How to think like an Infra Investor?
Hi All,
I'm in a process with an infra fund and had a chat with two VPs in the team post modelling test. I've been put through to the next round but its clear that I misunderstood a bit how to think like an infra investor
Intuitively, why are hard assets like e.g. the helicopter for a helicopter rescue service more attractive than e.g. providing repair and maintenance services to e.g. wind farms?
I tried to make the argument mission critical service, specialist hard to know technical repair knowledge, high margins because of specialist repair jobs blah blah but I was demolished by the VP who said that if this repair market existed with high margins, people would enter the market, steal my employees by offering higher wages etc. which is v. fair
I'm coming from an asset light banking team think Biz Services/TMT so the thinking style is a bit different where being asset light is often a selling point in the pitch/CIM
Would be great to have a bit more of an intuitive explanation to why owning these hard assets is the infra mindset, particularly when these hard assets are not your classic core/core+ infra of a toll road where you have an effective monopoly which is easier for me to understand the rationale behind
Thanks in advance!
bump
context is important, what strategy are you referring to i.e., MM, UMM, largecap, core, core+, core++, GP vs pension/insurance/swf?
Without giving too much on the fund, they operate as a GP in the Infra MM space - strategy feels more core++, no toll roads in portfolio
But question was more hypothetical intellectual debate so should hold regardless of strategy
well it doesn't because there is no universe where helicopter rescure would be categorised as infrastructure
you have answered your own question though, infra MM core++ isn't real infrastructure investing - it's basically normal MM PE whilst avoiding asset light businesses in order to support fundraising from LPs
if youre interested in infrastructure investing i reccomend you get comfortable with core/core+ first
I worked for a large energy developer for few years, so a bit different. But we would sell partial ownership of our assets to the large infra funds. A few off the cuff comments:
- high margin -> high risk. Infra wants de-risked, guaranteed cashflow over a long time horizon.
- Its fine if the margins are small percentage wise, because the check size is massive at the top.
- Their ultimate LPs are entities like pension funds. They need to deploy massive amounts of capital and need (near) guaranteed returns, even if its 100 basis points.
- There’s also an ESG component to this (for lack of a better term). The LPs have either mandates or desires to invest in hard assets that “make the world a better place”. Can sound corny, but remember ultimately if they’re semi public institutions (pension fund, endowment, sovereign wealth fund), they have some type of public oversight and responsibility to a population, not just a billionaire looking to grow their personal wealth.
- And what this ultimately ends with is “lowest cost of capital wins”. If I developed a portfolio of $4B hard, de-risked assets but only 150 bps of margin, and I’m looking to sell 49% stake to recycle that capital back into my development activities, its about whoever has the lowest return requirements on $2B. And that will be whoever gets that money basically for free (a la pension fund).
- So theres this food chain based on WACC. An early stage, not de-risked asset will get capital from a fund with a higher WACC and thus higher return requirements. And that fund will bundle alot of assets together, work to de-risk them, and then sell them to a bigger fund with a lower WACC. Fund A gets their return met by fund B. Fund B repeats the process, and this goes all the way up the chain until fund N takes a huge chunk of aggregated assets with (near) guaranteed returns at the thinnest margin and keeps them until end of life, using their cashflow to pay back their ultimate obligation, like pension disbursements. If you’re not holding the assets until end of life, or selling them to whoever is, you’re not top of the food chain.
- To bring it back to your example, if Im an infra developer or fund, I don’t want a helicopter repair service (or wind repair service). Too risky, too small, too messy. One bad CEO and its kaput. Uncertain cash flow and time horizon. Requires active management, which I’m not set up for. But those helicopters (or wind farms), will have fixed offttake contracts. They’re leased out for 10+ years, and as long as the owner/operator doesn’t break them or the offtaker goes bankrupt, I get paid. And I can scale that up - buy 100 helicopters, 1000, etc. Push the offtake contracts longer, build in more insurance and risk insulation for me.
- Theres still some risk here, mostly on the owner operator. Which is why I usually force them to stay as a partial owner of the asset. And I write the contract such that if they screw it up, I still get paid (as much as I can, at least). So thats 1/2 the job, and the other half is finding investments that meet all the above criteria and satisfy my LP’s criteria. And if I’m not top of the food chain in WACC terms, building portfolios of de risked assets to sell to someone who has a lower WACC than me. Rinse and repeat.
