“We’re in a better place now.” Surveying the immediate environment, you might be forgiven for thinking Thierry Déau is referring to the Royal Exchange, the impressive building in the heart of the city of London where seven European infrastructure investment and advisory professionals have gathered to discuss market trends.
Founded by Sir Thomas Gresham in 1565 as a centre of London commerce (though twice rebuilt after fires), the Exchange is home to luxury shops and a restaurant, where – from an upstairs room – we gaze down upon a scene of coffee cups being drained and tasty-looking delicacies consumed. It does indeed seem a better place than the chilly streets outside, from where we have sought refuge on this Wednesday morning in early November.
But Déau, founder and chief executive officer of Paris-based fund manager Meridiam Infrastructure, is actually commencing the conversation with reference to the Eurozone. It has taken steps forward, he believes, from when participants at our equivalent European fund management roundtable a year ago confessed to suffering harrowing visions of a Eurozone tearing itself apart.
Describing himself as a “Euro optimist”, Déau says: “The European Central Bank (ECB) has made clear, reassuring statements. In Italy, they’ve done their homework and made progress. It’s the same in Spain, Portugal and Ireland. The last country to deal with its issues is France, but there are fewer issues in France. Banking union will create more stability and make the Eurozone stronger.”
Marcus Ayre, director of infrastructure transactions in the London office of fund manager First State Investments, adds: “A year ago, we were talking about contagion. Now that there appears to be a firmer footing for the Eurozone, the focus is beginning to move away from rescue towards fostering growth. Infrastructure is seen as a key way to foster that growth.”
The last point made by Ayre has enormous significance for those in the infrastructure investment universe. Ever since the global financial crisis struck, infrastructure has been talked about by politicians as if it were the panacea for weaknesses that could only in reality be addressed by changes of a structural nature. But with the bulwarks against calamity having been erected, there is a sense that growth – however slow – may now be realistically contemplated. And it’s in this new phase that infrastructure may come into its own, as confidence in getting deals and projects underway rises.
“Most of the extremely drastic action has happened and there are new initiatives for growth,” agrees Alain Rauscher, founder and chief executive officer of Paris-based fund manager Antin Infrastructure Partners. “You have also seen the limits of austerity programmes, which can be devastating. It’s not just about cutting costs. The Spanish effort has been too costly in some ways – for example, the level of youth unemployment. But the ECB has made the Eurozone much safer, to the point where it could now absorb the cost of a Greek exit if it had to.”
Of course, this is all relative – as those quoted above would be quick to acknowledge. No one is saying that all the problems of the Eurozone have been miraculously rectified. If anyone needed a reminder of this, it came one week after the roundtable had convened when anti-austerity strikes were staged across the region and – not for the first time – violent clashes with police erupted. The region also dipped back into official economic recession.
Perhaps Martin Lennon, head of London-based fund manager Infracapital, had in mind the potential for such events when he made the observation that “Europe still has some work to do to win back unquestionable global confidence.” He added: “For some international investors, certain parts of Europe are still off the radar screen because of austerity measures and doubts about the future behaviour of politicians and policy makers. Stability supports investment, and a high degree of political risk is not particularly consistent with that. There is still a risk, albeit perhaps one that has receded, that a country or countries may come out of the Euro.”
The South’s ok
Nonetheless, things are slowly edging towards normality – even if it’s a new kind of normality. This includes what appears – to this observer at least – to be a slight warming towards opportunities in Southern Europe. The key thing – whichever country you are investing in – is to price risk appropriately, Rauscher argues. He says this is as important in the north of Europe as the south. “In Germany, assets are priced at high levels and you’re looking at 8 percent returns,” he points out. “Why do it for an 8 percent return? Do you not have a better home for the money? It shows that you need pricing discipline in the ‘lower risk’ countries as well.”
“You need a balanced view,” urges Ayre. “If you’re a European fund, it’s difficult to entirely exclude the third- and fourth-largest economies [Italy and Spain] especially when pricing levels appear to be challenging in the largest [Germany]. There may be appropriate risk-adjusted investments in Southern Europe – but you have to make sure you maintain a strong dialogue with your investors to make sure that they are comfortable with what you are doing.”
The point being made is to not rule out investments just because the investing environment in a particular country looks messy. Arguably, proof of adept management lies in carefully assessing the risk/return profile and then making a considered judgement based on the merits of each individual case.
“We want general partners (GPs) to be selective and disciplined,” says Fabian Poetter, an investment manager at Munich-based Golding Capital Partners, which advises German institutional investors. “You can’t pass on good opportunities just because investors might not like them straight away. However, GPs need to build a strong and compelling case for their investors.”
While much of the discussion in a European context has been about the relative merits of north versus south, I ask whether there are any signs of a renaissance for infrastructure investment in Eastern Europe – another of those promised lands that ceased to look quite so attractive when the Crisis exploded.
