Consortiums: Safety in numbers?
Institutional investors are turning to consortiums to put money into the highly competitive global infrastructure market. Is it the right approach?
Over the past year and a half there have been several high-profile consortium deals in the global infrastructure market. It is one of the quirks of the asset class: infrastructure investment often requires scale. The need for infrastructure investment is clear – a McKinsey study published last year estimated that $3.3trn (€2.8trn) needs to be invested annually to keep pace with global growth – but deploying capital can be challenging and time consuming.
Investing through a consortium brings obvious benefits: an aggregation of scale, and a sharing of risk and knowledge. But the practice can also be fraught with pitfalls.
“There is a significant appetite among pension funds for investment in infrastructure across the spectrum,” says Mike Weston, chief executive of the Pension Infrastructure Platform (PiP). “The issue is that most do not have the resources to do it themselves.”
James Wardlaw, head of infrastructure at Campbell Lutyens, an advisory firm specialising in private equity, private debt, and infrastructure, agrees. “When you are looking to go direct, you need to have origination capabilities, execution capabilities, and asset management capabilities,” he says. “It is rare to find the resourcing all in one place to do this. The big Canadian pension funds have built these skills in-house, but others go through consortiums to access these capabilities.”
One challenge in investing directly in infrastructure is the sheer size of the required investments, which “tend to be of a scale that a single investor does not have the power to invest, or they might prefer to invest with partners in order to share the load”, says Weston.
In June PiP facilitated the purchase of Red Funnel, the original Isle of Wight ferry company, by a consortium of UK and Canadian pension plans, led by the West Midlands Pension Fund. “The ferry deal is an example of the way things are going,” says Weston.
“It is desperately important to be in a consortium with like-minded investors who understand their respective ticket size and share an investment philosophy. These things require a lot of time and effort to get right,” he says. Collaboration is essential not only because the sales process is time consuming but also the deals tend to be long-term.
The purchase process for the ferry deal took more than six months, Weston says, but discussions began long before that. “We had known for two to three years that the initial owner was going to be selling,” Weston says, adding that in infrastructure, investors start positioning themselves well in advance. “It is a hallmark of the industry that all players tend to know each other – we are not starting from scratch each time.”
The need to compete against deep-pocketed players like Global Infrastructure Partners or Brookfield is another reason the consortium team has to work well together. “Their ability to put a bid on the table is very strong – but a consortium is only as good as its weakest investor,” says Wardlaw. “And the dynamics of a consortium in a competitive bidding situation can be quite challenging.”
Additionally, the ferry deal, for example, is based on a buy-hold strategy, so all consortium members have to be in agreement about governance and operational issues. “You have to view the deal as a whole – you are not going to create any value if you are not going to run it well,” Weston says. “The shareholder agreement has to deal with all kinds of eventualities.”
In consortium deals risk is still somewhat concentrated, even though there is mitigation since the consortium members take an active role in management.
Independent consultant Georg Inderst says the potential benefits of teaming up for infrastructure deals are straightforward. It not only increases the amount of opportunities – including larger deal sizes – but also allows investors to share costs, fees and expertise, and make use of the comparative advantages that the participants have in the investment process, for example, local knowledge.
“Also in terms of risk management, there is the potential for broader diversification, more clout in negotiations and ongoing management of infrastructure assets, better governance using best practices and best people, and reducing political and reputational risks in difficult cases,” Inderst says.
But serious hurdles tend to be overlooked, Inderst says. “Is there a proper alignment of interests? Is it stable? What are the mechanisms when one or more investors change their minds – for example, with corporate events or when the people change?”
There are other areas that need to be addressed, he says, such as, what happens if regulations in different countries or for different investor types suddenly change and how time-consuming and how costly the setting-up, ongoing management, and eventual break-up of consortia is.
Consortiums are just about achieving scale, says Duncan Hale, head of infrastructure research at Willis Towers Watson. “The most obvious benefit is that it allows for more firepower when looking at a deal. But I think that in many cases having others sitting around the table provides greater comfort on the management of the asset over time,” he says.
In a large deal concluded in June, institutional investors from several countries formed a consortium led by TIAA Private Investments and Antarctica Capital. The group, which included sovereign wealth fund China Investment Corporation (CIC), insurers China Life and Munich Re Group, and Denmark’s PFA Pension, bought InterPark from Alinda Capital Partners.
“By combining the resources of the investors in the consortium we are able to lift a large direct transaction like this – none of the investors could have made the transaction on his or her own – neither capital nor resource wise,” says Henrik Nøhr Poulsen, executive director, PFA Asset Management.
“In the past this type of investment has been acquired by infrastructure funds. An advantage of teaming up with other investors directly is that we can focus on long-term sustainable value creation – and that the costs by doing the investment are much lower.”
Pension funds and other institutional investors, Nøhr Poulsen says, are natural owners of infrastructure assets. “We find the long-term characteristics of many infrastructure assets attractive to us as a pension fund. It is very resource intensive and capital intensive to invest in large infrastructure assets – and we like to share this.”
In addition, investors can bring specialist knowledge and skills to an investment – for example, it could be by geography or type of asset or business, he says. “By sharing deals with each other we are all better off,” says Nøhr Poulsen.
For a deal to be successful, investors in a consortium should know each well, but do not necessarily have to be similar. “We think that it is important that we understand what drives the other investors and that we have a mutual understanding and agreement on how to run the business. Whether the investors are pension funds or sovereign wealth funds are of less importance.”
Inderst says: “Some syndicates have very similar investors, others are a combination of very different ones with different strengths and objectives.” But the types of co-operations vary as well. “At one end of the spectrum there is simple information-sharing and loose alliances. At the other end there are joint ventures companies or specialist subsidiary funds. And in between there are all sorts of syndicates and investor platforms, as well as opportunistic co-investments. This means, given the different types of investors, and the variety of co-operations, that one cannot generalise too much, since consortia all tend to be very different. For example, some are only specific to one project; others are of longer-term nature.”
Inderst expects changes in the way investors club together on transactions as they become more experience. “We have seen some development in this field over the last five years or so,” he says.
“Over time, investors will learn from the difficulties encountered in specific deals, and some will find that it is easier to invest directly on their own or via the usual fund routes that are becoming more competitive.” And, he notes, most co-investments in infrastructure have yet to stand the test of a market downturn.
PFA Asset Management says there is a lot of interest in infrastructure deals internationally and, by extension, increased competition. This is leading to higher prices and lower returns. “As an investor you have to be very disciplined in order not to overpay in transactions,” says Nøhr Poulsen. “That being said, we still see interesting opportunities in infrastructure – especially long term.”
Hale questions the level of risk that investors may have to take with infrastructure deals in the future.
“Given that many of the assets being transacted today are being bought by their long-term owners, there is a question about the quality of transactions going forward. Will the investors currently purchasing core assets still be able to find assets of the same quality going forward, or will they need to slide up the risk curve?”
The level of competition is pushing investors to seek all sorts of new investment opportunities, Inderst says. “This includes new strategies such as co-investments and consortiums for lesser known territory. Most of them still have to stand the test of time – some will be faring better than others, and we will all be a bit wiser after a full market cycle.”
Wardlaw says are strategies to mitigate lower returns. “Investors are seeing significant returns through private equity-type strategies applied to infrastructure assets, such as aggregating smaller deals into a platform, developing greenfield projects.” In a quest for higher returns “developing markets are probably the most interesting, because there is a fundamental need for infrastructure”, he says.