New opportunities for infrastructure investors

Renewed government confidence in privatization and a robust secondary market could create new homes for committed capital waiting to be invested in infrastructure, according to a study by Ernst & Young LLP. Right now, there is more capital available to invest in infrastructure deals than there are projects in which to invest. That imbalance could soon be reversed and build to nearly $1 trillion a year in new and secondary-market infrastructure transactions worldwide. New York-based Ernst & Young's study predicts $240 billion to $360 billion in annual private investment in new projects and $600 million annually in secondary transactions. More infrastructure deals could enter the market as infrastructure matures as an asset class, and as governments become more comfortable with privatizing, according to the study, "Investing in Global Infrastructure 2007: An Emerging Asset Class." A secondary market is already beginning to occur in more mature infrastructure sectors such as utilities and telecommunications. In 2006, there were $300 billion worth of global utility transactions and $300 billion in telecom mergers and acquisitions on the secondary market, the report noted. For now, competition to invest capital is brisk, pushing up prices and lowering returns. Investment managers have been building jumbo-sized funds just to invest in infrastructure. The Goldman Sachs Group Inc. of New York put together a $6.5 billion fund last year, the report noted. And just last month, as real estate returns dipped, institutional in-vestors began committing capital to an increasing number of infrastructure funds. For example, the $246.6 billion California Public Employees' Retirement System in Sacramento allocated $2 billion to the asset class in September.
"There's a lot of capital chasing a smaller number of deals," said one of the authors of the report, Chris Lawton, a partner with Ernst & Young's global real estate center in New York. Before this summer's credit crunch, very little equity was needed to finance these projects. In the United Kingdom, for example, between 80% and 90% of infrastructure projects were financed with debt. That meant that only about $5.2 billion to $10.4 billion of capital was needed for the 200 British infrastructure deals already under way, according to the study, which cited data from the U.K. Treasury. Recent infrastructure deals world-wide have been completed at 12 to 30 times debt to earnings before interest, taxes, depreciation and amortization, compared with a multiple between eight and 11 historically. In Europe, where the infrastructure market is more established than in the United States, prices on deals have been quite high, Mr. Lawton said. In the British water sector, public companies have been trading at premiums of 15% to 20% above regulated asset value. The recent turmoil in the credit markets took some of the heat out of infrastructure deals and im-provement projects worldwide, Mr. Lawton said. Deal prices began falling because easy and cheap debt no longer was available to finance these projects. "Financiers took a harder and closer look at the projects," he said. "The overall credit process has become a little more stringent." Returns on infrastructure vary depending on the nature of the project and its location, Mr. Lawton said. Developing countries such as India, Korea and China are perceived to be higher risks because they have more new projects, and because those countries don't have the established market histories that are found in some developed countries. Even within developed countries, not all projects carry the same return expectations. There is less return and less risk in owning an existing toll road than in building a new one, for example. Still, the world's enormous need for new infrastructure and revitalization of existing structures should push governments to accept privatization as a way of financing these projects. "Over time, as more governments get into it, there will be more projects for the private sector to look at," Mr. Lawton said. He declined to hazard a guess as to when that might be. The U.K. government began a nationwide push to privatize infrastructure 15 years ago. Called the Private Finance Initiative, it created a centralized clearinghouse for the nation's privately funded infrastructure projects. Other countries, such as India, are pushing privatization at a fast pace because the governments simply don't have the capital to finance the infrastructure needed to meet economic growth targets. But U.S. governmental entities are "taking a bit of time to grasp the private sector as a part of the solution," Mr. Lawton said. "We had thought it would have taken hold more quickly in the U.S."