects Arndt. “And there were not just domestic bidders but offshore fund managers coming into Australia for the first time in a decade.”

“After a decade of little primary transaction activity, expectations had been managed down,” adds Latham. “Now we’re back at the start of the cycle. There is an increasing focus by the likes of [industry bodies] Infrastructure Australia and Infrastructure NSW (New South Wales) on infrastructure as a mechanism to enhance productivity. These bodies provide an important interface between the politics and the corporate sector to promote investable infrastructure deals.”

Queensland still has some way to go with its privatisation programme. Despite the unpopularity of state sell-offs – thought to have contributed heavily to the annihilation of the Labor Party in the state election earlier this year – Queensland’s new Liberal National Party premier Campbell Newman has indicated his commitment to continuing privatisation as the only way to rein in state debt and win back the AAA rating that was lost in 2009.

Monetising brownfield

Unsurprisingly, given that we are currently sat in the state capital, it’s developments in New South Wales that occupy the minds of many of those present. There are strong similarities with Queensland. Here, too, a state election [in March last year] saw the incumbent Labor Party defeated in a landslide by a Liberal-National coalition. And here, too, a subdued market for deal flow is giving way to what many anticipate will be a booming market in the years ahead.

“The change in government here [in NSW] has been very important,” says Hoskins. “They are committed to monetising brownfield assets and reinvesting the proceeds in new projects. That model will be very useful and we expect it to be adopted by other governments.”

One of the deals being talked about in a New South Wales context is the 99-year lease of Port Botany, Australia’s second-largest port, which was announced in December last year. This is one of the examples of the trend cited by Hoskins where the intention is to channel the proceeds of the sale – expected to fetch around A$2 billion – into other infrastructure projects across the state.

“There’s a real demand for infrastructure investment,” asserts Roberts. “There has been a lot of discussion about [Port] Botany and consortia are coming together, even though the transaction is not expected to commence until October this year, finishing in mid-2013.”

However, Roberts goes on to make the point that, with a large number of projects set to come through the pipeline, how the deal flow is organised by government will be crucial. “There are a number of major projects but there is a need to bring order to the pipeline so that it’s properly planned. Different infrastructure bodies have their own lists of projects and there is a need to bring them together to develop clear priorities for major projects,” he says.

Thumbs up for desalination deal

“The process is very important, including the quality of the people leading it,” agrees Hoskins. “We’ve seen the government run poor processes in the past, like BAFOs [Best and Final Offers] and they have been very discouraging for the bidders. Equally, we [the private sector] need to make sure we give the government encouragement when they have got it right – as we believe they did with the Sydney Desalination Plant. New South Wales [government] had the right people on the deal and it turned out to be a refreshing process for all concerned.”

It should be noted that Hoskins is not commenting as an outsider on the Desalination Plant, as Hastings Funds Management was part of the winning bid team on the A$2.3 billion deal alongside Canadian pension Ontario Teachers Pension Plan in May this year. However, he is not the only roundtable participant to speak in glowing terms of the deal and to see it as something of a template going forward. Arndt describes it as “a good experience for the state government” while Roberts says the deal marked a “ratcheting up” of the government’s engagement with the private sector.

Hanna says he sees superannuation funds as the “perfect” owners of privatised assets. “Taxpayers still get to own them but through their super fund rather through the government. Super funds’ commitment to long-term, responsible and sustainable investment in assets is illustrated by the five capital city airports that we are an investor in: Melbourne, Brisbane, Darwin, Adelaide and Perth. A total of $2.9 billion in capital investment has been put in versus $1.2 billion taken out in distributions over the 2002 to 2010 period.”

With what Arndt describes as “tens of billions of assets on the balance sheet” in Queensland and New South Wales, it is clear why there is optimism that a lack of deal flow will be a thing of the past. However, if too many deals come on tap at once, it brings fresh worries. “The interest in privatisations in Australia will be significant over the next two or three years,” says Hanna. “Will that mean another pricing bubble? You will need to maintain discipline and buy well. The market could get quite hot.”

Latham counters: “This is an experienced market so the overheating risk is low. When overseas funds come in, I think they will mostly look to tie up with local players [rather than compete against them].”

Lack of debt

One factor which could dampen down any threat of over-heating is the supply of debt [or lack of it]. “Debt availability may constrain prices,” claims Arndt. “The banks are pretty supportive, but that’s right,” Roberts follows up. “We used to have 30 percent of the bank market for major infrastructure projects coming from the Europeans, so that has contracted.”

This brings us back to the point made at the outset about the flee of European banks in the face of the continuing Eurozone crisis. However, there is strong faith in counter-balancing factors that will enable Australia’s debt supply to remain relatively strong. “There’s still an important role for the banks,” insists Roberts. “The Europeans may have reduced their activities but Japanese banks remain active, for example, and we can also look with some optimism to the bond market.” He also points out that export credit agencies have helped fill the gap for longer-dated capital than the banks currently wish to provide.

There appears to be no sense – at least at present – of the debt markets significantly hampering the activities of those around the table. “With the Desalination Plant, it was 25 percent oversubscribed on the debt side,” says Hoskins. “The market was incredibly supportive.” Adds Hanna: “We’ve refinanced around A$7 billion and most of that has been oversubscribed, both here in Australia and in the US and European markets. There’s no lack of appetite.”

All of which said, it is acknowledged that sources of long-term funding are less easy to identify as the banks are only generally now prepared to commit for up to five years. “There is a gap beyond five years and we’ve seen some private debt issuance,” says Arndt. “We’ve seen Australian corporates going to the private placement market. But while you can access funding this way for larger projects, what about the smaller ones?”

