Ridgewood on the potential of the lower mid-market

Opportunities in the lower mid-market offer compelling returns for discerning investors, says Ross Posner, managing partner at Ridgewood Infrastructure

This article is sponsored by Ridgewood Infrastructure

Ross Posner

Against a backdrop of heightened market uncertainty and rising interest rates, there are plenty of reasons for infrastructure investors to remain optimistic. For those focused on the energy transition, recently ratified US legislation represents a major boon and another tentative step towards achieving the country’s net-zero goals.

For essential infrastructure investor Ridgewood Infrastructure, the current environment also underscores the benefits of a lower mid-market approach. For those sophisticated enough to create the right investments, the sector can offer notable inflation protection and a lack of correlation to the broader market, emphasises Ross Posner, managing partner at the firm.

Why focus on essential infrastructure in the US lower mid-market?

There are several key reasons, and the current economic environment illustrates them well. Our investments have long-term, contracted or regulated cashflows that are inflation-linked and non-correlated, and provide essential services to the communities we serve.

In the lower mid-market, there is a particular structural inefficiency, wherein there are many more opportunities than capital. That makes it a good fundamental backdrop from which to source deals.

We see essential infrastructure as providing a vital service to communities and other stakeholders. To take an example from our portfolio, the Vista Ridge Pipeline – the largest water public-private partnership in the US – is providing the city of San Antonio in Texas with 20 percent of its fresh water for 30 years.

That is a great example of the underlying essentiality crucial for providing water security to San Antonio and its citizens. Similarly, we own regulated utilities where we are the sole, monopoly provider of essential services to homes and businesses.

With inflation adding to recessionary pressures, how will the lower mid-market fare in the short- to medium-term and does this affect the value-creation opportunity?

The lower mid-market should fare well depending on where you invest. It really is about investment selection inclusive of the demand drivers creating the underlying cashflows and the structure of their contractual or regulated protections. This is a large reason as to why our investment strategy centres on investing in truly essential businesses and assets that have inflation-linked cashflows.

Even in a benign interest rate and inflationary environment, we have always focused on these factors given our experience and our underwriting discipline evaluating opportunities with a ‘through the cycle’ view. Given that, the essential nature of the services being provided to the communities we serve helps ensure expected demand even in recessionary periods and the protections we have in our businesses, which are long-term contracted or regulated, helps ensure inflation-linkage in their cashflows. As a result, this comprehensive approach to investing helps to ensure our investments and portfolio have strong performance despite any macro headwinds.

Our value-creation opportunity really does not change in an inflationary or recessionary environment. Communities still need water and other essential services for their citizens’ daily lives and for commercial and industrial activities. Therefore, our growth and project delivery value-creation strategies remain intact throughout cycles or idiosyncratic events. One could make the case that the recessionary impacts of lowering municipal revenue streams may make them even more open-minded to working with trusted private partners to accomplish their essential infrastructure priorities.

How do you approach potential acquisitions against the backdrop of this kind of economic uncertainty?

As I mentioned earlier, our underwriting really has not changed. We are focused on the visibility of cashflows and the preservation and growth of that cashflow wedge, which then leads us to think about the components and attributes of the revenue stream, as well as the ability to pass through rising costs. We screen out opportunities that fail to meet those standards.

We have not created a new thesis around underwriting because of what has unfolded over the last year or so. During the course of our careers, we have invested through multiple cycles and that experience is what informs our underwriting and investment management practices, regardless of where we are in any particular cycle.

Is the lower mid-market becoming too crowded?

Our general view is that the whole market has and will continue to become more competitive at every size stratification. Limited partners are continuing to understand the diversification and other benefits of infrastructure in their portfolio construction and, as a result, our view has been that significant capital inflows will continue. Having said that, I think the lower mid-market has very interesting moats around it that require a differentiated approach.

The entire investment cycle is different – how one creates investment opportunities, the ability and tool kit necessary to materially grow these businesses and the attractive exit market dynamics.

One example of the maturation of the industry is that the financial buyer part of our exit universe continues to get larger. It is a compelling backdrop when we are harvesting our investments to the core buyer, whether it is a strategic or a financial buyer.

Can ESG remain a priority if market conditions turn?

The focus around sustainability and ESG is here to stay. This is important to us not just as global citizens, but also as investors. From an economic standpoint, our team’s focus around climate and other ESG matters is long term and will continue regardless of the economic cycle.

That focus is inculcated throughout our investment cycle from the top end as it relates to thematic developments, screening of investments, due diligence, creating the appropriate ESG plan for companies and then implementing, evaluating, monitoring and managing.

How do you expect the Inflation Reduction Act to impact the lower mid-market?

It is a positive backdrop and a net win for cleaner energy in the US. Although there might be some crowding out of private capital, we view it as a positive development within our segment of the market; where we are focused on smaller projects, the federal regulatory support ought to be complementary rather than competitive.

We anticipate the Inflation Reduction Act will accelerate a significant number of projects and investment, primarily because it has taken out some uncertainty in terms of subsidies and other mechanisms that were scheduled to sunset. Several important programmes have been extended, which is really exciting, and part of why the energy transition is one of the areas likely to see disproportionate opportunity over the next several years within the US.

One area of acute growth is likely to be within electric vehicle charging networks. There are a lot of investors here and in Europe focusing on EV charging. If you look at statistics from any of the major carmakers, it is the fastest growing part of their business, and truck makers are adopting and focusing on EV growth. The rate of change will increase, and likely at a rate greater than many anticipate.

What is the most exciting sector to be involved in right now?

We are primarily focused on water, the energy transition, transport and regulated utilities. All of those sectors within the US lower mid-market present as wonderful investment opportunities.

For water, there is increasing need for enhanced management of that scarce resource. That importance is only going to grow and, in our case, to be a deeply experienced leader in the industry is very exciting from an investing standpoint. Our Fort Lauderdale water PPP, the third largest in the US, is just one example, where we are delivering a new water treatment facility for the city via long-term contract.

The energy transition will continue to create an abundance of investment opportunities at different stages of the risk/reward continuum. For us, it is about identifying those essential investment opportunities that can deliver for both the communities we serve and our investors.