“As greenfield investors, we have focused on Poland, Slovakia, the Czech Republic and Turkey, and maybe we will do something in Romania one day as well,” says Déau. “There is a lot of appetite and the European Bank for Reconstruction and Development is trying to help a number of countries. There was a recognition that when countries acceded to the European Union, they needed to develop their infrastructure further.”
“There are selective opportunities in Eastern Europe” adds Ayre. “Many of the Eastern European economies are showing continued economic growth and there are good prospects, but you need to balance that with the political risks and the robustness of their legal frameworks. Generally we are seeing more investable opportunities in the northern parts of Eastern Europe, than the southern parts.”
Poetter says he prefers to see funds adopting a selective approach to Eastern Europe rather than heading there with more enthusiasm than judgement. “If a fund is looking at the East, they might well choose to do selective deals there,” he says. “But we are wary of those who say ‘the future is in renewable energy in the East’ and seek to raise a lot of money specifically for that. It could be damaging to the investing environment as they will need to deploy all that money.”
The money is there
On the subject of capital deployment, those around the table are encouraged by the level of availability of finance for infrastructure. “The lending markets are robust,” says Ayre. “Lending has ebbed and flowed and there is certainly not the exuberance of 2006-07. That’s good because people have lost money through undisciplined lending. There are no longer the big sole bank underwritings but you can still find clubs of sensible lenders. And the capital markets are a big story today; they have played a major role in refinancing of infrastructure assets.”
Appetite for debt is a talking point. “At least 30 percent of our investors are asking me if they can access debt even though they have equity investments through our fund,” says Déau. “Three to four years ago they didn’t even think about it.”
“German insurance and reinsurance companies looking at the level of returns that are available from government bonds simply have to look at project finance debt and infrastructure fund debt,” adds Poetter. “You also have bank debt and you have debt funds, although most of the latter are complex products that are difficult to explain to investors.”
The picture painted is certainly rosier than some might imagine. It doesn’t seem all that long ago that the sclerotic financing environment in the wake of the Crisis appeared to have applied the brake to all manner of deal-related activity, including in the infrastructure sphere. That doesn’t appear to be the case now. However there’s no denying that, in the ‘new normal’, investors have to find a way of adapting to shorter tenors for bank finance – and that means having to confront the recapitalisation process more often than used to be the case.
“We have always estimated our returns without assuming any recapitalisation. Today, investors in infrastructure are typically faced with one or even two re-financings during the life of an asset,” says Rauscher. “That has implications both in relation to the pricing of deals and also the debt skills of the team. Do GPs have employees specialised in debt structuring and re-financing? It puts a lot of new pressure on our community. As far as Antin is concerned, we have integrated specialist financing skills from day one, realising this was going to be crucial to managing our investments in a tough environment.”
Bruno Candès, an investment director at Paris-based fund manager OFI InfraVia, believes that one of the problems facing the infrastructure financing market is a fundamental disconnect. “As an infrastructure owner you are looking at long-term debt within a structure that matches the amortisation profile of the asset. So there is an offer. On the other hand, investors want yield. So there is a demand. You need a market that connects the two. Transition between the project finance bank market and a deep infrastructure debt capital market has not happened yet, in particular as transfer of intellectual capital is often lacking.”
Failure not inevitable
One concern that seems to have receded somewhat is that a wave of infrastructure assets, facing an inability to refinance, would end in high-profile failure. “The banks are not being as aggressive as they might have been and collaborative solutions are being found,” says Lennon. “The predicted crescendo of infrastructure assets falling apart due to excessive leverage has not happened at the scale that might have been expected, although there are definitely investment opportunities coming off the back of the so-called refinancing wave.”
Talking of investment opportunities, few subjects have received as much attention within infrastructure circles recently as the prospect of pension fund money flooding into the asset class. Those present have not fallen for the notion that this will be a quick or straightforward process.
“Infrastructure has all the attributes many investors could want,” reasons Poetter. “There is a lot of talk about it for a reason. But pension funds are very conservative and that’s why getting them involved takes time. We talk to German corporate pension funds and they are still looking at it and working to understand the asset class.”
Lennon makes the point that – contrary to contemporary myth – institutional investors have long been involved in infrastructure financing, in some cases going back to the 1980s. However, Déau points out that “while pensions have always been on the scene, they have typically had 2 percent in alternative assets and only a little over zero in infrastructure. Now they want 5 to 10 percent in infrastructure and the question is how you get this money from pensions in a much bigger quantum”.
It is not lost on those present that there exists an apparent contradiction between the pension-related ambitions of politicians and the actions of regulators. “There is a lack of joined-up thinking,” asserts Ayre. “With Solvency II [the EU-wide insurance regulations due to take effect in 2014], there is the question of whether it will be extended to cover pensions as well and effectively kill off long-term infrastructure investment.”
