Why investors prefer ports in an economic storm

This year will likely see the value of ports and marine terminals set new records as cashed-up investors compete fiercely for these assets.

Global pension funds will jostle with private equity groups and public companies in the UK, Australia, the US and, indeed, anywhere else where such assets come onto the market.

Evidence of appetite will arrive in the coming weeks from two sales flagged late last year.

Goldman Sachs Infrastructure Partners is selling a 33.3 per cent stake in Associated British Ports Holdings (ABP), which it jointly owns with UK institution, Prudential.

And Hyundai Merchant Marine, part of the huge Korean chaebol (conglomerate) Hyundai, is finalising the sale of its terminals in the US to private equity firm, Lindsay Goldberg, for $140 million

Goldman Sachs led a consortium to buy ABP in 2006 for £2.8 billion (€3.6 billion; $4.2 billion).

SERIOUS INVESTORS

The stake, which could fetch up to $2 billion in today's market, has attracted serious investors, including, according to the Wall Street Journal, Malaysia's Employees Provident Fund, one of the world's largest pension funds

The deals will be a scene-setter for what could be a record-breaking price in Australia – and possibly in the world – for an infrastructure asset: namely, the highly-coveted Port of Melbourne, Australia's largest container port, in the state of Victoria

Victoria's newly-elected Labor government has reiterated its commitment to privatise the port, which has a value speculated to be upwards of A$5 billion (€3.5 billion; $4.1 billion). Given the level of anticipated competition, investors are expected to be prepared to pay high earnings multiples for the asset, possibly pushing the final figure to A$7 billion, according to industry sources.

Recent Australian ports were sold on earnings multiples of between 25 and 27 times – significantly higher than those for transactions elsewhere.

“It is about risk-adjusted returns rather than about multiples,” says Richard Hoskins, executive director of Hastings Funds Management, which paid a 27 times multiple for the Port of Newcastle, in New South  Wales, last year.

COMPETITION INTENSIFIED

Brett Himbury, chief executive of fellow Australian fund manager IFM Investors, says competition for infrastructure assets has intensified in the global low interest rate environment, and institutions are looking for certainty and higher returns (away from fixed income instruments, like government bonds). 

“We bought the Port of Brisbane (in the northern state of Queensland) three years ago. In that relatively short period, it has shown to be an excellent investment,” says Himbury.

IFM Investors manages A$52 billion in global infrastructure assets on behalf of 30 Australian superannuation funds, and is part of a consortium which paid A$2.1 billion for the Port of Brisbane, now valued at around A$6 billion, based on the sale of a stake in the port in late 2013.

Australia has led the world with port privatisations, realising a total of some A$8.5 billion over the past two years. Another half-dozen major ports around Australia are expected to be privatised in the coming years, generating proceeds of up to A$15 billion for government coffers.

Himbury says ports in Australia have monopolistic characteristics because often they are 500 to 1,000 kilometres apart.

“Ports face less competitive pressure compared with other infrastructure, like power generation,” he says.

THE LANDLORD MODEL

Australia offers what are termed “landlord ports” – regarded as a crucial distinction from ports in other parts of the world. With landlord ports, operational risks are borne by the tenants. 

Hoskins says ports overseas are mostly “operating style ports”. He compares owning a landlord port with owning an airport, and operating ports with owning an airline. Operating an airline exposes the investor to operational complexities, like dealing with the vagaries of the travel industry – and economic conditions. 

“As an infrastructure investor you have to be careful not to have too many operating ports in your portfolio. The more operating ports you have, the more risks you have to your cash flow and business model,” says Hoskins.

Investors also tend to avoid greenfield port projects, seeing cost overruns in these capital-intensive projects and start-up risks as possible pitfalls.

Depending on the traffic and location, Alistair Mackie, a partner specialising in infrastructure, including ports, with UK law firm Holman Fenwick Willan, says: “Ports are generally assets that give investors good returns and strong revenues. They are usually cash-rich.

Few types of infrastructure are more directly linked to the economic fortunes of a country than ports – described as lifelines for countries to the world, and more specifically to global trade. 

ON THE UP

The Geneva-based World Trade Organisation has forecast world trade growth of 4 per cent this year, with a dollar value of more than $2 trillion for the first time in history.

According to Drewy Maritime Research, annual volumes at global container terminals will rise by 5.6 per cent annually over the coming years, rising to 840 million 20-foot equivalents (TEUs) by 2018.

The firm says the increase will push terminal utilisation rates to 75 per cent in 2018 – up from 68 per cent in 2013.

Being the entry and exit points for goods, Mackie says ports have a captive audience. “Compared to ports, for instance, returns from toll roads can be fickle because drivers can take alternative roads – you can't make them use your toll road and new toll roads can be built.

Consequently when investors look to invest in ports – or terminals, which are more readily available than tightly-held ports – they seek to capture national GDP growth.

Rafael “Joel” Consing, vice president and treasurer of the rapidly-growing Philippine company, International Container Terminal Services Inc. (ICTSI) says: “The key is to understand a country's trade flows. We review the consumption trends, GDP and tariff environment as these are what drive our business.” 

