Infrastructure Beginning to Sizzle
After the boom and bust of the past few years, infrastructure investments are regaining their image as safe and sound, in addition to being looked upon as a solution to the world’s economic woes, as outlined in the first of the two-part article published last month. In this second part, recent developments underlining the short-term positives, negatives and uncertainties are highlighted. Events in two disparate countries emphasise the importance of politics in assessing infrastructure, a factor many investors overlook when carried away by short-term enthusiasm.
Parking meter controversy in the US
A major controversy has followed the hiving off of the operation of Chicago parking meters to a Morgan Stanley consortium in 2008, referred to in the first part of this article. This has potential implications for the willingness of US local authorities to continue their programme of infrastructure sales.
The consortium paid $1.15bn for the right to operate and receive the revenues from the parking meters in Chicago. It has now been estimated that over the 75-year period of the lease the total revenue received from the 36,000 meters by the operators will be over $11bn, arousing furious criticism. The operators have bumped up the fees quite substantially since they took over, in some places the hourly rate increasing from $3 to $4.25, and fees are scheduled to increase further to $6.25 from 2013. It is estimated that the profit made by the group will be 89% of projected revenue, compared with the mere 5% earned by Standard Parking, which runs the city’s O’Hare and Midway Airports.
Before the lease was sold, when the issue was debated in the legislature, a politician who opposed the plan estimated that the revenues over 35 years would be $4-5bn, compared with the above estimate of $11bn compiled by the new owners, pursuant to a debt sale. The city’s office of the Inspector General called the deal “dubious” in 2009, putting the contract value at over $2bn, compared with the $1bn paid. The city’s Chief Financial Officer, Gene Saffold, counters this by claiming that the present value of the $11.6bn over the next 75 years is consistent with the money paid, given the risks such as customers deserting the car parks for mass-transit systems.
Some $11bn over 75 years to be equated to an upfront figure of $1bn needs the revenue, assuming certainty of receipt, to be discounted at about 12% per annum, a high rate for an inflation-adjusted stream. Yes, there were risks on the downside, such as the mass-transit rival, but equally there was upside potential as well, some of it subsequently realised through parking-meter price hikes. So it certainly looks as if the operators have got away with a brilliant deal for themselves, at the expense of the Chicago public. This might lead to several consequences. It could strengthen the hands of those in the US who oppose infrastructure assets being hived off, with a possible detriment to overall US economic prospects.
This opposition could be overcome on the grounds that further such sales on a nationwide basis could be priced more stringently. But the problem is that the prospective investment bank purchasers will probably have much more expertise than the financially squeezed local authorities in assessing deals. Another risk is that the law-makers might be provoked to introduce price restrictions and other regulations that increase the political risk factors for all infrastructure deals. So, while this is just one deal, there could be repercussions both nationally and globally. The operators, in maximising their profits, as is entirely rational, might have done a serious disservice to the cause of infrastructure development globally and to prospects for the US economy.
Is India modernising at last?
Over $2bn was allocated to build a new terminal at New Delhi airport to turn it into a world-class facility. This attracted the comment by Bloomberg Businessweek that India may be turning the corner on its notoriously poor infrastructure. In addition to Delhi’s new subway system, this was one of a series of projects scheduled to be completed before the Commonwealth Games in October last year.
It has also been announced that India plans to set up an $11bn infrastructure fund to carry out much-needed renovation of shabby roads and clogged ports, both serious bottlenecks to India’s growth. It is hoped that up to 70% of this fund will be raised from the private sector, including foreign investors, with the government putting in only 30%, a little over $3bn. But the former are wary of the bottlenecks in India’s legal system slowing down infrastructure development, even after the deal is done.
It is fascinating that India happily spent over $2bn dollars overall on upgrading the Delhi Airport and has rushed to complete other projects before the Commonwealth Games. On the other hand, it wants to put in only about $3bn for the much more important long-term mission of unclogging economic growth obstacles.
The huge sums earmarked for the airport and Commonwealth Games projects are more to do with international image than economic priorities. This is redolent of what many African countries run by dictators have been notorious for in recent decades, with showpiece airports in tandem with squalor for the poor. What is budgeted by the Government for roads and ports is not much more than what was provided for upgrading the airport.
