As recession fades, threats remain

The discussion starts on a light note, with questions about how to pronounce “Ardian”, the new branding for the former AXA Private Equity. Ardian head of infrastructure Mathias Burghardt, who is among those assembled for our European fund management roundtable, is taking it all in good spirits. What is more, the good spirits continue when the “discussion proper” commences.

These may not be salad days but, compared with the gloomy mood that prevailed a few years back, the region’s infrastructure investors are decidedly perky.

Among the responses when asked about the macro-economic climate in Europe are the following: “The situation has improved and investors perceive this”; “The risk of the euro collapsing is behind us and we’ve seen very proactive policy from central banks, which has been good for infrastructure”; and “There have been two years of recession and next year we’ll be back to low growth”.

“It’s a fragile and unstable environment although it’s recovering,” adds Bruno Candes, a partner at Paris-based fund manager OFI InfraVia. “The risk of the euro collapsing is largely behind us. We’ve seen very proactive policy from central banks to stimulate liquidity and keep interest rates low.”


So, everyone is sitting a little bit more comfortably. But does that mean all the challenges facing Europe have been resolved? Not a chance. “There are plenty of issues to be fixed,” comes one view from round the table. “Debt is still too high, and so is unemployment. Plus, deficits present a big problem – and not only in weak countries.”

Fiscal pressures – resulting in disgruntlement among the general public when the pain is passed onto them – mean that even in those countries where better economic news is emerging, politicians and regulators will look for ways of prioritising consumers over investors (one participant cites the proposed energy price freeze in the UK as an example).

“Sectors are coming under scrutiny and, as an investor, you have to be super vigilant and incorporate the risks into your pricing,” says Rauscher.

There is a view around the table that the best way to counter regulatory risk is to diversify. “Regulatory risk has always been the risk,” says Burghardt.

“Regulation can be good for 10 years and then bad. What looks safe can turn out to be a nightmare, and the only thing that protects you is diversification.”

Adds Matthias Reicherter, principal and head of infrastructure at Munichbased asset manager and adviser Golding Capital Partners: “If you’re going into infrastructure, you should stay in for the long term and diversify by vintage year and type of fund etc. Diversification is important as there is a good chance you will get caught by the regulators in some shape or form.”

There are other concerns as European economies begin the slow journey back to growth. Reicherter is worried that the positive vibe around infrastructure may fade. “During recession there were good ideas about structural reforms with infrastructure at the centre of growth strategies,” he says. “But now there is a risk that they will be taken off the agenda because the pressure is easing.”


Candes has concerns about the lack of lending and believes that it’s now time for the banks to step up to the plate.

“Now that the banks have rebuilt their balance sheets, what needs to happen is for them to go back to core lending,” he says. “Corporates need to invest and consumers need to start consuming again. And it includes supporting infrastructure investment. In this regard, the ECB [European Central Bank] stress tests will be crucial for the banks.”

So it’s clear that anxieties remain. But so too does the conviction among infrastructure investors that somewhere out there is an opportunity. And, as recession turns to growth, sectors and geographies that were out of favour start to become fashionable again.

“There is caution about regulatory risk and we are looking at assets with volume risk, where entry prices are relatively lower and the market environment is getting better,” says Burghardt.

He also says interesting deals are being seen again in Southern Europe, which has been shunned by many fund managers post-Crisis. There is also a sense – though this is not said in a hubristic way – that Europe remains the centre of the infrastructure investment universe. “Brazil is still Brazil. There is no El Dorado,” says one participant, capturing the feeling that emerging markets – for all their potential – remain problematic.

By contrast: “There are massive capital flows in Europe today. Bill Gates has just invested in Spain [a 6 percent stake in Spanish infrastructure group FCC]. Europe is the good guy.”


Reicherter briefly adds to the positive sentiment.

“Deal flow is best in Europe and Europe is undoubtedly attractive.” However, he goes on to suggest that maybe the benefits have already been captured by those who have raised funds in the past years – and that now limited partners are expecting more than just a copy of those strategies.

“From the LP point of view there has been a broad range of GPs [targeting Europe] in the market over the last couple of years,” he adds. “But maybe that’s in the past and now it’s time for LPs to pause and watch how the capital is deployed. Will firms meet their IRR [internal rate of return] targets? Other geographies, such as North America and some developing infrastructure markets
may be more attractive over the next 12 to 24 months than Europe.”

Reicherter goes on to make the pointthat, for all the press coverage of high-profile new build projects, the reality is that greenfield deals are still lacking in Europe. Bruce Chapman, co-founder and partner at London-based capital raising and advisory firm Threadmark, refers to the example of the UK, where he says “it has taken three or four years to bring projects forward, and most are economic infrastructure rather than the social infrastructure that we were seeing up to 2008/09”.

In his view, this underlines the need to diversify geographically in order to see regular deal flow as “these [greenfield] programmes are highly cyclical”.

Searching for reasons for the lack of greenfield deal flow, Burghardt alights on a lack of debt finance. “There was a lack of debt with long maturity,” he states. “But now, with debt funds and the like, maybe the deals will be there again.”

Martin Lennon, co-founder and head of London-based fund manager Infracapital, picks up on the point about debt finance by clarifying that – for certain types of deals – there has not been a problem obtaining finance, even throughout the dark days of the Crisis.

