Life in the slow lane

For a country that prides itself on the quality of its highways, Denis Stas de Richelle’s choice of metaphor is ironic. The French infrastructure market, says Société Générale’s global head of infrastructure and asset-based finance, is like a six-lane motorway reduced to two lanes: enthusiastic investors are ready to push the accelerator pedal, but scant opportunities mean they’re being forced to hit the brakes.

The market’s deceleration has indeed been rather brutal. According to Infrastructure Investor Research & Analytics, French infrastructure deals totaled €5.4 billion last year – far less than the €9.9 billion recorded in 2012, itself a sharp fall from 2011’s €16.4 billion. The slowdown was especially pronounced for public-private partnerships (PPPs), which nearly halved in value in the space of two years (from €3.4 billion to €6.4 billion).

In part this is due to an unfavorable basis effect. In the wake of the Financial Crisis, the administration of president Nicolas Sarkozy set about stimulating the economy via significant infrastructure spending, most notably via three multi-billion high-speed link rail concessions awarded as PPPs. Figures confirm that the stalling is largely attributable to a drastic fall in transport deals, which accounted for €957 million in 2013 compared to €13.8 billion in 2011.

“We’re no longer at the peak of 2008 to 2009. But you can’t realistically expect to have €15 billion of rail projects every year for 15 years,” says Matthieu Muzumdar, investor relations director at fund manager Meridiam Infrastructure.

The government of François Hollande, in power since May 2012, has shown far less willingness to use infrastructure spending as an economy booster. As previous mega-projects reached their closings, the state backed away from sponsoring new ones; a number of flagship initiatives, such as the €4.3 billion Seine-Nord Canal or the €500 million A355 highway projects, were shelved.

This left many of the country’s infrastructure investors looking for direction. And it didn’t help that the government displayed a defiant stance on PPPs, says Olivier Jaunet, a managing director at Crédit Agricole. High-profile projects such as the €671 million Paris Court of Justice and the €730 million Ecotaxe electronic toll became ensnared in legal process and controversy, perplexing sponsors, contractors and investors alike.

Newfound pragmatism

Yet most insiders dismiss government rhetoric as a major factor behind the PPP drought. “There’s been a couple of emblematic PPP projects some politicians took as scapegoats. But none of them has actually been stopped,” says Fadi Selwan, executive vice-president and business development director at Vinci Concessions.

There’s a sense that the government has now adopted a more pragmatic approach towards the model, which president Hollande sees as being part of the “toolbox” he may use to bolster France’s competitiveness. “It’s not that the government has fundamentally become pro-PPPs. Today they just do them without talking about it when they actually think this is the most effective solution with regards to their public investment policy,” says Selwan.

He thinks the public sector has started to understand the economic value of PPP as a way to tap fresh ideas and expertise from private bidders. Authorities also face a concerted effort to demonstrate that partnerships are a good deal for the taxpayer: the EDHEC-Risk Institute, backed by Meridiam Infrastructure and placement agent Campbell Lutyens, recently showed that French PPPs suffer cost overruns of 2 to 3 percent on average – compared with 20 percent for publicly-managed projects.

So why is there not more happening? To Jean Bensaïd, chief executive of fund manager CDC Infrastructure, the political calendar provides a partial answer: with municipal elections scheduled at the end of March, politicians were eager to avoid causing a stir by launching controversial projects.

Public reticence to support the PPP model is also deemed responsible for clipping the wings of MAPPP, France’s PPP agency, which remains weaker than some of its Western counterparts. “Unlike Canada, the MAPPP is here to advise and intermediate and not procure and contract,” says Bruno Candès, a partner at fund manager OFI InfraVia. The resulting lack of standardisation in processes and documentation means development costs remain significant – especially when working on smaller projects.

But the slowdown has more obvious roots. “Administrations are being forced to rein in spending,” says Romaric Lazerges, a Paris-based partner at law firm Allen & Overy. “The budget ministry looks at contracts very carefully, and you have several administrative bodies zooming in on details of the transaction.” Pressures are especially strong at the local level, with municipalities taking a colder look at the real need for a new stadium or another swimming pool.

Go-shop period

With scarce greenfield opportunities on the horizon, some investors have set their hopes on the brownfield market. “We clearly noticed a push in transactional activity towards the end of last year,” says Mathias Burghardt, head of infrastructure at fund manager Ardian.

2013 did indeed witness a few landmark deals, including the €2.4 billion acquisition of Total’s gas transport and storage business by Snam, GIC and EDF, and the €800 million purchase of Bouygues’ stake in motorway operator Cofiroute by Vinci. The trend continued into 2014, with Ardian and Crédit Agricole Assurances jointly buying parking space operator Vinci Park for €1.96 billion in February.

Of course, says InfraVia chief executive and chief investment officer Vincent Levita, there’s unlikely to be more than two or three such deals a year. But he expects the same dynamics to nourish deal flow below the €100 million mark – where competitive auctions aren’t as frequent and direct investors rarely take the trouble to venture. This will be especially true in the energy and telecom sectors, he argues.

