Building from scratch

If there’s one thing guaranteed to rile an infrastructure fund manager it’s the meeting with the would-be investor who appears to believe that infrastructure is a bond-like investment where you commit the capital, put your feet up and wait idly for the dividends to come rolling in. To this investor, “asset management” and “infrastructure” are alien concepts (they may also wonder why fund managers raise the subject of management fees).

If that’s a source of frustration, it’s easy to see why. After all, by the end of a conversation with three investment professionals – Mark Crosbie of Antin Infrastructure Partners, Volker Haussermann of First State Investments and Peter Rossbach of Impax Asset Management – several real-life examples have been given of creating infrastructure companies from scratch; surely as demanding a form of asset management as you’re likely to find.

“We just bought a German gas grid [Ferngas Nordbayern] with no personnel,” says Haussermann. “It was a gas network which was unbundled and all the employees stayed with the commercial business. We effectively had a shell company and had to bring in all the management and operational team as well.”

Without pausing for breath, he rattles off asset management case study two. “We have also just acquired a large asset in Finland [the electricity distribution network sold by Fortum] which we bought together with Borealis Infrastructure, Keva and Elo. It is the largest distribution network in Finland with more than 20 percent market share and has a very ambitious growth plan. We’re looking to double the asset base within 10 years and this involves a real change of culture – before it was part of a large utility, but now it’s independent and focused solely on distribution.”

Examples such as these chime with Crosbie. “When you carve infrastructure out of a corporate, you have an asset but you may have to create the company from scratch,” he asserts. “We did that three times in our first fund – all the basics like finding premises, putting in the IT infrastructure etc. And you have to do it very quickly. In some cases we took management from the corporate but in others we had to bring in people from outside.”

NOT ALWAYS GOOD TO BE FIRST

Haussermann and Crosbie are clearly well equipped to deal with questions from anyone who ventures to suggest that infrastructure is a passive investment game. Rossbach, meanwhile, has a useful statistic to pull from the hat. “Depending on the project, about 40 percent of our value-add comes from the ownership and execution period – executing on the business plan and managing the unexpected along the way,” he says.

“Buying, leaving alone and then selling is not the way to go in this market. Back in the excitement of 2007/08, speed of asset creation was more valued. Infrastructure was a new sector and first-mover advantage was more important than any asset management advantage. These days, being first isn’t always an advantage. And while we are ‘first’ in some areas in the renewables markets, we take care that we can manage the issues that arise and fully execute the initiative, not just start it.”

The renewables market once thought it could leave asset management in the hands of local operators around Europe, but ironically experienced problems often due to “local circumstances”. Impax’s approach is one of “more centralised control in the UK” with internal staff providing the required expertise in operational functions ranging from construction contracting to accounting, management information systems (MIS) and insurance.

Explaining this policy of centralisation, Rossbach adds: “A number of times we’ve had to engage ad hoc specialists and the response time has been slow. Maybe we’re a bit top-heavy, but that’s what the management fee is for. If you outsource you can risk the chaos of different formats, a different tempo or standard of working – you can lose confidence.”

WATCH OUT FOR THE POLITICIANS

While it’s clear that asset management is a priority for the individuals around the table, they are keen to make the point that it should now be at the top of the priority list for any investment firms keen to succeed in infrastructure. This is because politicians, regulators and consumers have all become vital infrastructure stakeholders in the post-Global Financial Crisis world – and managing those relationships effectively needs to be at the heart of asset management strategies.

“We’re in a world where there are heightened political, regulatory and tax risks and, in a sensible asset management programme, there will be a focus on those issues,” insists Crosbie. “You need to find out who are all the stakeholders, what views they hold, and then engage proactively. Pre-Crisis you wouldn’t have seen political risk as being especially high but in recessions things change. Suddenly there’s pressure on politicians from consumers and you see governments acting in surprising ways. That’s the biggest lesson of the last five years.”

