Queuing up, cash in hand

When Australia’s Queensland-owned QIC placed a network of toll roads on the market last year, it attracted global investors with collective spending power of more than A$20 billion (€14.0 billion; $15.3 billion).

Here was an illustrious cast of some of the world’s most cashed-up entities: Canada’s Borealis, Singapore’s GIC, Spain’s Abertis Infraestructuras, the Netherlands’ APG and Malaysia’s Employees Provident Fund.

They lined up behind Australian fund managers – IFM Investors, Hastings Funds Management and Transurban (Australia’s biggest operator of toll roads) – hoping to acquire Queensland Motorways (QML), a 70-kilometre network of toll roads.

It was a rare opportunity to own the largest transport infrastructure in Queensland, Australia’s third-most-populous – and growing – state.

“There is significant capital available in the market, especially for core assets. We received three fully-funded bids with more than A$20 billion of capital committed for the sale of QML,” Matina Papathanasiou, QIC deputy head of global infrastructure, says.

The coveted asset went to a consortium led by Transurban, with a 62.5 per cent stake, AustralianSuper, (the nation’s largest superannuation fund) with 25 per cent, and Abu Dhabi Investment Authority (ADIA) with 12.5 per cent. The final price was A$7.057 billion – almost A$2 billion above analysts’ valuation of A$5 billion.

POLES AND WIRES

The coming months could witness even more dazzling transactions when Australia’s largest state, New South Wales (NSW), begins its privatisation programme. The highlight will be three separate electricity transmission and distribution assets.

Excluding retained government stakes for two of the assets – Ausgrid and Endeavour – equity required for the NSW ‘poles and wires’ assets will be around A$8 billion, says Papathanasiou.

Big dollars and fierce – some say acrimonious – competition has become a hallmark of Australia’s infrastructure market.

There is certainly no shortage of capital.

Just one infrastructure fund manager, Melbourne-based Hastings, has A$10 billion in capital under management. Hastings’ domestic rivals QIC and IFM Investors also have access to the scale of funds required to participate in large bids.

In addition to Australian superannuation (super) funds with billions to invest, there are at least 10 to 15 offshore investors – each with the capacity to write A$1 billion-plus cheques in the Australian market, observes Colin Atkin, Hastings’ executive director.

Routinely, investors pay more than 20 times earnings for prized Australian assets. The Queensland Motorways’ deal was done at about 27 times earnings.

PRICE ISN’T EVERYTHING

But the consensus among roundtable participants is that, when it comes to pricing an asset, it is really a matter of horses for courses.

Indeed, the notion is dismissed that the Australian market is becoming too hot, or that investors are overpaying for assets.

“The multiples and the price are only one half of the information, the other is how the asset fits in with your portfolio – and that is much more important,” says Atkin, who is also portfolio manager for Hastings Institutional Funds Utilities Trust of Australia (UTA).

“Almost all of our investments are made in the context of a portfolio. The cash flows and risks associated with those cash flows are matched against the risk bucket of the rest of the portfolio.”

“In the final analysis,” Atkin says, “different investors will have a different price or a different risk profile for every asset.”

Papathanasiou says an important consideration is whether the asset provides diversification. There is a need to properly understand the key value drivers and risks.

“For instance, managers would not want to have 100 per cent GDP-sensitive assets,” she says. “They want to get some portfolio benefit from returns, uncorrelated to economic trends. You have to stress-test an asset through different economic cycles to assess the level of risk – and what price will bring the appropriate equity rate of returns.”

She adds: “QIC focuses on three broad sectors where we have successfully executed and currently manage investments including transport, energy and utilities and PPP/social (infrastructure).”

David Byrne, head of utilities and infrastructure, Australia and New Zealand, at ANZ Bank, one of Australia’s ‘Big Four’ banks, says: “In the current market, there is elevated demand for projects.”

Paul Crowe, Plenary Group’s executive director and head of origination, adds that when discussing the high earnings multiples paid for assets, observers do not understand the internal drivers of the particular investor, whether it is QIC or Hastings.

Nevertheless, investors are being cautious.

“The amount of capital that is available drives us to have a degree of heightened caution,” says Atkin, adding that Hastings has been disciplined in how it deploys its capital.

