The crown jewel in their sights

Infrastructure fund manager IFM Investors pipped its nearest competitor at the post by what, in relative terms, was a mere whisker (A$14 million; €10 million; $12 million) to clinch ownership of two of Australia’s most prominent ports – Port Botany and Port Kembla – in a A$5.1 billion deal last year.

Now, the under-bidders have regrouped and are preparing to fight for what has been described as the “crown jewel” of Australian ports – Port of Melbourne – which is expected to come onto the market next year.

Port of Melbourne is tipped to fetch at least A$5 billion and possibly as much as A$7 billion, according to industry sources, who base their estimates on recent port privatisations in Australia plus the demand from global and domestic contenders for such assets.

Price notwithstanding, Australia’s largest container port could attract new entrants to the sector, according to sources, who name China Investment Corporation, Korea’s National Pension Scheme and Hong Kong infrastructure giant, Cheung Kong Group, as likely candidates.

HUNGRY FOR MORE

But existing players are also hungry for more ports – and they will likely be the front-runners when the tender is put out.

Hastings Funds Management, which lost Port Botany and Port Kembla, both in New South Wales, to IFM Investors last year, is reportedly leading the charge through a joint venture with Kuwait-backed Wren Investment Management.

Three other groups are already in the queue, according to financial daily, the Australian Financial Review. Two of these are IFM, which is going it alone, and US-based fund manager Global Infrastructure Partners (GIP).

The third is a consortium made up of Canada’s Borealis Infrastructure, the Future Fund (Australia’s sovereign wealth fund), and QIC (the Australian institutional investment manager).

Brendan Lyon, chief executive of Infrastructure Partnership Australia, the industry’s peak body, told Infrastructure Investor: “Melbourne is the number one port in Australia by some distance in terms of a container port. It is the crown jewel.

“Port of Melbourne is a very high quality asset. A large amount of capital expenditure has just gone into upgrading the berthing facilities. It is a well-connected port and a mature business.”

‘DEVIL IN THE DETAIL’

Lyon says that a number of factors will dictate the final value of the port. One, he says, is the shorter term of the concession – 40 to 50 years compared with 99 years for the NSW ports.

Length of lease is front-of-mind for key players such as IFM and Hastings. IFM’s head of Australian infrastructure, Michael Hanna, says: “On the face of it, Port of Melbourne is an attractive opportunity. But as with all transactions, the devil will be in the detail.
“There is some uncertainty on the length of the lease to be offered. Then there is location – close to the city – which means that it is potentially capacity-constrained. This could restrict future expansion to accommodate growth in container trade, and then there is the prospect of a potential competing port.”

Richard Hoskins, executive director of global asset management with Hastings Funds Management, agrees that many issues, not least of all length of the lease, have to be resolved before Port of Melbourne is privatised.

Both sides of Victorian state politics are committed to building a second port to cope with future growth – but at different locations. The current Conservative coalition government favours Hastings, south-east of Melbourne, while the opposition Labor Party wants to locate the second port at Bay West, to the west of Melbourne. (Victoria is due to go to the polls at the end of November).

COMPETITOR

Lyon says a second port will be a competitor to the Port of Melbourne. This raises the question of protection of equity at the existing port. “All these issues, including the structure and delivery of the second port, have to be addressed in the due diligence and pricing process,” he says.

While the Victorian government works through its options, the potential bidders are preparing for battle. Expect a tough fight for ownership of Australia’s busiest port.
As mentioned earlier, just A$14 million separated the winning bid and the runner-up in the tender for Port Botany and Port Kembla in NSW. The NSW Ports Consortium, led by IFM Investors and including the Abu Dhabi Investment Authority (ADIA), AustralianSuper and QSuper (Queensland’s largest super fund), clinched the deal at A$5.07 billion – A$2 billion more than the NSW government’s budgeted price.

IFM Investors’ Michael Hanna explains that assets like Port Botany are gateway assets. They provide the single largest entry and exit point for a large range of goods and services in a broad geographical area.

In many other countries, he explains, airports and seaports actively compete for the same business. But in Australia, the nearest (container) ports are at least 700 kilometres apart, with only small proportions of total trade being contested between ports.
Given the vast distances between cities, Hoskins agrees that Australia is unlike the UK or New York, where there are multiple ports within short distances.

Hastings and its joint venture partner, China Merchants, successfully bid for the Port of Newcastle, north of Sydney – the world’s largest coal port. The final price was A$1.75 billion, compared with what was reportedly the NSW government’s original expectation of A$700 million.

HIGH MULTIPLES

In all recent port sales in Australia, investors have paid historically high earnings multiples to secure the assets. In the case of Port of Newcastle, for example, the price-earnings (PE) ratio was 27 times.

An asset allocation consultant to Australian super funds, Ken Atchison, says that at these high PE multiples, the returns are around four per cent – only marginally better than bond yields.

“But if you are an investor coming from Europe, where the German bond rate is 0.98 per cent, four per cent is still a good yield,” says Atchison, managing director of Atchison Consultants.

However, a leading global fund manager, who targets smaller infrastructure assets, questions whether the low return is adequate for assets that tie up capital for the long term. The truth, he says, is that there is pressure on fund managers to place their money in a market where there are few assets for sale.

