The opening of Actis’ 12th global office in Mexico City in June this year was a timely development. After all, as Michael Till, a partner and co-head of energy at the firm, tells Infrastructure Investor: “Latin America is one of the most important regions for our energy fund at the moment.”
Till relates that Actis, the emerging market fund manager, took a look across the infrastructure space to decide where it should concentrate its efforts shortly after closing its $750 million Actis Infrastructure 2 fund in October 2009. The outcome of this deliberation was to prioritise power, which Till says accounts for over 50 percent of infrastructure investment opportunities in emerging markets.
Reasons for the pre-eminence of the power sector have their origins in the development of the Independent Power Producer (IPP) model combined with a continuing mismatch between strong demand for electricity and scarce supply. Investors have responded, Till notes, “resulting in a high penetration of private investment in power generation – much higher than in any other infrastructure sector in emerging markets”.
Within Latin America, Actis has chosen to focus its energy strategy on building power generation plants and aggregating individual projects into high growth operational businesses. “We change the risk profile by de-risking assets and we rapidly build scale to present a strong exit for our fund while presenting further growth opportunities for a buyer,” explains Till.
According to Till, the regulatory environment in Latin America has been a relatively benign one following reforms implemented in the 1990s. This has made it the most developed for private sector investment of any emerging market region. He relates that the firm invested around 25 percent of its capital in Latin America from Fund 2, but that this figure could rise to around 50 percent for the $1.15 billion Energy 3 fund which the firm closed in December 2013 and from which it is currently investing. When including co-investment by some of the fund’s investors, this would equate to around $700 million of capital investment over a three to four–year period.
In particular, Actis is attracted by the opportunity in renewable energy. “When it comes to power, governments want low costs, reliability and minimal environmental impact. Renewable energy technology is now solving all three of these issues,” explains Till. Furthermore, Latin America benefits from great natural resources when it comes to wind and solar irradiance. “The region has many world-class wind and solar sites and there will be a window of opportunity for many years,” says Till. At the current time, most of the investment opportunities are in wind with solar less developed – although Till says he envisages solar catching up with wind within the next decade.
Actis has a legacy of nearly seven decades of investing in emerging markets. With $7.6 billion funds under management, it invests in private equity, real estate and energy businesses. Its second energy fund, Actis Infrastructure 2 recently announced successful exits from its two power generation platforms Globeleq Africa, the leading independant power generation business in Africa and Globeleq Mesoamerica Energy (GME), the leading Central America renewable energy platform established by Actis and local partner Mesoamerica in 2010.
From the most recent fund, Actis Energy 3, the firm has so far invested in five renewable energy platforms in Brazil, Chile, Mexico, India and Africa, taking the total to eight such platforms Actis has created globally. All of the platforms, says Till, begin from the premise of “an attractive growth opportunity, a competitive strategy, and then the ability to de-risk assets and build businesses with scale and an attractive growth profile”.
In Brazil, the firm has committed $355 million to Atlantic Energias Renovaveis (Atlantic). The firm develops, owns and operates wind farms across the country, as well as a small run-of-the-river hydro plant, with a grid that connects remote areas to major cities such as São Paulo, Rio de Janeiro and Belo Horizonte. Actis is aiming to increase Atlantic’s power generation capacity to more than 600 megawatts (MW) by 2018.
“We had a view that the wind sector in Brazil was very attractive,” relates Till. “There was a clear, transparent and reliable auction system and a strong equipment supply chain and financing in place. Atlantic had a strong pipeline of wind projects, a good management team, and we were able to bring capital, financing and structuring knowhow.”
Since first investing, Actis has been rapidly scaling the business by successfully bidding for projects in auctions.
Once a PPA (Power Purchase Agreement) is won at auction, the focus is then on negotiating the finance – which is a very different task in each of the markets in which Actis operates and usually involves a combination of local banks and bond markets such as Brazilian Development Bank (BNDES). “As we have built up our operations in Brazil, we have worked very closely with BNDES, which provides 50 or 60 percent of financing for energy projects,” Till says. “But you also need to tap the bond market and private banks to make up the full financing package.”
He adds: “In Chile and Mexico you have more of a developed corporate banking market providing project finance with some involvement of development finance institutions (DFIs). In Central America, project finance is much more reliant on regional, US and European DFIs rather than the local banks, which tend to struggle with long tenors.”
Of the overall financing environment, he concludes: “It’s all about accessing multiple sources of finance and having relationships with both local organisations and DFIs is very important.”
After the financing, the focus switches to managing risk, creating value and building scale through the construction period.
Ultimately, the firm is seeking to build a platform that will either be “an attractive target for consolidation”, according to Till, or a candidate for an initial public offering (IPO) that will offer investors growth prospects.
In Chile, Actis teamed up with Mainstream Renewable Power – a global developer it had previously joined forces with in South Africa – to launch the Aela Energia platform in June 2013. Actis committed $200 million at the time of the deal, with a view to building wind and solar plants across Chile to provide some 600MW of power to the country’s inhabitants.
