Infrastructure M&A Breakfast Briefing
EU
RenewablesMarket UpdateIn a market where institutionals continue to up their allocations to infrastructure, and more such groups are prepared to bid directly, competition for deals is greater than ever. GP-managed funds are increasingly pushing out the definition of the asset class, although deal selection must be based on market fundamentals, panelists concurred at the inspiratia infrastructure M&A breakfast briefing hosted by EY on 4 November
The market continues to see fierce competition for auctioned assets, with direct investors now established as the dominant force at the large end of the core infrastructure space. However, further down the chain, GP-managed funds are optimistic they can bring their hands-on skills to bear, either with innovative strategies on auction processes, or by carving out bilateral opportunities ahead of the market. In some instances, this core-plus focus is leading to a convergence between infrastructure and private equity.
"We have two groups of clients - those who focus on core, low risk infra and the cost of capital game, which is very competitive, and those looking for enhanced returns," EY corporate finance head Dougald Middleton said yesterday [4 November] at the inspiratia infrastructure M&A breakfast briefing in London.
In the former case, institutionals dominate (see Figure 1 - below). In the latter, funds hoping for higher returns are focusing on the mid-stream value chain.
"It could be across oil and gas, mining and minerals, it could be payment services, the health sector - the edges of what private equity traditionally looked at, and what infrastructure is currently looking at, are becoming very, very blurred," he said.
As a result of institutional appetite in core UK infrastructure, GP-managed funds are likely to be more active in other markets. While 50% of Deutsche Bank's first infrastructure fund was made up of UK assets, for example, only a small proportion of its second infrastructure vehicle will be invested in the UK, according to Deutsche Bank European infrastructure head Hamish Mackenzie.
There is a continued focus on Germany meanwhile, and a push southward:
"Italy and Spain are markets where we can perhaps add a bit more value than in the UK, which is generally a more transparent and executable space."
He added: "What we're seeing there now, following the financial crisis, is a wave of privatisations and restructuring, both of utilities and other businesses – having spent eight to nine years investing in relationships in that market, there is now an opportunity to harvest those relationships".
The dream deal
Panelists agreed the mythical proprietary deal was the most sought after scenario. But to do so, investors must get in early.
"Eurofiber, the dark fiber business we bought in the Netherlands this year – we started discussing that in 2012," Antin Infrastructure managing partner Mark Crosbie said, while the team had also spent four years working on the CATS mid-stream deal in the UK, an asset which it acquired in two stages, this year and last.
Bilateral deals can also sometimes be secured by offering a price for something that corporates don't understand the full value of.
Take mid-stream, for example. "Mid-stream is owned by oil and gas, but their DNA is about exploration and production," Crosbie explained. He said: "Mid-stream is just seen as a facilitator to get to the market – they don't know what its value is because they haven't thought of it that way."
As a result "sometimes you can put an offer on the table that surpasses their expectations".
As to fresh dealflow from the utilities and oil and gas majors, while a lot of the more obvious things have come out from Nordic and German utilities, there is still "some way to go", according to Mackenzie, with Italian, Spanish and Portuguese utilities or conglomerates looking to sell assets.
Many of these deals are far better suited to GP funds than institutionals.
"If an oil major has got something they don't know what to do with - it's a bit dirty or they've got a management team that needs help – I'm sure that's going to get more traction from GPs like Mark and Hamish that want to get their hands dirty and change things," Macquarie Capital senior managing partner Adam Hain said.
He added: "That's the beauty of the big corporates. There will always be deals coming out of these guys, they're so big and diverse, they're constantly looking at how to make their balance sheets more efficient, and to re-invest capital."
In addition, there are a large number of utilities in central government or municipal hands that are slowly starting to come to market.
And even if a sale does go to auction, having met corporates early has an impact.
"Corporates like it, and more importantly for GPs, it's a way of shaping what a deal may be when it comes to market," Hain says.
Communication with the management teams of the assets themselves is also important.
"If you look at how private equity operates in more operational businesses, getting close to management is often the key to unlocking some of these opportunities," said Middleton.
Competitive advantage can also be gained by finding a situation where there is an alignment of interest between buyer and seller.
In two of its fund 1 partnership deals, Peel Ports in the UK and Tank & Rast in Germany, Deutsche Bank was able to secure investments without being the highest bidder, for example.
"Because we were able to offer a partnership structure and a relationship that went back over time, we were able to secure those transactions without pushing it," Mackenzie said.
Shifting definitions
Infrastructure investors have sometimes come in for criticism for investing in businesses not deemed to be infrastructure, but, according to the panelists, time has proved their value - and their infra characteristics.
Take UK rolling stock business Porterbrook:
"10 years ago – people would have said it's leasing, trains, on wheels. Now people look at it in more detail and see how it's evolved over good times and bad times, and institutional clients take a view that in the long run that's a sector they'd like to get into," Hain said.
Crosbie is hopeful that eventually this same change in perception will occur with other assets in Antin's portfolio, such as recently acquired German medical diagnostics business Amedes.
"In terms of hard assets – it's a scaled business and the barriers to entry are significant. The chances of disrupting that market are very, very slim indeed," he says.
The regulatory structure is also such that it has all the characteristics of infra.
Whether medical diagnostics or crematoria business, Crosbie is confident of an eventual institutional sale.
"If our LPs are a bellweather of what LPs in general think about these assets I have every confidence that we can sell these assets to other direct investors, because ours love them."
In essence, this shifting attitude to what constitutes infrastructure has come about because not only GP-fund managers, but also institutionals, are spending far more time focusing on businesses themselves, rather than the sectors they may be in.
"People are actually dissecting the business, the geography it's in, and the market position it has, relevant regulation, and what fundamentally drives the business. And then they are making an assessment on where it sits in the risk spectrum," Hain said.
This is a natural development, according to Mackenzie.
"The reality is that infrastructure evolved as an asset class to deliver a certain profile and return. There is a lot of confusion around how you define core, core plus and what sits in the middle. Our role as managers is to be true to the return profile we are targeting for investors, irrespective of the underlying label that you would apply to the sector," he said.
While all panelists agreed there is a wall of capital chasing deals, competition is typically fiercest at the top end of the market, in the £1 billion (€1.4bn $1.54bn) plus equity cheque space.
Below that there is a huge amount of opportunity, although returns are under pressure.
"If you spoke to people in the market, they would say that returns are not coming down, but what people are doing is taking more risk with businesses," Mackenzie explained.
In the current market, the assumed business case will be at a premium to the IM business case, whereas three to four years ago people would take the IM case and then discount it back, and use it as a basis for the return, he says.
Pre-emption rights
Many of the large M&A deals to occur in the UK infra space in recent quarters have involved use of pre-emption rights – which have drawn out some processes and caused others to be abandoned. In all instances, communication is key.
"With pre-emption there has to be clarity. Amongst existing shareholders in the first instance, and then, to the extent you can communicate it to the market, what is going to happen or not happen under the rules of the shareholder agreement," Hain said.
Agreeing a strategy with partners is vital.
"This happened with Tank & Rast - the way to maximise value for a very large but complex deal was to offer a vanilla transaction to the market, a 100% sale, with management locked in, and a business plan they agreed with," Mackenzie added.
In the case of Associated British Ports, meanwhile, it took over a year to agree a sale, with a result that is "still probably viewed as sub optimal by some of the selling parties".