A manager like IFM has a long queue of capital waiting at its door, says this fund manager. “At one point, there was A$4 billion in the queue, and that figure is probably higher today.”

IFM’s Hanna counters that it is misleading to quote high multiples – because they do not reflect what each specific deal entails. In the case of Port Botany, for example, the price paid took into account over A$1 billion worth of capital works delivered by the state government, including an entirely new stevedoring terminal and intermodal terminal which had yet to start generating revenue at financial close.

This results in a business where future capital requirements are significantly less relative to its peer group so free cash flow will be much higher – this, in turn, supports a higher earnings multiple, he says.

MISLEADING INDICATIONS

Hanna also believes that governments’ indicative prices for assets can be very misleading as they are usually calculated before the final structure of the deal is agreed, including the specific assets to be sold and the risk allocation between the government and the investor. Because of this, he says, the indicative price should not be used as a reference for the eventual sale price.

While there is undoubtedly truth in that, the final price is also driven by a flood of global liquidity – all of it searching for the same core or core-plus assets, particularly sizeable assets for better economies of scale and critical mass.

When GIP offered its 26.7 per cent stake in Port of Brisbane for sale last November, brisk bidding pushed the price to A$1.4 billion. The stake was originally purchased for A$236 million in 2010.

Canada’s Caisse de Depot et Placement du Quebec (La Caisse), which was keen to own trophy infrastructure assets in Australia, bought the GIP stake. The Canadian investor unsuccessfully bid for Port Botany and Port Kembla in partnership with Hastings and the Ontario Teachers’ Pension Plan.

The price paid valued Port of Brisbane at A$6.2 billion – a 20 per cent premium to Port Botany and Port Kembla, which are Australia’s second-largest container port and largest car importing and commodities port, respectively.

Ross Israel, head of global infrastructure at QIC, a co-owner of the Port of Brisbane, says the port was privatised in 2009 (post the Global Financial Crisis) when the market was quiet.

STRONG DEMAND

Values have risen since – driven by strong demand for “core/core plus” assets, he says. Port of Brisbane serves a state with a growing economy and population.

Israel says: “We believe there is less volatility in Australian landlord port investments compared to concession investments QIC has in European and Latin American ports.

“Over time, the risk and reward profiles of port investments show that they offer good diversification for an infrastructure investor.” He adds that the capital outlay for ports can be far less than for other sectors of infrastructure.

Israel says Australian ports have crucial roles to play within Australia and globally. As an example, he says, the Port of Newcastle is critical to the flow of coal to customers overseas. (Australia is the major supplier of coal and iron to feed Asia’s economic growth.)

Hastings has good experience with “bulk ports” like Newcastle. Its first port investment was Port of Portland in Victoria acquired in 2000. Hoskins says the investment has produced “very strong returns”. Hastings has successfully diversified into commodities, including bauxite, woodchips, hardwood and aluminum. “If we had depended solely on grain, it would be volatile because output is dependent on the weather.”

Hoskins adds that bulk ports like Portland and Newcastle are less exposed to the vagaries of the global economy, pointing out that while the Global Financial Crisis hurt global trade and container volumes dropped sharply, bulk ports like Newcastle, were less affected.

Investors place a high value on Australian ports because they are brownfield assets with proven cash flows and predictable income streams into the future.
“The first thing to understand with Australian ports is that they are different to international ports on the market,” says Hoskins.

“From an operational aspect, the stevedoring is done by third parties. As the owner of the port, we lease the land and charge shipping companies for berthing and the use of the wharves.”

LIKE AN AIRLINE

He uses the analogy of owning an airport versus running an airline. The latter is far riskier as a business. And operating port terminals is more like running an airline.
Ken Atchison says the value of the ports lies in the simple fact that they are monopoly assets.

Jason Peasley, head of infrastructure with A$80 billion AustralianSuper, Australia’s largest industry superannuation fund, confirms that investors face less operational risks owning landlord ports.

“We have stevedoring companies as long-term tenants. Rents are indexed to inflation. This gives us a reasonable ability to forecast future earnings,” he says.

Peasley shares the view of his peers that with the information that is available on economic trends and population growth, it is possible to make long-term revenue projections and predict investment returns.

He also believes that, while there may be hiccups from time to time, global trade will continue to grow in the next 30 to 40 years.

Collectively, state governments in Australia raised A$8.25 billion last year from port sales. They are poised to reap another A$15 billion, and possibly more, over the next two to three years from privatisation of another half a dozen major ports around Australia.

‘HAPPY SITUATION’

Those who spoke to Infrastructure Investor say these include “two ports of substance” – Port of Fremantle in Western Australia and Port of Darwin in Australia’s Northern Territory.

“In effect, we have got a happy situation where Australia needs to retire its debt at exactly the time when there is very strong global competition for exposure in core and core-plus assets,” says Lyon.

“In our analysis, Australia is coming into the most active period we’ve ever had in terms of restructuring and divestment of brownfield government-owned assets.”

Fund managers agree that Australia’s state governments have embraced privatisation of existing projects to recapitalise their budgets and to fund new capital programmes.

Even with competition from the release of other infrastructure assets for sale, Lyon is confident that interest in ports will be sustained rather than necessarily seeing a tailing-off in prices.

He says: “You’ve got a good story in terms of the underlying fundamentals of the Australian economy, and owning ports gives global investors exposure to Australia’s economic growth.”