Opportunities to invest in public infrastructure will increase during the next few years, but so will competition for deals.
Robert N. Palter, Jay Walder, and Stian Westlake
February 2008
Rarely have investments in global infrastructure—everything from roads, bridges, and tunnels to schools, hospitals, and power plants—held the spotlight as they do now. Governments around the world are increasingly comfortable using private money to finance such projects, while investors have poured large sums into specialist funds in hopes of obtaining attractive inflation-adjusted returns. From 2006 to mid-2007, we estimate, private investment funds raised $105 billion for infrastructure projects.
All of this interest heightens competition and creates a problem for fund managers and investors seeking profitable infrastructure opportunities. If funds follow the crowd, bidding to operate existing assets under a business-as-usual model, they run a double risk because of the sheer volume of dollars now chasing deals and driving up prices: either they lose out to more audacious competitors, or they risk overpaying and achieve suboptimal returns. Yet funds are under growing pressure to invest the money they raised. They can’t sit on the cash indefinitely.
So infrastructure investors must raise their game in two ways. First, they should become better at extracting value from projects by improving their operational capabilities. Second, they ought to use this more sophisticated operational perspective to assess the risks of nontraditional infrastructure deals—such as those that involve complex operations, emerging markets, or new assets.
If this story sounds familiar, it should: private-equity firms followed a similar path over the past decade. Leading ones evolved their business models to create value from not only financial engineering but also managerial and operational improvements; at the same time, they gained the confidence to invest in more and more complex businesses. By learning the same lessons—and understanding best practice from industries, such as oil and gas, that routinely face the same sort of complexity in unfamiliar locations—infrastructure funds should produce returns that will keep investors happy.
The money is here—what about the deals?
During the past two years, the flood of money into infrastructure funds has been astonishing: the world’s 20 largest now have nearly $130 billion under management, 77 percent of it raised in 2006 and 2007 and about 63 percent from new entrants. Taking into account leverage, a billion dollars of equity funding could, in some situations, pay for up to $10 billion in projects.
Where will all the money go? The value of infrastructure buyout deals has already grown from roughly $20 billion in both 2003 and 2004 to $106 billion last year. The volume of the developed world’s remaining traditional brownfield opportunities—those in existing infrastructure, such as owning and operating a toll road—won’t satisfy investor demand over the next three to four years. Bidding for these deals is already intense,1 which has pushed up price-to-earnings multiples. The multiple of 9 achieved by Italy’s Aeroporti di Roma when it was sold in 2002, for example, is dwarfed by the multiple of 27 that investors paid for the UK’s London City Airport in early 2007; in the ports sector, the multiple of 9 paid for Hesse-Noord Natie in 2002 was less than half the multiple of 20 achieved by Orient Overseas in 2006. Meanwhile, in North America the competition for road projects has become increasingly heated —as seen in the multiples commanded by the Indiana Toll Road and Chicago Skyway deals. High valuations mean that funds must work much harder to generate satisfactory returns.
Investors hoping to avoid these sky-high valuations can target more attractive deals if they are willing to look beyond existing infrastructure in developed economies and consider the following:
* projects in emerging markets—which, we estimate, will require more than $1 trillion in capital over the next ten years
* complex brownfield deals, which typically have a substantial construction element because of the upgrade and refurbishment work involved
* wholly private infrastructure opportunities, such as private industrial rail lines and power plants or the full privatization of infrastructure providers
Exhibit 1 shows what this approach might mean for the global transport sector. Of the $360 billion of transport-related projects we have identified from now until 2010, around $305 billion are either located outside the Organisation for Economic Co-operation and Development (OECD) countries or lack established income streams.