“Today the deal flow stems more from companies cleaning up their portfolios than public authorities tendering for infrastructure upgrades. Large utilities like EON, GDF or Veolia are under a lot of pressure.” And while portfolio reorganisation may only provide carve-out opportunities for so long, Candès says corporates will also need investors to fund growth in other markets or more strategic areas of business.

Emmanuel Gillet-Lagarde, a managing director at banking group Natixis, thinks this will be complemented by a pick-up in secondary deals: the first generation of infrastructure funds, raised in the mid-2000s, will soon be looking for exits. But there is a caveat. “Today the liquidity available clearly outweighs the number of investable projects,” Gillet-Lagarde observes.

Inflationary pressures

Although not the only factor, the return of readily available financing is helping feed this resurgence in competition. A number of lenders have finally repaired their balance sheets; faced with a drop in revenues, they have more appetite to do deals. Some have also lengthened the average term of their deposits to match their eagerness to provide long-term lending. As a result, says Stas de Richelle, Japanese, American and some European banks are likely to remain active in the market.

Yet more momentous is the emergence of debt capital markets as a purveyor of liquidity – and the increasing popularity of project bonds as competitive financing solutions. “This used to be reserved for large corporates. Now we see it on transactions below €100 million,” says Renaud de Matharel, chief executive of fund manager Cube Infrastructure.

Institutional investors helped three flagship deals reach financial close last year: the €170 million ‘Music City’ in Boulogne-Billancourt and the €590 million Marseilles L2 bypass, both supported by Germany’s Allianz Global Investors, as well as a €300 million PPP tender for three prisons, backed by French insurer Ageas alongside Natixis. All involved vehicles with a 30-year-long tenure.

The credibility of new players as long-term lenders is forcing banks to simplify their procedures, says Julien Touati, corporate development director and investment director at Meridiam. “The French market has long been characterised by an over-sophistication of lending processes. Sometimes simple deals became hard to execute because they had several remote legal risks that were magnified in spite of their low probability.”

Lazerges recalls the extreme case of the €7.8 billion SEA high-speed rail deal, which took 15 months to close. The teams involved came out somewhat drained from the negotiation process, he says. “They even hired consultants to understand why it took so long to make it happen.”

But the easing of liquidity conditions has its downsides. De Matharel points out that the average debt-to-EBITDA ratio has jumped from three to between four and five over the last couple of years, with the Vinci Park deal even reaching a multiple of seven times. This has helped push prices to fresh highs, and led some to wonder whether the brownfield market is not getting excessively frothy. “Over the last few months I have seen things that remind me of the pre-Crisis years,” Gillet-Lagarde says.

And while this doesn’t seem to apply to greenfield assets, fund managers recognise that returns on both equity and debt have come down across the board. But few go as far as fearing a bubble. “We are in a market that’s getting enthusiastic again,” says Levita. “Risk premiums are pushed down, leverage is going up. But it’s when risky assets are priced like non-risky ones that things may suddenly deflate.”

Side roads

While the French market may not be about to implode, it remains a tough one for those with a lot of capital to deploy.

That’s why a number of managers are venturing internationally: medium-sized to large funds tout their diversified exposure and scout for deals in more dynamic markets. In so doing they follow large developers, which are now competing for projects in Asia, Latin America or Turkey. Yet most are keeping a keen eye on their motherland. Levita expects 40 percent of InfraVia’s latest fund to be deployed in the country, for example – on par with the proportion invested in France by its predecessor.

So where will the deals come from? Investors like to point out that a number of large greenfield projects could come back on the radar: the government is currently tendering for three highways PPPs, including a relaunch of the A355 in February. There is also recurring talk of what observers describe as France’s ‘hydras’ – monster-like projects that keep resurfacing in the political debate. Among them are the ‘Grand Paris’, a 10-year, €35 billion transport master plan for the capital, and the CDG Express, a €1.7 billion rail project linking Paris to its largest airport.

It remains unclear when these will reach a close – if they ever do. In the meantime, potential buyers are positioning themselves on smaller deals. Tellingly, the ‘mid-cap’ label is being adopted by an increasingly diverse array of funds. Data from Infrastructure Investor Research & Analytics shows the average deal size has dropped nearly fivefold since 2011.

Investors also see much potential in sectors less often in the media spotlight: energy efficiency and heating networks are singled out as areas where France trails far behind Northern neighbours, for example, while the deployment of high-speed broadband could yield sizeable opportunities. Another industry that’s seeing surprisingly strong activity is renewable energy, says Christine Poyer, a partner at Allen & Overy. She says her team has been “100 percent busy” over the last 12 months, despite expectations of changes in the regulatory and economic climate.

Barring an accident, France should remain one of Europe’s top infrastructure markets – albeit a tricky one for investors to navigate. Those which can afford to take to the country roads will probably keep moving forward; others may find themselves stuck on the slow lane for a few more years.