A Focus on the Infrastructure Sector

2016-12-12

'Infrastructure' describes the basic physical structures and facilities needed for the society to operate efficiently. They provide the framework for economic growth and social development.

It includes therefore Electricity, Highways, Bridges, Railroad, Airports, Oil & Gas Pipelines, Transmission & Distribution Systems, Water Treatment & Waste Management Facilities, Cable Networks, Communication Towers, but also Alternative Energies, such as Solar, Wind or Biomass industries.

According to some estimates, USD 57 trillion worth of infrastructure investment is required by 2030. Every year[1], governments have difficulties achieving their annual infrastructure targets. Across the globe, insufficient or run down infrastructure presents key economic and social challenges that governments and the private sector must tackle together. Without the necessary infrastructure, economies are held back; not allowing them to unravel their full growth potential, and in turn economic and human development suffer.

Not all the governments are addressing these issues with the proper Capex budget.

For years, studies have witnessed billions USD of annual costs in excess fuel costs and road congestion time in the United States.

While China has aggressively invested in its infrastructure so that infrastructure is never a bottleneck for business[2]. China's spending on infrastructure as a percentage of GDP, a clear indicator of government's spending priorities, is the highest in the world.

[2] source https://www.quora.com/Why-hasnt-India-been-able-to-build-a-large-scale-infrastructure-comparable-to-Chinas

The global economic growth and population growth are creating demand for infrastructure investments. In most developed countries, there is a need to upgrade or to replace aging infrastructure. There is an acute demand for new infrastructure, especially for electricity generation, water and sanitation. Deferred maintenance for roads, water systems, dams and electric grids is now requiring substantial capital outlays.

Projected Average Annual Infrastructure Investment Requirements in OECD Countries(for Electricity and Water, in USD Billion) [4]

4) Source page 23 https://www.oecd.org/futures/infrastructureto2030/40953164.pdf

Because many governments have been facing budgetary constraints, infrastructure projects have taken a new form of existence. They involve now a mix of different relationships between the Public (Government) and the Private Sectors (Corporates)[5].

It can range from:

- the simple execution (construction) of the infrastructure project by a private company (through a Tender Process),

- to the PPP (public-private partnership), in which the private company provides a public service and assumes substantial financial, technical and operational risk in the project, while the government might provide a subsidy in the form of a partial financing, and facilitated access to the World Bank financing, some tax breaks or a guaranteed annual revenue for a fixed time period; PPP is a broad term that can be applied to anything from a simple, short term management contract to a long-term/more complex contract such as an O&M (Operate & Maintenance) a DBFO (Design-Build-Finance-Operate), a BOO (Build-Own-Operate) or a BOT (Build-Own-Transfer) contract,

- to the Privatization, that can be the simple sale of an existing infrastructure asset to the BBO (Buy-Build-Operate) of a new infrastructure project.

From 1990 to 2009 nearly 1,400 PPP deals were signed in the European Union, representing a capital value of approximately €260 billion[6]. Since the financial crisis of 2008-2011, the number of PPP deals closed has fallen. Governments are now focused on the budget and fiscal policies.


The European politics have recently addressed these issues. Guenther Oettinger (European Union Commissioner) said that Europe needs to invest USD 800 billion in its digital-communication infrastructure. (digital communication); the Executive Director of the Community of European Railway and Infrastructure Companies, Libor Lochman, reported that it is vital to build a seamless European rail infrastructure (individual member states of the European Union have rail networks that have particular areas of incompatibility – voltage types used being just one).

If we take the US in General, and Mrs. Hillary Clinton's program in particular, we notice that she has presented a 5-year Infrastructure plan estimated at 55 billion USD, involving renovation of roads, bridges, public transportation, telecommunication and water distribution, as well as a 10-year plan (estimated at 700 billion USD) for the education, of which a 20% would be used to renovate or build public schools and colleges.

All this will require multi government and individual company commitments, allowing listed corporates and dedicated private equities to participate and share the profits.

Infrastructure investments typically have long durations with a useful life that can span even hundreds of years. Projects typically have a long time horizon to generate cash flows and those cash flows have the potential to increase over time. Cash Flow distribution (usually in the form of dividend yield) has been, historically, above market rates and represents an attractive factor.

The industries involved are very capital intensive and require specialized industry-related expertise, leading to high barriers to entry.

Infrastructure assets are rather a necessity than a complement; therefore demand typically remains undisrupted even when prices climb.

In general, pricing is regulated or even inflation-linked, therefore these assets have a built in inflation protection.

All this is making the Infrastructure an interesting and attractive investment theme. There would be different investment options; they can be taken separately or jointly, depending on the risk profile of each investor.

