June 2017

INSIDE VIEW: Asset resilience

RoadDominic Helmsley, head of infrastructure equity at SL Capital, offers insight into how asset managers  differentiate between different types of infrastructure investments.

They form a relatively small segment of the infrastructure market in terms of deals, but transportation assets continue to be highly sought after by investors across the globe.

But why does a segment that only represented about a fifth of the asset class last year get so much attention?

Broadly speaking, it comes down to the segment’s positive infrastructure investment characteristics. We have seen that the transportation segment often outperforms the infrastructure market more broadly when it comes to risk-adjusted returns.

Transportation assets are often a useful way for investors to diversify their infrastructure portfolios into an area which generally has a strong defensive risk profile.  Not only do they tend to have stable long-term indexed cash flows, but their value can be enhanced through active asset management.

That said, investors still need to apply a range of investment strategies across the segment. Transport can come in all different shapes and sizes. And success isn’t guaranteed.

On the one hand, you have fixed-revenue type assets such as availability-based revenue roads or motorways, which are driven simply by state of maintenance and availability to the end user. At the other end of the spectrum, you have assets operating in a highly competitive environment with a direct exposure to GDP, such as cargo and baggage-handling at ports and airports.

To try and capture the exact diversity of the sector, we ran a simplified market-mapping exercise that showed the various sub-sectors attract a broad church of investors, from stable ‘core’ to ‘value-add’ or ‘core-plus’ strategies and even private equity players.

Asset resilience
So, how does this diversity play out in real life? Let’s take a look at what happened across the segment during the financial crisis. On the basis of a ‘peak-to-trough’ measure (defined as the total decline in traffic from the highest point before the global financial crisis, to the lowest point before the subsequent rebound in traffic), select traffic performance – a primary resilience indicator for transportation assets – was as follows:

   • Roads: APRR (France) recorded a 1.2% decline in traffic, while M6Toll (UK) recorded a 22.2% decline;
   • Seaports: Associated British Ports (UK) recorded a 18.9% decline in traffic, while Great Yarmouth Port (UK) recorded a 26.8% decline; and
   • Airports: Edinburgh Airport (UK) recorded a 4.9% decline in traffic, while the overall airport market outside of London (UK) recorded a 16.4% decline.

So it’s often hard to predict what will happen, even within a sub-sector of the segment. Experience, caution and due diligence are required.

However, a number of historic examples show that robust investment appraisal, structuring and asset management can generate strong returns to investors.

For example, in 2011, MAp Airports sold its interests in regulated European airports in Brussels and Copenhagen, generating reported internal rates of return (IRRs) of 23.9% and 24.6%, respectively.

But high returns aren’t a guarantee – you have to get it right. One investor, who acquired and disposed its interest in airports around the same time as MAp Airports, essentially handed over Glasgow Prestwick and Kent Manston Airports at nominal value because the equity had been squeezed out by unsustainable levels of debt, along with poor operating performance of the assets.

Similarly, the club of lenders recently agreed to a disposal of M6Toll debt after taking over ownership of the asset in 2013. M6Toll suffered from an unsustainable level of leverage versus low traffic resilience.

All of this shows that managing a transportation asset isn’t straightforward. It’s crucial to have boots on the ground and a strong sector and local knowledge to ensure that individual investments are managed appropriately.

One sector that we are involved with is UK passenger rolling stock. In 2016, we financed two rolling stock fleets totalling 528 electric and bi-mode (i.e. electro-diesel) vehicles. These trains will operate out of Moorgate and Liverpool Street in London as well as the East Anglia region.

These investments benefit from all of the key characteristics that you would expect from a core regulated infrastructure asset.

They provide an essential service to end users, making them defensive in nature. Furthermore, they offer long-term operating profiles with no volume risks, and have limited counterparty risk.

In addition to these strong investment fundamentals, these transactions have a positive impact on the performance of our fund and for our co-investors that we brought into our consortium.

Furthermore, despite the relatively smaller deal flow that the transport infrastructure sector offers (versus utility and renewables assets), we are still seeing sufficient deal prospects, with attractive characteristics for our infrastructure platform, in this space.

So, transport can be lucrative, but can often be hit and miss. Deals in the segment require robust due diligence, structuring and asset management expertise. And it’s relevant expertise which leads to returns.

©2017 funds europe