Intouch Spring/Summer 2008
Infrastructure investing for the future
Budget-constrained governments across the world are looking to private investors to fund urgently needed investment in energy, water and transport infrastructure – but it takes investment firms with proven expertise and the ability to commit long-term capital to succeed in this rapidly evolving market.
Infrastructure has emerged as one of the world's fastest growing specialist asset classes.
Expanding populations and the demand for higher living standards create pressure in both the developed and developing worlds for greater investment in essential services like roads, airports, water and power. In the West the economic drag threatened by a generation of under-investment in basic infrastructure is beginning to be addressed, from the renewal of Britain’s Victorian sewer system to the refurbishment of the United States’ highway network. In the developing world, and especially in the rapidly growing BRIC1 economies, there is a strong recognition that investment in basic infrastructure is the foundation on which their future rapid growth will be built.
Attracted by the secure, low-volatility returns that infrastructure assets can generate, a growing number of specialist infrastructure investors are starting to fill the funding gap created by this burgeoning demand. Increasingly, private investors are financing, building, operating and maintaining crucial infrastructure around the world that would traditionally have been owned by the public sector. Despite the scale of the opportunity in the global market, it takes a unique type of investor to operate effectively in the infrastructure space – one that is both an investment specialist, and also a long-term operator of complex industrial assets.
For governments, private finance not only opens up a rich source of funds, but also generates operational efficiencies that benefit the general public. Global investors like 3i can take and apply best practice from around the world, in a way that nationalised operators would find difficult.
Global growth in demand for infrastructure
Demand for infrastructure is set to expand significantly at a time when, simultaneously, government finances in developed countries are becoming increasingly constrained, and the growth aspirations of developing countries reach ever higher.
Developing countries like India recognise the greatest need for new investment. Any visitor that has travelled along the pot-holed highways of Mumbai or experienced black-outs in the summer heat of Delhi will attest to the fact that a dynamic economy, which is growing at over 8% a year, needs to invest much more than its current 4.6% of gross domestic product (GDP) in basic infrastructure if its growth is to be sustained. The Indian Department of Economic Affairs calculates that US$450bn (€296bn) needs to be invested in India’s infrastructure by 2012. To meet its growth targets India needs to double its power generation capacity, nearly double airport capacity and grow cargo tonnage by over 50%. 3i estimates that US$150bn of equity capital will be required to fulfil these plans, much of it from private sources.
While investment in developed economies tends to focus upon the renewal of existing infrastructure as much as greenfield construction, the existing asset base means the demand for investment is no less strong.
Across Europe and North America, budget-constrained governments are increasingly looking to the private sector to rehabilitate and upgrade public infrastructure that has gradually deteriorated since the end of the post-war investment boom.
In the United States, the American Society of Civil Engineers estimates that US$1.6trn is needed in the five years to 2012 to repair the country’s crumbling bridges, roads, dams and highways.
Stable long-term investment returns
Dedicated infrastructure funds appeal to long-term investors, including pension funds and sovereign wealth funds, because of their potential to provide stable and predictable returns. These assets often enjoy regulated returns or long-term supply contracts that are linked to GDP growth and are protected from the negative impact of inflation.
Within the sector the range of returns available reflects the different levels of risk. Greenfield infrastructure investments, especially in developing economies, can deliver levels of return similar to private equity. At the other end of the scale, mature operational assets such as power and water utilities in developed countries carry lower risks and deliver lower returns. The challenge for skilled investors is to manage value from assets across the different stages of the asset life cycle, in different sectors and different economies, to deliver the blend of yield and capital growth that investors demand.
A specialist investor
So strong is the demand for new investment, and the willingness of investors to provide capital, that many commentators expect infrastructure financing to outstrip traditional privateequity investment over the next five years. To succeed in this market, funds will need to combine increasingly large sums of long-term capital with specialist approaches to investment and asset management.
With investors based in London, Frankfurt, Mumbai, Delhi and New York, 3i today operates a dedicated US$3bn infrastructure investment business, making it one of the leading global players. Michael Queen, 3is Managing Partner for 3i Infrastructure, says that 3i's entry into the market was perfectly timed.
“We recognised that it takes a specialist approach to succeed in this sector and a long-term view that goes beyond the traditional private equity perspective. We built a team and a portfolio before many others recognised the opportunity.”
3i's infrastructure team advises a global investment company, 3i Infrastructure Limited, which listed on the London Stock Exchange in 2007. It has also recently closed the fundraising for a dedicated US$1.2bn infrastructure fund for India.
“The scale of the opportunity in India, and the potential for private equity returns from infrastructure assets, was too great to ignore. And to understand the local market and to go and put the package together, you need a team on the ground.We think we are the first international blue-chip firm with both a team on the ground and a dedicated infrastructure fund for India” says Queen.
A sense of responsibility
The 3i team takes pride in the positive contribution that its investments make to the communities it serves. In the UK, 3i controls 16% of the Osprey consortium that in 2006 acquired Anglian Water Group in a £5.7bn public-to-private deal.
The company supplies water to six million people in eastern England, and 3i’s approach to the business illustrates that with infrastructure businesses, accountability goes far beyond the usual imperative to maximise financial returns. Anglian Water is subject to strict regulation
and reports regularly to customers on its performance.
“There is a huge social responsibility associated with investing in these assets. Since we have owned the business it has come first out of all the water companies across a wide range of performance measures,” says Queen. In its latest report Ofwat, the UK water regulator, has ranked the company first across the areas of water quality, waste water treatment, leakage, health and safety and environmental issues.Investors need to recognise when entering these sectors they are inviting legitimate public scrutiny from governments and from the public.
They must be aware that where basic services are concerned they are accountable not only to their shareholders but also to their customers and, often, to governments and regulators.