The caveat from those present is that capital is global, and that it goes to where it can find best relative value.

Hastings could not match the price paid for Queensland Curtis LNG (QCLNG) – the world's first project to turn coal seam gas into liquefied natural gas – also known as the QCLNG Pipeline, which was owned by BC Group before it was sold to APA Group for A$6 billion last year.

“We invest in multi jurisdictions, which means that if the price is going to be too hot in one jurisdiction, we divert the capital to another,” says Atkin. “We bid for QCLNG at the same time as we were bidding for Porterbrook Rail Finance – one of the three major rolling stock leasing companies in the UK.”

Hastings partnered with Canada’s Alberta Investment Management Corporation, Germany’s Allianz Capital Partners and France’s EDF Invest to secure Porterbrook for more than £2 billion (€2.78 billion, $3.06 billion) last October.

OWNERSHIP IS KEY

Irrespective of price, says Atkin, ultimately the key is to ensure that assets do not go to what he calls “not a natural owner” as a consequence of the high level of liquidity that is available in the system today.

This concern is front-of-mind for Australia’s state governments considering privatisation of public assets. They are rightly worried about political ramifications that could spill over from selling an asset to the wrong operator.

While the Labor party tends to be wary of privatisation, conservative politicians can be more pragmatic.

The newly-elected conservative government in NSW is pressing ahead with privatisation of the biggest pool of assets in Australia – to fund an enormous pipeline of greenfield projects to be built over the next five to 10 years.

Bidders have already lined up for the poles and wire businesses. Australian media has reported that three consortia are waiting in the wings. Aside from Australian companies, the foreign groups interested are said to include State Grid Corp of China, Canada’s Caisse de dépôt et placement du Québec (CDPQ), and Wren House, part of the Kuwait Investment Authority.

Byrne says Queensland faces significant challenges because, ideologically, the new Labor state government is opposed to a lot of the techniques which have been used in other states to deliver infrastructure.

In Western Australia, although the Liberal government has historically been resistant to privatisation, it is nevertheless planning to lease or sell off more infrastructure, including its electricity system.

Byrne says all the states face fiscal constraints to some degree, and they have to find sources of capital other than government debt or current account revenue to fund much-needed infrastructure development.

SOVEREIGN RISK

The challenge for investors is to cope with political decisions – or indecisions in some instances – sometimes when the bidding process has begun, or even once it has been completed. For foreign investors, political decisions become an issue of sovereign risk.

Plenary Group, which has a portfolio of $20 billion of projects, is one of two consortia bidding for the A$800-million Capital Metro, a light rail system for the capital city, Canberra.

Crowe says: “There is a threat of the other side of government cancelling the contract – this doesn’t help. But we will investigate and do our due diligence on the political risks.”

Roundtable participants say bidders can use their commercial contractual agreements to protect them against “certain outcomes”.

When the incoming Victorian Labor government cancelled the A$5.3 billion East West Link project after taking office in March this year, it negotiated a A$339 million compensation package with the winning consortium, led by Lend Lease and including France’s Bouygues, Capella Capital and Spain’s Acciona.

But Byrne says there is bipartisan support in Victoria for the privatisation of the Port of Melbourne, Australia’s largest container port. The process has commenced with the necessary legislation being introduced into Parliament recently, and an expectation that the formal lease process will begin later this year.

Says Byrne: “Beyond that, the industry is engaged with the new Victorian government to see what else it can bring to market.” He adds: “The state has some work to do to continue to build a credible and substantial pipeline (after cancellation of the East West Link).”

THE PPP FACTOR

Crowe says the Victorian government is pressing on with public-private partnership projects (PPPs), to upgrade existing infrastructure and build additional capacity such as developing social housing and new schools.

In its first budget, the new Victorian government has allowed for 15 new schools to be built by the private sector under its A$730 million allocation for school infrastructure.

Crowe says the state has its second schools package in the market, while NSW and Queensland have done two schools packages each. Western Australia currently has a schools package in the market. He also sees opportunities to package other infrastructure assets such as rail grade separation and to develop regional and suburban train stations in Victoria.