“You have to be careful about definition,” he says. “In 2009/10, a lot of infrastructure investment was in existing utilities and that was taking place in the eye of the storm – and there was no problem financing those deals.”


The conversation moves onto the subject of competition, and pressure on IRRs [internal rates of return]. In recent years, direct investors have made their presence felt in infrastructure investment – and it’s clear that their growing influence causes concern.

“The main problem for the industry will be skinny teams doing deals,” says Rauscher. “There is too much money being invested by too few people. They do not have the deal experience and above all the capacity to monitor investments and manage risks effectively.”

“The march of the direct investor” becomes a big talking point. And why wouldn’t it? With their lower cost of capital, direct investors are an obvious threat to fund managers. The defence put forward by fund managers is that their experience and expertise come at a price.

“Our competitive advantage is having people on the ground doing asset management,” says Burghardt. Nonetheless, it’s not an easy argument to win at a time when limited partners are so sensitive about manager compensation. Burghardt goes on to make the point, however, that you see fewer GPs competing for the large, “trophy” deals these days. This is arguably both a positive and a negative observation: positive in that the direct and GP investors are keeping competition against each other to a minimum; negative in that GPs are being forced out of the larger end of the market and into a mid-market that inevitably then becomes more heated.

Burghardt goes on to make the point, however, that you see fewer GPs competing for the large, “trophy” deals these days. This is arguably both a positive and a negative observation: positive in that the direct and GP investors are keeping competition against each other to a minimum; negative in that GPs are being forced out of the larger end of the market and into a mid-market that inevitably then becomes more heated.


“Large, direct investors will remain focused on the trophy assets because they are offered structured solutions and the assets are very visible,” says Chapman. “Plus, they can outsource the operational oversight to someone else and be solely the economic holder of the asset. There’s room for that approach in the market and it’s here to stay.”

Candes agrees that direct investors will remain a permanent feature of the landscape as “they are engaged and sophisticated investors with a competitive cost of capital” but he adds that “if interest rates go up, they may decide they’d be better off in fixed income”.

But rather like the coach of a sports team determined to stay focused only on how their own team is performing rather than worry about the opposition, one participant adds: “As fund managers, we should not be paying 16 or 17 times [EBITDA] for airports, and it’s only what we are doing that we should be worried about.”

Burghardt picks up on the airport reference to note that perhaps fund managers should not be too complacent about pigeon-holing direct investors and what they are – and are not – prepared to invest in. Airports may be fully fledged commercial businesses, but institutional investors have been regularly snapping up stakes in them.

“It’s interesting that direct investors have been buying stakes in airports,” says Burghardt. “It’s clear that these guys won’t
limit themselves to water companies.”


However, airport investments notwithstanding, Chapman detects the emergence of a new class of holders of core infrastructure – and, in this respect, he sees infrastructure following in the footsteps of its real estate cousin.

“It’s still at an early point in terms of the development of the market,” he suggests. “There are risks in infrastructure that don’t exist in real estate but there is a large degree of overlap. Vehicles will evolve that are appropriate for holding stable, core assets – and Europe is further along that curve than anywhere else.”

Chapman notes the sell-down from fund managers to institutional investors that has taken place in some core assets – such as the UK’s Thames Water, for example – and speculates that, in some cases, the original fund investor might be handed a contract to manage the asset on an ongoing basis on behalf of the institutions.

This hints at a more cooperative – rather than confrontational – relationship between fund investors and direct investors. When the subject then turns to coinvestment, it would be easy to assume the roundtable participants would wax lyrical on the joys of such relationships. In fact, the message is a tough one – there’s a place for co-investment (at least for the time being) but no-one should be tempted to think it’s an easy ride.

“There is a lot of potential interest in co-investment,” asserts Lennon. “But in five years, I think plenty will have tried co-investment and not enjoyed the experience. A lot of people are learning what it really means, especially in terms of exposure to abort costs. If you’re involved in two or three failed bids, that can mean several million in abort costs and, in an institutional environment, you feel the heat for that.”

“We want investors to understand that co-investment is a very important commitment to the companies’ success and growth,” says Rauscher. “They have to participate in meaningful decisions such as approving capital expenditures or possibly replacing a CEO. We put a lot of emphasis on this responsibility and, in fact, offer our co-investors the option to manage their participation on their behalf.”


Reicherter points out that co-investing means having to move quickly, which is something large institutional investors are not necessarily geared up to do. “You have to work towards a tight deadline – and that means internal processes need to be clearly defined,” he says.

“Upfront, direct co-investment is not something for everyone,” concludes Lennon. “In private equity, it can be done quite aggressively – you may have three or four weeks to commit to a deal and then you’re either in or out. I’m not sure that kind of aggression is easily transferable to infrastructure.”

Burghardt says Ardian offers an alternative, which is effectively a syndication model. Rather than having its co-investors shoulder-to-shoulder when a deal is done,

Ardian underwrites deals and then sells down to its co-investment club. “True coinvestment is too risky,” he says, “as the execution risk is too high. The GP should lead the deal and manage it.”

As the conversation draws to a close, it is clear that the right way to invest in infrastructure is a major talking point – as it arguably has been since the asset class first emerged. Perhaps the final word should go to Candes: “The more offerings on the table, the better for investors and the better for the infrastructure industry as a whole.”