Many bright spots forming on infrastructure horizon

With national budgets under pressure, it would be rational to assume that European infrastructure projects are running close to empty, with consequent poor future outcomes for infrastructure investors.

However, a closer look reveals that both investment in and sales of infrastructure assets in the post-financial crisis period are relatively buoyant.

In the UK the government axed or suspended £10.4bn (€12.6bn, $16.1bn) worth of projects in the first few months of the year. However, infrastructure was one of the few winners in the UK budget in June.

The government decided to retain Infrastructure UK, the Treasury body that is helping to funnel £40bn-£50bn of private investment a year to economic infrastructure.

It also announced investment for 13 transport projects, estimated to cost £29.8bn over five years, with £14.3bn contributed by the private sector. In addition, it put the National Air Traffic Control System and the High Speed One rail link up for sale.

The UK is not the only bright infrastructure spot. The European Investment Bank has become a significant infrastructure player, lending nearly €70bn a year for projects across Europe.

An uplifting picture has emerged as a result of these and other measures: 58 significant deals were announced in Europe between December 2009 and February 2010, according to AMP Capital Investors, with a total value of $22.2bn.

AMP Capital believes deal activity could pick up further as deleveraging continues in the corporate sector and bargain assets emerge. “We have a great pipeline of opportunities now,” says Rob Gregor, head of European infrastructure.

“Many European conglomerates have portfolios of infrastructure assets built up over 10-20 years that they don’t consider core any longer – this applies particularly to companies with large levels of leverage. Some of these are seeking to deleverage by selling off assets.”

The deal-making stalemate is also starting to break down, he believes. “For the first time since the crisis broke there are now willing vendors, willing buyers and willing lenders.”

In short, infrastructure investors appear to have more to celebrate than to mourn. But how will the future actions of governments impact returns?

In terms of capital spending, AMP Capital believes European governments have every incentive to emulate the US and China and stimulate their economies via capital spending.

The US Federal Highway Administration, for instance, estimates that every $1bn spent on transport infrastructure creates 47,000 jobs and up to $6bn in additional gross domestic product. a multiplier of six. “For developed economies in Europe there is clearly economic benefit to continuing to spend on infrastructure,” says Mr Gregor.

The post-crisis spending has focused on economic infrastructure, which holds out the prospect of higher returns than social infrastructure if and when the global economy recovers. Mr Gregor says: “There has certainly been a shift from social infrastructure – such as schools and hospitals – to transport and other economic infrastructure, where capital investment can have a greater impact on economic growth.”

However, whereas cashflows from social infrastructure are insulated from economic cycles, economic infrastructure remains vulnerable to further shocks. Mr Gregor says: “Cashflows from roads, ports and airports were all hit due to their linkage to GDP growth and would be affected again if a subsequent recession kicked in.”

Even if the pro-spending European governments reverse tack, the infrastructure bandwagon could still keep on rolling because the private sector is likely to step in.

“Let’s make no mistake – the last two years have put pressure on investment,” says Mr Gregor. “In Spain alone, there has been a €6bn cut in public sector investment. But projects can be financed in a private capital structure. Our expectation is that with increasing fiscal pressure, private capital will play a larger role.”

He sees particular opportunities in Germany. In a 2008 study, McKinsey said Germany would have to spend €220bn on infrastructure to grow at just 3 per cent a year to 2020, or €60bn more than is budgeted.

Unlike Britain and France, Germany has not yet embraced the PPP approach but may need to in order to achieve even these modest growth targets. “Without PPP, Germany will find it more difficult to deliver on its infrastructure needs,” Mr Gregor says.

Of course, for many investors Asia offers greater potential capital growth than Europe, and Asian infrastructure funds are proliferating.

India has been spending about 6 per cent of GDP on infrastructure over the medium term, while China has been spending close to 8 per cent. But the crisis has convinced some investors to re-examine their investment theses.

“Two years ago when the world was on an even keel, a lot of investors believed European assets were expensive and saw that a lot of capital was chasing the available opportunities,” says Mr Gregor. “So, many became more interested in Asia.

“This is still the case for many growth-oriented investors, but others have become more risk-averse and prefer the predictability of European yields and capital values.”

In addition, he says, mature regulatory and legal frameworks and low levels of competition have created high barriers to entry that favour incumbent companies. He notes there is a higher level of acceptance in Europe for public assets to be held in private hands. “A lot of Asian infrastructure is in public hands and there is no telling if and when that will change.”