“Across the country,” says Crowe, “private sector skills could be brought to work on the upgrade of infrastructure. That is where we see the market heading.”

New opportunities will come from a collection of assets, rather than just one single asset, he adds.

Under PPP projects, Byrne says investors receive a fixed payment stream from the contracting government for construction risk, together with ongoing facilities maintenance over the life of the concession.

Crowe concedes that, because of the lower equity outlay, large investors stay away from PPP projects such as schools. Schools packages are usually 85 to 90 per cent debt funded and the project size is typically in the order of A$300 million. The ticket size for other types of PPP can, of course, be much bigger, ranging from A$200 million to A$1 billion, he says.

Atkin concurs. “If you are trying to deploy a cheque size of $400 million to $1 billion at a time, it is hard to find something that will fit. But it could work with the right collection of assets.”

Crowe says long-term investors who “can get their head around the greenfield risks” are now chasing both construction risk premium and liquidity premium in the PPP space.

QIC and its partners, Transurban and Canada Pension Plan Investment Board (CPPIB), successfully reached completion earlier this year in an unsolicited A$3 billion proposal to the NSW government to build a nine-kilometre tunnel linking Sydney’s M2 motorway with M1 Pacific Motorway, to be known as NorthConnex. The consortium already owns Sydney’s Westlink M7 toll road.

Papathanasiou says: “We negotiated a deal with the NSW government to extend the M7 concession term and to increase truck tolls on the M7. With the value generated through that transaction, together with a government contribution, we will fund development of NorthConnex, which will take four years to complete.”

Similarly, she says QIC – which has a 25 per cent stake in Brisbane Airport – is committed to build an additional runway there costing A$1.5 billion.

“To fund such a major piece of infrastructure, we required certainty of the future revenue stream to support what is a 100-year asset,” says Papathanasiou. “We were able to reach an agreement with all the airlines around the pricing structure for the runway.” She adds that projects such as these have elements of greenfield characteristics.

Papathanasiou continues: “Investors will invest in greenfield projects when they can be linked to existing assets. We call them ‘khaki’ assets. Investors have reduced appetite to take on full demand risks, so you have to work with the government to structure a deal that, from a risk return perspective, both the government and the shareholder group providing the funds are comfortable with.”

UNSOLICITED AND UNORTHODOX

Byrne says NSW is the first state to make an unsolicited bid, like NorthConnex, work. Other states are still mulling over such initiatives.

He says Transurban has approached the Victorian government to consider Melbourne’s “Western Distributor” project as a market-led proposal. With Transurban proposing to majority fund the project through tolls and an extension to its concession for Melbourne’s City Link toll road, some level of government contribution is likely to be required to make the economics work, says Byrne.

Hastings is creating its own opportunities – and is prepared to take construction risk. “When we analysed our portfolio recently, half of it would be deployment for organic growth,” says Atkin.

Increasingly, Byrne expects investors to consider “non-traditional” opportunities.

One such area could be buying infrastructure, such as ports, railways, terminals and other facilities in remote regions of the Australian outback, which have been developed and are owned by resources companies.

Given the state of the resources sector, says Papathanasiou, it may make sense for some mining companies to partner with a long-term infrastructure investor in the ownership of their infrastructure.

“But,” she adds, “obviously you would deal only with top-tier resource players who are cost-competitive on an international basis.”

International commodity prices will continue to be volatile, but the volume of commodities produced will not decrease, says Atkin. “Australia is cost-competitive globally, and the commodities are going to continue to be delivered.

“It is about managing the price of infrastructure for the service – rather than the price of the commodity. That is fundamental to whether the asset is attractive to you as an investor and your portfolio. Separating commodity price from the underlying activities is really the first step,” he says.

GOOD REGULATION

Far from stifling investment, participants say Australia’s regulatory environment is supportive of investors.

“On the world stage,” says Atkin, himself a global investor, “the Australian regulatory environment is superior to other countries. It is established, transparent and has a good track record.”

He says: “Global capital is attracted to Australia because our operating environment is supportive and gives them confidence. It will change progressively into the future to accommodate different circumstances or environments, but we are not put off by that at all.”

