Infrastructure is a buzzword throughout the investment community, and secondaries market traders and investors are increasingly paying attention.
To the politician and policy-maker, infrastructure investment promises an economic panacea: a stimulant to growth and a creator of jobs. And to the investor, infrastructure’s promise of strong, stable yields in uncertain times is undoubtedly attractive.
The question for policy makers is: how to match investor appetite for the sector with short-term political goals? This is particularly crucial in secondaries because increased allocations to the asset class without greater supply will inflate pricing and unrealistic infrastructure requirements from politicians will deter new investors.
The secondaries industry knows the asset class is attractive and growing – estimates of global infrastructure financing have been placed at between $50 and $70 trillion for the period up to 2030. In addition, there are investment opportunities from trading existing assets.
New opportunities have blossomed for private investors following the liberalisation of infrastructure ownership globally. This means that there is an increasing focus on “infrastructure” as a distinct and definable asset class with unique characteristics (high barriers to entry, regulatory stability, monopolistic or quasi-monopolistic characteristics and criticality of service).
The infrastructure secondaries market has grown up in parallel to the traditional private equity model. This is in part due to specialisation of the infrastructure funds, particularly those focused on PPP, which have been the source of most deal-flow to date.
What makes the infrastructure secondaries market different?
“Simple” indirect secondary trades of investor interests have not been that prevalent so far in the infrastructure market. The natural cycle of many infrastructure investments is that risk decreases as projects move from the construction/greenfield stage to the operation/yield/brownfield phase and the liquidity opportunities for funds at this stage have been sufficient to meet most investors’ requirements.
Lender controls associated with some common infrastructure fund financing approaches also detract from the appeal of trades of investor interests in those funds.
So, the market has been led by a combination of:
- Per asset and portfolio disposals of interests in projects by industrial sponsors, such as construction contractors looking to achieve a capital gain and recycle capital into new greenfield opportunities;
- Whole-fund transfers by the early primary or greenfield funds into continuation funds;
- The growth of the listed fund sector and seeded yield funds in which funds were primed with operational yielding projects and listed on a main exchange; and
- Auction sales of fund portfolios at the end of the fund’s investment period. These often include the option of preserving at least some of the underlying fund structuring within the sale group.
Dealing with diversity
This diversity of approach is one of the issues facing any secondaries market participant – at what level is the trade best structured? The enhanced drivers on settling the exit structure for infrastructure investment include:
- Preservation of financing: many infrastructure investments are project financed with long-term commitments. A key objective of the process is often to preserve this finance in place as the cost of a refinancing is prohibitive; and
- Regulatory Oversight: transactions are often structured to minimise the enhanced regulatory oversight that is a feature of the infrastructure sector.
Secondaries appetite and trends
A very high percentage of the opportunities thus far have been taken up by specialist secondaries infrastructure funds. In general, they have preferred to acquire assets as close as possible to the yielding asset. This means buying less of the exiting investor’s investment structure so that the investments acquired can be more readily incorporated into the new owner’s structure.
The nature of secondaries investors has also been influential in driving deal size – selling a mega-portfolio would limit the potential pool of buyers, whilst selling relatively small assets (which many infrastructure equity investments are) piecemeal would be inefficient.
More recently, managed account funds and direct investors have been competing for assets, particularly on whole fund exit processes. To these investors, in particular, sales further up the fund structure can often be more attractive as they have greater flexibility to allow the purchaser to structure their investment on a one-off basis to suit and/or grandfather the underlying structure for management and tax purposes.
Charles Ford is of counsel and a member of Hogan Lovells’ infrastructure, energy, resources and project teams. He is based in the firm’s London office.