“When we set up the business, renewable energy technology was clearly becoming more important to Chile,” recalls Till. “It had an expensive electricity tariff, was over reliant on hydro and imported fossil fuels and wanted to diversify its energy mix – so they tweaked the auction model to make it more favourable for renewable energy. The country has a well-developed project finance market and is well regulated.”
To return to the point made in the opening paragraph, Mexico is currently a major focus for Actis, evidenced by its recent opening of a new office. As with many private equity and infrastructure investors, Actis is expecting to take advantage of a raft of anticipated opportunities arising from the opening up of the country’s energy industry to the private sector. The new office will also allow the firm to capitalise on the many other opportunities in the region driven by consumer and infrastructure growth.
“Mexico is interesting because it is the second-biggest economy in the region but much of its energy market was effectively closed to private investors until recently,” Till notes. “The Mexican reform programme is the most interesting story in the Latin American infrastructure sector at the moment. Two years ago we could see it coming and decided to invest ahead of what we thought would be a serious reform process.”
TAKING THE PLUNGE
Following a successful partnership in Central America, Actis teamed up again with Mesoamerica in September last year, committing $250 million for a 70 percent stake in Zuma Energia, a platform it established to acquire and develop renewable energy generation projects across the country – ultimately to provide over 500MW of newly installed energy capacity. “We set up our own platform because we couldn’t identify a developer with an attractive portfolio of projects, so we decided to do it ourselves,” says Till. “There are currently opportunities to set up industrial off-take arrangements and, at the beginning of 2016, the last piece in the jigsaw will be the implementation of a new auction system. We are looking forward to participating in the first energy auctions next year.”
The energy opportunity in Mexico does not stop with wind, Till goes on to point out. He says the firm sees lots of opportunities in gasfired power and is also beginning to see opportunities in the still nascent solar market as well.
Indeed, Till is impressed by the progress Mexico has made in general towards attracting private investment. “There is a new model of regulation. The government has sought to consult with the private sector, has listened carefully, and has come up with a bankable model that is very important in terms of building investor confidence.”
Actis sees opportunity in the renewables space elsewhere in the region too. Central America, where Actis recently sold it its wind business, Globeleq Mesoamerica Energy, “has smaller economies but they are well regulated and have less competition,” says Till. “They are also US dollar- denominated in terms of the off-take so you avoid foreign exchange risk. We have had a very good experience in this region with our last two funds.” Peru and Colombia are cited as other markets with potential.
The conversation then turns to how Actis goes about adding value to its investments in Latin America. Till points out that the focus is on how to implement the strategy of creating businesses and controlling risk while building scale.
It also has an operations group with project management and engineering experts “who will come into deals and ensure that the right risk mitigation and project development processes are being undertaken”.
Till goes on to say that the firm has 20 professionals in its energy team, working across Africa, Asia and Latin America, who are involved in every business the firm invests in. Some of the most important tasks include optimising the governance structure of portfolio companies, ensuring risk is mitigated, building scale and ensuring that environmental and social impacts are favourable.
Furthermore, there is a strong focus on identifying and supporting the best management teams. “As we build businesses, a big factor is building management teams,” relates Till. “Finding the right CEOs occu- pies us heavily in the first year to year-and- a-half of funds as we build out the founda- tions. We put together management teams appropriate to the strategy.”
THE BIGGER PICTURE
Till notes that many of the aspects men- tioned above – including choice of management, governance, negotiation of contracts and managing risk – are all within Actis’s control and are key components of the value creation process that attracts the funds’ investors. This is not to say that investors have no concerns when it comes to Latin America, but those worries are mainly in relation to macro economic factors that fund managers have less immediate control over. This is where the layers of risk mitigation that Actis puts in place are important, along with a long-term view of these markets, that allow it to invest and operate in emerging markets in spite of occasional macroeconomic and political volatility.
“The issue we end up talking about most at the moment is the macro environment in Brazil, where it’s undoubtedly challenging,” concedes Till. “The economic data has not been good and we’ve seen the corruption scandal continually in the headlines over the last 12 months.”
On the positive side, he believes that “you can interpret it as a sign of maturity, the way in which the institutional environment is getting to grips with this issue” in Brazil. ‘’This has got to be a positive for investment in the long run’’.
Another talking point is exchange rate volatility and high inflation. Till points out that when inflation is high, investors in the power generation sector are protected via an inflation adjustment in their tariffs, which over the longer term also mitigates the resultant depreciation in the local currency.
He thinks that for many of those investors who invested in Brazil three to four years ago, achieving profitable exits in US dollar terms is clearly going to be challenging.
In addition to the inflation protection via tariff adjustments, Actis expects to mitigate this FX risk by investing over a relatively long period. “We intend to continue building our asset base over the next three years, and we will see the exchange rate average out over that period. For us, this kind of issue is just a part of being thoughtful in how we mitigate risk.”