Infrastructure investment has not caught on in the US, compared with institutional investing peers such as Canada, Australia and the UK. But Arjuna Sittampalam, research associate with EDHEC-Risk Institute and editor of Investment Management Review, argues infrastructure is perceived as a way out of the morass in which the US finds itself.
The sector has not caught on in the US, compared with Canada, Australia, UK and other developed nations in continental Europe, where infrastructure thrived in the few years preceding the credit crunch.
Massive investment in infrastructure, embracing both new developments in areas such as green energy and badly needed regeneration of existing stock, is seen as not only essential for the global economy but also providing it with a substantial stimulus in the years to come.
This sector has had a bad time during the recent credit crisis, but there are signs of it picking up. It might seem far-fetched but infrastructure looks like being a possible way for western economies to solve their huge public sector debt problems. At least, this might be particularly true of the US.
The year 2009 was bad for infrastructure in Europe as fund-raising dropped by over 80 per cent to $2.6 billion, a much higher fall than the 55 per cent decrease in all European fundraising, according to Preqin, the private equity intelligence provider. This fall had followed a golden period of fund-raising in Europe, which had multiplied 15 times in the three years to 2007, to just under $16 billion.
In the boom years immediately preceding the credit crunch, infrastructure investment had been considered a safe solid long-term bet, with returns linked to inflation and a comfortable margin on top. This very safety was to be its undoing when a wide spectrum of asset classes were synchronously bid up to unsustainable levels. Excessive infrastructure prices in particular were based on high private equity-type leverage and disregard of political risk, both of which were unsustainable. Subsequently, in infrastructure, just as in other classes, the credit crunch brought a hangover and the drying up of demand.
In 2010, strong signs emerged of a rebounding sector. Several forces are at play. The buy-out firms still have a strong incentive to invest in this area, in view of the relative lack of opportunities elsewhere. Investors disillusioned with conventional portfolio returns are once again being attracted to the safety of the asset class, given that the heady valuations of the boom years are subsiding. A third reason is that banks see infrastructure as a safe area to lend to and, as they increase their lending, this sector, with its attractive and stable cash flows, should benefit. Wind farms, high-speed rail across Europe and the new port in the Thames Estuary are some of the projects luring investors with stable returns.
HSBC, for example, has collected nearly $600 million for its infrastructure fund targeted at investing in public-private partnerships (PPPs) in sectors such as hospitals, prisons, property and transport. It intends to back early-stage or green-field projects, to manage their design, construction and initial operation before selling them on.
This approach can be distinguished from the large infrastructure funds that focused on existing mature assets, which they considered less risky, but which actually proved to be more so due to the bidding up of prices during the boom, as mentioned above. Over its 15-year history, HSBC’s infrastructure arm has invested $15 billion in areas such as the Dutch high-speed rail link and the John Radcliffe Hospital in Oxford. It has been bidding for, among others, the Singapore national sports hub and a Canadian Government accommodation project.
Governments will welcome these developments. According to the OECD, nearly $2 trillion a year needs to be spent on basic infrastructure in the next 10 years. But governments cannot afford it, banks are retrenching and the securitisation route has dried up. Cash-rich long-term institutions, such as pension funds and insurance companies, are seen as part of the solution.
Interestingly, the Canadian pension funds are already heavy backers of infrastructure in Europe. They have a massive commitment to infrastructure because of their inflation-linked characteristics, and there is a paucity of opportunities within Canada itself. The Canadian pension fund industry, the fourth largest in the world, at C$1.2 trillion, has already invested through consortia in, for example, airports in Bristol and Birmingham, and UK water companies.
Infrastructure is perceived as a way out of the morass in which the US finds itself.
The sector has not caught on in the US, compared with Canada, Australia, UK and other developed nations in continental Europe, where infrastructure thrived in the few years preceding the credit crunch. The concept of public-private partnerships (PPPs) is well established in Europe, and is referred to as PFI in the UK, for instance. In the USA the concept is referred to as P3s, but the US is 20 years behind in implementing it.
Americans are dedicated to the capitalist society and the role of the private sector, more so than any other country in the world, but when it comes to infrastructure they have been strangely hostile to private control of public facilities such as roads, airports and bridges. They tend to regard these as their birthright, with free access, and not as assets to be sold off. Matters have been exacerbated by the attitude of the unions, who have traditionally relied on public sector-run infrastructure facilities as a source of jobs and contracts.
In the mid-noughties, infrastructure had an encouraging start with the privatisations of the Indiana Toll Road and the Chicago Skyway. Subsequently, however, there have been quite a few high-profile setbacks. The leasing of the Pennsylvania Turnpike system fell through as the state legislature did not approve. The local politicians considered it as a vehicle for getting votes in return for jobs and favours. That had a negative impact on the market as a whole. Other failures included the Chicago Midway Airport deal falling through. In Florida, Fortress Private Equity paid $4 billion for a railway, but the state legislature did not come through with the funding for the expected development of a rail corridor on which their investment depended.
A project that did go through was the lease of 36,000 parking meters to a Morgan Stanley-led group. The new operators quadrupled some rates, provoking outrage.
In an article, ‘The new shape of private equity’ in Investment Management Review (volume 5, issue 1, Autumn 2009), the author wrote: “Morgan Stanley … along with a group of other investors, paid over $1 billion last December for 30,000 parking meters in Chicago. Given the universal hatred of these meters, Morgan Stanley needs to be wished the best of luck in implementing their policy of allaying concerns.”
