Bridges to somewhere
Mark Weisdorf knows a thing or two about how and why pension funds invest in infrastructure assets. Before joining JP Morgan Asset Management (JPMAM) to set up its infrastructure investments group in 2006 he developed the real estate, private equity and infrastructure strategies for the Canada Pension Plan Investment Board’s CA$130bn (€92bn) portfolio, experience that led to his founding Mark Weisdorf Associates, a consultancy dedicated to advising institutional investors on their allocations to these asset classes.
This has generally been a pretty dull part of the portfolio, as pension funds have gone to infrastructure for the kind of steady cash flows that are pumped out of core utility assets, investing with a multi-decade view. But now, if your budgets can afford it, Weisdorf feels that the time is ripe to take on some risk that is being offloaded cheaply in an environment of shorter-term caution and tight credit. Where to buy? In two places: emerging markets and global transportation assets like toll roads, bridges, seaports and airports.
The emerging markets story is well-worn, and JPMAM itself closed an $860bn (€623bn), 10-year Asian infrastructure fund back in January. Interest had been high before 2008, tailing off as investors struggled to find liquidity for new allocations in the teeth of the crisis but, in the event, more than one-third of that $860m was committed in the last three months of 2009.
“Asians could never understand why North American and European investors would tell them there was a higher degree of risk in Asia,” says Weisdorf. “I wouldn’t say that the risk is lower than in the OECD, but clearly OECD risk has gone up, while emerging market risk has gone down more than prices. The relative resilience of these economies combined with their huge need for infrastructure presents a huge opportunity.”
The suggestion that a tilt towards more economically-sensitive assets in developed markets like transportation infrastructure is a little more unusual. It takes some nerve to look past the 5-15% drop in toll-road traffic, the 8-10% drop in air travel and the 20-30% collapse in rail and sea-going container traffic that has hit the economy over the past two years.
Looking at the spreads and availability of credit on those assets does not help. While spreads of US or European utility-asset debt over US Treasuries or German bonds have recovered almost to pre-crisis levels, transportation-asset debt spreads remain elevated. That has caused problems for investors who bought during the boom years when credit was freely available and prices reflected a belief that even a toll road’s demand inelasticity was robust enough to see out a recession. The reality has left them with rising long-dated gearing-to-EBITDA multiples.
Others who geared assets with short-term debt, expecting to improve, expand and synergise those assets before applying longer-dated debt, are now finding it a struggle to re-finance. Banks and bond investors are now all too aware of the ravages of declining traffic on these assets’ EBITDAs.
But for newcomers, more risk should mean more premium. The risk-averse, with one eye on Europe’s austerity programmes and the rising cost of sovereign and bank debt, may want to stick with regulated utility assets or 20-year contracted power assets, Weisdorf concedes. But he warns that the window of value opportunity for those investments has been and gone.
“You should assume that you will be paying the same kind of prices for those assets as you were during the peak period, and one certainly shouldn’t expect to receive higher yields than were available two or three years ago,” he says. “On the transportation side, however, you have greater economic sensitivity and risk and less debt available at higher cost and, as a patient, long-term contrarian investor, that makes us think that this is an interesting place to invest if you have the risk tolerance. Prices are still lower than they were in the heady days, and you are buying during a period of depressed economic activity and utilisation, at a substantially lower multiple to an already lower EBITDA.”
Whatever you are looking for, today’s market is a buyer’s one with an abundance of new opportunities as the cash-strapped and the consolidators move to offload assets. While corporates are not as distressed as they were 18 months ago, many are sufficiently bruised to want to retreat to their core businesses after years of stockmarkets rewarding growth for growth’s sake. Those markets now look askance at anything resembling a bloated balance sheet.
Oil and gas companies have been selling their mid-stream distribution and pipeline assets as they refocus on exploring and developing oil and gas fields, for example. Having potential liquidity tied up in those kinds of low-risk, low-return, capital-intensive assets begins to look sub-optimal to these companies - but they are exactly the kinds of risks that institutional investors seek out. This is happening among US firms, but Weisdorf also draws attention to Spain’s Iberdrola’s sale of its US-regulated gas distribution assets (Connecticut-based electric utility UIL Holdings Corp is expected to close the deal in 2011).
Similarly, its compatriot construction engineering giant Grupo Dragados had spent years building and expanding ports at home and in South America, and while it kept hold of the concessions to operate those ports during the boom year, it has now announced a desire to sell off those assets to fund other investments.
“Those are just examples of the kind of thing that is going on all over the corporate world,” says Weisdorf. “The market is now rewarding appropriate long-term economic decisions. And as long as the market continues to do that, management has the incentive to offer these opportunities. “
In government, an age of austerity means a cutback in funding from the public purse - but, in the meantime, all those broken bridges, beaten-up roads and leaking water pipes are not fixing themselves. “From the perspective of the private sector, the fact that there are fewer sources of capital available for these projects might suggest that governments will be more welcoming to other sources of capital,” Weisdorf reasons.
Moreover, government assets are more likely to include some of the higher-risk items that he feels offer the best opportunity. Several US states and municipalities have brought assets to market, including six cities offering up their parking facilities for concession. Just a few weeks ago JPMAM (together with partners who take a 2% share) won the $451m bid to acquire a 50-year concession for all of the City of Pittsburgh’s parking assets, subject to final approval.
Meanwhile, Ontario has hired Goldman Sachs and CIBC World Markets to advise on the potential sale of its electric power generation and transmission assets, as well as its Lottery and Gaming Corporation and liquor distribution business; while Queensland has a AUD15bn (€10.6bn) programme of privatisations and private-public partnerships planned for the next three to five years, which will include prized rail, port and road assets. “Other Australian states are exploring similar programmes,” says Weisdorf.
Of course, while austere times are what force these privatisations, they may inspire governments to drive harder bargains, too. They already have clear ‘value-for-money’ mandates, but are they also likely to want to protect their hard-up voting population from high utility tariffs and road tolls, or demand more capital expenditure on the assets they offer up for concession?
“They definitely try to push for these things,” Weisdorf concedes. “But that’s offset by the fact that both risk and the cost of capital has increased. In that situation, if governments push too hard an asset may not get privatised. In the end, private sector investors - who are, after all, largely the same citizens represented by their pension funds - have to make rational economic decisions.”
Helping things along is the fact that there is objective evidence as to the prevailing cost of capital and the level of risk in the form of the debt capital markets. “Governments can negotiate for lower tariffs and more capex, but here’s the price we can afford and the level of investment we can make,” says Weisdorf. “If we’re asked to pay too much we won’t be able to get the debt financing to make the transaction or get the appropriate risk-adjusted returns for our investors.”
In the current environment for infrastructure, fortune favours the holder of long-term capital, the world’s most in-demand asset, and opportunities abound for pension funds that can put themselves on the right side of this exchange.