Private investors eye infrastructure market poised for explosive growth

By Chris Witkowsky and Sam Sutton

Earlier this year, Blackstone Group said in an interview with Bloomberg it could foresee spending $40 billion on infrastructure investments if it decided to get back into that business. The announcement came as infrastructure is one of the major pillars of the administration of President Donald Trump.

Yet private infrastructure as an asset class has exploded in popularity over the past few years outside any political pronouncements. Global infrastructure funds raised $62.2 billion last year, more than any other year in the past decade, data provider Preqin says. The average fund size almost doubled to more than $1.27 billion from $672 million.

And institutional investors’ appetite for the strategy is growing. More than half the institutions Preqin surveyed said they planned to increase their allocations to infrastructure longer term. A little less than 40 percent of those surveyed said they would do so in the next 12 months.

“I don’t think I’ve been as enthusiastic about my space — in any of the 16 years that I’ve been at KeyBanc — than I am right now,” said Steve Hughes, who heads KeyBanc Capital Markets’ construction, engineering and infrastructure practice.

Capital flood?

The result of all this enthusiasm could be a flood of capital into the space. Asset prices are high these days, but the opportunity could be great if the U.S. government partners with the private sector to fix the nation’s decaying roads, bridges, airports and rail system.

“If the market was hot before Trump, it’s even hotter now,” said Kathryn Leaf Wilmes, head of Pantheon’s global infrastructure and real assets practice. “Trump’s love affair with infrastructure should provide strong tailwinds, but the devil’s in the details.”

Return expectations have come down as competition has sharpened and asset prices have risen. Investors these days generally expect 10 percent or less return for core infrastructure strategies, Stephen Dowd, partner at adviser Caledon Capital Management, said. LPs would expect bigger returns for higher-risk strategies within infrastructure, he said.

Nonetheless, LP appetite for infrastructure is growing. Investors see a relatively young market in which supply well lags demand. Many LPs have separated infrastructure into its own bucket for the first time, and others are increasing their exposure to the asset class.

LPs are also meeting their exposure targets to the sector, a process that has taken a few years, Dowd said.

Infrastructure fundraising is concentrated on a handful of managers who’ve been around for a few funds and have something of a track record to show LPs, even though many funds have not yet sold off investments, said Martin Day, partner at Caledon.

“Compared to private equity, there’s really very few funds that are much beyond a second or third fund,” he said. “The bar is a little bit, or significantly, lower in some ways.” Absent a track record of realized returns, LPs seek managers who have “carried out the strategy they said they would carry out; they’ve done the kind of deals they hoped they could do,” Day said.

Because infrastructure fundraising is concentrated, demand for those funds is heavy. As an LP, “if you want to be guaranteed an allocation today, you need to be there at the first close,” said Leaf Wilmes.

Top funds have one-and-done fundraisings, are oversubscribed and are paring LPs’ preferred allocations, she said. More than half the funds raised last year “raised more than their initial target,” she said. “It’s a very healthy market today. We’re arguably back in the good old days in 2006 when it comes to fundraising.”

Some top names recently in the market include Stonepeak Infrastructure Partners, EQT Infrastructure, iCON Infrastructure and i Squared Capital, along with megafund manager Brookfield Infrastructure Partners.

One of the industry’s largest managers, Global Infrastructure Partners, closed its largest fund to date, on $15.8 billion, earlier this year. Managing Partner Adebayo Ogunlesi has Trump’s ear, with a seat on the President’s Strategic and Policy Forum led by Blackstone Group Co-Founder Stephen Schwarzman.

National interest

Trump is not the only major political figure to call for expanding the nation’s infrastructure. Congressional Democrats recently pitched a $1 trillion spending package for infrastructure.

The Democrats’ plan differs from what Trump and his advisers proposed during the campaign, which would create $137 billion in tax credits for private investors in infrastructure projects. The Trump plan is also projected to result in $1 trillion of investment.