While there are calls – as in other markets around the world – for more long-term pension funding, there are particular issues in an Australian context. “Governments say they want more from pensions but then the advent of My Super [a new, low-cost but basic superannuation product introduced by the government] is pushing funds towards more liquid investments, so there is a disconnect,” says Latham.

He continues: “Also, there is a trend more towards defined contribution schemes in Australia rather than defined benefit. Most schemes globally are defined benefit, where there is less of a liquidity issue and greater comfort with long-term investing.”

PPPs ‘need a solution’

One additional financing concern brings us onto the next topic of debate: public-private partnerships (PPPs). The concern is over those PPPs that will require refinancing or a consent from the lenders before the end of the project’s life. “When they come to be refinanced or are repriced, the equity value will not be the same,” points out Hoskins. “For the PPP market to survive, we need to find a solution. Funding a viable, long-term market for debt is critical; otherwise, PPPs could hit a brick wall.”

“Refinancing risk is a major issue that must be managed,” agrees Taylor. “There is a cost of capital difference, and there are a number of government initiatives looking to address this. But there are many large infrastructures projects required and the private sector brings innovation and value for money for the state, so the market is still quite strong overall.”

Aside from refinancing risk, the other issue that gets brought up frequently in discussions about PPPs is the lack of contract standardisation. “Each state has a different approach and is resourced differently. There is not a single national procurement agency,” points out Hoskins.

“All that happens in the UK is that you look at any departures from the standard contract,” adds Arndt. “In Australia, we don’t have that standard contract, so the cost [for bidders] is higher. So that has limited the market.”

On the point about cost, Hanna adds: “It takes four times as long to do greenfield PPPs compared with brownfield deals and there’s five to seven times more bid costs.” According to some estimates, which take into account investment banking fees, around 16 percent of the bid costs for a typical PPP go out of the door on day one.

Another inhibitor on the PPP market, according to Boyer, is a “limited competitive environment”. He adds: “A lot of deals are done by the top four or five players. A lot of other deals could have been done by now but there’s the time, the cost – which can be prohibitive – and the regulatory requirements. The government should take on more risk in order to to make projects more cost effective.”

Hankering for hybrids

Boyer, adds, however, that he is confident a more optimal model will be applied to PPPs going forward. “There have been examples where there has been demand risk, especially in the transport sector, that have not worked and new hybrids are being looked at between demand risk and availability payments. There will be a morphing with a better sharing of risk between government and its private partners.”

Taylor is optimistic that the government will continue to keep PPPs flowing, and not just for reasons of funding. “What we also bring is the innovation of the private sector,” he claims. “In Australia, many PPPs have been larger and more complex than elsewhere and we bring innovation benefits in design and delivery. It’s another reason why the government looks to PPPs – innovation, not just funding.”

As an example of this innovation and complexity, reference is made to the A$2.5 billion Royal Adelaide Hospital PPP, which closed in June last year and was led on the equity side by the UK’s InfraRed Capital Partners with support from 15 banks.

Another reason why he is optimistic, Taylor adds, is that he sees a lot of appetite for Australian PPPs from international capital providers – especially on the equity side. “There is long-term international capital coming into greenfield PPPs,” he says. “That’s not been seen for a long time and I believe it’s here to stay.”

Boyer says more PPPs could emerge from the pipeline if there were more of a focus on smaller projects rather than the complex deals Australia is famous for. “Small projects have a shorter timeframe, and would have the benefit of allowing governments to shout about their achievements within electoral cycles.”    

Resource-rich

By now the clock is ticking, but there is still time to discuss some of the other issues exercising the minds of those round the table. Among these is the potential of the resources sector. What is not in doubt is that, a resource-rich nation, Australia is currently experiencing a resources boom – with rocketing demand from China in particular. According to a report from the Bureau of Resources and Energy Economics, Australia’s resources exports reached a record A$190 billion in 2011 – a 15 percent increase on the previous year.

What is in some doubt, however, is exactly what the role of infrastructure investors should be – if any – in helping to build out the infrastructure that mining and resources companies increasingly require in order to ensure the efficient transportation of their goods.

Taylor is optimistic. “The size of the resources boom and required infrastructure spend means that that the miners are likely to turn to external investors to fund the construction needs. We have recognised this and established a group to target these opportunities,” he says. 

There have already been some notable resource-related deals. The Abbot Point Coal Terminal deal referred to earlier saw Indian infrastructure firm Adani Enterprises pay A$1.8 billion in May 2011 for a 99-year lease of the terminal, which serves as the gateway to Queensland’s coal-rich Galilee Basin. Infrastructure fund interest in the deal was strong, with rival bids from the likes of Brookfield Infrastructure Partners, Macquarie, Cheung Kong Infrastructure and RREEF beaten away.

Meanwhile, the Wiggins Island Coal Export Terminal, also in Queensland, achieved financial close in September last year with A$2.5 billion of private funding for development and construction through a financing package of senior and subordinated debt arranged by ANZ. 

In addition to deals such as these, Latham believes opportunities may also stem from resource companies divesting non-core assets. “There has been an ‘unbundling’ process in Europe which extends beyond that prescribed by regulation and increasingly encompasses divestments for economic reasons so that capital can be redeployed into higher-earning assets. We’ve seen it in Norway with [the] Gassled [transaction], we’ve seen it with MLPs [Master Limited Partnerships] in the US, and we’ll see it here. Mining companies will look at their balance sheets and see lazy assets that they don’t need to own.”

When social critic Donald Horne famously dubbed Australia the “Lucky Country” in a 1964 book, it was not meant to be a positive assessment. These days, however, it’s hard to appreciate the irony that Horne intended. With its resource-fuelled economy still moving strongly ahead, and opportunities apparently springing up for infrastructure professionals such as those gathered around me, it certainly doesn’t feel like an unlucky place to be.