The subject of the UK water industry crops up in relation to the need to nurture relationships with regulators – undoubtedly among the most important stakeholders these days. The industry has come under enormous pressure from the media and many politicians over the returns being made by investors amid the perceived high cost to consumers.

Haussermann points out: “The infrastructure used to be poor and new infrastructure was desperately needed. The investors [in UK water] successfully delivered the investment in infrastructure that was needed and that may be needed again in the future.”

This apparent anomaly between the capital expenditure (capex) committed by investors and the flak they have faced in certain quarters may be an example of relationships not being managed optimally. Arguably, more time could have been spent making the regulator understand the capex that was needed.

Rossbach believes that regulation tends to interact with markets in cycles. “You have the launch of an industry, then you have growth, then indigestion and then you have consolidation forced either by the regulator or by the market. You have to join the cycle at the right point.”

THINKING ESG

Aside from having to react to pressure from a longer list of stakeholders, another asset management challenge that has grown in recent years relates to environmental, social and corporate governance (ESG). It’s another aspect of what Haussermann refers to as “learning how to manage assets properly” – a journey that, as a young asset class, infrastructure is still undertaking.

He continues: “Investors look for ESG and ask questions about it; they expect you to have policies. At First State we are signed up to the United Nations Principles for Responsible Investment (UNPRI) and it means there are certain standards we have to bring into our companies and we have to produce regular reports. There are more and more investors doing it. As an asset class, there is a lot more we can bring to this area and we are committed to leading the way on this.”

“It [ESG] can be a ‘gating’ issue for investors but it also produces real value for investors,” adds Crosbie. He points out that Antin has placed particular emphasis on safety issues within portfolio companies. “We believe that employees should be able to return safely to their families at night and we’ve found it’s something that’s not taken seriously enough. We’ve put it at the top of our agenda and, surprisingly, we’ve met a lot of resistance.”

Crosbie adds that when you want something like safety to be prioritised you need to make it a “top board agenda, engrain it in the culture and link it to rewards”. He thinks a caring attitude as an investor is not just laudable for its own sake but will also result in more committed employees and better productivity. He says the firm is seeing key performance indicators (KPIs) on safety “massively improving” but that it may take time – and patience – before the difference can be observed from the point at which you first prioritise it.

The conversation moves on from specific asset management issues to consideration of asset management strategies – both pre- and post-acquisition. Haussermann says that a lot of work goes into possible acquisitions even before the distribution of information memoranda takes place. In the case of the Fortum asset, he reveals, the firm was doing its due diligence two years before the deal was struck.

“You need to get to know the asset and the culture really well,” he says. “You need to know what the legal and regulatory frameworks are like in different geographies, how the company is currently managed and how the managers think.”

CULTURAL DIFFERENCES

Understanding the different cultural approaches in different countries is a vital factor as far as Haussermann in concerned. He points out, for example, that in Germany co-determination rights and corporate governance are approached very differently to the UK. In some countries, such as Finland, you have a highly consensus-oriented approach whereas in other countries you tend to have CEOs calling all the shots.

Rossbach brings an interesting perspective to the discussion in revealing that Impax frequently buys an operational ‘pilot’ asset before deciding to do a ‘new build’ asset in the same country. “We’ve done this in Poland, Ireland and Germany. This way, you know what the planet looks like before you land on it,” he maintains.

An anecdote came up in the discussion. “Some time back, we had learned that our projections had embedded an engineer’s assumption for several years. When we studied this ‘line loss’ issue, we discovered we could both cut these losses – or that they had been overestimated – and then systemically outperform the engineer’s projections. It was worth 5 percent in increased net income in fact.”

Post-acquisition, it appears that much of the focus is on ensuring that the right management team is in place and well incentivised. “You need the right people on the bus,” insists Crosbie. “With respect to the make-up of the management team, it’s better to take a difficult decision early and move on. Time is everything when you have a defined timeframe, as you do with a closed-end fund.”

