Looking for traction

For a nation associated with self-restraint, Germany has done particularly well at projecting its influence on the global scene. Europe's largest economy is often hailed as an example of budgetary discipline, industrial competitiveness and productive social dialogue. Its authority weighs heavily on all economic or political matters affecting the European Union (EU), as illustrated by its de facto power of veto over efforts to resolve the Eurozone or Ukraine crises. And it dominates international football, having mesmerised every other team during last year's World Cup in Brazil.

Yet when it comes to infrastructure, the country's importance as an investor playing ground seems to remain rather small. “For an economy the size of Germany, the volume of deals we've witnessed in recent years is disappointing,” says Matthias Reicherter, head of infrastructure investments at Munich-based fund of funds manager Golding Capital Partners.

Figures seem to prove him right: according to Infrastructure Investor Research and Analytics , Germany saw 28 infrastructure transactions in 2014, less than half France's tally of 64 and a fifth of the UK's 151 deals. Germany's total disclosed deal value, at about €5.2 billion, also fared poorly compared with the UK's £53 billion (€71.4 billion; $80.5 billion).

There were a few notable transactions, such as the €630 million financial close of the European Investment Bank-backed Schleswig-Holstein University Hospital; the €600 million final close of the A7 Motorway public-private partnership (PPP) project, with the support of Dutch fund manager DIF and developers Hochtief and KEMNA Bau Andrea; and the €420 million acquisition of rolling stock leasing business Railpool from German lenders HSH Nordbank and KfW by fund managers Paribus Capital and Oaktree Capital Management.

But local practitioners remain unimpressed. “In general the deal flow remains rather slow,” says Claus Fintzen, director of infrastructure debt at Allianz Global Investors, the asset management arm of insurance giant Allianz. “There's certainly a lot of talk about it – but it's much ado about nothing,” adds Thomas Alberghina, a director for road and rail PPPs at state-owned KfW.

Few expect the market to markedly rebound this year. This is particularly the case for large trophy deals, says Holger Kerzel, managing director for infrastructure at MEAG, the €240 million asset management business of German insurers Munich Re and ERGO. “There's clearly more dry powder than deals,” concurs Verena Kempe, a director for private equity at German asset manager Feri Group.

IN THE SLOW LANE

Not everybody is so negative about the country's prospects, however. Carl Jobst von Hoersten, head of Germany at DIF, points out that federal highway tenders have given rise to a regular flow of opportunities over the last two years. As the country continues to upgrade its prized Autobahn system, this is likely to continue.

Yet it will take time for these projects to see the light of day. On the list are extensions to the A94, A75 and A6 – none of which, reckons Alberghina, will be enacted before 2016. Neither are other transport projects of significant scale, such as a €2 billion scheme to equip Munich's train networks with new rolling stock and another to equip the city with a new tunnel, likely to close this year, adds Marcus Kleiner, head of infrastructure and rail at Hamburg-based HSH Nordbank.

No surprise then, that managers with the most serious grievances are those which operate in the PPP space. “If you were exclusively focusing on public-private partnerships you would probably find the picture rather sad,” says Fintzen. Kleiner believes there will be a handful of regional projects, such as a plan to build a new laboratory in Berlin Brandenburg and a new, large police office building in Hesse. These will be joined by a number of local PPPs, such as social housing, fire stations and schools.

But few believe they will be of a size likely to attract institutional investors. What's more, explains Luc Avérous, a senior vice president for European infrastructure at Swiss-based investment manager Partners Group, developers tend to take the lead on such PPPs, adding equity at the start and syndicating the financing to low-cost capital players when the project becomes operational. That doesn't leave much room for other investors to get involved. 

Investors suggest transaction opportunities are more likely to come at the brownfield end of the market, with energy clearly in focus. “German utilities are struggling. They've been hit by the shutdown of nuclear capacity and the rise of renewables,” says Avérous. Whether the resulting sale of non-core generation assets will result in flourishing deal flow remains unclear, however. “These transactions generally don't involve tolling agreements or medium-term protection. So they're more suited to corporates or private equity players than infrastructure investors.”

Volker Häussermann, a director at fund manager First State Investments, adds that big utilities have already gone through a phase of restructuring. Having sold part of their electricity networks in more troubled markets, they're holding on to their German assets and see them as core to their activity.

ALTERNATIVE PIPELINES

Other sectors may have brighter news in store. Avérous says French utility GDF Suez, which tried to sell its stake in transmission network GRTgas in 2013, could well try its luck again in the hope of getting a better price. Gascade, a company jointly owned by Russia's Gazprom and Germany's Wintershall, could be shedding a number of transportation and storage assets. VNG, a Leipzig-based gas business, also has some pipelines it could potentially divest.

Kleiner adds that capital expenditure may be required by private operators to upgrade and expand the fiber optic network. He also thinks buyout transactions, in line with the sale of Railpool, could also materialise as banks continue to streamline their balance sheets.

