Openings for infrastructure investment are burgeoning as governments pull back from direct funding of projects. Paul Strohm reports
When the Trans Bay Cable project is completed in 2010, there will be a new 53-mile-long electricity transmission line beneath the waters of San Francisco Bay. It will provide an alternative source of power for the City of San Francisco while helping to lower long-term energy costs and improving reliability of supply for the entire Bay Area.
Financing was arranged by Australia-listed global investment and advisory firm Babcock & Brown, which led a private sector group that initiated the project, the first purely privately proposed and financed solution to address reliability of a US regional grid. The project will provide capacity for the transmission of 400MW of electricity. Construction will start at the end of this year.
Historically, governments and their agencies were always the providers of most of those items grouped together under the term "infrastructure".
Nowadays, governments are keen to cut back their expenditure and control their borrowing, which makes building and maintaining a country's infrastructure an expense that many can no longer afford. Faced by significant demand not only for new infrastructure but also in many cases to replace old and now inefficient predecessors, increasingly infrastructure has been commoditised so that private investment can step in.
The types of project that come under the term infrastructure include transport items such as roads, bridges, tunnels, ports, airports, rail, ferries, trams and rapid transit systems, and car parks. Utilities such as electricity, gas and water, distribution, storage, generation or treatment come under the heading. Communications infrastructure has dramatically expanded in the past two decades to provide investment opportunities not only in fixed-line networks but also in mobile telephone masts, satellite systems, broadcast facilities and switching centres. And then there is social infrastructure, including education facilities, hospitals and other health care provision, prisons, court houses and government buildings.
Precise figures are difficult to obtain to judge the scale of the investment needed on a Europe-wide basis. However, according to a PriceWaterhouseCoopers report, "Delivering the Promise", in 2004 and 2005 about 206 public-private partnership deals worth approximately US$52bn (€42bn) were closed around the world. Of these, 152 projects with a value of €21bn were in Europe, including Bulgaria, Romania, Turkey, and Norway. And of these deals, around 66% were done in the UK, with Spain and Portugal accounting for 9-10% each.
PricewaterhouseCoopers says that there has been a increase in PPP deals in Germany, Spain, Italy and Hungary; in particular, school projects in Germany and projects in the health and water/wastewater sectors in Spain.
ING helps to gauge the future scale of demand for private funding. It points out that the UK Treasury recently noted its intention to deliver £26bn-worth (€39bn) of private finance initiative projects between 2006 and 2010. In continental Europe, a PPP pipeline worth €99.2bn has been identified. The EU's Trans European Networks (TENS) programme for the modernisation of major road, rail, airport and port systems will require €330bn of funding up to 2013.
The private sector has stepped into the breach with some enthusiasm.
A recent example is RREEF Infrastructure. This is part of RREEF Alternative Investments, the global alternative investment management business of Deutsche Bank's asset management division. It has launched a closed-ended Pan-European Infrastructure Fund that closed with total commitments of €2.1bn to be invested mainly in the mature infrastructure sector of the major economies of Europe.
The 40 investors in the fund are mostly pension funds and insurance companies from 11 European countries but they also include some Asian and North American investors.
The fund closed in August 2007 and is focusing mainly on established infrastructure assets across Europe, including transport infrastructure. Its targets include toll roads, airports, ports, energy distribution and transmission, water treatment and distribution, communications infrastructure, hospitals, education facilities and specialist sectors including tank storage and car parks.
RREEF's infrastructure fund had been active in the market since its first closing in August 2006 and had already bought a 49.9% stake in UK and Ireland-based port operator Peel Ports when the fund finally closed to new investment. It also bought 48.6% of German motorway service operator Tank & Rast and Maher Terminals, a privately owned operator of port terminal facilities in Port Elizabeth, New Jersey, and Port of Prince Rupert, British Columbia. The fund is also the sponsor and lead financial investor in a public-private partnership to design, build, finance and operate the first section of Austrian capital Vienna's northeastern bypass.
Another example is Goldman Sachs, which closed its first infrastructure fund with $6.5bn in assets in December 2006. Investors included pension funds, insurance companies and banks.
The GS Infrastructure Partners fund was Goldman Sachs's first fund dedicated to infrastructure investment, which it will deploy globally.
The scale of the Goldman Sachs fund is such that it is able to participate in large-scale investment opportunities while also achieving portfolio diversification. It too is seeking investments in traditional infrastructure sectors including transport infrastructure, such as toll roads, airports and ports as well as regulated gas, water and electrical utilities.
Although global, the fund's focus will be on larger investment opportunities in developed markets with established legal, political and regulatory frameworks - likely to be mainly in Europe and North America.
Investments to which it is already committed include UK-based port operator Associated British Ports and Kinder Morgan, one of the largest pipeline transportation and energy storage companies in North America.
Goldman Sachs has committed approximately $750m of the fund's total capital.