Rossbach adds that getting good in-country management is important. “Having dysfunctional management in an investee company is a deal issue first – rather than asset management issue – but it becomes an asset management issue if you don’t do anything. In one investment, we knew we’d have to replace those at the top who were responsible for a sick culture that had in part caused the seller to enter into a fire sale in the first place, and, although it was a bumpy ride, it made a huge difference that we cleaned house. We simply couldn’t have retained that old culture at the top.”

‘GENUINE ALIGNMENT’

Once you are sure you have the right people, the next step is to make sure they are well incentivised – but in a way that aligns interests. “We like management teams to co-invest with us rather than just getting a big bonus when things go well,” says Crosbie. “If you want genuine alignment, you should be prepared to put your hand in your pocket.”

Rossbach points out that not all infrastructure investment requires a management team at the investee level. “In infrastructure, some low-risk physical assets such as wind and solar projects grow in value over time but not from growth in customer sales like a cargo-port or airport,” he notes. “There is therefore more work for the asset management company.”

Rossbach notes the incentivisation arrangements for management may not always apply in a transitional private equity mode. “In energy, value growth is not always a sales question but you do need to keep focused on capacity utilisation – the percentage of time that an asset is operating and delivering revenues. We set KPIs at the asset level but also in those investees where we have in-house management.”

Crosbie responds: “From our point of view, we don’t see it [infrastructure] as anything other than private equity. It’s a specific subset but the skills are exactly the same. A lot of people ask us and we say it’s private equity but it’s lower volatility, more predictable, cash and yield generating etc. But the value-driving tools are the same.”

Thoughts turn to the perception of asset management from that all-important category of stakeholder: the fund investor. To return to the hypothetical scenario of the opening paragraph, anecdotes are not in short supply regarding the investor who appears to think that infrastructure and asset management have no obvious relationship.

“Everything we do is asset management – that is what we are here for,” asserts Haussermann. “Investors sometimes don’t understand how deep asset management is and how comprehensive an understanding of the asset has to be. They are more acquainted with portfolio management rather than asset management.”

Adds Rossbach: “You will often be taking over what we call an ‘asset in transition’ – one that is, for example, still in construction, needs permits or a change of management. There’s the ‘first 100 days programme’ and there’s a need to really get a handle on post-completion undertakings, the MIS [management information systems] etc. The complexity of the handover from the deal team to the asset management team is often underestimated.”

IT’S WHAT WE’RE PAID FOR

Equally, there are those investors who appear to have rather unrealistic expectations. “Investors sometimes think you have 50 engineers that you can just parachute in, but the reality is that very few firms have that luxury,” says Crosbie. “You have a lot of assets and the economics don’t allow you to do that. For us, it’s about knowing what the issues are and driving performance and getting the right people embedded within those assets. It’s not about having a big group of specialists sitting within Antin who parachute in and then return to Antin.”

The conversation ends with rumination on the increasing influence of direct investors. While the direct investment trend is well established, fund managers often put forward the argument that many institutions do not have sufficient operational resources to make a success of it in the long run. It could be, therefore, that the fund managers will live or die by their ability to differentiate themselves on the basis of asset management skills.

“Asset management is what investors pay us for,” says Haussermann. “Otherwise, they would go direct. So it’s really an existential thing.”

Around the table

Mark Crosbie, Antin Infrastructure Partners
Mark Crosbie is a managing partner at Antin Infrastructure Partners. He was previously for seven years a director of corporate strategy, development and M&A, and a member of the executive committee, at UK utility Centrica. He also had previous roles at UBS in London and Peregrine Investment Holdings in Hong Kong.

Volker Haussermann, First State Investments
Volker Haussermann has been a director of investment management for the First State European Infrastructure Fund since November 2013. He was previously a vice president in the RREEF European infrastructure team based in London for just over six years and, before that, worked for German utility EnBW.

Peter Rossbach, Impax Asset Management
Peter Rossbach is a managing director at Impax Asset Management, which he joined in May 2003. He has driven the creation of the NEF I and II portfolios while heading the Impax Private Equity and Infrastructure team. Rossbach has been involved in the financing of energy projects since 1983.