Across Europe, sovereign wealth funds are financing
much-needed infrastructure projects — and realizing
big profits. But shifting regulations pose risks.
In Spain, a huge infrastructure deal is close to completion.
New York investment bank Morgan Stanley has put its
Madrid-based natural gas distribution company Madrileña
Red de Gas on the market for around €1.8 billion ($2
billion) — and demand is off the charts. Three
separate investor groups are reportedly battling for the
assets, with two sovereign wealth funds in the fray: the Abu Dhabi Investment Authority (ADIA) and
Gingko Tree Investment, a unit of China’s State Administration of Foreign Exchange
The Madrileña sale is just one of a series of big
European infrastructure deals in the pipeline. In Sweden, ADIA
and Singapore’s GIC are teaming up on a reported
€7 billion bid for an electricity distribution business
owned by Helsinki-based energy company Fortum Corp. The Qatar Investment Authority (QIA)
meanwhile, reportedly has plans to spend up to £10
billion ($15 billion) on British infrastructure, with an
intercity high-speed railway among the projects the fund is
discussing with the U.K. government.
"Sovereign wealth fund activity in infrastructure is
increasing significantly," says Mike Wilkins, a managing
director on the infrastructure team at Standard &
Poor’s Ratings Services. "Sovereign funds like the
steady capital growth on infrastructure assets, and economic
infrastructure — telecoms, utilities, transport
— is the flavor of the moment."
So-called economic or hard infrastructure —
including everything from motorways and airports to electric
transmission lines — generates revenue based on usage,
and can deliver relatively stable cash flow over decades. This
makes it a good fit for sovereign funds, with their
intergenerational investment horizons. And the returns
available often exceed those of other asset classes,
particularly bonds. At a time when European government bonds
are trading at negative yields, the double-digit returns on
infrastructure assets are a big draw.
So far in 2015, sovereign wealth funds have been targeting
existing assets rather than those under construction. In
January, for instance, ADIA bought shares at the initial public
offering of Madrid-based Aeropuertos Españoles y
Navegación Aérea (AENA). The deal saw a late
surge of interest that pushed up the share price, valuing the
airport operator at €8.7 billion — making it
Europe’s biggest IPO since 2011.
Competition is pushing up valuations across the asset class.
The reported asking price for Morgan Stanley’s
Spanish gas distribution business, for instance, is more than
15 times 2014 earnings before interest, tax, depreciation and
amortization (EBITDA) of $149.2 million.
Bigger, more established companies will fetch more. Hong
Kong-based conglomerate Hutchison Whampoa is reportedly set to
pay £10 billion for O2, the British mobile phone company,
which it wants to merge with its Three Mobile network
— and several sovereign wealth funds, including the
China Investment Corp. (CIC), QIA, GIC and Temasek Holdings are
rumored to be vying for a multi-billion dollar slice of the
Despite rising prices, experts discount the notion of an
infrastructure bubble. Giles Frost, CEO of London-based Amber
Infrastructure Group, says current prices reflect the long-term
yields likely to be generated in the asset class.
"There’s certainly strong competition, and prices
are rising, but that makes sense in the current environment,"
he says. "In a world where lower yields are the norm, people
are going to pay higher capital prices for yielding assets.
Higher valuations reflect the fact that investors expect the
low interest-rate environment to continue for some time."
"Second Hand Cars"
Funds that want better value and higher yields, however, are
looking at a more direct approach — partnering with
construction firms to invest in as-yet-uncompleted projects,
so-called greenfield assets. The idea is that by taking on an
element of construction risk, they can generate better returns.
And in Europe, there is certainly no shortage of construction
projects to choose from.
Since the financial crisis of 2008-’09,
European governments have drastically cut public spending, and
that’s left holes in infrastructure networks.
According to Standard & Poor’s, Europe will
need almost $200 billion above pledged government spending each
year between now and 2030 to meet its infrastructure needs.
"Across Europe, there is a pressing need to refurbish creaking
and decrepit infrastructure, and sovereign funds are helping to
fill the funding gap," says Wilkins.