It was premature for Bloomberg Businessweek to have suggested that India is turning the corner on infrastructure. This also has a moral for the rest of the world in assessing the future for this global sector, as political priorities might always be predominant.
Infrastructure beginning to sizzle
As outlined in the first part of this article, the last boom saw many types of assets bid up to excessive levels, leading to subsequent losses in the crisis. Infrastructure was no exception. The consequent waning of interest is now giving way to renewed recognition of the attractive long-term story, relatively safe and high inflation-adjusted returns.
Opportunities in this new asset class embrace partnerships with governments, particularly in running social assets, purchasing or leasing of economically sensitive assets from the public sector, acquiring infrastructure investments of conglomerates, as they hive them off, and finally emerging market opportunities.
A steady stream of investment opportunities is now beginning to emerge, but by and large institutional investors still seem to be cautious. This may well be a good thing, in that it averts the problem of too much money chasing too few opportunities and the risk of overbidding as in the last boom.
It is welcome that infrastructure has regained its status as a good, solid long-term investment with a decent inflation-adjusted return well above that on government bonds, rather than just being seen as an opportunity to make a quick buck. Furthermore, the building and renewal of infrastructure might be just the solid fillip the global economy needs, in contrast to the current recovery financed by loose fiscal and monetary policies.
Whether the scale of this asset class will come up to the heady expectations of a few years ago is a moot point. Global figures of $20-30 trillion have been bandied around, but to date this still looks like speculation. In particular, whatever the total infrastructure pot, the share available to the private sector is another major question.
While solid and attractive, it is not certain whether it will become a substantial asset class. From another perspective, it does not appear that retail investors will have many opportunities to invest in it. The mutual fund format will obviously be unsuitable, given the illiquidity of the assets. Perhaps there is an opportunity here for asset management companies to come up with a different type of vehicle.
References
Parking meter controversy in the US
A major controversy has followed the hiving off of the operation of Chicago parking meters to a Morgan Stanley consortium in 2008, referred to in the first part of this article. This has potential implications for the willingness of US local authorities to continue their programme of infrastructure sales.
The consortium paid $1.15bn for the right to operate and receive the revenues from the parking meters in Chicago. It has now been estimated that over the 75-year period of the lease the total revenue received from the 36,000 meters by the operators will be over $11bn, arousing furious criticism. The operators have bumped up the fees quite substantially since they took over, in some places the hourly rate increasing from $3 to $4.25, and fees are scheduled to increase further to $6.25 from 2013. It is estimated that the profit made by the group will be 89% of projected revenue, compared with the mere 5% earned by Standard Parking, which runs the city’s O’Hare and Midway Airports.
Before the lease was sold, when the issue was debated in the legislature, a politician who opposed the plan estimated that the revenues over 35 years would be $4-5bn, compared with the above estimate of $11bn compiled by the new owners, pursuant to a debt sale. The city’s office of the Inspector General called the deal “dubious” in 2009, putting the contract value at over $2bn, compared with the $1bn paid. The city’s Chief Financial Officer, Gene Saffold, counters this by claiming that the present value of the $11.6bn over the next 75 years is consistent with the money paid, given the risks such as customers deserting the car parks for mass-transit systems.
Some $11bn over 75 years to be equated to an upfront figure of $1bn needs the revenue, assuming certainty of receipt, to be discounted at about 12% per annum, a high rate for an inflation-adjusted stream. Yes, there were risks on the downside, such as the mass-transit rival, but equally there was upside potential as well, some of it subsequently realised through parking-meter price hikes. So it certainly looks as if the operators have got away with a brilliant deal for themselves, at the expense of the Chicago public. This might lead to several consequences. It could strengthen the hands of those in the US who oppose infrastructure assets being hived off, with a possible detriment to overall US economic prospects.
