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Long Term Investors: Needs, Opportunities and Open Issues The Case of Infrastructures Domenico Siniscalco and Corrado Celestre 12 July 2017
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Long Term Investors: Needs, Opportunities and Open … · Development Phase Brownfield (operational history) vs Greenfield (new development). Construction and technology risks for

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Page 1: Long Term Investors: Needs, Opportunities and Open … · Development Phase Brownfield (operational history) vs Greenfield (new development). Construction and technology risks for

Long Term Investors: Needs, Opportunities

and Open Issues

The Case of Infrastructures

Domenico Siniscalco and Corrado Celestre

12 July 2017

Page 2: Long Term Investors: Needs, Opportunities and Open … · Development Phase Brownfield (operational history) vs Greenfield (new development). Construction and technology risks for

Infrastructure Investments Are Badly Needed

From Market Failure to Appropriate

Structures of Financing…

…in Search of Intermediaries and Investors

Infrastructure Funding Needs Various

Forms of Long Run Investors

Long Term Investors Need Stable, Predictable,

Long Term Returns

Is There a Market?

Is There a Case of Market Failure?

Concepts for Discussion

2

June 2015_Infrastructure as an Asset Class_vF.ppt\05 JUL 2017\10:43 AM\4

Page 3: Long Term Investors: Needs, Opportunities and Open … · Development Phase Brownfield (operational history) vs Greenfield (new development). Construction and technology risks for

Key Drivers for Investing in Infrastructure Increased Attractiveness of Infrastructure in a Low Yield and Uncertain Environment

3

• The attractiveness of

infrastructure as an asset class

has increased in recent times

– Diversification

– Cash yield

– Attractive historical risk-

adjusted returns

June 2015_Infrastructure as an Asset Class_vF.ppt\05 JUL 2017\10:43 AM\4

Defining Infrastructure

Infrastructure assets typically display the

following characteristics

• Long, useful lives

• Significant degree of stability and

predictability in cash flows derived from

– Regulated environments and/or

– Long-term contracts and/or

– High barriers to entry and/or low

competition

• Essential to society or the economy

• Cash flows often indexed to inflation

Benefits of Infrastructure

Key benefits of infrastructure include

• Portfolio diversification

– Low historical correlation with public

capital markets, well suited in a volatile

environment

– Narrower distribution of outcomes

• Cash-generative assets paying

current yield

• Long-term assets match long-term

liabilities

• Inflation indexation, well suited to match

inflation-indexed liabilities

Note

The opinions are those of the presenters as of the date of the presentation and are subject to change at any time due to changes in market or economic conditions.

Page 4: Long Term Investors: Needs, Opportunities and Open … · Development Phase Brownfield (operational history) vs Greenfield (new development). Construction and technology risks for

Examples of Infrastructure

4

• Regulated electricity assets

• Transmission and distribution systems

• Water distribution and treatment facilities

• Oil and gas pipelines

Energy and Utilities Assets

• Airports

• Ports

• On/off street municipal parking facilities

• Toll roads

• Tunnels

• Bridges

• Rail and mass transit networks

Transportation Assets

Communications

• Cable networks

• Communication towers

• Satellite systems

Social Infrastructure

• Education facilities

• Healthcare facilities

Other

Page 5: Long Term Investors: Needs, Opportunities and Open … · Development Phase Brownfield (operational history) vs Greenfield (new development). Construction and technology risks for

Key Infrastructure Risk Factors Understanding Nuanced Nature of Individual Asset Performance Drivers

5

• Shared risks amongst

Infrastructure asset categories

– Degree to which asset

exposed is individual to each

asset

– Bottom-up analysis required

to understand nuances of

risk drivers

Unique Risks Associated With Infrastructure

Risk Description

Regulatory Changes in regulation over allowed returns, changes to

competitive environment

Demand / Patronage Revenues are volume-based and/or based on customer usage

Political PPP or full privatization support by Government and Voters

Contractual Privatized, PPP, Concession, Perpetual license. Required history

of strong legal system and clear separation from political

branches

Development Phase Brownfield (operational history) vs Greenfield (new development).

