The Australian market has hogged the limelight in recent years when it comes to infrastructure — and rightfully so, considering a spate of high-profile privatisations that raised billions through the sale of assets such as Queensland Motorways, Port of Melbourne and TransGrid. In the process, shoring up state governments’ balance sheets and whetting investors’ appetites.
“I think what Australia has been through over the last few years has been an almost unprecedented level of activity in the infrastructure sector and it would be, in some cases, unreasonable to think it’s going to continue at that pace,” says Ashley Barker, executive director at IFM Investors.
“If you look at the quality of the assets that have been divested – the three East Coast ports together with the New South Wales transmission and distribution businesses – they are absolutely world-class assets,” Barker continues.
Andrew Faber, executive director and head of new investments for Australia at Hastings Funds Management, which in 2015 led a consortium that was awarded a 99-year lease for TransGrid, NSW’s electricity grid, for A$10.3 billion ($7.8 billion; €7 billion), agrees that, while the pace may inevitably be slowing, “there is still a significant amount of high-quality core infrastructure assets without a doubt,” with participants pointing to high-quality assets currently sitting on the balance sheets of NSW, Queensland and other state governments.
THINKING OUTSIDE THE ‘BOX’
But investors are not just waiting for opportunities to fall into their lap. Instead, some are expanding their horizons and looking at new asset classes with infrastructure-like characteristics.
“We’ve taken an approach over the last few years where we look not just at core infrastructure asset classes but we’re also looking at some new infrastructure-like and infrastructure-related asset classes,” remarks Mark Hector, portfolio manager, infrastructure, at First State Super, one of Australia’s largest superannuation funds. “The important thing is that you look at the right risk-return. We’re less concerned about whether it fits neatly in the infrastructure box or a property or private equity box, but essentially, we’re looking for good investments,” he adds.
Land titles are one example of this, with First State Super, together with Hastings, recently clinching a deal in the sector in NSW. First State Super has also participated in a consortium to consider acquiring an Australian lotteries business with long-term, stable cashflows.
Another ‘new’ sector worth mentioning, according to IFM’s Barker, is the water sector.
“It’s always been a politically sensitive sector in Australia and it hasn’t been open to private sector investment, but if you look at the UK experience, where the water distribution is largely in private hands, there is a huge opportunity set in Australia that, with the right political vision, could unlock a better experience for users and create a new sub-asset class in infrastructure for us as investors,” he comments.
Hastings would also like to see Australia open up the sector to private investment. “We’ve invested in the Sydney desalination plant, so that’s a start,” Faber acknowledges.
“Given the politically sensitive nature of water, opportunities for the private sector are likely to emerge in the mid-market in the form of smaller assets such as treatment plants which are clearly one-off and separate pieces to the broader network,” remarks Edward Lloyd, director at Infrastructure Capital Group.
However, while politics may play a role in the sector, IFM’s Barker believes private capital can further the cause by “being good stewards of the assets we already own as an industry”. A case in point is the Indiana Toll Road Concession Company, the private concessionaire operating the 157-mile divided highway in the US state of Indiana, which went bankrupt in 2014 and which IFM acquired in 2015 for $5.7 billion.
“We’ve had a lot of interest and inquiry from the US government back into IFM with regards to ITR and it’s not so much the acquisition that has driven the interest, it’s the improvements that private ownership has brought to that corridor in terms of the user experience,” Barker says.
But, in addition to the user experience, a positive outcome for the vendor is also key.
“As other governments have reaped benefits from the reinvestment process from the sales, I think over time those who seem to have a contrary view will start to change their viewpoint and I think a lot more assets will come to market,” comments Paul Orton, global head, project & export finance, international & institutional banking at ANZ.
Some of the assets that could come to market include WestConnex, the A$16.8 billion motorway project – Australia’s largest – being developed in Sydney; as well as Horizon Power, a state-owned electricity company in Western Australia, according to Hastings’ Faber.
But success can sometimes be a double-edged sword for private investors, “unless the industry reinvests in selling the message”, ANZ’s Orton remarks. “Because public perception sometimes is that the private owner/operator is actually making too much money — leading to questions such as, ‘Why didn’t the government hold on to that asset and that dividend?’ The industry has to do a better job communicating with the public, explaining they have actually invested in that asset’s growth, something governments have been slow to do,” Orton argues.
Speaking of clear messaging, the conversation turns to regulatory and political risk. While the past few years have seen Australia successfully privatise some high-profile assets, there have also been a handful of incidents that have called into question the country’s continued appeal for investors.
“As investors, we want transparency around what the rules are and we want those to be applied in a relatively consistent fashion,” IFM’s Barker states. “Now that may not always be the case, but I think – to take Ausgrid as an example – there are characteristics around that asset that determined a certain outcome,” he says, referring to the federal government’s last-minute decision to reject two bids from Chinese institutions citing national security concerns. The decision struck a blow to the NSW government that had spent months negotiating the deal.
A few weeks later, however, one of Australia’s largest superannuation funds, AustralianSuper, teamed up with IFM to acquire the 50.4 percent stake for A$16.9 billion, making it one of the largest M&A deals globally last year across all sectors.
“As long as the system is stable and the government articulates what that system is, I think history has shown that you can withstand a shock once in a while,” ANZ’s Orton points out. “Recently, the government has done well in terms of articulating what that process and system are and future governments need to continue to do that.”
One such shock was the April 2015 cancellation of the A$5.3 billion East West Link motorway project by Victoria’s then recently elected Labor government, one year after its predecessor had signed a contract with a private consortium comprising LendLease, Bouygues and Acciona.
“Despite the experience with the East West Link, we’ve had a highly successful sales process in NSW,” Orton remarks. “Melbourne Metro PPP is being bid and the level of interest from contractors, both debt and equity, has never been greater.”
