Founder and Managing Director of YIELCO Investments, Uwe Fleischhauer, shares his views on emerging exit trends in this new and long-term asset class.
Infrastructure as a private markets asset class is in its infancy. It really came into its own in the hunt for yield following the financial crisis of 2007-8, and has yet to complete a full investment cycle. Following his panel session at SuperReturn Infrastructure, Uwe Fleischhauer of YIELCO Investments talked to SuperReturn about the first sustained wave of exits as first and second generation funds approach the end of their lifespan.
What are the key considerations when exiting infrastructure investments?
From a GP perspective, it's mainly driven by the fact that the standard model for infrastructure investment funds, following the mould of private equity funds, is a closed end fund structure. There are some open-ended funds in the market that don't have the pressure to exit at a particular point in time, but the majority are closed end. The average term of these funds is 10 years, up to 12-15 years; with an investment period of three years these funds can be looking to sell some of their underlying assets after just seven years. As a result, fund managers really need to be preparing to exit from the very beginning.
The underlying contracts for infrastructure assets typically have a duration of 10-15 years going up to 25 years for the likes of toll roads. A GP with a closed end fund needs to start with a short/mid-term perspective on the asset, starting with a 100 day business plan to establish what needs to be done, where value can be added and where improvements can be made in this period of 5-7 years.
So one of the main considerations for a core-plus asset, is the added value required within that 5-7 year period to make it a core asset. The typical appetite from institutional investors - and core infrastructure funds - is to get a mature, yielding asset. This is the task from the perspective of a core-plus manager when preparing to exit.
It's a bit different for pure core funds, but even here we’re seeing a number of secondary buyouts. Core funds will sell assets to other core funds because they're coming to the end of their fund lifetime. They may have achieved slight improvements and stabilised cash flows that are locked-in for long periods of time. With the example of toll road concessions, after 10 years it may be sold to another peer with still 15-20 years for the contract left to run. This can be attractive for the buyer who benefits from locked in yields without much to do.
What are the biggest threats/challenges to a successful exit?
From the buyer’s perspective there are deep due diligence requirements spanning a range of different issues - political, economic, regulatory, societal and environmental risks may all need to be factored in. As a result, it’s often not price that determines the exit; there are regulatory and political issues that come into the equation.
This in fact doesn’t just affect the buyer but the seller as well. Take the example of Lübeck port in Germany which had a number of political issues driven by the higher levels of unemployment there and the strategy of the buyer that was planned. In this instance, the asset seller had to be satisfied with the buyer.
That's a very important factor in infrastructure assets; a seller doesn’t want too aggressive a strategy from their buyer as this could impact the reputation of both the asset and the seller. Continuity is important to avoid reputational risks; the handover of the asset needs to be handled properly and the buyer needs to broadly share the same philosophy and approach.
Do you see any issues that will affect infrastructure exits in the next 12 months/3/5 years?
What I’m seeing in the market - and this an observation based on the current private equity climate - is that we are affected by market parameters like market valuations, entry multiples, leverage loads and private debt, while covenant light is back in the market also. We saw all of this before when the private equity market bubble burst in 2006/7 and it could point towards the current cycle coming to an end with a correction coming to the private markets. It's obviously difficult to say with regards timing but we would expect a private markets correction in the next 5 years.
The question that will need to be answered in that event is if and how infrastructure will be affected. Will it respond like private equity or not? Personally, I don't think the impact will be so strong. A correction will affect the universe of potential buyers, that's clear, but it could actually serve to make conservative infrastructure more popular than classic PE assets, keeping the exit market relatively buoyant. I would expect the attractiveness of premium infrastructure investments with stable yields to remain and not be so affected like the private equity market.
Also infrastructure is less affected by other markets (like the IPO market) as private equity. Finally, what we’ve seen to date is that investments in infrastructure have been far more strategic with investors wanting to get into specific assets or industries; those reasons are likely to remain even during a correction.
"It will be interesting to see what the reaction of infrastructure will be in a downturn market, but I feel like it could expose some of the advantages - rather than weaknesses - of the asset class and it could prove resilient as a result."
What are the preferred exit routes for infrastructure investors?
What we're seeing primarily is sales to strategic, institutional investors; direct investors. The large Scandinavian, Australian and Canadian pensions funds in particular are all very active in investing in infrastructure assets.
I think there will be an increasing trend towards secondary buyouts - either a greenfield fund will sell to a core-plus fund, or core-plus will sell to core infra. This is the typical way as an underlying asset develops and I think we’ll continue to see this. The secondary market is a recent development, but that’s driven by the fact that infrastructure only really started 10 or 12 years ago and we're just getting to the end of the first generation of funds coming to the end. But the way it’s going, I believe infrastructure is taking its lead from PE as far as this is concerned.
And I think we will also see the emergence of continuation or rollover funds so that when a GP decides it is not able to sell, or the LP base doesn't want to sell the assets and wants to maintain the yield of the portfolio, we'll see them move the assets to a new fund structure. That is certainly something different in the case of infra versus PE.
"What we do see from time to time however are opportunistic sales driven purely by the fact that large institutional investors are looking for yielding assets."
As I mentioned before, GPs will have an exit scenario in mind, more or less, when they're sourcing a particular deal. What we do see from time to time however are opportunistic sales driven purely by the fact that large institutional investors are looking for yielding assets. There are a lot of capital inflows currently with good and high prices being offered so we do see some quick exits within 1-2 years. I can’t see that as sustainable and isn't going to be the normal scenario with infrastructure assets going forwards.
What was the one impression from your panel at SuperReturn Infrastructure that you would like delegates to have left with?
I think I would like to go back to one of the headlines I read in the press recently; which was: “Infrastructure can also exit”. I remember when I started to work in infrastructure 10-12 years ago this was one of the biggest concerns for investors. We had a number of potential clients ask us: "how do we get out of this infrastructure?” Today it’s very different; the major LP concerns are now more related to regulatory changes and a lack of deal flow. The proof of concept is ongoing for infrastructure but for me, one of the positive takeaways is the development of the whole asset class.