Construction and technology risks for both

Growth Profile Government stimulus, population driven, GDP- or inflation-linked

Inflation Linkage Implicit or Explicitly defined in contractual agreements

Interest Rate Refinancing risk; exposure in credit and term loan facilities

Page 6: Long Term Investors: Needs, Opportunities and Open … · Development Phase Brownfield (operational history) vs Greenfield (new development). Construction and technology risks for

Different Positions on Infrastructure Risk Spectrum Infrastructure space is divided into four major segments (1)

• Depending on one’s definition

of infrastructure and the

associated risk profile, target

IRRs typically range from 7% to

20%+

• The "art" is to combine various

classes of investors to structure

the needed financing (no one

would invest on a stand-alone

basis)

• Implicit government

guarantees offer

returns with a

premium over

government bonds

Notes 1. The chart is being provided for illustrative purposes only; there can be no assurance that any investment will achieve high returns. 2. In setting the target return, the general partner will consider forecasted cash flows, forecasted valuations at future dates, market conditions for relevant assets, and anticipated

contingencies, among other matters.

• Often in regulated

environments or under

concession

agreements

• Mature businesses

with long-term

performance history

• Regulated or unregulated

assets

• Lesser performance or

volume history for new or

existing assets

(brownfield)

• Assumes some

operational and

development risks

• More often unregulated assets

• More limited visibility into future cash

flows as either greenfield project or

exposed to additional risks

influencing performance such as

commodities, competitive

alternatives, macro and micro

economy dynamics

• Developing country investments with

less regulatory, political, legal history

PPP/PFI (Secondary) Core Private Equity Cross Over

Lower Risk

Targ

et

Retu

rn (

Gro

ss IR

R)

Risk

8%

12%

15%

18%

Higher Risk

PPP/

PFI

Core

Core Plus/

Value-Add

PE Cross Over

Core Plus/Value-Add

6

Page 7: Long Term Investors: Needs, Opportunities and Open … · Development Phase Brownfield (operational history) vs Greenfield (new development). Construction and technology risks for

Infrastructure Investing Trends

Strong Demand Due to Characteristics of Infrastructure

• Cash-generative characteristics

– Target c.50% of total return from current yield (from end of investment period)

• Potentially attractive substitute for fixed income with typically higher targets for both current

yield and all-in returns than many fixed income products(1)

• Portfolio diversification

– Lower correlation of infrastructure to the business cycle relative to traditional asset classes

• Continued strong interest in the

infrastructure asset class amongst

global investors

• For various reasons, focus of direct

investors is on efficient, de-risked

assets with some operational and

financial track record (in many

cases coming out of fund portfolios)

• Direct investment programs are

therefore primarily focused on so-

called core infrastructure

7

Greenfield Ramp-up

De-risking

Efficiency improvement

Steady-state operations

Phase 1 Phase 2 Phase 3

Infrastructure Asset Life Cycle

Lower Risk Higher Risk Risk

7%

12%

15%

18%

Core

PE Cross Over

Core Plus/Value-Add

Infrastructure Risk Spectrum Target Return (Gross IRR)1

Note

1. There can be no assurance that any investment will achieve its target return. When comparing asset classes, keep in mind that each has differences. Fixed income investments are subject to

interest rate and credit risk. The risks associated with investing in infrastructure include: the risk of an impaired exit valuation in depressed markets; the potential for realized revenue volumes

to be significantly lower than those projected and / or cost overruns; the risk that the nature of the concession fundamental ly changes during the life of the project (e.g., the state sponsor

alters the terms); and macroeconomic factors such as low GDP growth or high nominal rates raising the average cost of funding

Page 8: Long Term Investors: Needs, Opportunities and Open … · Development Phase Brownfield (operational history) vs Greenfield (new development). Construction and technology risks for

Approximate Infrastructure Return Expectations by

Geography and Sector

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• The above table is for illustrative purposes; returns vary on deal by deal basis

• The above table is for illustrative purposes; returns vary on deal by deal basis

• Such situations would likely be proprietary in nature and/or would involve opportunities for operational value add

