Ridgewood on the lower mid-market

Investing in the lower mid-market offers structural advantages at origination, value creation and exit, say Ridgewood Infrastructure managing partners Ross Posner and Michael Albrecht.

This article is sponsored by Ridgewood Infrastructure

Ridgewood Infrastructure invests in the US lower mid-market, targeting what it views as truly essential infrastructure companies, assets and projects. It is a niche where operational and strategic enhancements prove especially valuable.

What makes opportunities in the lower mid-market particularly compelling?

Ross Posner: The lower mid-market is rich in opportunities, but relatively underserved. Approximately half of all deals in our target geography require $150 million of equity or less, while only 10 percent of capital raised focuses on that size segment. That means there are structural elements to the lower mid-market that make it compelling on both an absolute and relative basis.

It all starts with origination. We are able to create compelling essential infrastructure investments on a direct and bilateral basis, at attractive valuations. In fact, all of the investments in our fund have been originated outside of investment bank auction processes.

We also feel that operating in the lower mid-market provides us with a more prudent due diligence period than highly intermediated and competitive situations generally allow. Meanwhile, capital sizing also enhances our ability to access unique investments, such as regulated utilities and long-term contracted assets, which are not as readily available for those that have to deploy much larger amounts of equity in single transactions.

You talk about creating opportunities. What do you mean by that?

Michael Albrecht: Creating is the operative word. We are not just looking at what investment opportunities may be available; we are actually going out and making them happen.

It all begins with a thematic approach to origination, which means being highly focused and informed about individual industries and where the market is heading. As Wayne Gretzky is credited with saying, we always want to make sure we are skating towards where the puck is going and not where it is.

We begin by selecting the most attractive investment themes. Then, we identify where we want to invest within those themes. We are not participating in competitive, prescribed auctions, as Ross said, so our outreach it highly targeted. We source opportunities through long-term relationships and deep roots in the marketplace and we negotiate opportunities on a bilateral basis.

All that means that our approach is already accretive from an entry valuation perspective and that we have more time to conduct due diligence, and therefore to identify and mitigate risks, as well as complete robust value creation planning.

How do you create value in this lower mid-market segment?

RP: From a value creation perspective, operating in the lower mid-market means we have the opportunity to transform businesses with high growth potential by scaling, stabilising and professionalising. We do that through an operationally orientated, controllable and repeatable set of processes.

MA: An excellent example of those controllable and repeatable operational strategies in action would be our portfolio company SiEnergy, which is one of the fastest growing gas utilities in the US. The scaling strategy we originally implemented with that business was threefold. First, we enhanced customer relationships through targeted outreach to existing and new companies.

Second, we utilised a multi-step, process-orientated approach that tracks the customer growth pipeline at each phase. Third, we grew and restructured the customer development team, organising it by geography and market segment. All of that allowed us to scale the business to best-in-class industry-wide growth, that then outperformed our underwriting.

The company also benefited from our focus on professionalising its operations. During our due diligence, we identified an opportunity to proactively invest ahead of the growth of the company. That included upgrading the IT platform and adding two new executives to the management team.

That professionalisation allowed SiEnergy to achieve that best-in-class growth, but in a controlled manner, given those operational enhancements. So, while we always have a tailored plan for success with each investment, the value creation strategy always focuses on increasing underlying uncorrelated cashflows and de-risking the business.

And what about exit? Is that another benefit of the lower mid-market?

RP: Once we have implemented our value creation strategies and these transformations are complete, at the end of our period of ownership we are able to harvest our investments in a highly attractive exit market. We benefit from healthy competition between strategics and financial buyers, all of which are seeking those core infrastructure attributes that we will have created during our tenure with the business.

The key point is that we are able to invest in these opportunities at a point where lower cost of capital and longer investment horizon buyers either cannot or will not, perhaps because the deal is too small, or because they do not have the operational expertise or appetite to execute on a value creation strategy. But they are more than willing to own these assets once they have been repositioned.

It is worth noting, though, that all of these attributes we are describing in relation to the lower mid-market are only relevant if you have a business model and team that is optimally set up to execute in this space, as we do. That is easy to say, but harder to do.

What is your approach to ESG in these lower mid-market infrastructure investments?

MA: ESG and responsible investing are certainly core to our culture and are integrated in all aspects of our investment process. Many of the investments we review have a strong culture of employee health and safety, as well as an understanding of ESG more broadly. However, we often find that once we have invested and started engaging with these management teams, our partnership approach provides them with additional knowledge and a framework with which to implement underlying ESG goals and

A good example would be our portfolio company Undine, a business focused on building a regionally concentrated, mid-sized, regulated water utility through the consolidation of the independently owned, regulated water and waste-water market. In this instance, Ridgewood was able to establish specific and measurable ESG goals for the company and to implement processes that assisted the management team, whilst supporting them with our own internal resources. Undine has successfully met each of those goals and continues to expand its platform of ESG initiatives.

RP: These management teams often have the essence of ESG, but what we are able to do is to bring a greater knowledge, fluency and ability to focus on these issues, which they embrace. Given the size of the companies with which we work, we are able to make a disproportionately positive impact in this area.

How are you seeing the infrastructure market continue to evolve in terms of fund and deal sizes?

MA: The infrastructure market has evolved and proliferated significantly in terms of volumes of capital, with both fund and deal sizes growing tremendously over time. Many investors have now experienced the resilience of essential infrastructure first-hand and so appetite is soaring, and fund managers have doubled, or even tripled their fund sizes in a short period of time. This has created immense competition for those larger deals and has therefore resulted in return compression.

Conversely, while almost half of deals fall into the lower mid-market category, less than 10 percent of investment fund capital serves this segment. That means not only are we able to create fantastic returns, but we are able to do so in both an absolute and risk-adjusted manner given our focus on the lower mid-market.

And what does the future hold for this part of the market?

RP: This opportunity that the lower mid-market presents is only going to continue, and the investor universe is just starting to recognise that.

Given the team and skillset that we have directly focused on those opportunities, coupled with the maturation of LP interest in the segment, I think there is a long runway ahead of us. We look forward to continuing to help these businesses professionalise and scale.

How would you describe LP appetite for US lower mid-market infrastructure today, and is it changing?

More in the tank: Undine has found plenty of opportunities to consolidate independently owned, regulated water and wastewater utility systems, which larger competitors see as ‘subscale’

RP: Investor appetite is definitely changing as the market matures. Investors increasingly appreciate the distinctions between the smaller and larger ends of the deal spectrum that we have been describing and I think they understand the benefits that investing in this part of the market can bring. In the lower mid-market, we are able to create unique portfolio exposures and deliver strong absolute and risk-adjusted returns, whilst GP/LP alignment is exceptional, simply given the size of the funds involved.

LPs are seeing the advantages of size stratification and of augmenting their portfolios with strategies like ours. They are doing so because they see the benefits of being able to buy low, implement controllable, transformational value creation processes, and then exit into a very competitive part of the market. That is particularly true in a geography such as the US, where the investor base has become increasingly educated and sophisticated in its understanding of the infrastructure asset class in the past five to 10 years.