The good captain

It’s easy to forget, now the sound of champagne corks popping has died down at number 20, Place Vendome – AXA Private Equity’s (AXA PE) palatial Parisian headquarters – how easily it could have all gone wrong.

We are referring here to the fundraising for AXA PE’s third infrastructure fund, which closed in March on €1.45 billion, with a further €300 million earmarked specifically for co-investments.

After all, Fund III’s fundraising momentum slowed down considerably when, in September 2011, insurer AXA announced a strategic review of AXA PE. At that point, the infrastructure team had managed to raise some €750 million. It would take until April 2012 for the fundraising to pick up steam again.

Across the border in Germany, another infrastructure team on the fundraising trail – and which was also undergoing a strategic review – was two months away from taking a turn for the worse.

For it was in June 2012 that New York- and Chicago-based Guggenheim Partners would end exclusive negotiations with Deutsche Bank on buying RREEF. This triggered a chain of events that forced RREEF Infrastructure to give back to limited partners (LPs) the €620 million it had raised for its second fund, precipitating the departure of team leader John McCarthy.

AXA PE’s infrastructure fundraising, though, went in the opposite direction.

“We raised close to €1.8 billion, which is a circa 50 percent increase on what we had managed to raise for our previous fund,” says Mathias Burghardt, AXA PE’s head of infrastructure. “The fundraising shows that AXA PE and its infrastructure team have the capability to raise such an amount even in a challenging environment.”

So how did the team manage to reassure LPs through the ups and downs of a long-lasting spinout?

“I think investors, when they look at the shareholding structure of general partners (GPs), basically look for three things. Firstly, they want continuity and visibility, and the new structure really gives that, with AXA continuing to be a significant shareholder and AXA PE management now being the largest shareholder.”

“Secondly, they want empowerment. And lastly, critically, is an alignment of interests. There’s been some debate about GPs run by investment banks, so the fact that we have a fully aligned shareholding structure with no conflicts of interests is a real plus.”

The co-investment club

The other critical element in raising AXA PE’s third infrastructure fund was the team’s bet on putting together a solid co-investment programme.

“We knew co-investment was important from the very beginning, but that became even more obvious when we started fundraising, and I would say it was one of the critical elements in our success,” Burghardt argues.

The numbers certainly support Burghardt’s assertion. Of the little over €700 million invested by Fund III, 50 percent involved co-investment.

“I think what differentiates us from other GPs is that we co-invest in a very ‘clubbish’ way, and aim to provide it to not just large LPs but also medium-sized LPs. We co-invest by underwriting deals that we then sell down to our LPs. Out of the four deals we have made, two were co-investments and they were very successful,” he recalls.

Burghardt is enthusiastic about what he sees as the ‘win-win’ characteristics of co-investment.

“It’s good because it allows LPs to deploy more money at a good cost, since co-investment doesn’t pay management fees. Secondly, it allows LPs to shape their portfolios by choosing, say, more energy than transport, or more investment in northern Europe than southern Europe.”

“Thirdly, I think co-investment is a way to gain intimacy with LPs. There are two ways to do co-investment – both of which we have tested. The first is to underwrite a deal and then sell it on. The step beyond that is to then, once you grow closer over a few deals, to work alongside LPs through the bidding process.”

“When you work alongside your GPs you learn how they do their due diligence and you forge a very close relationship. Plus, it gives LPs a chance to assess the investment team. Actually, I do the same with my portfolio companies. Sometimes, I like to bid together with them – it’s a way to assess and be closer to management,” Burghardt concludes.

But if these are the highlights of co-investment, the AXA PE infrastructure head is also well aware of the drawbacks.

“For everyone to be happy with co-investment, it must not hamper your performance [as a fund]. For example, some GPs during fundraising think it might be a good idea to team up [on deals] with certain investors because they believe that will make them invest in their fund. I think that’s a mistake. You should choose your consortium partners based on what gives you the best chances of success [for a deal], and not your fundraising,” he argues.

Burghardt continues: “Co-investment should also not jeopardise your governance. LPs are investing in a fund because they trust the team to take decisions in everyone’s best interests. This way, even those [LPs] who don’t [do co-investment] can appreciate its merits, such as allowing the fund to take a globally larger stake [in an asset].”

“When you exit [a deal], you should be in a position to maximise your exit by having everyone exit at the same time. And if you can’t secure that, you must bear in mind you have to do what’s most efficient for the fund.”

Sprechen Sie Deutsch?

It’s a brave new fundraising world out there, and Burghardt found that AXA PE would have to cast a much wider net to reach its intended target.

“In the old world, you managed to raise a fund between family and friends. Now, it’s much more demanding. We have about 40 LPs [for Fund III] and some 24 are new investors – not just new to infrastructure, but new to AXA PE,” Burghardt points out. Of course, the obvious upside, as he readily acknowledges, is that “we are bringing new clients to the group”.

But it’s not just that the net has to be cast wider; the fish that are being brought to the surface are also quite different.