Even as the political climate has been sour, KeyBanc’s Hughes said the outlook for an infrastructure package remains optimistic. A compromise would likely contain some combination of tax credits and infrastructure funding, Hughes said. “Either way, it’s a win for constituencies that are sitting around infrastructure projects that are being considered.”

As of mid-February, shares of publicly traded infrastructure companies like MasTec and Tutor Perini were at or near five-year peaks. An infrastructure package, coupled with the Trump administration’s plan to deregulate sectors like energy and financial services, should uncork capital for new projects over the next few years, multiple sources told Buyouts.

“You’re going to hear more and more folks talking about infrastructure, not just on the LP side but also new entrants coming to market,” said Eric Zoller, founder of Sixpoint Partners.

Infrastructure matches long-dated assets with long-term liabilities, making it a good fit for institutional investors like public pensions and family offices.

Newer entrants could include major asset managers, including Blackstone, which recently signaled its plans to open a formal vertical for infrastructure assets. The firm previously invested in natural-gas-export facilities and cell towers through its energy and special situations funds, The Wall Street Journal reported.

“It’s something we’ve been looking at for a while. I’m not going to give you any idea of timing but, yes, there are plans to add funds in that space,” Blackstone President Tony James said during an earnings call. On a separate call with reporters, James said the firm has already invested around $6 billion in 25 to 30 infrastructure deals, delivering internal rates of return in the 40 percent range. “The returns are nothing short of spectacular,” he said.

Uncertain political outlook

Even with bipartisan support for infrastructure spending, some sources have urged caution. Within the administration’s first week, Politico reported the “yawning” gaps between the plans set out by the Trump administration and congressional Democrats, which could throw an eventual compromise into question.

“Count me as doubtful,” Sen. Brian Schatz (D-Hawaii) told Politico.

“The question is, there’s been a lot of announcements in the past that didn’t materialize,” said Mathias Burghardt, head of infrastructure at Ardian. “We are all very excited about the prospect of an infrastructure program, but just waiting for it to materialize.”

Should a viable plan emerge from U.S. policymakers, a mitigating factor will be rising interest rates. In December the Federal Reserve lifted interest rates for just the second time in 10 years, and continued economic expansion and job growth could prompt additional rises.

“The last two years we’ve seen a kind of significant expansion in volumes and prices … fueled by quantitative easing and lower interest rates,” Burghardt said. “There’s been a change around this summer, or [around] Trump’s election, because investors perceive a risk in higher rates.”

Details that need to be worked out include how the private sector is going to earn a return on some of the projects envisioned, Leaf Wilmes said. Another: What kind of impact might the Trump administration’s tough talk on trade have on U.S. ports, airports and railroads? she said.

The other uncertainty is the political pushback regarding private ownership of infrastructure assets that come with toll roads, higher parking-lot fees and foreign ownership of ports. These factors have proved burdensome on public-private-partnership projects — the kind Trump seems to be talking about.

Leaf Wilmes said the pushback may not be as intense this time around. “Over the years, we’ve seen a gradual unlocking of the PPP market in the U.S., with high-profile projects like” New York’s LaGuardia Airport. “I do think the market was already opening up, but much slower than people wanted. A strong federal or national drive behind the use of PPP will absolutely help accelerate that opening up of the PPP market.”

“Taking a step back, one thing is clear: It’s not business as usual,” Leaf Wilmes said. It’s not clear who are the winners and losers. [But] infrastructure is in the sweet spot. I expect more good news than anything else.”

Action Item: Contact Martin Day at Caledon:  www.caledoncapital.com/team_member/martin-day/

Plants grow on the Ferrovia do Nordeste section of the Transnordestina railway track in Missao Velha, Ceara State, Brazil, on Oct. 25, 2016. Photo courtesy/Ueslei Marcelino

Reach Chris Witkowsky at cwitkowsky@buyoutsinsider.com and Sam Sutton at ssutton@buyoutsinsider.com

Updated: The story was updated to include more information about Steve Hughes’ title.