This opposition could be overcome on the grounds that further such sales on a nationwide basis could be priced more stringently. But the problem is that the prospective investment bank purchasers will probably have much more expertise than the financially squeezed local authorities in assessing deals. Another risk is that the law-makers might be provoked to introduce price restrictions and other regulations that increase the political risk factors for all infrastructure deals. So, while this is just one deal, there could be repercussions both nationally and globally. The operators, in maximising their profits, as is entirely rational, might have done a serious disservice to the cause of infrastructure development globally and to prospects for the US economy.
Is India modernising at last?
Over $2bn was allocated to build a new terminal at New Delhi airport to turn it into a world-class facility. This attracted the comment by Bloomberg Businessweek that India may be turning the corner on its notoriously poor infrastructure. In addition to Delhi’s new subway system, this was one of a series of projects scheduled to be completed before the Commonwealth Games in October last year.
It has also been announced that India plans to set up an $11bn infrastructure fund to carry out much-needed renovation of shabby roads and clogged ports, both serious bottlenecks to India’s growth. It is hoped that up to 70% of this fund will be raised from the private sector, including foreign investors, with the government putting in only 30%, a little over $3bn. But the former are wary of the bottlenecks in India’s legal system slowing down infrastructure development, even after the deal is done.
It is fascinating that India happily spent over $2bn dollars overall on upgrading the Delhi Airport and has rushed to complete other projects before the Commonwealth Games. On the other hand, it wants to put in only about $3bn for the much more important long-term mission of unclogging economic growth obstacles.
The huge sums earmarked for the airport and Commonwealth Games projects are more to do with international image than economic priorities. This is redolent of what many African countries run by dictators have been notorious for in recent decades, with showpiece airports in tandem with squalor for the poor. What is budgeted by the Government for roads and ports is not much more than what was provided for upgrading the airport.
It was premature for Bloomberg Businessweek to have suggested that India is turning the corner on infrastructure. This also has a moral for the rest of the world in assessing the future for this global sector, as political priorities might always be predominant.
Infrastructure beginning to sizzle
As outlined in the first part of this article, the last boom saw many types of assets bid up to excessive levels, leading to subsequent losses in the crisis. Infrastructure was no exception. The consequent waning of interest is now giving way to renewed recognition of the attractive long-term story, relatively safe and high inflation-adjusted returns.
Opportunities in this new asset class embrace partnerships with governments, particularly in running social assets, purchasing or leasing of economically sensitive assets from the public sector, acquiring infrastructure investments of conglomerates, as they hive them off, and finally emerging market opportunities.
- Schools and prisons. Government-backed infrastructure assets linked to social projects, such as the maintenance of schools, hospitals, prisons, street lighting and law courts, are seen as safer than those linked to economically sensitive activities, such as running harbours, toll roads and airports. Barclays and John Laing have launched an infrastructure fund focusing on these social assets and the aim is to produce a 6% dividend yield and overall return of 7%-8% in the longer term.
- Channel Tunnel. However, economically sensitive assets are still in demand, as they produce higher returns, although with more risk. An example is the UK’s Universities Superannuation Scheme joining a consortium to bid for the high-speed rail link between London and the Channel Tunnel.
- Clubbing together. Many pension funds, not having the resources to go it alone, are clubbing together to invest directly, rather than through banks or investment managers. Industry Funds Management in Melbourne is a prime example, being owned by 35 Australian pension funds.
- Construction company becomes fund manager. In a fascinating development, a non-financial player is entering the infrastructure market, drawing upon its experience as the largest construction group in the UK. Balfour Beatty is planning to diversify into fund management with the launch of a £1bn infrastructure fund, and hopes to raise money from institutional investors, including pension funds and insurance groups, in addition to its own money. The fund will purchase and run assets such as toll roads and airports.
- Governments lavishing money. US, European and UK governments are committing themselves heavily to infrastructure spending, with President Obama announcing a spend of $50bn. The UK has also announced £30bn for several transport projects, including national air traffic control and a high-speed railway, with just under £15bn coming from the private sector. Overall, the UK Government is retaining a Treasury body to facilitate £40-50bn per annum of private investment in this sector.
- Germany stays out. In contrast to Britain and France, Germany has not gone for the public/private partnership, but it is expected to have to join the band.
