Vauban: Covid crisis breeds caution

Rigorous downside scenario analysis, simplified and more robust debt structures and a focus on diversification will dominate as infrastructure recalibrates from covid-19, says Vauban Infrastructure Partners chief executive Gwenola Chambon

This article is sponsored by Vauban Infrastructure Partners

How is covid-19 transforming the infrastructure investment landscape?

Gwenola Chambon

There’s a clear expectation that governments will seek to boost their economies through investment in infrastructure. But those governments lack the financial capacity to do it alone. Our asset class will therefore have a major role to play in driving the global recovery. Different countries will take different approaches, of course, but there are common themes dominating everywhere.

The first is the energy transition. We’re seeing widespread commitments to enhancing renewable energy generation, as well as refurbishing utilities and buildings to make them more energy efficient.

The second major theme is digitisation. We’ve all experienced how critical digital infrastructure has been during the pandemic. Economies have only been able to withstand the crisis due to digital connectivity. Governments everywhere are therefore seeking to accelerate the digitisation process. These are both pre-existing trends, but they’ve now gone up several gears.

When it comes to digital infrastructure, which pockets of opportunity are most appealing to you?

We’re long-term investors in core infrastructure and so, historically, we’ve only been involved in rolling out fibre that will then be in operation on an open-source basis for 25 or 30 years.

That matches our strategy nicely. We’ve also looked at opportunities involving data centres, but everything we’ve seen to date has either fallen more within real estate parameters, or else the growth profile has lent itself to a value-add approach.

That’s not to say we don’t want to invest in data centres in the future, but we need to find the appropriate deal that matches our risk/return profile. For the same reason, we’ve steered clear of towers, which tend to have an M&A growth story and are not a good fit for a traditional long-term contracted cashflow model.

The sheer scale of demand for connectivity during the crisis has made fibre a hot sector. How has that impacted pricing?

The surge in appetite we’ve seen for the sector has been incredible. Ten years’ ago, we were just one of a handful of organisations doing this. Indeed, until recently, many investors struggled with the definition of digital assets as infrastructure. Today, however, pretty much every asset manager has an allocation – and usually a growing allocation – to this market. And, of course, that additional competition is creating pressure on pricing.

The way we’ve responded is to create a platform out of all the exposures that we’ve built over the years, with more than 22 different FTTH networks in France, addressing both rural areas, mid-dense areas and urban areas, and this coverage has been achieved over the course of the past decade. The value of the whole is so much greater than the individual assets and we believe the move has given us a competitive advantage when it comes to the concessions still under procurement.

First, thanks to the pooling of our underlying diversified cashflows, our broadband platform is much more resilient and capable of raising competitive financings. We also have the advantage of already having contractual frameworks in place with all the incumbent operators and we’ve a track record of delivering high-quality service to public entities. After all, price is not the only deciding factor in these situations. Public entities want to know that you are going to deploy on time and with respect to the contractual terms in place and we’re known to reliably deliver on what has been promised and that is really important.

Finally, I would add that we see significant opportunities for value creation which are not built into that initial price. Public entities are going to want to adapt usage of the internet capacity we provide to help create smart territories, for example. Having these concessions evolve into something much bigger – helping the public entities address, not just the internet of things, but the internet of everything, has vast value creation potential. Effectively, we’re managing the passive network, but can then also benefit from the active infrastructures that get put on to that network in the future. Even while digital prices may be climbing, there is still a lot of value to be found in these assets.

Returns are also coming under pressure for renewables assets. Where do you choose to invest in the energy transition process?

Renewable energy generation cannot currently match the risk/return profile we’re targeting. There are great assets out there, but as investors go crazy for these opportunities, targeted IRRs are going as low as 4 or 5 percent. For us, there’s more value to be found in energy transition investment. The utilities owned by public entities and industrials lack the firepower to address all the changes required by evolving regulation for a more environmentally friendly operation. That means major refurbishment and major capex. Therefore, we’re seeing lots of opportunities to come in alongside these incumbents and provide that much-needed capital.