ATTRACTIVE LONG TERM

He says that if investors have the view that the economy in which the port or terminal operates will always require raw materials to create the exports or to import goods for domestic consumption, then there is an attractive long-term business to buy into.

ICTSI owns and operates port concessions in eight key terminals in the Philippines, Brazil, Poland, Madagascar, China, Ecuador and Pakistan, and is looking for opportunities in Africa. Currently, 50 per cent of its business is coming from Asia, 38 per cent from the Americas, and 12 per cent from Europe, the Middle East and Africa (EMEA).

Mackie says West Africa is going through the same sort of transformation as China – shifting from investment-led to consumption-led economic growth, and that countries such as Nigeria enjoy population growth with a growing middle class.

That said, so-called substitution risk is ever present. Unlike Australian ports, says Hoskins, US ports face this kind of risk.

Some shipping companies carrying goods from Asia to the US have stopped calling at the San Pedro port complex – Los Angeles and Long Beach on the West Coast – where they used to drop cargo to be freighted by rail to markets in the Midwest and East Coast.  

DIVERSIONS

Instead, they have gradually chosen to bypass the congested West Coast for what are known as “all-water services” to the Port of New York and New Jersey on the East Coast. More such diversions will be possible on completion of the expansion of the Panama Canal next year.

HFW's Mackie says: “Transshipment of containers can be quite mobile as they are not tied to a domestic port.”

He says that sometimes countries want to make a statement, as it were, that they need their own port – even though, from a logistics and cost effectiveness point of view, there is insufficient volume to support the facility.

In 2000, Singapore lost the Danish container line Maersk to the then newly-developed Port of Tanjung Pelepas, in Malaysia's southernmost state, Johor. Port of Singapore reportedly lost 15 per cent of its business when Maersk made the move.

Another potential problem is the upgrading of vessels. Container ships have grown from 11,000 TEUs (20 foot equivalent units) in 2007 to 15,000 TEUs in 2010 and 18,000 TEUs in 2013. The latest class of ships are built to 470 metres in length, requiring a depth of 21 metres to anchor.

Consing says port owners and terminal operators need to understand the demands and requirements of shipping companies.

“We talk to shipping companies to understand their plans in terms of ship acquisition so that we can anticipate the size of vessels and future volumes of trade,” he says.

Ports may need dredging to keep pace with the size of vessels and natural phenomena like silting.

RECOVERING COSTS 

However, capital expenditure can be recovered from customers, says Hoskins, citing the case of Port of Melbourne, which imposed a significant levy on its customers for dredging of the port. 

“If you own toll roads, typically the risk of capex and maintenance issues is far more acute, because if the toll is $1.50 and you spend $1 billion, you can still only charge $1.50 a car,” he says.

The longevity of the port leases, which in Australia run to 99 years – 30- to 50-year terms are more common elsewhere – can make evaluation of risks and returns difficult.

Investors and consultants told Infrastructure Investor that it is possible to have good visibility of performance and returns in the first decade, but it will become less clear beyond that.

Says Hoskins: “One measure we focus on when making investments is the payback time. If we can get anything under 10 years, it will be great.

The longer it takes to get paid back your investment, the higher the risk.”

Hastings and its partner, China Merchants, paid A$1.75 billion for their recent purchase of the Port of Newcastle, north of Sydney, last year.

Beyond the first decade, investors say the residual value of an investment is around 10 per cent. Consequently, they say, risk becomes “relatively benign”.

RISK ASSESSMENT

Unforeseen risks can come from global warming, climate change and rising sea levels. Such risks, says Himbury, are harder to quantify, but, as an investor, IFM Investors says it employs the best analysts to assess the risks.

Himbury says diversification to reduce reliance on a particular product such as cars or commodities is one way of mitigating risk.

The appetite for ports and terminals is not surprising when considering their economic importance and that, as an asset class, they still form a small portion of the overall portfolio of infrastructure investors, according to a research note from First State Investments.

London-based BTG Financial Consulting says that “investment in marine terminals, particularly container terminals, has often been considered a safe play, neatly slotted within an institutional investor's infrastructure portfolio of pipelines, toll roads, rail, transit, airports and waterworks”.

CASHING OUT

However, history has shown that they are not always such a safe bet. 

In the lead up to the Global Financial Crisis, when cash was plentiful – as it is today – private equity groups regularly outbid public companies to clinch marine terminals.

Observers say it is questionable whether these investments delivered the expected returns. Some of those investors are cashing out today.

Recently, APM Terminals sold its terminal in the Port of Virginia to Alinda Capital Partners, one of the largest infrastructure fund specialists, and UK-based Universities Superannuation Scheme. The price was not disclosed, although media reports suggested around $540 million – the same price as APM Terminals paid in 2007.

While ports are attractive for a reason, the caution that is applied to all other infrastructure assets during bidding needs to be applied to them also. Something worth bearing in mind perhaps as the queue for available assets grows ever longer.