- Asia not in favour. Asia, including India and China, offers plenty of opportunities, but global investors have become more risk-averse and prefer the more reliable returns from Europe. It is felt that political opposition will be tougher in Asia. Local companies will tend to be favoured, in addition to much of Asian infrastructure being publicly run.
- US politics problematic. In the US, the debate on infrastructure is hotting up. Infrastructure sales are clearly the answer to the huge holes in public sector finances at federal, state and city level, though massive political opposition still exists. Many cities are thinking of selling off their parking meters, including Pittsburgh, but the controversial outcome in Chicago is giving ammunition to its opponents It is therefore still not clear how fast the US will go in its development of infrastructure. For example, its high-speed rail ambitions seem to be thwarted by justified opposition from groups carrying freight on the railways.
- Green growth. Globally, green energy is a growth story, particularly in Africa. India hopes to invest $1 trillion in the five years following 2012. Many European power conglomerates are under pressure to divest themselves of non-core parts of their business.
- Road failure. Britain’s only highway charging for use, the M6 toll road, is in difficulties, with performance below expectations, and its debt has fallen below its issue price.
- Heathrow disaster. Ferrovial got stung quite badly in its purchase of British Airports Authority (BAA). It had the bad luck of being blamed in Britain in the years following this takeover for the poor standards and bottlenecks at the main airports.
A steady stream of investment opportunities is now beginning to emerge, but by and large institutional investors still seem to be cautious. This may well be a good thing, in that it averts the problem of too much money chasing too few opportunities and the risk of overbidding as in the last boom.
It is welcome that infrastructure has regained its status as a good, solid long-term investment with a decent inflation-adjusted return well above that on government bonds, rather than just being seen as an opportunity to make a quick buck. Furthermore, the building and renewal of infrastructure might be just the solid fillip the global economy needs, in contrast to the current recovery financed by loose fiscal and monetary policies.
Whether the scale of this asset class will come up to the heady expectations of a few years ago is a moot point. Global figures of $20-30 trillion have been bandied around, but to date this still looks like speculation. In particular, whatever the total infrastructure pot, the share available to the private sector is another major question.
While solid and attractive, it is not certain whether it will become a substantial asset class. From another perspective, it does not appear that retail investors will have many opportunities to invest in it. The mutual fund format will obviously be unsuitable, given the illiquidity of the assets. Perhaps there is an opportunity here for asset management companies to come up with a different type of vehicle.
References
- “Windfall for investors, a loss for the Windy City”, Darrell Preston, Bloomberg Businessweek, 16.08.10
- “India plans $11bn infrastructure fund”, Prasanta Sahu and Abhrajit Gangopadhyay, Wall Street Journal, 01.06.10
- “Finally, a modern Passage to India”, Subramaniam Sharma and Vipin V. Nair, with Bruce Einhorn, Bloomberg Businessweek, 05.07.10
- “Paving the way for India’s economy’, Harsh Joshi, Wall Street Journal, 20.07.10
- “Interest in infrastructure re-emerges”, Ruth Sullivan, FTfm, 08.11.10
- “Balfour to launch £1bn infrastructure fund”, Ed Hammond, FT.com, 30.11.10
- “Many bright spots forming on infrastructure horizon”, Phil Davis, FTfm, 06.09.10
- “Barack Obama announces $50bn infrastructure plan”, BBC News Website, 06.09.10
- “False expectations”, The Economist, 23.10.10
- “Demand grows for infrastructure assets”, Sonia Kalsi, Financial News, 25.10.10
- “The bad news awaiting Chicago’s next mayor”, John McCormick and Darrell Preston, Bloomberg Businessweek, 20.09.10
- “U.S. cities with budget gaps sell parking, airports, zoo”, Ianthe Jeanne Dugan, Wall Street Journal, 24.08.10
- “Clock ticks down on Pittsburgh’s pensions crisis”, Nicole Bullock, Financial Times, 26.10.10
- “The big sell”, The Economist, 18.09.10
- “Investors eye debt of motorway toll group”, Anousha Sakoui and Ed Hammond, Financial Times, 18.10.10
- “Not flogging a dead bourse”, The Lex Column, Financial Times, 26.10.10
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