What is changing?
All three levels of government in the US, at federal, state and local level, are deeply in debt and are faced with having to raise taxes and/or cut spending, including highly valued services.
The global concerns about the US public sector debt and the need to contain ongoing deficits are causing a sea-change in American attitudes. The US public and politicians are now focusing on raising money from an abundant public resource, namely existing infrastructure assets, as a way out of their difficulties. New investment is also seen as a way to lift the economy. President Obama told the US Congress “there’s no reason Europe or China should have the fastest trains.” These and other green-field projects understandably now meet with less resistance from the US public, but even existing assets badly need refurbishment. From 1950 to 1970, infrastructure spending in the US was 3 per cent of GDP, but it has fallen to 2 per cent since.
What sort of money is involved in a potential hiving-off of US public assets? According to the Bureau of Economic Analysis (BEA) of the US Commerce Department, the total value of US Government fixed assets in 2008 was $9.3 trillion, of which $1.9 trillion was held by the federal government and $7.4 trillion at the state level. Though not all the assets can be sold, substantial chunks can and, to put it into perspective, the US Government’s budget deficit was $1.4 trillion in 2009.
The potential for escaping from the mire of debt is already causing public and political opinion to shift. Tolls on hitherto free facilities might be out of the question, but a possible precedent arises from Florida obtaining financing for improvements to the I-595 roadway, the first PPP project to be completed. What is interesting is that, rather than the private operator levying tolls, the state would recompense it, according to performance measures based on the road’s operation. This is seen as an important model for the future.
In another significant departure from previous practice, Carlyle Group was involved in a $200 million PPP transaction to manage 23 service areas along Connecticut’s highways for 35 years. No leverage was involved and, most importantly, Carlyle worked hard to win the support of state officials in transport and environment, as well as community groups and labour unions. An important feature of these privatisations, attractive from the perspective of the taxpayer, is that the disposal is not in perpetuity, unlike the UK privatisations of the 1980s, which started the ball rolling internationally. The assets are leased out over periods ranging from 20 to 100, but typically 30 to 40, years.
One of the major obstacles to private sector financing of infrastructure deals is the availability of funds and credit finance. Here again, the atmosphere is changing. Many long-term investors are attracted by the prospects of stable returns in a country such as the US. A top executive at Macquarie suggests that there is a wall of money waiting to go in. It is not expected that it will all go in suddenly, but the population would not stand for that anyway. An initial incremental process in small projects could lead to a flood in future years.
There has been an increasing perception that the wholesale privatisation of public infrastructure assets could achieve several desirable objectives: reducing public sector debt, pouring much-needed investment into ailing infrastructure, itself a source of inefficiency, and reinvigorating the US economy back onto a growth path. What is described as potentially one of the largest-ever monetisation exercises of publicly-run facilities could lead to the development of one of the biggest emerging markets in the world, though based in the US.
In the last few years, projections have been published of $20-30 trillion of infrastructure investment opportunities worldwide in the next decade or so. There is a case for considering some of these as illusory. Outside the West, the emerging countries, including the BRICs (Brazil, Russia, India and China), have more cash of their own than they know what to do with and do not really need global investors, except perhaps for their expertise temporarily. Investing in infrastructure is much less complicated than space programs, for instance, and the know-how is easily acquired by the emerging countries.
In an article, “Infrastructure – two opposite perspectives” in Investment Management Review (volume 5, issue 3, Spring 2010), the author wrote: ‘Why would Asia need western cash when it might only make investing its own cash more difficult? The answer … is the expertise that foreign investors bring … Eventually Asia will develop all the skills it needs, particularly with returning émigrés who have already begun to set up private equity enterprises … the need for foreign expertise comprises just a narrow window of opportunity that might disappear within five to 10 years.’
It does look as if the US and possibly the continent of Europe could provide the major opportunities for investors, allowing infrastructure to grow massively as an asset class. Infrastructure investment is increasingly seen as an answer to the debt crisis and other ills in the US, helping to restore the country to its pre-eminent global standing
Privatisation of the US’s vast pool of infrastructure assets is beginning to be seen as a potential solution to its huge and growing public sector debt burden. The public, the politicians and the unions are shifting from hostility to at least a resigned acceptance that hiving off these assets is preferable to extra taxes or cuts in services. The estimated total of $9 trillion, even if sold off only in part, could make a substantial hole in the ballooning public debt.
Selling publicly held infrastructure assets just to reduce debt is only a palliative and makes no contribution to curing the underlying malaise in the economy. But there is more to the infrastructure story than that. Private money could ensure a badly needed regeneration of the existing decaying stock of infrastructure, eliminating inefficiencies and bottlenecks. Funding new green-field ventures such as high-speed rail will spur entrepreneurial activity and put the real economy on to a growth path. A flood of cash is reportedly waiting to pour in from investors excited by a potentially massive asset class in the politically safe US.
While there is plenty of hope, there has not yet been much concrete action. The US story might never happen, but as at least a partial solution to its debt difficulties and reinvigorating its economy there does not seem to be an equally attractive alternative.
But politics remains key and predicting political outcomes is always fraught, particularly in the US, with its complicated separation of powers between the federal, state and local levels, each zealous of their rights. Perhaps the growing vociferous chorus against the US debt burden and the need to cut services will be the spur.
The above is the first part, covering mostly the long term potential for this all -important sector, of a two-part article. The second part, dealing with recent short term developments, will appear in next month’s EDHEC-Risk newsletter.