PPP OPPORTUNITIES AND CHALLENGES
Aside from its successful privatisation programmes, Australia is also known as a forerunner in the PPP market. The question is, which sectors and which states are likely to offer the greater number of opportunities?
“We see ongoing activity in road and rail in both NSW and Victoria,” Orton replies. “What actually drives the PPP programme in those states is the expertise that sits within the relevant departments. As governments change, the expertise remains, resulting in political certainty for the investor community.”
IFM’s Barker agrees that the rail sector will continue to offer plenty of opportunity. “We think that the longer-term outlook for the urban, regional and interstate rail is very positive,” Barker says, in light of increasing urban congestion.
But for superannuation funds, the PPP landscape looks somewhat different.
“It’s quite challenging to do direct investments as a superannuation fund, unless you’re aligned with a principal advisor,” explains Diana Callebaut, infrastructure manager at the Construction and Building Unions Superannuation Fund. “There are constraints and barriers to investing, it’s not that we don’t want to invest in greenfield infrastructure – Cbus is committed to investing directly into greenfield infrastructure – however there are challenges.”
“There are also resource considerations, particularly for direct investments without managers,” First State’s Hector adds. “Greenfield tender processes are a hard slog and take a long time, so for super funds to invest directly and commit the time required is quite significant compared to brownfield acquisitions.”
RENEWABLES’ RENEWED UNCERTAINTY
Another segment of the Australian market those around the table viewed cautiously was the renewables sector.
“We find Australian renewable equity investments a real challenge at the moment,” Hector states. “We’ve seen returns continue to come down while at the same time, merchant pricing risks are going up.”
ICG’s Lloyd agrees that building a renewables portfolio from scratch now “is more difficult for newer investors to the sector as people aren’t offering the same quality of off-takes and there’s probably a lot less certainty, which makes it difficult to strike a traditional infrastructure-like renewables deal similar to those in which ICG has invested over the past decade”.
While Lloyd acknowledges that the Renewable Energy Target (RET), which the Australian parliament agreed in June 2015 has helped the sector in providing some certainty, “the challenge now for infrastructure investors comes around to agreeing off-takes of sufficient duration to encourage investment by both debt providers and equity providers”.
The cause of uncertainty that is keeping some investors from investing in the sector is that the RET, which involves generating 23.5 percent of the country’s overall electricity from renewable sources by 2020, expires that year.
“It’s not just the RET, it’s what kind of scheme will be brought in,” ANZ’s Orton points out. “There will be a scheme brought in whether it’s EIS [Emissions Intensity Scheme] or whatever it will be called, with some price on carbon and some price on emissions, which will start to impact how the RET works.”
Still, it’s not just the RET that will determine what happens after 2020, “it’s the changing technology, the ongoing reduction of the cost of solar, battery storage and how the government – both state and federal – will change the market,” Orton says. “So, there’s all sorts of uncertainty that I can imagine would be of interest to some investors but not to others, depending on the terms of their mandate.”
As rules, regulations and market conditions change, the consensus around the table is that the investor community is also changing – maturing and becoming more sophisticated.
“At First State, we’ve undergone a pretty significant transformation,” Hector says. “Until a few years ago, we had a broad mandate to be the single lowest-cost fund in market, which made it difficult to do high-cost alternatives,” he explains. “That was until the board realised – looking at their net performance compared with our competitors with materially greater unlisted alternatives allocations – that we were lagging behind.
“Now we have a more flexible mandate to be a low-cost fund with a greater focus on unlisted investments, including some pure direct investments for added benefits to our members,” Hector says.
According to Callebaut, Cbus is also going through changes. The fund, which has been investing in infrastructure for over 20 years through Hastings and IFM, expects its funds under management to double over the next five years. While the allocation to infrastructure will remain at about 11 percent, more money will be invested in the sector as Cbus’s overall portfolio grows.
“This means evolving the relationship [with our fund managers] into one that is more collaborative; working more closely with them in co-investments and other opportunities,” Callebaut explains. While the fund is looking to work more with its current fund managers, it is also looking for other mechanisms through which to access the market.
“That’s not a reflection on our fund managers,” she is quick to point out. “But it’s a reflection on our need to diversify. We have a high level of risk with two fund managers and we need to build out our platform.”
Hastings has also witnessed this evolution on the LP side. “We’re being challenged all the time to demonstrate how we’re adding value and I think that’s entirely appropriate,” Faber asserts. “I think for us, the challenge is to evolve with the more innovative ways investors are looking to access investment opportunities and in those new ways demonstrate how we add value,” he says.
But LPs’ growing sophistication does not necessarily diminish the role of the fund manager.
“Managers need to evolve their offering to match LPs’ increasing sophistication,” Lloyd argues. “In our experience, separate accounts work best when they are tailored for each specific investor – each LP is looking for something different out of a separate account and with increasing sophistication we are seeing them typically more involved in the initial investment and ongoing oversight of the asset. By providing LPs with greater flexibility we are finding that we’re developing more productive long-term relationships with our investors.”
In Barker’s view, the co-investment model works, albeit with some exceptions to that rule. “It seems to work quite well when you have a combination of a fund manager and an LP sitting side by side in an asset. There’s a duality in that relationship that can lead to successful outcomes for both the LP and the fund manager’s core fund-related products.
“We contend that the Australian LP industry – if not the most sophisticated in the world, is pretty close to it,” Barker continues. “And I think that Australia has been at the forefront of that for a number of years,” he concludes.
He could add asset recycling, privatisation and PPPs to that list, all of which seem to be continuing at a fair pace, despite whatever bumps the market has encountered along the way.