Ridgewood Infrastructure: Value creation in the lower mid-market

This article is sponsored by Ridgewood Infrastructure

Why is value creation critical in a challenging macroeconomic environment?

We believe that repeatable, operationally orientated and controllable value creation is always critical, regardless of the macroeconomy – it’s just good business. But certainly, in a high inflation, high interest rate environment, there’s an even greater premium for those of us that can drive intrinsic value.

What are some of the value creation levers that you commonly employ?

We think about value creation in terms of strategically repositioning everything we own. Given our focus on the lower mid-market, we are investing at a point in a company’s life cycle where others either can’t, because it is too small for their fund, or won’t, because the stage at which we invest isn’t one of their core competencies. Once our work is done and the investment is strategically repositioned it’s then highly attractive to a broad-based universe of buyers. 

To accomplish this strategic repositioning, we implement several repeatable and controllable value enhancing activities. We grow businesses, organically and inorganically, via acquisition. We also stabilise assets through the delivery of large-scale construction-stage projects. We did this with the largest water PPP in US history and are currently doing so with the third-largest water PPP in US history. 

We professionalise our investments; augmenting management teams and enhancing operational systems. We also future-proof our investments to ensure there is a deliberate focus on sustainability. Our focus on sustainability is the right thing to do as stewards of these assets, while also having the economic benefit as we harvest our investments as the next owner will appreciate that they are more resilient and built to last. 

What is your approach to M&A and what are some of the challenges that can involve? 

As I shared, we focus on both organic and inorganic growth. M&A therefore plays an important role in the value creation strategy of a portion of our investments, as we increase scale, diversify geography and drive greater operational efficiencies. 

That is best illustrated with an example from our portfolio. We have an investment called Undine, where our intention at the outset was to build a mid-sized regulated water utility through the acquisition of several smaller companies. Our strategy was to form geographically concentrated clusters to drive operational efficiencies while also providing the eventual buyer of our company with targeted scale-level market share in attractive markets. It’s helpful to frame the opportunity by sharing a bit about the market structure. There are 65,000 regulated water and wastewater utilities in the US, with 90 percent of those serving fewer than a few thousand people. 

As a result, these assets are too small for a large- or mega-cap fund, yet they are truly essential infrastructure companies as the sole provider of these critical services to the communities they serve. To execute our investment strategy, we created an exclusive partnership with a specialist management team that has been executing on this specific buy-and-build strategy in the sector for the past 20 years. We have made more than a dozen acquisitions to date and Undine now serves approximately 25,000 customers, on its way to 35,000-40,000 customers. This scale, which is consistent with our underwriting, will be highly attractive to a broad-based buyer universe, and would not have happened were it not for a very active focus on M&A.   

A challenge can be timing. For example, Undine’s pace of acquisitions slowed during the pandemic. Undine’s acquisition efforts  involve, what I call, ‘kitchen table M&A’. As a result, during the height of the pandemic we were not able to meet with potential sellers, so the flow of opportunities slowed. However, as we’ve come through that challenge, M&A activity has picked up significantly for Undine. 

Are you seeing attractive valuations for bolt-ons in the current environment?

Yes, we are. One of our advantages, due to both the part of the market upon which we focus along with the sophistication of our team, is that we’re able to direct source our investments, including the platforms, which helps us create attractive entry valuations. We also approach transactions with a solutions orientation. We work with our counterparties, which are oftentimes our future partners, to understand what they’re trying to solve for and then create a mutually beneficial transaction. 

As a result, while valuation is certainly important, oftentimes we’re helping to solve for other important transactional elements. A great example is when we recapitalise a company where the prior owners maintain a significant minority equity position. In most of these cases, while valuation has to fair, they’re focused as much on their second bite of the apple and the quality, capabilities and character of their future partner. This is a dynamic in which we excel, and oftentimes leads to compelling entry valuations. 

How do you employ new technology or systems to create value?

What we do in the lower mid-market is take businesses that are run by great executives that may not have had the experience or resources to do everything that they would like to do. For example, in our water utility business we typically upgrade their capital equipment, which both improves performance levels and lowers demand for electricity. We also often upgrade internal systems, such as installing ERP systems, to help ensure our investments are able to absorb the scale that are about to undergo in a controlled fashion. 

Do these investments frequently have an environmental angle?

ESG is an important element of every one of our investments. It’s inculcated throughout our investment cycle, from thesis development to origination, through due diligence and during our ownership period. We approach this in two ways, what it is in which we invest and then what it is that we do once we invest.

With regard to what it is in which we invest, an important thematic focus of ours is on sustainability and the energy transition. We have several investments that we’ve made relating to these themes. For example, our Vista Ridge water pipeline investment, which is supplying the city of San Antonio, Texas, with 20 percent of its fresh water, is reducing the demand on an aquifer from which that city had previously been sourcing its water, enabling greater recharge and restoration of its aquaculture. Another example is our Environmental Infrastructure Partners Investments, where we own sustainable infrastructure for the MUSH market. Illustrative projects in this investment include smart water meters, LED lighting and EV charging stations. 

Further, as examples, the businesses we own, their assets and the services they provide help to reduce water leakage, create significant greenhouse gas avoidance and use less electricity. We are highly focused on creating positive environmental impact both in the improvements we make to assets across every sector and through investments that directly drive beneficial outcomes for customers and all their stakeholders, including the planet.

How does value creation differ in the lower mid-market when compared to larger funds and assets?

I think it is very different. Oftentimes, the businesses that we invest in will have done relatively well but may also have been somewhat under-managed. We can help to bring best-in class expertise to the table and drive disproportionate impact through operationally orientated and sustainable value creation. 

The different dynamics at play in the lower mid-market also mean, however, that a different leadership and partnership style is required. It takes a different way of interacting with company executives than is oftentimes the case in the large- and mega-cap market. It is important to be very hands on in this space and our team, our operating partners, our industry senior advisers, all engage directly with the businesses. We create a human capital roadmap that helps to ensure our investments achieve their full potential. 

We created a business focused on this unique part of the market, whereby we create exposure to essential infrastructure and can drive repeatable value creation on behalf of our investors.

The social dimension 

“The importance of the social element of ESG, in terms of creation and preservation, is a hugely important topic that too often gets lost. Everything that we do involves the provision of essential services to communities, so social impact is critical,” says Ross Posner.

“For example, we supply the city of San Antonio with 20 percent of its fresh water. San Antonio is the seventh largest city in America and the fourth fastest growing. It is also highly diverse. That growth cannot continue unless the city can increase and diversify its source of water. 

“Our investment there, called Vista Ridge, is helping the city accomplish those goals. We are starting a project in the city of Fort Lauderdale, Florida, that is quite similar. It too is a high-growth city and a large tourist destination. We’re going to deliver a new water treatment facility which is intended to provide the city with >75 percent of its fresh water for the next 30 years.”

Posner continues: “In our water utility example, we are often acquiring systems which have had declining service levels for some time as the prior owner had been focused on maintaining a consistent personal cashflow level, or they have not had the expertise to maintain the systems. We come in and meet with the communities. We ask them to share their challenges and then put together a capital investment plan to enhance services, while continuing to meet with the community on a regular basis. 

“We are also mindful when formulating our capital investment plans about the affordability of services for citizens. In that sense, social engagement is key.” 

Diversity is also a priority. “Ensuring fair and equitable opportunities for people to realise their professional growth and economic rewards within a company is hugely important,” Posner adds. “If you have a satisfied and professionally challenged workforce, where people are recognised and developed, that will typically lead to a strong culture, and we believe this is a significant factor in differentiated economic performance.”