The diversity of the investment types embraced by the term infrastructure are mirrored by the characteristics of the investments within the class. A recent report from RREEF, ‘Performance Characteristics of Infrastructure Investments', describes infrastructure as a "hybrid asset class" that shares common features with bonds, private equity, and real estate. "Investors could potentially create a blended return series from these comparable asset classes to create a composite benchmark for private infrastructure," the report says.
The infrastructure sector has broad characteristics in common, however. One key distinction that can be applied across the board is between primary or secondary stage projects. Primary stage projects are, as the description suggests, in the development phase of the asset. Secondary stage projects are mature and up-and-running.
Infrastructure assets are usually large-scale investments with high initial fixed costs, which act as a barrier to entry for new entrants. This creates monopolies or near-monopolies that in turn tend to ensure a high degree of regulation.
At one end of the spectrum are legal monopolies such as electricity or water utilities where the threat of new competition is removed by government regulation. At the other are assets such as toll roads or airports where demand levels are to some extent under threat from alternative roads or airports, although the high costs of construction mean that even at this end of the spectrum the threat of competition is not great.
Demand for infrastructure assets tends to be inelastic. They provide "necessities" for which demand does not react to price movements and this in turn means stable cash returns.
Infrastructure projects tend also to be of long duration, making them similar to real estate, typically over 50 years, which can suit the long-term investment horizons of institutional investors.
ING REIM Research also distinguishes "demand" and "availability" assets. Demand assets provide revenue related to the actual use of the service - such as transport, communications and utilities - which means that some degree of "demand risk" is borne by the operator. Availability assets provide the private operator's fee from the public purse and include hospitals, schools and government buildings as well as prisons, and are often good candidates for PPP and PFI.
Australian investment manager Colonial First State Global Asset Management (CFSGAM) has looked in more detail at the characteristics of the different infrastructure investment sub-sectors.
CFSGAM points out, for example, that toll road charges are usually linked to inflation and, while expected returns are highest for greenfield toll roads, this is to compensate for risks such as those imposed during construction and by traffic forecasting. Traffic use of new toll roads tends to undergo a ramp-up period (developing stage) before reaching a stable level of traffic growth.
Airports are generally operated on long-term leases and revenue is often diversified, with income from aeronautical, retailing and property services. CFSGAM says this diversity helps dissipate income volatility where external events affect travel patterns.
Sea port revenue is often diversified by transport and export companies taking out long-term leases of berths and container facilities, and other diversification opportunities arise from the ability to develop land at the port.
Telecommunications infrastructure needs the whole network to be up and running to see a return and, as with toll roads, there is a ramp-up period while new users sign up to a new service. Mobile phone users can be fickle and returns can be volatile but capital value starts to appreciate as risks diminish and the business proves itself.
Investments in power generation facilities are susceptible to the generator's ability to secure long-term fuel purchasing agreements. However, the returns on mature power transmission infrastructure such as high-volume gas pipelines and high voltage electricity cable networks are underpinned by the essential nature of the service and by population growth.
RREEF looks at the returns and risks of infrastructure investment and while mature gas and electricity transmission projects, mature toll roads and mature telecoms and water projects carry low risk they also offer commensurately lower returns. Airports, seaports and mature toll roads with expansion possibilities offer higher risks and rewards, and new toll roads, telecommunications projects and power generation and transmission projects have higher risks and rewards associated with them.
ING says that the performance history for infrastructure investments is fairly limited, partly because infrastructure investments are comparatively new, and because data collection is sporadic and expensive in relation to the market size for this data.
"Not only are infrastructure returns not publicly available, but the data on the risk/return characteristics of these assets is relatively short. This makes it even harder to make predictions of future performance," says the firm.
Recently, UBS, in conjunction with Standard & Poor's, has calculated a listed benchmark for infrastructure and utilities for the whole world and major regions, including the US. The aim is to provide a benchmark against which the performance of listed infrastructure funds and their various sub-sector constituents can be tracked.
On a 10-year basis, infrastructure returns as measured by the UBS index have averaged 12.7%, less than private equity and public real estate but more than hedge fund, public equity and fixed-income returns. The volatility measure of the UBS index, at 18.3%, has exceeded only that of fixed income and hedge funds, but trails that of public real estate and private equity.
"UBS believes that the trend among asset managers to allocate funds specifically to the infrastructure & utilities sector will continue to be strong," says Craig Stafford, UBS head of infrastructure and utilities research.
Certainly the opportunities appear unlikely to diminish. While investment in the mature and replacement infrastructures of the west, particularly the US and Europe, offer one level of risk and reward, the rapid urbanisation and development of the emerging economies, particularly of China and India, appear to offer different types of more pioneering opportunity. Investment manager Invesco has a fund targeting that region. The fund's senior manager, Maggie Lee, says that levels of urbanisation remain low by international standards but increasing urban population imposes ever greater demands on infrastructure facilities and services.