And then, Häussermann says, there is always the possibility for smaller transactions to emerge – though deal flow tends to be less predictable in the mid-market. “You really might not be into the typical core strategies investors like,” Kempe notes. “You are probably in more assets with GDP correlation – something investors are sometimes more hesitant to commit to.”

Where there is always promising deal flow, she says, is in the renewable energy sector, which in Germany benefits from a stable feed-in tariff regime. But some investors remain cautious. “We've done a lot of German renewable deals in the past but have recently paused to assess the market,” says Jobst von Hoersten. Häussermann expresses similar reserve: for him, renewables “rarely qualify as core infrastructure”.

One reason for the general restraint is that renewables tend to vary greatly in scale – with large portfolios of assets, the only really attractive targets for institutional investors, heavily competed for. “There is a lot of demand from institutional capital for brownfield assets. Valuations have been pushed up quite a bit over recent years,” says David Daum, a vice-president for European infrastructure and renewables at Partners Group.

Some think his observation extends to most regulated assets: Avérous cites the acquisition of gas network EVG by First State last October as example of a transaction that recently “broke records” in terms of both regulated asset base and EBITDA multiples.

Others have a more nuanced view. Häussermann underlines some of the strategies First State is pursuing to boost revenues at EVG, such as creating synergies with Ferngas, an adjacent network First State also owns. Uwe Fleischhauer, a founding partner and managing director of Munich-based investment manager Yielco Investments, says Germany tends to be less competitive than other large European markets. “It is a more complex one to enter. Investors need more local contacts.”

PUBLIC ENEMY

Yet if views on competition and pricing sometimes differ, everybody agrees on the diagnostic: there's just not enough deals. And most also concur on who the main culprits are.

“It's not like France or the UK. The public's perception of private ownership of infrastructure is still negative in Germany,” says Reicherter. That's particularly true of PPPs, notes Alberghina, which he reckons “are not at all accepted here”.

One lingering, related question is whether they represent value for money. “Is it really going to benefit the taxpayer? The public remains unconvinced the answer is yes,” elaborates Kempe. She adds that there is also a general hesitation towards privatisations, with the state even renationalising a number of grids – in Berlin and Hamburg, for instance – in a bid to placate opposition and raise revenues.

Another key factor behind the slow progress of large deals, many point out, is the federal nature of the German state. “The country is made up of 16 states, with no single PPP legislation or documentation. It's a very fragmented market,” says Reicherter.

It's no coincidence that the only PPPs to regularly make it through are highway projects, notes Fintzen, because they fall under the remit of the federal state. Germany otherwise lacks a standardised authority, making coordinating municipalities, state institutions and federal authorities an arduous task. “Germans like to make things complex. PPPs often take over two years from start to finish.”

Some work is underway to try and oil the procurement wheels. The Economy, Finance and Transport Ministry are all involved in conversations with stakeholders to try and come up with proposals to plug private capital into infrastructure projects.

One thing that would be especially helpful, notes Alberghina, is if the government could be fully transparent on what form of procurement process it chooses for a given project. When it opts for the PPP route, Kempe adds, it should provide investors with more clarity on risk-sharing arrangements and the public with more information on the scheme's merits.

HUNGRY FOR YIELD

Many investors believe progress in some shape or form will at some point have to materialise: Germany's infrastructure is ageing, and states' budgets are constrained. A commission set up in 2014 estimated that Germany would need around €7 billion annually over the next 15 years.

But the current state of affairs on financing markets is prompting domestic investors to act before then. “In a world of ultra-low interest rates middle-sized institutions are on the hunt for yield,” says Kleiner.

Investors are therefore attracted to infrastructure. This is despite a fall in expected returns, which Kleiner reckons have dropped from 10 to 12 percent to 6 to 8 percent internal rate of return (IRR) for equity and from up to 3 percent to lower than 1 percent margins for infrastructure lending. “When you contrast these to the very low rate you get on state paper it remains quite a good deal.”

A mini-wall of German capital targeting the asset class is slowly forming. Fleischhauer reckons two out of three German institutions have concrete plans to increase their allocations to infrastructure with an average target of 3 percent, which would bring inflows worth about €30 billion to the sector. In many cases, infrastructure is their first venture into the alternative space.

Stefan Kalau, deputy head of private equity, infrastructure and timber at the €62 billion Bayerische Versorgungskammer, says that for these late starters investing in funds or funds of funds in the first instance makes sense. Not only can it bring instant diversification in a portfolio, it can also help an investor reach beyond his country's borders.

Few domestic investors are looking to invest directly. Apart from the very largest insurers, such as Allianz or Munich Re, many institutions lack the capabilities to do so; others have been disappointed when giving it a try in the last few years. Limited partners, explains Kalau, would rather commit to a mix of European and global core funds as well as specialist vehicles, such as renewables or greenfield ventures, to add a couple of extra basis points of returns.

That doesn't mean domestic LPs are forgetting about their homeland, however. “Of course we would like to invest more in Germany. We're a German pension fund,” says Kalau. Their local market may not currently offer enough to meet their needs, but German institutions stand ready to benefit should their country – at its own pace – pursue an ambition to become an infrastructure champion.