This article is sponsored by Vauban Infrastructure Partners
Core infrastructure has not had the easiest of rides of late, with the Thames Water scandal, for instance, highlighting issues in the way many of these assets have historically been managed. But there is reason to believe the tide is now turning, according to Gwenola Chambon, CEO and founding partner of Paris-based Vauban Infrastructure Partners.
The firm, which manages some €10 billion of assets with a focus on the European mid-market, regards core infrastructure as its speciality, having been active in the space for the last 15 years. As Chambon explains, this is a space that benefits from predictable, resilient and inflation-correlated cashflows, while also boasting significant opportunities for value creation. If, that is, investors are willing to get hands-on, and ultimately remain mindful of the importance of maintaining a social licence to operate.
Is the attraction of core infrastructure for investors changing?
Absolutely. Core infrastructure has always been regarded as a ‘safe haven’. This is because, at the end of the day, core assets are by their nature protected by monopolistic situations, closely correlated to inflation, and uncorrelated to general economic conditions.
The sector has amply demonstrated the importance of these qualities during the challenges of the last five years, from covid and the disruption to global supply chains, to the war in Ukraine and the energy crisis.
There has also been a much more effective repricing exercise in the core space compared to the value-added or core-plus sectors. This has led to renewed interest among investors, as they seek to channel investment allocations towards the core space.
In addition, we are seeing a kind of revolution in how these core assets are managed, which is creating new opportunities for investors.
What exactly do you mean by a revolution?
Historically, there has been a push by many asset managers to leverage assets and to refinance regularly, tapping into an ever-liquid market of debt. But now there is a growing realisation that this is something asset managers should be very careful of. When investing into core assets, you have to structure the transaction properly. We can’t predict the future, but we do need to be prepared for it. And for that you need to have an appropriate degree of leverage, so that you can face whatever situation the market throws at you, including a potential scarcity of liquidity.
In the past, too, owners of core infrastructure assets regarded their role as that of a caretaker. That has evolved. Now we have to make sure that we anticipate the challenges and also the opportunities created by trends such as digitalisation. There has also been a realisation that infrastructure assets have to serve their communities in different ways.
Finally, there is a growing realisation that there are more value creation opportunities to be had in owning infrastructure equity than in simply piling up debt. After all, there are tonnes of operational efficiencies that we can achieve in equity assets. We can optimise their management and drive efficiencies, and we can also build more opportunities. There are also more and more layers of services that can be added on, thanks largely to digitalisation and the evolution of different communities’ needs.
What value creation levers can managers pull in the core space?
Well, you need to have the proper team of experts working hand in hand with the management of the company and guiding them in trying to figure out the best business plan for what they want to achieve.
This means incorporating a lot of different KPIs, which you monitor on top of financial performance, including parameters on social and environmental performance. These are things that people were not really focusing on 10 years ago, but now they are of paramount importance.
I would say at the end of the day it comes back to having the proper team on the ground to drive value from these assets. And this equation only works with a long-term perspective and with efficient interactions between all stakeholders.
Are there opportunities to do this in Europe?
I think 70 percent of the opportunities in infrastructure today are either in the US or Europe. There is an enormous need for capital in Europe given the myriad opportunities in energy, the environment, digital and transport. It amounts to trillions of euros.
“Infrastructure assets have to serve their communities in different ways”
Industrial companies are faced with a major need for investment, and they don’t have the firepower to deliver it. In some cases, they just sell the asset. But in others they are looking for a partnership. Most of the transactions we do are based on bilateral discussions with industrial companies where we build platforms with them. And we look to repeat these partnerships and to ensure that they feel safe working with us to meet their capex requirements. This is probably the major driver of opportunities right now in Europe.
Of course, you also get different kinds of opportunities in different markets. There is a lot going on in eastern Europe, but businesses there tend not to have the track records which would make them safe places to invest.
There are also many other good reasons for investing in Europe. All European governments are very much in debt and are therefore looking for private capital to address their infrastructure needs. So, we have a momentum of opportunity. We also have a legal framework which is tried and tested, and investor-friendly regulators, at least in most European countries.
How important is the regulatory support for the energy transition coming from the European Commission?
I think it’s really quite important. In Europe, you do feel that regulation is something that is going to support your investment.
Of course, at the same time, asset managers will naturally want to look at what they can do to guard themselves against regulatory action. Regulators do sometimes create a new law or a new tax which disrupts business, after all.
The other thing to consider is that we have seen increased questioning of the very legitimacy of the private sector in investing in core assets. The Thames Water scandal, for instance, has put the whole topic of private equity investment in infrastructure at the top of the political agenda. Too often in the past, companies have been promising things they couldn’t achieve.
It’s important to invest in assets that are delivering a proper service, and which have a social licence to operate. That means demonstrating that you are investing capital and that you are not trying to just take value out of an asset and then hand over what’s left, essentially a stranded asset, to someone else.
Taking care of your social licence to operate is definitely something that matters. There has been far too much rotation of assets. I believe the average holding period was down to as little as three and a half years at one point.
How do you see the core infrastructure space evolving in the future?
I think core infrastructure has great potential given the need to address the capex needs of the various subsectors, which are huge. And the demand is there from investors. These factors are fostering the evolution of the market into something more mature, and we have seen more and more mergers of GPs as part of this.
“It’s important to invest in assets that are delivering a proper service”
When you see the big multi-asset managers purchasing infrastructure specialist managers, it also shows you that the investor interest is there. Investors have developed an appetite through investing in funds and doing co-investments, and they have an increasing desire to allocate to infrastructure.
But the reality is that infrastructure requires more and more sophisticated expertise because of the revolution we have discussed. Managers have to have the right people on the ground. So, while many are looking to make direct investments themselves, there is no way they can achieve a proper investment strategy in infrastructure without developing such teams. That is a challenge because of the sophistication and the complexity that is required.
This is especially true in Europe. If you are doing a deal in Portugal, you are going to need complete Portuguese experience. Not just someone who speaks the language and understands the market, but someone who is also familiar with Portuguese regulations and Portuguese contract law. And, crucially, someone who understands the particular social licence required there.
Which sectors are interesting in Europe for core infrastructure investors?
I would say energy and the energy transition represent half of the opportunities. After that, digital and transport have an equal weighting at around 20 percent, and the rest is social infrastructure, which is growing fast.
But for core infrastructure investors, there are also reasons to be careful of sector choice. When investing in fibre, for example, it is a very different investment in Germany or the UK than in France or Spain, principally because of the different regulatory frameworks. In the UK, it has been something of a Wild West situation, a winner-takes-all market. This is the kind of thing that has created stress among investors, and more importantly made them realise that these are not really core infrastructure investments.
A true core investment has to display predictability of cashflow and strong correlation to inflation. It has to be a monopolistic or quasi-monopolistic situation. In the core space, if this framework is not there then you do not have a true core infrastructure opportunity. Fibre in France has these aspects, but electric vehicle charging does not. It has no protected attributes and inevitably there has been a pricing war, meaning there is no predictability of cashflows.