3i’s renewed push into infrastructure comes as some sector followers warn returns have peaked and investors may be riding for a fall.
Demand for infrastructure assets has risen much faster than supply over the past three years, industry practitioners say. Investors are attracted by the stable, inflation-proof returns that such assets supposedly generate. Infrastructure transactions – ranging from toll roads and ferry operators to airports and waterworks – have risen from $33.8bn in 2004 to about $147bn (£75bn) in 2006, according to Thomson Financial.
Standard & Poor’s, the ratings agency, said in November that the sector was at risk of a “dual curse” of overvaluation and excessive leverage that could deflate like the technology bust.
Mike Wilkins, S&P’s infrastructure analyst, says the worrying trends that prompted him to issue that warning have continued into 2007. Investors may find that their treasured infrastructure deal becomes the next Eurotunnel.
“There’s been no let-up. The deals we have seen this year have been pretty highly leveraged and have been struck on high valuations. I think there’s going to be a point when the market can’t carry on like this,” Mr Wilkins says.
Banks are still relaxing covenants when lending to infrastructure buyers, he says. Meanwhile, leverage – measured by debt as a multiple of earnings before interest, tax, depreciation and amortisation – is being offered in the mid-teens, compared with high single digits for conventional leveraged buy-outs.
Returns generated by acquisitions of mature infrastructure assets have fallen from 12 per cent to 7 to 8 per cent over the past two years, according to S&P.
Not all industry experts are making such predictions. But some acknowledge that the sector has become crowded.
“There was a point a few years ago when you could get really good assets that were undervalued – they fell into your lap,” says Tony Roper, fund manager at HSBC Infrastructure Company. “There’s much more money chasing infrastructure assets but it’s not clear that there are many more assets around.”
Yet Mr Roper says many infrastructure assets today are fairly rather than over valued. It is also easier to find value in larger infrastructure deals, given they can only be acquired by consortia.
Some bankers have warned that the scarcity of assets may tempt investors to buy what looks like infrastructure but does not fit the bill. For example, motorway service stations may appear to be a stable monopoly but they are still exposed to the economic cycle. Likewise, care homes may be relatively immune to the cycle but barriers to entry are low.
Lakis Athanasiou, utilities analyst at Collins Stewart, says the water sector is especially risky since regulators can demand increased capital expenditure. “You’re going to have some dire problems with your investors if your asset stops being an income play,” he says.