At a fundamental level, infrastructure private equity mirrors the mechanisms of other private equity forms. Enterprises garner funds from external investors (Limited Partners), employing these funds to make investments in assets, oversee their operations, and ultimately sell them to generate substantial returns.
Subsequent profits are shared between the Limited Partners (LPs) and the General Partners (GPs), with the GPs representing the private equity firm itself.
Comparable to traditional private equity, professionals dedicate their efforts to origination (identifying new assets), execution (conducting deals), the management of existing assets, and fundraising.
However, the distinction lies in the focus of infrastructure private equity firms: they invest in assets integral to delivering essential utilities or services.
This parallel can also be drawn to real estate private equity, as both categories target assets rather than companies.
Yet, the divergence emerges in the nature of real estate private equity investments, which centre on properties for residential or commercial use, lacking the provision of “essential services.”
Within the realm of infrastructure, sectors encompass utilities (gas, electricity, water distribution), transportation (airports, roads, bridges, rail networks, etc.), social infrastructure (hospitals, schools), and energy (power plants, pipelines, and renewable sources like solar/wind farms).
Many of these assets exhibit remarkable stability and longevity, often remaining functional for decades. Some, such as airports, even possess natural monopolies, rendering them exceptionally valuable, albeit with exceptions like during a pandemic.
Key Shared Traits of Infrastructure Assets:
Relatively Low Volatility and Stable Cash Flows: Infrastructure assets like power plants are designed to sustain operations over prolonged periods with minimal disruptions.
Strong Cash Yields: Unlike traditional leveraged buyouts, where returns are often contingent on the exit, infrastructure assets commonly generate robust cash flows during the ownership period.
Link to Macroeconomic Environment and Inflation: Infrastructure assets are frequently regarded as “inflation hedges” due to their connection to factors like population growth, GDP, and other macro indicators that influence the demand for such assets.
Low Correlation with Other Asset Classes: Investments in infrastructure exhibit relatively low correlation with returns from traditional private equity, equities, fixed income, and even real estate.
The Evolution and Scale of Infrastructure Investment
The institutional practice of “infrastructure investing” is a relatively modern phenomenon, gaining substantial traction only around the year 2000.
Its origin can be traced back to Australia in the 1990s, followed by expansion into Canada and Europe during the early 2000s, with subsequent entry into the U.S. market.
The nascent nature of infrastructure private equity is reflected in its lower capital raising compared to real estate private equity and traditional private equity:
Infrastructure PE: Approximately $50 to $100 billion globally per annum
Real Estate PE: Roughly $100 to $150 billion
Traditional PE: Generally between $200 to $500 billion
Despite the relatively lower funding, “small-scale deals” are rare in infrastructure due to the specific characteristics of the assets involved.
Average deal sizes exceed $500 million, with the top 10 deals annually often reaching multi-billion-dollar ranges, sometimes surpassing $10 billion.
Distinguishing Public Finance, Project Finance, Infrastructure Private Equity, and “Infrastructure Investing”
Numerous terms are closely linked to infrastructure, necessitating clarification of their distinctions before proceeding:
“Infrastructure Investing”: A broad term encompassing investment in the debt or equity of infrastructure assets. It involves financing new asset construction or acquiring existing stabilized ones. Investors encompass private equity firms, pensions, sovereign wealth funds, and other entities.
Infrastructure Private Equity: Pertains to equity investments in infrastructure assets to achieve ownership and control. While there are dedicated infrastructure private equity firms, various entities such as pensions, major banks, SWFs, and others also engage in equity investments in infrastructure.
Project Finance: Refers to investing in the debt of infrastructure assets, encompassing both new and existing ones. This primarily involves assessing downside risk and structuring terms commensurate with the associated risk.
Public Finance: This relates to investing in the debt of infrastructure assets to support governments and tax-exempt entities in raising funds for asset development.
Infrastructure Private Equity Strategies: The principal investment strategies in infrastructure private equity mirror those in real estate private equity: core, core-plus, value-add, and opportunistic.
Distinctive nomenclature characterises these strategies: “greenfield” refers to newly constructed assets, while “brownfield” pertains to existing assets acquired by a sponsor.
Briefly summarised by category:
Core: Predominantly stable with limited growth, typified by regulated electricity distribution assets where governmental regulations set rates, mitigating revenue risks. Returns primarily stem from cash flows, and anticipated IRRs generally remain below 10%.
Core-Plus: These assets offer moderate growth prospects, whether via additional capital expenditures or improvements. Alternatively, they might be stabilised assets in less developed markets. Expected IRRs may range in the low teens.
Value-Add: Involves assets necessitating substantial operational enhancements or repositioning. This strategy carries higher risk and potential returns, emphasizing capital appreciation more than cash flows during ownership. An example is acquiring a small airport and expanding it to serve as a regional hub.
Opportunistic: These ventures are the riskiest, often entailing limited or no cash flow over extended periods. They rely on constructing unproven assets like new power plants or toll roads. Potential IRRs might exceed 15%, but the downside risk is substantial.
Infrastructure private equity firms could operate several fund types, each specializing in one of these strategies. However, in practice, the first three strategies tend to dominate.
Furthermore, public-private partnerships (PPPs) constitute another strategic avenue within this sector. For instance, a private firm might build a toll road, with the local government guaranteeing a predetermined annual revenue to incentivize project completion.
In some instances, PPP deals may be categorized as “core,” even if the asset undergoes significant transformation or construction due to the lower revenue risks associated with government backing. While construction delays and cost overruns remain potential concerns, the overall risk is diminished.
Prominent Infrastructure Private Equity Funds
Infrastructure investors fall into several primary categories:
- Private equity firms (fund managers)
- Large banks
- Pension funds
- Sovereign wealth funds
- Investment arms of insurance companies
While only private equity firms officially constitute “infrastructure private equity,” other entity types also invest in infrastructure asset equity.
Fund managers dominated the market for a significant period, although institutional investors like pension funds have established internal teams for direct deal execution.