“Previously, insurance companies represented 70 percent of our LPs; now they only represent some 40 percent. What’s changed? Pension funds. They are now very much the dominant LPs in the market. That’s because, with Solvency II, maturity matters for insurers – there is a price for maturity. Pension funds are not there yet, so today they are our biggest clients,” Burghardt explains.

“The second big change is geography. The largest number of LPs [for Fund III] comes from Germany, comprising over 25 percent of the fund,” Burghardt says. “And it’s a diversified investor base, including pensions, insurance companies, funds-of-funds…”

Crucially, he believes German LPs are here to stay: “Before this fundraising, we had no German investors – except for AXA Germany – in our infrastructure funds; now they are the number one investor base. That says a lot about how the market’s changed.” In case you’re wondering, Burghardt, despite his Teutonic-sounding surname, doesn’t speak a word of German.

“Another important change is Asian LPs, which now represent some 20 percent of our fund. Obviously, we have LPs from northeast Asia, from places like Japan and Korea, but we also have LPs from south-east Asia. Emerging market investors are entering infrastructure, which is quite an interesting trend because it shows there is a massive amount of new investor money to be deployed.”

European-focused GPs, in particular, stand to benefit from this new wave of emerging market investors. As Burghardt explains: “Emerging markets infrastructure offers more greenfield opportunities and the promise of better long-term returns due to growth expectations. But at the same time, emerging market LPs can’t find core, mature, regulated assets providing yield from day one. So I think they will become a bigger and bigger presence in Europe”.

Overcrowded Europe

All of this increased attention is great, but for a GP with almost €2 billion to invest primarily in brownfield opportunities across Europe, is Burghardt not concerned he will find himself chasing assets with highly inflated, perhaps even bubble-like, prices?

“In infrastructure, perhaps more so than in other asset classes, there is an imbalance between supply and demand. Right now, there are many people trying to access infrastructure or increase their exposure to it. At the same time, there aren’t that many assets around, especially mature ones. That means you run the risk of overpaying, or having certain assets passed off as infrastructure,” he answers.

“On the plus side, there is a massive, ongoing corporate disposal programme, which is something that has been going on for a few years now and will continue. There is also a big privatisation programme in the wings that will pick-up – Portugal’s airports sale being a good example of what to expect.”

“So the supply/demand balance is not that bad: you just have to be cautious not to focus on trophy deals and instead maybe spend a bit more time chasing smaller deals and then make follow-on acquisitions.”

AXA PE has used the bolt-on model successfully, particularly in Italy. There, together with Italian fund manager F2i, AXA PE first bought gas network Enel Rete Gas in September 2009. The team then followed that up with two back-to-back acquisitions in April and June 2011, respectively acquiring E.ON Rete srl and G6 Rete Gas.

When the dust settled on the acquisitions, AXA PE and F2i had a 17 percent market share in terms of customers managed in Italy – second only to energy giant Eni – and were providing 6 billion cubic metres of gas per year through a 53,000-kilometre grid to 3.8 million customers.

In short, the partners built their own trophy asset over two years. As Burghardt advises: “Don’t try to deploy all your money at once.”

A SAUR deal

You might not be familiar with it if you are not French or don’t follow the press in that country, but SAUR, France’s third-largest water company, is the country’s great infrastructure drama.

Counting AXA PE, Cube Infrastructure, French sovereign wealth fund FSI, and Seche Environnement (Seche) as shareholders, SAUR has become a cautionary tale of what can happen to a good asset when you load it with too much debt and – crucially also – when not all shareholders want to go in the same direction.

To cut a long story short, Seche, SAUR’s second-biggest shareholder, embarked on a failed takeover of the water utility against fierce opposition from the firm’s other shareholders, which feared the takeover would trigger a refinancing of SAUR’s circa €2 billion debt pile.

The bickering got so bad it eventually paralysed the company, triggering a debt restructuring process that has seen SAUR recently receive three takeover/refinancing offers in a bid to alleviate its debt burden. The end result: the company is now worth at the most half of its €2 billion-plus acquisition enterprise value, equity shareholders are facing a wipeout, and the creditors a massive writedown.

Burghardt is philosophical about SAUR.

“One of the mistakes [made] in the market was to use too much leverage. A few years ago, we almost had to fight [off banks] to refuse leverage for our transactions. The asset is actually quite good, but when you have too much leverage, even a good asset turns bad. That’s one of the lessons the industry has learned,” he argues.

He continues: “That investment also corresponded with a pretty violent turning in the cycle. Not all investments in infrastructure have gone well and, as a consequence, a lot of the bigger players have disappeared or scaled down significantly. Because of this time in the cycle, probably all fund managers have a company in their portfolio that hasn’t performed according to plan.”

Did SAUR ever become a sour talking point during fundraising, though?

“I think LPs understand that in every portfolio there could be an investment that doesn’t work out as planned. What they don’t want is too many bad investments. They want to know that, despite the cycle, you have invested according to guidelines,” he answers.

“But you should not try to complicate the situation further,” Burghardt reflects. “You make a mistake and you take your loss.”