The article below is from our BRIEFINGS newsletter of 04 February 2020
As investor focus on infrastructure continues to expand, so too has its scope, according to Goldman Sachs’ Brian Bolster and Michael Sachs, who lead the firm’s investment banking coverage effort for the sector. We sat down with Brian and Michael who shared their views on infrastructure’s evolution
To set the stage, how do you define infrastructure and what are you seeing in the space?
Brian Bolster: The definition is evolving. Historically, the infrastructure asset class has been associated with bridges, toll roads, ports and other “hard” assets that produce consistent, low-risk dividends to investors because of the essential nature of the asset. In recent years, as demand has outstripped the supply of attractive projects to invest in, investors have tried to identify other asset classes that retain some of the core elements of public infrastructure. In doing so, they expanded the traditional definition of infrastructure. Therefore, we have seen investors moving into other infrastructure-like investments—such as data centers, energy infrastructure, pipelines and renewable projects.
Michael Sachs: Investors are looking to find assets that resemble core infrastructure—that is, hard assets that provide long-term, stable cash flows and which typically have a low correlation to other asset classes. Like traditional infrastructure, these assets are capital intensive and have high barriers to entry, making it hard for other companies to compete.
Can you expand a little more on how the supply-and-demand dynamic for investors evolved in recent years?
Brian Bolster: One of the biggest changes is the amount of capital available to be deployed. Investors raised $97 billion last year and a record $104 billion in total equity in 2018. Not only are infrastructure funds exceeding their fundraising targets—leading many to close at a rapid pace—but mega funds (typically funds larger than $5 billion in assets) are also increasingly dominating the landscape. In 2019, for example, investors raised the largest-ever fund at $22 billion, with additional mega funds looking to close in 2020. The trend toward ultra-large funds changes the scale of the potential investable universe and also creates a new dynamic in the competition for assets.
Michael Sachs: One of the challenges facing investors is that the supply of attractive projects hasn’t kept pace with demand. Core investment opportunities across Europe and Australia have largely been identified, while projects in North America have remained mired in red tape. Late last year, for example, St. Louis, Mo., pulled the plug on a multi-year-long effort to privatize its Lambert airport. With all of this capital flowing into the sector—indeed, there’s an estimated $200 billion of dry powder from infrastructure funds waiting to be deployed—funds are looking outside of traditional infrastructure to non-transport-related sectors. We have been part of this migration, having recently advised renewable power firm Pattern Energy on its sale to the Canada Pension Plan Investment Board. We also served as advisor to Macquarie Infrastructure Partners on its acquisition of Netrality Data Centers, among others in this space.
How has this evolution changed the industry?
Brian Bolster: First, you really have to be able to look across a lot of different industries to examine all the possibilities. Second, we have seen a stratification within “infrastructure.” Investors are also looking at different risk profiles. Generally, core infrastructure is used to describe traditional infrastructure: airports, bridges, tunnels and roads. Core-plus encompass the broader definition of infrastructure-like assets which typically offer higher returns—but with higher risks. At the other end of the spectrum is the super-core category, which is considered the most conservative category of infrastructure (typically utilities and water assets) which generate levered returns in the mid- to high-single digits. Funds are generally looking to target assets which fit into one of these categories.
How are infrastructure investors approaching these non-traditional sectors?
Brian Bolster: Essentially what we’ve seen is a recognition that the characteristics that make core transport assets attractive are not limited to transport. Take, for example, a company called Restaurant Technologies. This is a business that supplies and disposes of cooking oil for restaurants and other food-service operations, and counts McDonalds as a key customer. By building and investing in infrastructure around the country to support the delivery and removal of cooking oil, the company has infrastructure-like characteristics—an extensive installed base and strong recurring cash flow underpinned by long-term contracts—that has attracted infrastructure capital (Goldman Sachs’ Merchant Banking Division made an investment in the company in 2018). The company also has a competitive advantage because it would be very difficult to replicate its existing market position.
What’s the outlook for M&A in the sector?
Michael Sachs: We expect to see more M&A opportunities, given the expanding definition of infrastructure and the large amount of capital infrastructure funds are looking to deploy. And with the larger amounts being deployed, the deal sizes are also getting larger.