Valuation and pricing of secondaries (infrastructure) investments require a bottom-up and sum-of-the-parts approach with respect to all underlying portfolio investments. In our view, secondaries valuation should combine individual valuations of all portfolio assets with the evaluation of general fund aspects, such as the overall life-cycle of the infrastructure portfolio and return assumptions for the unfunded portion of the fund under consideration.
Valuation and modelling of infrastructure assets in the secondaries context is quite different from the secondaries private equity or secondaries real estate approach. This is driven by several peculiarities:
- Concentrated portfolios. Typical infrastructure funds are more concentrated than those in the private equity It is not uncommon to see single asset concentrations of 20 percent of fund size and more. Naturally, this requires a higher level of scrutiny with regards to the respective asset and sometimes leads to the need to build a detailed asset-specific model for the key portfolio value drivers.
- Yielding cashflow profile. One of the key differentiators of infrastructure assets, as compared to private equity investments, is the yield component. While cashflows to equity in typical private equity deals are generated on exit, infrastructure deals typically generate substantial ongoing cash yields, which have a significant impact on valuation. Therefore, an investor in infrastructure secondaries must have an understanding of the cashflow profile in order to come up with appropriate distribution scenarios. Accurate evaluation of the profitability of infrastructure secondaries requires a careful consideration of the time value of money and interim cashflows before the final asset disposal. This adds a degree of complexity to the model compared to the private equity space, where typically all return is realised at the end of the holding period when the company is sold. Focus on cash yield requires a more detailed modelling of the cashflow statement, which goes beyond the profit and loss statement modelling typically carried out in the private equity space.
- Greenfield investments. Many infrastructure funds invest into assets prior to or during construction. In that case, no historical information is available. Extrapolation of the historical financials is therefore not a viable valuation approach. Further, the cashflow profile includes a number of draw-downs over time, often made after the secondaries transaction has been completed. Granular modelling of the cashflow profile tends to require rather complicated models, which are more difficult to standardise.
- Permanent leverage. A number of perpetual infrastructure assets maintain constant levels of leverage (as opposed to paying back debt over the holding period, which can be observed in the private equity space). Cashflow generated by the asset would be used in that case to pay interest on debt and dividends to the equity holders as opposed to sweeping all the cash flows as debt repayment. Accurately modelling the refinancings, as well as tax implications, of equity distributions requires a substantial effort.
- Limited exit comparables. Modelling exit scenarios for infrastructure assets can be challenging because there are often only a few public or private comparables available for benchmarking purposes. As a result, the secondaries investor must apply different exit valuation methodologies depending on the asset types. Classic private equity valuation metrics, such as EV/EBITDA, become less relevant; alternative measures such as EV/MW (for power generation assets) or EV/RAB (regulated asset value, applicable for regulated assets) need to be considered.
Structuring and execution
In order to structure an investment, an internal team, including legal, tax and structuring professionals, is necessary to identify and assess any issues that may complicate the completion of a secondaries transaction. Having execution professionals in-house enables established secondaries players to better anticipate the timing of the transaction and improve their competitive position in a secondaries sale process by increasing the speed of execution.
Structuring measures help address the specific needs of the seller by determining how to structure an investment in light of applicable legal or tax considerations, while meeting the requirements of all parties involved. Once the corresponding investment vehicles are set up, ongoing monitoring and administration is required in order to maintain optimal structures. Ultimately, legal and tax considerations have a direct impact on the cashflow profile of an investment and, therefore, also have implications on secondaries valuations. Our experience shows that accurate evaluation of tax leakage and correct timing of distributions out of the fund (which do not always coincide with the distribution timings at the underlying asset level) can have a higher impact on pricing and returns of the secondaries transaction than the financial development of any single underlying asset.
In recent years, the use of financing has become widely accepted in secondaries transactions, especially on the private equity side. While financing can clearly enhance secondaries returns, we believe that permanent fund-level leverage should be used very carefully in the context of infrastructure assets for three reasons:
- Infrastructure assets are often significantly levered themselves, therefore adding permanent leverage as part of the secondaries transaction would push up the risk profile.
- Use of financing can undermine cash yield, which represents one of the key attractions for infrastructure investors.
- Many infrastructure secondaries transactions still represent single LP interests, characterised by bulky discrete proceeds as opposed to a more consistent realisation path, which is seen in a mature portfolio of private equity interests. At the same time, using financing for near-term distribution bridging is a valid tool for optimising capital efficiency.
The infrastructure fundraising market continues to be buoyant with a number of large-scale funds raised recently. We believe therefore that the infrastructure secondaries market is likely to continue growing in the short- to mid-term. This is partially counterbalanced by the fact that LPs, in general, are seeking to increase their allocation to infrastructure. Therefore, one can hardly expect the willingness to sell infrastructure positions on the secondaries market to be high in the near-term.
Tail-end liquidity solutions are emerging as a new sub-sector of the market. We expect that this will result in a significant pick up in volumes of transactions closed in between 2016 and 2019. While fully covering the infrastructure allocation through secondaries remains a challenging task due to the niche nature of the market, we believe they will continue to serve an important role as part of the global and integrated approach to infrastructure investing.
Evaluation of infrastructure secondaries remains a highly complex and specialised task, which requires significant manpower and expertise. Growth in the number of market participants has been observed over the past few years, resulting in increased competition. This dynamic is likely to persist in the future, as the asset class matures. We believe that diversification and yielding aspects of a typical infrastructure secondaries will support continuing investor appetite, while complexity of secondaries due diligence and execution will continue strengthening the competitive position of a number of selected secondaries infrastructure players.
Dmitriy Antropov is senior vice-president of private infrastructure at Partners Group and co-leads the firm’s worldwide integrated infrastructure investment activities, which include primary and secondaries fund investments, as well as joint investments. He has been with Partners Group since 2008 and has 12 years of industry experience. Antropov holds a PhD in world economics from Financial University in Moscow. He is also a certified financial risk manager.