And do you expect social infrastructure opportunities to emerge from the pandemic as well?

I do. Many industrials have developed portfolios of social infrastructure on their balance sheets and while they are not necessarily willing to exit entirely, the pandemic has created financial pressures. They need cash. We’re seeing plenty of opportunities to partner on social PPPs, which often require a public entity to retain a minority stake, in any case. In those circumstances, the vendors favour a partner that will enable them to recycle capital but then remain alongside them for the life of the concession. That is another advantage of our long-term approach.

What does that long-term approach actually involve?

When we designed our strategy back in 2014, a long-term approach, targeting core infrastructure, made sense to us, enabling us to capture the yielding nature of these assets in what has been a very low interest rate environment. Managers looking to lock in a capital gain in five to seven years, meanwhile, risk exposure to rising interest rates.

A long-term approach is also a way of aligning us with our public entity and regulator stakeholders. We’ve all seen the backlash against private sector involvement in public infrastructure projects in the UK. That social licence to operate has been debated vehemently. The fact that the private sector has sometimes made large capital gains on essential assets has been perceived as outrageous. But investing for the long term, alleviates a lot of that tension. Positioning yourself as a committed lifetime partner removes the barriers between public and private. You are both in the same boat and on the same journey. Therefore, it reinforces our capacity to constructively commit to long-term stewardship and fits with our stakeholders’ approach.

What lessons can the asset class take from the covid crisis?

We’ll see more caution come into the market. Owners of mobility assets, for example, have always run sensitivity models to see how those assets would fare if traffic was severely reduced in a crisis. But no-one ever perceived a situation where all of that mobility infrastructure, everywhere in the world, would face lockdown measures at the same time. So, we will see greater scrutiny of downside scenarios and a broader understanding of risk.

I think we’ll also see a more cautious approach to financing. As appetite for infrastructure has soared, some managers have been placing increasing levels of debt on the underlying assets in order to win the bid. Adding holdco or mezzanine layers, for example, can distort the fundamental infrastructure characteristics of an asset and can become more risky if you’re relying on dividends to make the repayments. The covid crisis has, I think, made that very clear. Finally, the pandemic has made asset managers more aware of the importance of diversification. Diversification is the ideal protection against something you cannot predict because even if one part of your portfolio is badly affected, other parts are likely to remain unscathed.

Do you think that will impact LP appetite for specialist funds?

I do think that appetite for generalist asset managers will increase at the expense of single strategy managers. But I also think that appetite for infrastructure, in general, will grow and grow. Infrastructure, as an asset class, has weathered this storm well, in comparison to private equity or real estate, for example. Resilience is the key priority for investors right now and so I think they will want to see a larger slice of infrastructure in their asset allocations going forward. Covid has shown us that anything can happen. n

Given the sense of uncertainty that prevails in the first part of 2021, what does the future hold for the infrastructure asset class?

The asset class is, I believe, set to grow faster than it was even a year ago, as public entities turn to private sector support to help launch major infrastructure projects that will boost the economic recovery.

The EU, for the first time, has raised €750 billion in funds to help foster these activities in Europe. That wasn’t even in the pipeline 12 months ago. At the same time, underlying investor appetite is also increasing substantially in the wake of the crisis, so everything is aligning to help the asset class reach new heights.

From a Vauban perspective, meanwhile, we became a fully-fledged affiliate at the end of 2019, launching the new brand, with much fanfare, unwittingly just as the world was about to go into lockdown. Nonetheless, during 2020, we’ve increased our AUM from €3 billion to €4.7 billion through largely remote fundraising practices and have continued to significantly deploy capital in some exciting opportunities (we managed to deploy €1.2 billion in a pool of diversified assets in 2020). And in line with the growth of the asset class, we expect to continue to build and diversify. Indeed, we fully expect to start targeting core infrastructure assets outside of Europe in the medium term with our next generation funds.