Stephen Bartholomeusz
The new model
Chris Lynch’s dramatic re-shaping of Transurban last week, radically de-leveraging the tollroad group and slashing its distributions, has added to the scepticism about the sustainability of the model for listed infrastructure vehicles. There is, however, a disconnect between the fear and loathing raging around these vehicles in the listed space and the eagerness of banks and pension funds to invest in them in the unlisted arena.
The model, usually referred to as the 'Macquarie Model' after the bank that pioneered it, isn’t broken. It will, however, have to be adapted to take into account the very different debt and equity market conditions that now prevail and some of the lessons learned as the aftershocks of the sub-prime crisis stress-test the model.
The intellectual under-pinnings for the Macquarie model are quite straightforward.
Long-duration infrastructure assets, like tollroads, with concession periods measured in decades and with CPI-plus annual increases in revenue bases that are inherently resilient, are analogous to super-charged inflation-protected bonds.
That makes them incredibly attractive to institutions, like pension funds, that have liabilities that mature in decades. The assets themselves (as opposed to their market value) are an inherently low-risk asset class with very low volatility. Without any financial engineering, they deliver solid returns, something better than fixed interest securities but something less than equities.
Macquarie re-engineered the investment arithmetic for listed infrastructure funds by recognising that the assets could tolerate gearing and that leveraging them would enable the funds to deliver souped-up yields to income-hungry investors.
Without any engineering, the distributable cash flow from a tollroad would swell over decades, pouring more and more cash into the coffers of investors towards the end of the concession period – perhaps 30 years hence.
But by gearing the assets, revaluing them annually and funding a large part of the distributions from borrowings the model effectively averages the distributions over the life of the assets – in the near term they are higher than they would otherwise be and in the long-term they are lower. The model brings forward future excess cash flows.
In the listed environment, the value of the super-charged yield was inflated by the long period of historically low real interest rates and has subsequently been deflated by the spike in rates triggered by the sub-prime crisis.
Those severe fluctuations in value largely reflect changes in the capitalisation of yield – the rising long-term cashflows from Transurban’s tollroads won’t be damaged by the market conditions, although there would be an increased in its cost of borrowing as its facilities mature.
Banks are willing to finance and re-finance the underlying assets in the funds managed by Macquarie, Babcock & Brown and other infrastructure asset managers because they recognise the inherent robustness of their cashflows and value. Pension funds are willing to invest in Macquarie and Babcock’s unlisted funds – and, in Transurban’s case, its listed securities – for the same reason.
Macquarie has been shifting its emphasis from listed funds to unlisted vehicles for the past four or five years. Last year about 85 per cent of the $22.4 billion it raised for its specialist funds was invested in unlisted entities. Babcock similarly started focusing on unlisted vehicles about two years ago.
The unlisted funds have a number of advantages for investors and managers. They aren’t subject to daily equity market volatility; pension funds are awash with cash and therefore don’t need engineered yield – which means the funds are simpler and can be less highly-geared – and the managers don’t face the same scrutiny and controversy over the governance arrangements that secure their fee income streams. These are deals between consenting, informed and sophisticated adults.
In the post sub-prime environment, where the cost of debt has risen sharply, clearly both listed and unlisted infrastructure funds will be more conservatively geared and investors’ expectations of returns will have to be lowered.
Equally, however, if the change in the cost of debt is seen to be structural, it should be cheaper to acquire new assets for the funds (although the evidence of recent transactions suggests that some investors have been slower to appreciate that than others).
Banks will be warier of lending to the managers than against the underlying assets. The problems afflicting Babcock, Allco and Centro et al relate largely to their corporate centre debt, which is effectively supported by the value and cashflows attributable to their management rights.
The Transurban response to the new environment is dramatic and is at the extreme end of the spectrum. Some de-leveraging at the asset level but more particularly the manager level (which isn’t an issue for the conservatively-geared Macquarie) would be prudent. The changed environment has already seen asset values adjusted and won’t allow aggressive revaluations in the near term, which will moderate growth in distributions for the listed vehicles.
The foundations of the infrastructure fund model, however, haven’t been demolished by the impacts of the sub-prime crisis.
Valuations will fluctuate with market conditions and the current conditions will force some unwinding of the more aggressive financial engineering but the underlying cash flows of the infrastructure assets – and the fee income streams they generate for their managers – will continue to grow in real terms over very long time horizons.
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