The fight for utilities
If anywhere is seeing a “flood of money” at the moment it’s the large cap regulated utilities space, which has been attracting particular attention. The sector is “fiercely competed over”, says Lennon, who adds: “It’s perceived as lower risk and therefore as a relatively comfortable route for direct investors so it lends itself to scale and therefore to the involvement of sovereign wealth funds.”
“There is plenty of money out there and that increases the pressure to do deals and impacts pricing,” adds Candès.
Not everyone thinks the deal arena is crowded, however. Rauscher, for example, insists Antin is typically up against “one or two parties” in any given bid process. However, as core infrastructure in particular has attracted attention in recent times, it has placed a renewed focus on asset management as the way to drive an acceptable return.
“We’ve talked a lot here about buying, but these are businesses that need managing,” asserts Ayre. “There is a considerable amount of risk that needs to be managed. It’s very difficult for direct investors to do this and still make the economics stack up.”
The conversation has led to place that infrastructure investment professionals will often be guided towards by limited partners when fundraising. Namely, what is infrastructure really? With appetite cooling for government bonds, there is a trend for fixed income investors to shift allocations to lower-risk infrastructure: creating an impression that it is merely a higher yielding form of fixed income. But many of those on the infrastructure investment frontline would see that as an insult to their ability to drive value creation.
“Fixed income simply involves monitoring investments, but for us, asset management is crucial,” says Lennon. “The equity upside is vital and it’s delivered through asset management.”
Rauscher describes Antin’s approach as “private equity investment with attractive yield. It’s not a mere 8 percent return and 2 percent yield. It should be paying a good yield – better than the stock market. As for total returns, Antin aims for mid teens. To do this, you need to be disciplined enough to buy well, ensure the appropriate leverage structure is in place and work actively on value creation within the portfolio companies. The only way to get a 15 percent return is to work hard.”
Appreciating the difference
As the investor base matures, there is little doubt that more accurate distinctions are being made between different types of infrastructure strategy. “It’s very different now from four or five years back when people were investing in infrastructure for the first or second time,” says Rauscher. “Now they have typically invested with several managers and they have seen how GPs perform in tough times.”
Candès says this maturing of the investor base has created a better fundraising environment. “It’s diverse on the GP side and there is a sophisticated dialogue now. LPs with consultants can decide which strategy suits them. I wouldn’t call it a tough [fundraising] market. It’s a new norm. It was probably too easy before [pre-Crisis].”
One subject being raised more often as part of this GP/LP dialogue is that of the ESG (environmental, social, governance) aspects of investing. With infrastructure assets typically held for the long term, used frequently by the general public and subject to environmental impacts, ESG is arguably more pertinent than for other asset classes.
“Infrastructure funds, given their longer time horizons, are arguably more exposed to sustainability issues such as climate change, biodiversity and community pressures which are only likely to significantly increase over time,” points out Mark Hoff, a partner for Central and Eastern Europe at sustainability consultancy Environmental Resources Management.
He adds: “Limited partners and investors increasingly want to see the evidence that infrastructure funds have the necessary ESG processes and systems in place to manage such issues effectively. Some development finance institutions make the presence of an appropriate ESG management system a pre-requisite prior to fund commitment. The mandatory UNPRI reporting in 2013 is expected to further drive transparency and disclosure on ESG issues in this sector.”
Hoff thinks that traditional environmental due diligence “rarely covered such longer term forward looking issues with the degree of robustness it requires”.
In a way, Hoff is preaching to the converted. A recent US Environmental Defense Fund report showed that 92 percent of private equity general partners (GPs) expect to increase their focus on managing ESG issues in the next three to five years, while 54 percent of GPs are already leveraging ESG management to reduce risk and boost earnings.
ESG “suits infrastructure extremely well,” adds Candès, “as it matches what we’re investing in. The assets are connected with a lot of stakeholders and communities and, if ESG is managed properly, you’ll have a good relationship with all those stakeholders. If you don’t there’ll be a problem when there’s a bump in the road.”
The deal’s off
Candès says he has gone so far as to call a halt to a “trophy” deal that had “good economics” because of an unsatisfactory ESG framework. “So you can actually refuse to make what looks like a good investment because, in reality, it could pull the house of cards down.”
“It [ESG] is a significant management commitment and it’s a costly process,” adds Déau. “But no investor would want to come near you if it’s not a real commitment that drives greater efficiency and delivers improved yield.”
The conversation is by now drawing to an end. A lively debate was only briefly punctuated when the lights went out. If this had been due to a power outage, it could have provided a compelling reference point for a conclusion based on the need for more infrastructure investment. It transpired, however, that the reason for being pitched into temporary darkness was merely a blown fuse.
