Infrastructure’s Future Looks a Lot Like Private Equity
The world of infrastructure investing is undergoing structural shifts that require investors to take a more active role in managing their portfolios. Investors can no longer count on generating double-digit returns from core assets with stable risk profiles. Instead, they need to broaden their definition of infrastructure; develop a transformational plan to grow, improve, and reposition investments; and recruit an investment and management team that can manage companies in an environment of greater uncertainty and complexity.
Here, we will focus on what has changed and—at a high level—what investors should be doing in response.
The changing face of Infrastructure
Until very recently, the fundamental nature and service patterns of infrastructure projects had not materially changed in decades, perhaps centuries. Such projects tended to be large, fixed, government-financed structures designed to enable the provision of an essential service, often through a natural or regulated monopoly. From the outside, bridges, seaports, and water treatment plants don’t look much different today than they looked long ago. But five market forces are shifting the playing field for infrastructure investors in crucial ways.
1. Flagging Government Commitment.
Because of fiscal constraints, governments—historically the funder of first resort for infrastructure—are investing insufficiently in new projects or the rehabilitation of existing facilities, despite the critical need for them. Private capital must accept a growing role to ensure the delivery of essential services considering the paucity of public financing.
2. Investor Demand.
Over the past decade or so, investors have flocked to infrastructure projects. Both the amount of money raised each year and the amount of dry powder—investable funds—on hand are rising.
However, investors tend to chase a group of traditional infrastructure assets—including toll roads, airports, and electrical-generation facilities—that provide predictable, long-term cash flows. The resulting influx of money is driving down returns, which have been cut in half. To reap rewards comparable to those that investors gained in the past, today’s investors must look beyond the core assets and develop strategies to generate additional service income.
3. Technological Innovation.
Today, digital technology is fundamentally changing infrastructure in ways that create opportunities, disruptions, and competition. The opportunities lie in technology’s ability to open service channels, improve asset management, and widen the universe of investable assets.
Technological advances such as smart metering can enable infrastructure providers to offer new services, while the Internet of Things technologies can support predictive maintenance capabilities. Technology’s disruptive force is also apparent in infrastructure investing. The days of investing passively in infrastructure are over. Investors need to analyse all these factors when assessing an investment’s risks and returns.
4. Customer Behaviour.
Many users and customers of infrastructure projects expect greater customization, responsiveness, and innovation, of the sort they have grown accustomed to in other aspects of their lives. This expectation heightens the degree of difficulty for owners of infrastructure—because they must add a service component to their offering—but it also creates revenue-generating opportunities.
5. Regulatory Evolution.
For private investors to play a larger role, governments must be willing to offer them relief from outmoded regulations that constrain infrastructure owners by supporting traditional monopolies and restricting public-private partnerships.
A new playbook for Investors
These developments suggest that the infrastructure investment market is both broadening and deepening. It is broadening to include a new class of smaller, distributed, tech-intensive infrastructure assets. It’s deepening in the sense that traditional infrastructure projects, which are not disappearing, now require more active management and the development of alternative revenue streams.
In this new era of infrastructure, investors must play a double game, recalibrating their expectations for and their approach to traditional infrastructure even as they pursue new opportunities.
Source: Boston Consulting Group