A Fixed Income option:

The Dreyfus Municipal Bond Infrastructure Fund is investing at least 80% of its assets in US municipal bonds issued to finance infrastructure sectors and projects in the United States. The top 5 sectors (as of end of September 2016) include: Transportation Services (Toll Road, Airports, Ports, Railroad, Tunnels & Bridges) at 21%, Health Care at 16%, Education (Schools and Convention Centers) at 11%, Industrial (Waste management, Water) and Utilities (Power plants and Natural Gas Transmission) at 7%. This closed end Fund pays monthly dividend, with an average yield of 5% per annum.

A Global Equity option:

iShares Global Infrastructure ETF is an exchange-traded holding large-cap transportation (40%), utility (40%) and energy (20%) stocks, with its largest allocations split between North America (47%), Western Europe (25%) and Asia/Pacific (20%) and Emerging Markets (8%). The Fund is listed in the NYSE and has a distribution yield of 3.4%.

An European Equity option:

Kairos Key is an equity long-short Fund that invests in equities of regulated and semi-regulated infrastructure companies. The investment universe of the fund comprises of energy, transport and telecom with a strong focus on Europe. As of end of end of September 2016, the 3 major investment themes in the portfolio were represented by the Italian municipal utilities (Iren and Acea), the broadcasting and telecom towers (Raiway, Ei Towers, Cellnex) and stocks managing concessions and infrastructure related to the gaming industry (IGT , OPAP, Playtech). The Fund can also offer an annual dividend distribution (1.5% yield).

A Private Equity Exposure:

Most of the large Private Equity players have dedicated human and financial resources to invest in a variety of Infrastructure projects and assets. Some of them, like Isquared, InfraRed, Dutch Infra Fund or Global Infra Partners are 100% dedicated Infrastructure Private Equity Funds.

Because the Private Equity Fund and the underlying assets are usually not listed, investors have to realize that the liquidity of their investment is linked to the Fund General Partner to liquidate the underlying asset (selling the Infrastructure asset to another company; or listing it in the market).

Infra PE Fund have become strong alternatives to the large listed industrial conglomerates, to the point where they sometimes partner and share similar infrastructure projects. The PE Fund have also been earlier adopters of renewable energies, that would typically represent is good 25% of any new Infrastructure PE Fund.

Even though Infrastructure PE Funds' size are quite high (in excess of 1 billion USD), accessing to open and available Funds is not easy. They are not publicly marketing their new Funds to the public, but rather to some pre-selected institutional investors and they seem not to have any difficulty in raising money: Isquared Capital, for example, was able to raise up to 3 billion USD for their latest Infrastructure Fund (in 2014).

What makes them attractive is their predictable rate of return. They have easily achieved IRRs in excess of the 15% and are distributing annual dividends (from 5% to 7% per annum). They buy physical assets, which makes investors feeling more comfortable.

A Listed "Private Equity" Exposure

Some pure Infrastructure Asset Managers have also proposed to HNW investors the possibility of accessing this theme via a listed vehicle: a closed end Fund. They can be listed either in London or NYSE and trade daily. They usually trade at a discount or a premium to the NAV, which depends on the expected performance of this strategy by the investors (because the NAV of the Fund is not performed daily, but rather quarterly, bullish investors purchase the closed end Fund ahead of the NAV publication and would agree on paying a premium to the last recorded NAV).

In order to offer continuing liquidity to the investors, the Asset Manager of the Fund will select more liquid, more stable assets and typically avoid development projects.

InfraRed launched in 2006 its listed vehicle, called HICL. It has now a market capitalization of over USD 2.5 billion.The strategy focuses on assets positioned at the lower end of the risk spectrum, generally with public sector clients (schools, student accommodation, hospitals, public buildings, roads and rail). The investment portfolio comprises stakes in 106 infrastructure projects with a weighted average concession life of over 21 years. Dividends have been consistently paid at a yield of 4.5% per annum. The stock has been regularly performing over the years.

This report is intended only for the use of the individual(s) to whom it is addressed. It expresses an opinion but does not represent an investment recommendation. It does not create or change any contract relationship with Generation ALFA SA.

Mirko VISCO


1 Source : (source https://sustainabledevelopment.un.org/content/documents/2096Chapter%201-global%20investment%20requirement%20estimates.pdf)

2 https://www.quora.com/Why-hasnt-India-been-able-to-build-a-large-scale-infrastructure-comparable-to-Chinas

3 Source : https://www.quora.com/Why-hasnt-India-been-able-to-build-a-large-scale-infrastructure-comparable-to-Chinas

4 Source : page 23 of https://www.oecd.org/futures/infrastructureto2030/40953164.pdf

5 Source https://en.wikipedia.org/wiki/Public%E2%80%93private_partnership

6 Source https://en.wikipedia.org/wiki/Public%E2%80%93private_partnership