The changing face of infrastructure

Infrastructure implies solidity and stability. But as an investment, there are few other asset classes that can match infrastructure’s dynamism, at least in terms of growth and diversity.

Not long ago, infrastructure referred to transport (roads and bridges), energy (poles and wires) and water (treatment plants). Now it includes a plethora of assets, from the traditional through to data centres for cloud technology and the 5G cell towers that will pop up on power poles and lights around the country over the next couple of years.

Some investments that have not been considered infrastructure are now being caught under that umbrella term and defining infrastructure has become much more difficult. Assets that fall under the infrastructure moniker, at least in investing terms, need to have the following attributes.

• They must provide an essential service. 
• There must be strong governance and control of the asset. 
• The asset must generate stable cash flows and robust margins. 
• Barriers to entry are a characteristic of the asset, whether it be via government regulation, natural monopolies, or even reputation.
  

New opportunities bring new challenges

While the growth of investable infrastructure assets is a boon for fund managers and clients alike, it also introduces a degree of risk that has not been typical of infrastructure assets. Investors need to be careful about chasing, and paying up for, the next big thing in infrastructure.

How do investors control for this greater risk? Strong and deep operational knowledge is more critical than ever before. Managers need to understand the asset they are buying and that is becoming more difficult and complex as the range of infrastructure assets grows.

Investors need to be confident that fund managers, and their operational team, understand the role, outputs and risks of specific assets. As infrastructure assets move further away from governments and regulated income, so does risk and the potential for sub-optimal returns.

Understanding social and macroeconomic factors is more critical when investing in infrastructure. For example, what does the ageing population mean for health assets? What impact does the explosive growth in data and security requirements have on byte transmission and storage? What will the impact be of low-cost renewables on fossil fuel energy?

Back to basics

In this new operating environment, management theory has become part of the investing process. Applying Porter’s five forces is just as important in infrastructure investing as it is in running a business. The five forces – named after Harvard academic Michael Porter – are:

1. Competition in the industry
2. The potential of new entrants
3. The power of suppliers
4. The power of customers 
5. The threat of substitute products.
   

Investors need to think through an investment with each of these forces in mind.

Infrastructure as a social good

The role of infrastructure as a social good is now more prevalent, and another factor an investor needs to consider. Increasingly, governments are seeing the construction of infrastructure not as an end in itself but a driver to deliver the outcomes that we want as a society; which means investors need to focus not just on economic infrastructure but on fully developed social infrastructure as well. For example, a residential development needs to focus not just on water, sewerage, roads and electricity, but also on schools, sports stadiums, community health centres and aged care. (These assets, of course, also come with a cost involved with operating the assets.)

The ultimate object of good infrastructure is a better community, access to jobs and an improved quality of life. Along with the risk-reward spectrum, macro factors, management theory and operational risk, the outcome for society is worth keeping in mind when investing in infrastructure assets.

Sourcing, financing and exit routes

As new sub-sectors of infrastructure develop, so do ways of sourcing investments, financing and structuring deals, and exit routes.

While large core infrastructure assets tend to be in the hands of asset owners, new sector assets are often still in the hands of entrepreneurs or are spin offs of other businesses. Our recent acquisition of the UK disability care business, Care Management Group (CMG), from the successful entrepreneur Dr Chai Patel is a case in point.

One trend in financing of infrastructure assets is the increased availability of debt capital from non-traditional sources, particularly infrastructure debt funds. There is also a growing market of US Private Placement debt in non-US dollars.

In terms of exit options, it depends largely on market conditions though the growing appetite for infrastructure investments means there will remain a healthy competition for assets.