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PlayBook 3Q 2018

Barbarians fixing the gates? Why infrastructure is primed for PE investment

When PE firms make headlines, it’s usually for a billion-dollar fund, a billion-dollar deal or a PE-backed company’s bankruptcy. Infrastructure fundraising? Not so much. Here’s why that could change.

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When PE firms make headlines, it typically involves the closing of a billion-dollar fund, the completion of a billion-dollar deal or a PE-backed company saddled with debt finally going bankrupt.

Infrastructure fundraising on the front page? Not so much.

But last year proved the exception when Blackstone announced plans to raise a $40 billion infrastructure fund, with the Public Investment Fund of Saudi Arabia pledging to match up to $20 billion in LP commitments. The fund’s goal: Invest more than $100 billion in infrastructure projects predominantly in the US, using debt financing to come up with the other $60 billion+. The vehicle will reportedly target businesses involved in midstream energy, telecom, water and renewables, as well as public-private partnerships.

The fundraising announcement came more than a year after Blackstone co-founder Stephen Schwarzman first met with Saudi prince Mohammed bin Salman, the chairman of the PIF, and urged him to back Blackstone’s latest infra-focused vehicle. Bin Salman agreed, and, despite initial difficulties in raising capital and a reported power struggle over who would ultimately control the investments, Blackstone finally closed its first round of fundraising on $5 billion in 2Q, with the PIF investing $2.5 billion as promised.

Though it has yet to reveal any investments, don’t expect the vehicle to stay quiet for long. Schwarzman said on the firm’s most recent earnings call that the infrastructure team in charge is “fully in deployment mode and (is) evaluating a pipeline of interesting opportunities.” Former Blackstone president Tony James, meanwhile, said in a February interview that fundraising could take a decade or so, a rare timeframe in a PE world where it typically takes an average of about a year to raise a PE fund, per the PitchBook Platform.

Improvements are needed for aging highways, bridges and other infrastructure across the globe. That became especially apparent in August, when a bridge collapsed during a rainstorm in Genoa, Italy, killing 39 people and prompting Italian prime minister Giuseppe Conte to declare a 12-month state of emergency in the country’s Liguria region.

Perhaps it’s no surprise alternative investors are pouring capital into infrastructure investments, which, in general, typically involve less risk.

“Just the nature of core infrastructure is that these are stable investments that can generate a stable set of returns, which on a risk-adjusted basis are quite attractive,” said Cherian George, a managing director of infrastructure & project finance at Fitch Ratings. “You don’t have the same boom or bust cycle that you have in other sectors like technology, retail and other things.”

Infrastructure investors have been particularly busy this year. Stonepeak Partners, a New York-based firm headed by former Blackstone execs, closed its third infrastructure fund on a $7.2 billion hard cap in July, more than doubling a predecessor that brought in $3.5 billion in 2016. Later that month, news broke that Sweden’s EQT is planning to raise at least ¤8 billion for an infrastructure fund of its own.

The level of sustained fundraising seen in the accompanying chart bolsters a global infrastructure sector that’s had capital pouring in so far in 2018. Consider: 13 infrastructure funds have already raised a combined $27.8 billion, according to PitchBook data, on pace to crush last year’s $31.1 billion total. With a strong finish, this year could surpass the largest annual infrastructure fundraising total in at least a decade, when 25 funds nearly brought in some $40 billion in 2016.

Why has infrastructure fundraising surged?

The answer is multi-tiered, as covered in a 2017 analyst note from JP Morgan. Infrastructure targets can be a bargain in today’s high-valuation environment, and these deals are often largely independent of the volatility swings that can affect other asset classes including fixed income, equities and real estate. Not to mention, they provide steady cash flows in many instances, with utilities contracts, for example, that can span 30 years. The sector can also be more immune to an economic downturn or inflation because of the monopolies some infrastructure companies (e.g., utilities) hold over their respective markets.

There’s also a need for infrastructure investment in the US, in particular. The American Society of Civil Engineers gave the US a D+ in its 2017 report card grading the country’s infrastructure, with the cost to make the necessary improvements estimated to be worth nearly $4.6 trillion. Of all the specific categories graded, only “Rail” got better than a C+, checking in with a B.

President Donald Trump has pushed for increased infrastructure spending, promising to introduce a $500 billion infrastructure bill during his 2016 campaign. But more than 20 months into his presidency, no such bill has materialized. Granted, the administration made a lackluster attempt earlier this year, pledging $200 billion in federal-backed funds that would go toward grants and incentives over the next decade. State and local governments and private investors would then come up with the rest, in hopes of exceeding $1.5 trillion. Trump called it “the biggest and boldest infrastructure investment in American history.”

“We will build gleaming new roads, bridges, highways, railways and waterways all across our land,” Trump said. “And we will do it with American heart, and American hands, and American grit.”

That sounds great, in theory. But the US still needs to come up with enough money.

“I think they are faced with the same fundamental problem that there isn’t a (public) revenue source,” George said. “It should be an easy thing to do, but it hasn’t been.”

A Wharton School study out of the University of Pennsylvania, Trump’s alma mater, determined that the package, even if somehow funded, would come up more than $1 trillion short of what’s needed. But not doing anything could make things much worse, with the ASCE noting that failing to launch a major infrastructure spending package would lead to estimated losses of $4 trillion in the US GDP and 2.5 million jobs by 2025.

It remains to be seen what role PE will play in improving the country’s public infrastructure, and not all of the existing data about public-private infrastructure projects is positive. For instance, a 2014 report from the Congressional Budget Office found that of the 10 privately financed road projects from 1995 to 2012, three filed for bankruptcy and one needed to be bailed out by the government with a private-to-public buyout.

“The public sector is trying to find the best formula for private involvement. That is the challenge.”

—Cherian George, managing director at Fitch Ratings

George, though, said the results of public-to-private projects have recently trended positive.

“It isn’t an all or nothing kind of scenario,” he added. “Sometimes when the projects don’t work out, it’s because the government has structured a project with the private involvement in a way that can’t be successful. And sometimes it’s because the private sector fails at it. But very often, it’s because the public sector is trying to find the best formula for private involvement. That is the challenge.”

If an infrastructure package could get passed in the next few years, it would provide a PE industry that’s been oft-criticized for aggressive leveraging and lucrative management fees the chance to make an investment that could benefit the greater good. And in return, they’d still get a good return on their investment, with their limited partners coming away happy.

Imagine a world where PE firms were no longer just viewed as corporate-raiding “barbarians” that look to milk every penny out of a business for a few years before selling the scraps. Instead of headlines about the lucrative salaries pulled in by Schwarzman and his rivals, attention might turn, at least somewhat, to helping shape the future of US infrastructure.

In the end, that alone could be worth the risk.

  • adamlewis.jpg
    Written by Adam Lewis
    Adam Lewis was a financial writer covering private equity for PitchBook. He covered dealmaking, company and investor news for the PitchBook newsletter and blogs about the intersection of private equity and politics. A graduate of the WSU’s Edward R. Murrow College of Communication, Adam was previously a sportswriter covering the Mariners and Seahawks.
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