Governments are keen to tap state-owned
investors’ vast pools of capital for a range of
infrastructure projects. The U.K., for instance, has been
encouraging sovereign wealth funds to invest in British water
infrastructure since 2012, when it succeeded in persuading CIC
and SAFE to allocate a combined $3.2 billion to water
facilities. And now other sovereign wealth funds, including QIA
and ADIA, are reportedly involved in bidding for the £4.2
billion ($7 billion) Thames Tideway Tunnel, a massive sewer
construction project that will run beneath the streets of the
"Funds are realizing that there’s profit to be
made for getting in first on big infrastructure assets," says
Frost at Amber Infrastructure, which is leading a consortium
bidding for the Thames Tideway alongside several large
institutional investors. "In infrastructure, the saying goes,
second hand cars are more expensive than new ones —
people pay a premium for not having to go through the
development stage of a project, with the associated risk."
On the Thames Tideway bid, Amber is taking an active role,
negotiating with regulators and drawing up plans, while
partnering with big institutional investors that provide the
bulk of the capital. Increasingly, this is the model for how
sovereign wealth funds are investing in infrastructure.
This way of partnering makes sense for state investors,
which share the long-term investment horizons of dedicated
infrastructure companies. In addition to higher profits, it
allows them to gain more control and flexibility over their
investments than they normally would by allocating to
infrastructure funds. "One of the benefits of being a long-term
investor, with different liabilities from more-traditional
investors, is the tremendous flexibility you have to buy and
sell when the time is right, not when you are forced to,"
ADIA’s Global Head of Infrastructure John McCarthy
told the Sovereign Wealth Center last year.
Partnerships also let funds leverage infrastructure
companies’ specialist expertise and spread
construction risk. But construction risk is not the only hazard
funds face in the current environment — political and
regulatory issues are big concerns, too. "The main risk that we
see in infrastructure is related to politics and regulation,"
says Wilkins. "Governments have changed the rules of the game,
reneging on promises and implementing tariff changes, for
example. That’s one of the biggest issues in
European infrastructure right now."
Many investors perceive Europe to be safer and more stable
than emerging markets — but it is not as simple as
that. Last year the Alberta Investment Management Co. (AIMCo),
which manages C$80 billion ($64.5 billion) for 27 pension and
endowment funds based in the Canadian province, including
sovereign wealth vehicle the Alberta Heritage Savings Trust
Fund, told the Sovereign Wealth Center that emerging markets
such as Chile have stabler, more consistent regulation on
infrastructure than many European countries. AIMCo said the
U.K. is one of the less consistent jurisdictions, citing the
government’s recent changes the regulatory
framework for water works.
A Pen Stroke
But at least those changes left existing arrangements in
place. Some other countries — including Spain and
Italy, two of the countries keenest on attracting
infrastructure investment — have introduced
retroactive changes, cutting already-agreed upon tariffs in the
solar power industry, for example. This has affected the
profitability of existing assets — and burned
investors in the process.
Regulatory change is Europe-wide issue. In December 2014,
French Environment Minister Segolene Royal called for motorway
operators to rip up their contracts and freeze tariffs
(although no legislation has been issued yet). And even Norway,
once a beacon of legal stability and transparency, has had a
tendency to move regulatory goalposts. Last year
Stavanger-based Solveig Gas Norway, an infrastructure company
backed by ADIA and other large institutional investors,
launched a legal challenge to the Norwegian
government’s decision to reduce by 90 percent the
tariffs that Gassled, Norway's undersea pipe network, can
charge for bookings from 2016. The case will be heard at the
Oslo District Court in April 2015.
For some market participants, regulatory risk is, to an
extent, unavoidable in the infrastructure sector. "With
infrastructure, the negatives are the flipside of the
positives, in a sense," says Frost. "The advantages are that
it’s a key, long-term asset and therefore has to
be maintained by governments — but by the same token,
governments can be inclined to meddle in it, because
it’s so politically sensitive."
What’s certain is that, as funds look for
profit in the increasingly competitive European infrastructure
market, they should stay attuned to political shifts —
especially when considering sinking billions into a deal.
Sometimes the long-term profitability of such investments can
be compromised by the stroke of a legislator’s