Ok this is more helpful but I'm still not 100% clear,
re. the helicopter rescue, they have availability based contracts with local gov's providing them a steady stream of payments regardless whether there is a call out or not making the revenues more forecastable and visible and infra like but anyway
Let's take a step back to hard assets more generally
From a competitive positioning standpoint, why does having the hard asset of e.g. the wind turbine for renewable energy infra or a maritime tanker that you lease out to e.g. Maersk. Why is that more secure and defensive than providing e.g. niche repair and maintenance services
Sure. So the other comments about what area of infra (core, core++, etc) apply here. If the helicopter rescue had good govt contracts and strong cash flow visibility, for some smaller funds it could be right up their alley.
But for the bigger ones, it comes down to scale and risk. Scaling the rescue company to new localities requires real on the ground maintenance. And it can only get so big. If I need to deploy billions of capital, its too much work for too little total $ return (maybe nice on % margin or IRR, but I need to write big checks).
And on the risk front, even with fixed contracts, the counter party matters. Again, for funds with smaller targets, this comes with the territory. But for a big fund, I need counterparties with great credit. If I’m giving $1B to someone, I’d choose Maersk over a bunch of western/coastal US municipalities (where helicopter rescue is needed). Even if they could come up with some type of letter of credit or parent guarantee from the state (very unlikely for a helicopter rescue contract), thats so much work for me. Now there is diversity in this credit exposure, and some funds may be able to leverage that. But they’re going to be smaller, more active, and more risk-on than someone funding a tanker fleet for Maersk.
Now if we’re talking muncipalities for more critical infra like energy, highways, dams, airports, large real estate, then the state or other backers will get involved to help with the credit and scale issues.
But I imagine this is generally what that VP was trying to say, a service business like that is not a large funds competitive advantage. Its that they can come in with billions tomorrow, credit guarantees, iron clad contracts, and the lowest cost of capital and get key infrastructure build and deployed. Obviously its still about returns, but for large funds its also about actually getting the assets built. They need to “do good in the world”. Again its corny, but its important. Thats what their ultimate owners invested in them for.
And just to emphasize again, for some funds that helicopter business could be perfect. But if they’re set up for that and its what their investors want, they’re probably not holding it until end of life. They’ll eventually try to bundle it with other assets and sell it. And so it would be one ingredient in a larger portfolio for someone who would hold it to end of life. Just spit balling, it could be compelling in a portfolio of other muni assets mentioned above if the credit risk and term risk (what happens when the contracts run out) was
removed by another counterparty. But its also just as likely for the buyer to want it removed because it doesn’t fit with their strategy.
How do these assets and cash flows go from being not de-risked to becoming de-risked?
I think I gave some examples in the previous comments, but the short answer is contracts. With infra, someone is going to actually use it for something. And we sign a long-term contract that says they'll pay me cost + return for the right to use it. That contract will also have provisions for things like insurance, cost overruns, inflation adjustment, maintenance cost, etc. Anything that could reasonably be expected to affect me getting paid my costs + return.
I am not going to read what the other posters wrote, but the way I think about infra assets, as someone should have mentioned it, has all the following characteristics:
Hard physical assets whose replacement / liquidation value is either more or less stable or will increase over time (if it's inflation-linked)
Assets generate stable cash flows underpinned by long term (15-20 years) contracts with investment grade counterparties.
Truly mission critical (or nationally/locally/regionally important) in the sense that if the assets shut down, there will be a direct and significant impact on the economy or customers that the assets serve
For the above three reasons that I enumerated, I will be comfortable targeting lower returns from an infra asset that I would from a non-infra asset - all else equal
I think people are missing the point of your question. Any infra investor will tell you that hard assets are attractive because (1) ownership of a hard asset provides downside protection - i.e. even if everything goes wrong with the business, at the end of the day you can still sell the helicopter itself and have some decent recovery, and (2) markets or industries that require hard asset ownership present higher barriers to entry, mitigating competition risk
Yes thanks, this is exactly more what I was looking for - the business fundamentals of why hard assets stripping away all stuff of LPs etc.
Fixed asset leverage. Currently at an infrastructure developer in the transportation space, and we like owning fixed assets (vs asset-light) businesses, because the cost structure around these assets typically lend significant operating leverage. For example, if you own an airport you have a very large base of fixed expenses. These are obligations you have to satisfy regardless of whether or not you have very large passenger volume or very small. So if you can funnel more passengers through this business, you can "sweat the asset" and grow your revenue without proportionally increasing your costs, thereby expanding your margin. This is not possible with asset-light service based businesses, where volume-based revenue growth is usually just offset by variable expense growth.
This is great upside, but presents a risky downside case. Therefore, everything above about de-risked offtake agreements, minimum annual guarantees, etc. are extremely important to any infrastructure investment.
Yes this is helpful, exactly what I was looking for, thanks
I’d also add that a real advantage to hard assets is the ability to add substantial leverage (either at an asset or corporate level). This is materially different to asset-light businesess which you might be more familiar with.
Chicken and egg IMO
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