Says Byrne: “For us, regulation fits in to what is the appropriate covenant structure to support an asset. I get a lot more comfort if there is a completely independent regulator as distinct from one that is politically motivated.”

Papathanasiou confirms that Australia is one of the world’s leading infrastructure markets with a well-established regulatory regime.

Byrne explains: “But the regulatory environment underpinning ports and airports, power transmission and distribution has been around for 20-odd years. It is stable, transparent, well understood and completely independent of government influence.”

BEWARE THE RE-FI WAVE

As Crowe sees it, the biggest risk facing infrastructure investors is refinancing, especially after investors have shown aggressive risk appetite in the competition for assets. “Transactions that were done post-GFC [Global Financial Crisis] will hit the refinancing market this year.”

He believes long-term investors may be attracted to debt investment as well through these re-financing opportunities.

Byrne says: “The perennial problem in Australia is the mismatch of available funding and the length of the concession over the economic life of the asset. Banks are not able to bridge this gap.

“Whereas the larger corporates and infrastructure companies are able to tap into euro, domestic and Asian markets, you are not seeing a significant supply of institutional money in Australia into long-term infrastructure debt.”

The US private placement market remains the main source for the long-term funding of infrastructure investment.

Compared with uncertain economic outlooks in other parts of the world, especially Europe, Papathanasiou says: “Australia still has reasonable growth forecasts and a good banking system. It is an attractive market for infrastructure investment with a strong pipeline of privatisation projects.”

Crowe agrees: “Many of the fundamentals are strong in Australia – and the pricing of assets reflects the economic environment and expected population growth.” He points out that population growth is one of the fundamentals driving infrastructure needs and investment.

So global investors continue to flock to Australia. Asian groups – the Malaysian-government-owned asset manager Khazanah, China Merchant Bank, and China State Grid Corporation – are notable new entrants to the infrastructure market.

In May, another new player – Californian pension fund, CalPERS – announced a A$1 billion Asia Pacific partnership with QIC to invest in high-quality infrastructure assets in the region, including Australia.

Meanwhile, Canadian groups Borealis and OPTrust have entrenched themselves in Australia. Both have opened offices in the country to be close to where the action is.

In the eyes of global infrastructure investors, it seems, Australia is a land of emerging opportunities.

AROUND THE TABLE

Colin Atkin’s primary role is portfolio manager for the Hastings Utility Trust of Australia (UTA), a A$5-billion core infrastructure fund which owns assets in North America, the UK, Europe and Australia. Prior to running UTA, he ran the listed Hastings Diversified Fund, which has since been wrapped up at the end of its nine-year term. Before joining Hastings, Atkin was with the international ratings agency Standard & Poor’s for seven years. He comes from an investment banking background, having worked in this sector in the UK and Australia.

David Byrne heads the Utility Infrastructure business in Australia for ANZ Bank. His primary role is to set strategy in areas where the bank will be involved in funding. He looks at existing portfolios and at new opportunities to support clients when they are considering those particular types of transactions. Byrne joined ANZ five years ago from the French bank BNP in London, where he managed an acquisition finance unit for Europe. An accountant by training, he has also worked at Deutsche Bank.

Paul Crowe is head of origination at Plenary Group, a leading infrastructure developer. Crowe is deeply involved in sourcing and bidding for greenfield PPPs. His team also structures transactions, invests capital and manages projects through construction to successful operation over the life of the concession. Crowe joined Plenary Group since its inception a decade ago and has followed what he describes as “a pretty interesting phase for infrastructure growth for Australia”. He was previously with a major commercial bank executing transactions within the infrastructure and utilities sectors.

Matina Papathanasiou, deputy global head of infrastructure with QIC, co-founded the corporation’s Global Infrastructure team with Ross Israel, global head of infrastructure at QIC, in early 2006. She has wide-ranging responsibilities from asset selection to transaction and portfolio management. Reflecting QIC’s strategy, Papathanasiou is focused on transport, utilities and PPPs. Client relationships also falls under her remit. Currently, she is a director at Brisbane Airport Corporation and Westlink M7 – two of QIC’s largest assets. Before joining QIC, Papathanasiou had been in the industry for 30 years during which she witnessed the different cycles of the Australian infrastructure market.