No one around the table is blowing a fuse about prospects for the future of the asset class. They do have concerns though, and chief among these is the regulatory issue. “I’m worried by the unintended consequences of legislation for insurers, pensions and banks,” confides Ayre. “We’re long-term investors and we need long-term capital alongside us. Legislation which forces the financing community too short term would be adverse.”
This reminder of how law makers can act against their interests may help galvanise infrastructure investors to defend their corner. “We have a responsibility to approach governments and engage with them. But there’s not a tradition of speaking out, so it requires a change in mentality,” says Déau.
But while this presents a future challenge, a more immediate preoccupation is with the state of the market. Reflections on this allow for a positive conclusion to proceedings. “What gives me encouragement is the huge asset pipeline,” says Poetter. “There might be competition but there’s a diverse pipeline, there are more and more investments.”
Having returned to Europe with OFI-Infravia towards the beginning of 2012 after a spell with Canadian fund manager Fiera Axium, Candès says: “What strikes me is the quality of the deal flow, especially in brownfield. Most of it is coming from industrial players which are capital constrained, and that deal flow is here to stay.”
By his own admission, Déau’s optimism is of the mild variety. “Long term in Europe, infrastructure investment looks quite solid,” he says. “And that’s enough for me.”
The smiles around the table as he speaks betray a profound acknowledgement: namely, that to have “Europe” and “solid” is the same sentence is highly gratifying.
AROUND THE TABLE
Marcus Ayre, head of Infrastructure transactions, First State Investments
Ayre is responsible for sourcing and securing mature economic infrastructure investment opportunities in Europe. He is a member of the global infrastructure senior management team, which overseas First State Investments’ €2.7 billion global infrastructure investment business, and sits on the investment committee of the First State European Diversified Infrastructure Fund. Since joining First State Investments in 2007, Ayre has led the acquisitions of Electricity North West, Reganosa and Digita. Prior to First State, he spent a decade in European mergers and acquisitions at Merrill Lynch and HSBC and is a qualified barrister.
Bruno Candès, investment director, OFI InfraVia
Based in Paris, Bruno principally focuses on fundraising as well as on deal origination and execution for the firm’s mid-market European infrastructure funds. Prior to joining OFI InfraVia, Bruno was a senior investment director and one of the founding members of Fiera Axium Infrastructure, a Canadian-focused infrastructure fund. He also served previously as a director for Babcock & Brown, ABN AMRO’s infrastructure capital group, as well as Egis Projects.
Thierry Déau, founder and chief executive officer, Meridiam Infrastructure
Déau has over 18 years of international experience in the project finance community. Prior to his involvement at Meridiam Infrastructure Managers, a fund manager focused exclusively on public-private partnership (PPP) investments in Europe and North America through dedicated fund vehicles, Déau served in various roles for Egis Projects (the investment arm of Caisse des Dépôts France in charge of transport project development, financing and operation) and became chief executive officer in 2001. Déau also served as a member of the group’s risk assessment committee and strategic committee.
Mark Hoff, partner in Central Europe, ERM
Hoff is a partner at Environmental Resources Management (ERM) based in Frankfurt, Germany. He specialises in the power and infrastructure sector and has more than 12 years’ experience with environmental, social and governance (ESG) issues, risk management and sustainability. During his professional career he has been working with financial institutions, investors and multinational corporations, assessing and quantifying ESG-related risks during transactions, normal business operations and project development. Hoff is ERM’s global transaction services lead for power and infrastructure.
Martin Lennon, head, Infracapital
Lennon has over 20 years of infrastructure-related experience gained in the corporate and financial sectors. He joined the Prudential Group in 1998 where, before founding Infracapital, he led the Project & Infrastructure Finance business at M&G Investments, developing a substantial and diversified business investing in the infrastructure sector across a wide range of financial instruments.
Fabian Poetter, investment manager, Golding Capital Partners
Poetter joined Golding Capital Partners as an investment manager in 2012. He is responsible for the identification, analysis, due diligence and selection of infrastructure funds and the management of the infrastructure funds portfolio. Poetter gained experience in infrastructure project finance and the structuring of renewable energy portfolio transactions for institutional investors both at UniCredit and Bank Vontobel. Prior to joining Golding Capital Partners, Poetter worked for REpower Systems and was responsible for equity investments in wind farm projects as well as advising project developers on the financial structuring of power generation projects.
Alain Rauscher, founder and chief executive officer, Antin Infrastructure Partners
Rauscher founded Antin Infrastructure Partners in 2007 to capture the growing opportunity in European brownfield infrastructure investment. He is chief executive of Antin Infrastructure Partners, sits on three portfolio company boards and has over 25 years experience including M&A and advisory with BNP Paribas, Lazard Frères, Lehman Brothers and Bain & Co.