Industrial strength

Global Infrastructure Partners (GIP) may hold the crown for the largest infrastructure fund ever raised, but in the ‘Infrastructure Guinness Book of Records’, Swedish investor EQT stands a fair chance of claiming the fastest-ever mid-to-large scale infrastructure fundraising.

We are talking here about EQT Infrastructure II, which closed this January on €1.9 billion, hitting its hard cap and surpassing an original fundraising target of €1.5 billion. The time it took EQT to achieve that mark: just 11 months.

In fact, after a mere six months on the fundraising trail, EQT posted a first close on €1.1 billion. In the end, it was forced to turn down some investors, with market sources suggesting it could have closed Fund II on €2.2 billion had it wanted to.

So the first question I ask Lennart Blecher, EQT’s head of infrastructure, when we meet in London is: why do you think fundraising was concluded so speedily?

“I think EQT’s industrial operation model has really come true after the financial crisis. Funds with operational expertise are preferred by many limited partners (LPs) today,” Blecher offers. “The fact that EQT had 11 portfolio companies in Fund I and concluded an exit in the middle of the fundraising at very good terms also helped spur the whole process.”

“If you look at what happened in 2011, when EQT VI, EQT´s buyout fund, was raised – that fund was also raised in record time and closed oversubscribed, just like EQT Infrastructure II. So I think the investor community out there recognises EQT’s industrial model,” he adds.

EQT VI  also helped bring several new investors aboard EQT Infrastructure II, which in turn substantially changed the composition of Fund II’s LPs compared with EQT’s first infrastructure fund, which closed on €1.1 billion in 2008 (see accompanying charts).

“When EQT VI was raised, we had a very strong commitment from many of the world’s sovereign wealth funds and several institutional investors around the world. When we then continued with the EQT Infrastructure II fundraising, many of those investors already knew what EQT stood for and decided to come onboard. They had learned about EQT’s governance and industrial model through EQT VI,” Blecher explains.

“We also had a very high re-up rate, with some 60 percent or 70 percent of the investors from EQT’s first infrastructure fund investing in Fund II,” he adds.

Skin in the game

EQT’s famed industrial model – which it has pioneered and practiced since it opened for business in 1994 – is a comprehensive investment and asset management solution that draws on a network of professionals from some of the world’s most famous companies. As Blecher puts it:

“EQT has a group of over 100 industrialists – ex-senior managers from large industrial companies in Europe and other countries – that work together with EQT in order to identify investment opportunities and identify industrial value creation plans. Once EQT acquires a portfolio company, these industrialists form the non-executive board of directors in all our portfolio companies – both on the buyout and the infrastructure sides – and they are invested in EQT’s portfolio companies.”

He continues: “So when EQT buys an infrastructure asset, for example, we draw on this network of industrialists both for the due diligence and later to form the board of the company. EQT then aligns interests between the management team, those industrialists and us. Both the industrialist board members and the management team have to have skin in the game,” Blecher stresses.

That combination – a large and deep network of industrial partners and the requirement that all parties involved in the acquisition and management of the assets actually have a material commitment – seems to be working well for EQT.

“This is the model we have applied at EQT ever since we started in 1994 and we now have 20 years of using it. It’s a very value-oriented model,” Blecher states.

Still, there are important differences between the infrastructure and buyout sides of the business.

“The investment professionals for infrastructure are totally different – we have our industrial professionals and they have theirs. But the investment strategy is the same. Our industrial acceleration model, the access to the industrialists, our operational and governance models – all of that is the same,” explains Blecher.

Value creation

The other thread that runs throughout the entire EQT group is its approach to value creation. Call it a private equity approach or call it what you will, but you will not find Blecher’s infrastructure team buying availability-based school public-private partnerships somewhere in the UK.

“Very passive assets where there is nothing to do from an operational perspective don’t interest us,” Blecher deadpans. But he is open-minded about the different routes into infrastructure investing.

“There are different models for investing in infrastructure. We look at certain criteria. Firstly, the assets [we invest in] must provide essential services to society; then after that, we look at cash flow and earnings – there must be stability and visibility on cash flow and earnings and high barriers to entry, he adds.

“And then what differentiates EQT from other funds is that there must be an operational value-creation potential – that is a key differentiator between us and many of the other infrastructure funds,” Blecher concludes.

Blecher explains the firm put a hard cap on the fund because the team is “focused on mid-size transactions and we didn’t want the fund to be too large”. But even though EQT also targets the mid-market, it employs a diametrically opposed strategy to last month’s Insider interviewee, French fund manager OFI InfraVia.

As OFI InfraVia president Vincent Levita told Infrastructure Investor in that article: “What we want is to take real asset risk. We don’t want to invest in a company which relies on a growth story; we want to invest in an asset that relies on demonstrated demand.”

EQT’s infrastructure team, on the other hand, won’t go near an asset if it can’t see a growth story for it.

“EQT tends to buy good companies which are then developed to their full potential,” Blecher offers. “We are not a restructuring organisation, so we don’t normally go into a company to slash costs and fire people. EQT has a history of actually growing the number of employees at our companies by an average of more than 10 percent per year.”

“EQT invests in growth and efficiency. Each company is different of course, so with some companies we focus more on growth than efficiency and with others it’s the other way around,” he adds. That strategy should translate into some high returns for its infrastructure funds. Blecher declines to talk numbers, but admits EQT is targeting returns in the “mid-to-high teens”.

So far, EQT has only exited one asset, US power plant Midland Cogeneration Venture (MCV) – the first investment from its debut infrastructure fund – which it sold to Borealis Infrastructure, the infrastructure investment arm of Ontario Municipal Employees Retirement System. But if market rumours are correct, EQT has netted an internal rate of return of 40 percent from MCV.

Predictably, Blecher is not commenting on how much EQT made from the deal. But it’s still possible to get a decent insight. The 1,633-megawatt plant, which opened in 1991, saw its sales increase by 27 percent and its earnings before interest, tax, depreciation and amortisation (EBITDA) rise by 49 percent from 2009 – when EQT and Fortistar bought the plant from an affiliate of the Blackstone Group – to 2012, when it sold it to Borealis, EQT revealed when announcing the sale.

In fact, the group as a whole has a good track record of exits, having sold close to 50 of its 100 investments. On its website, EQT boasts of having increased sales in its portfolio companies by an annual average of 11 percent and claims that over 75 percent of the value created in its divested companies can be attributed to operational improvements and top-line growth.

Or as Blecher puts it, “we are not creating value through financial engineering”.

“Exits are a big selling point for EQT. It is very important for us that the company we hand over to the next owner should be a better, stronger, and more sustainable company than the one we originally bought – that goes to the heart of EQT,” he stresses.

Risks

Of course, EQT’s investment model, like every other infrastructure investor’s, faces its fare share of risks.

“One obvious big risk is that we cannot execute on our growth plans,” Blecher admits. “And always in infrastructure, there are some political elements to some of these assets, although we tend to focus more on already-privatised assets where there is more of a commercial dynamic around them.”

Blecher continues: “We are very concerned about assets that have too much political risk around them. You can’t hedge against political risk. You can try and mitigate it, but it’s easier in my experience to mitigate commercial risks than political risks.”

Political risk has shot to the top of fund managers’ agendas since the global financial crisis erupted and cash-strapped governments across the world have been forced to find “creative” ways to save money.

A painful reminder of that came earlier this year, when the Norwegian government proposed to cut tariffs on future transportation contracts for gas monopoly Gassled by 90 percent. The tariffs are a major factor underpinning the pre-tax return of 7 percent private investors expected to net from the gas monopoly in which they invested about $5 billion. Needless to say, a significant cut to future tariffs will impact investor returns in the medium-to-long term.

EQT is also invested in a Scandinavian gas monopoly – Sweden’s Swedgas, which it bought in early 2010 for a reported €200 million. Given the Gassled regulatory jolt, is Blecher getting cold feet on EQT’s Swedgas investment?

Blecher would not be drawn into commenting on Gassled, but he did shed some light on EQT’s plans when acquiring Swedgas:

“If you remember, EQT first bought Swedgas and after that EQT bought another gas transportation pipeline in Sweden which was owned by E.ON,” Blecher points out. The latter acquisition, done by Swedgas for about €110 million, took place in the summer of 2011 and effectively gave EQT full ownership of Sweden’s entire high-pressure natural gas transmission network.

“That was the industrial logic behind why EQT bought Swedgas from the very beginning – we already had that [bolt-on acquisition] in mind,” Blecher explains.

While he does not directly highlight it, there seems to be a stark contrast between EQT’s industrial approach to Swedgas and the approach taken by investors in Gassled. As described by consultancy Deloitte, “the risk profile of the investment in Gassled can best be described as a Norwegian government bond”. That statement hints at a very different way of approaching a similar investment.

Besides the industrial angle and the search for assets with significant growth potential, there is another side to EQT’s investment strategy.

“At EQT, we always like to invest with a trend. We try to always find a sustainable trend,” Blecher says.

“We recently did this deal where we own and lease broadband to offshore oil platforms in the North Sea. This type of deal is of great interest to EQT because we have a great amount of experience in our buyout funds, where we have been very successful in owning and developing a number of cable TV and fibre optic companies over the years,” Blecher explains.

“Fibre optic is a trend and EQT has a lot of industrial expertise around fibre optic,” he concludes.