Americas Europe OECD Asia Pacific

Oil & Gas Infrastructure ~12-17% ~10-15% ~10-15%

Renewable Energy ~10-15% ~8-13% ~8-13%

Seaports ~12-15% ~12-15% ~10-14%

Airports ~12-15% ~12-15% ~10-14%

Americas Europe OECD Asia Pacific

Contracted Power ~9-12% ~8-12% ~8-12%

Utilities (gas, water, electric) ~8-11% ~8-12% ~8-12%

Page 9: Long Term Investors: Needs, Opportunities and Open … · Development Phase Brownfield (operational history) vs Greenfield (new development). Construction and technology risks for

Infrastructure Within Alternatives Space Investment Characteristics Compared

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• Infrastructure investing may

offer stable, low-risk returns

over a long-term investment

horizon

• Infrastructure frequently

compared to Real Estate and

Private Equity alternatives

investments to inform allocation

and management decisions

Notes

1. The opinions are those of Morgan Stanley as of the date of the presentation and are subject to change at any time due to changes in market or economic conditions. When comparing

asset classes, keep in mind that each has differences. Investments in infrastructure may be subject to a variety of legal risks, including environmental issues, land expropriation and

other property-related claims, industrial action and legal action from special interest groups. Due to the appraisal methods for valuing real estate, there may be inherent issues when

comparing real estate to other asset classes. Private equity may be subject to additional risks.

2. The target returns are not intended to reflect, and do not reflect, a target return for any Morgan Stanley investment. The target returns are based on historical analysis and are subject to

change. There can be no assurance that any target return will be achieved. The chart is being provided for illustrative purposes only. There can be no assurance that any investment

will achieve high returns

Infrastructure Is a Unique Asset Class1

Metric Infrastructure Assets Real Estate Private Equity

Investment Profile

Risk Profile Stable/Lower-Risk Varied/Medium-Risk Varied/Higher-Risk

Target Returns 2 Core: 8-11%; Core-Plus:

12-15%+

Varied Across Spectrum >20%

Investment Duration Medium-Long Medium-Long Short-Medium

Industry Development

Stage

Emerging and Mature Mature Mature

Barriers to Entry Medium to High Low to High Low to High

Investor Requirements Yield/Total Return Yield/Total Return Total Return

Complexity of Transaction Medium to High Low to High High

Page 10: Long Term Investors: Needs, Opportunities and Open … · Development Phase Brownfield (operational history) vs Greenfield (new development). Construction and technology risks for

Key Differences: Equity vs. Infrastructure Risk Mission-Critical Assets Backed by a Comprehensive Contractual and/or Regulatory Framework

• Infrastructure investments

represent an equity claim on

assets, but the sector risk

profile is governed by

fundamentally different drivers

– Strategic considerations

– Revenue

– Cost

– Inflation exposure

– Financing philosophy

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Note

For illustrative purposes only. Does not reflect specific implementation of MS strategy. When comparing asset classes, keep in mind that each has differences. Investments in

infrastructure may be subject to a variety of legal risks, including environmental issues, land expropriation and other property-related claims, industrial action and legal action from

special interest groups.

Private Equity

Risk

Moderate and

long-dated

leverage

Contractual

cost

mitigation

Contracted or

regulated

revenues

Focus on assets

vs.

businesses

Infra-

structure

Risk

• Less strategic complexity

• Better performance visibility – fewer

moving parts

• Mandated service rates authorized by

regulation or concession agreement

• De-coupling from volumetric considerations

• Explicit monopoly authorization

• Authorized cost recovery via regulatory

mechanism

• Explicit and implicit inflation protection

• Levering to “investment grade”

standard

• Match financing duration to asset life

Page 11: Long Term Investors: Needs, Opportunities and Open … · Development Phase Brownfield (operational history) vs Greenfield (new development). Construction and technology risks for

11

Regional vs. Global Managers

Note

The opinions are those of the presenters as of the date of the presentation and are subject to change at any time due to changes in market or economic conditions.

Regional Managers Global Managers

Pros • Local currency

• Local inflation

• Investor (LP) familiarity with assets

• Geographical proximity

• Societal aspects

• Local sustainability considerations

• Diversification

• Ability to “cherry pick” regional valuations

• OECD countries display inflation correlation

• Global sustainability considerations

Cons • Requires global network to source and execute on deals

• Emerging markets (if included) are different risk profile

• Currency risk (if no hedging)

• Correlation between assets

– GDP

– Political risk

– Financing markets

• Dependency on regional economic cycle and market valuations

• Level of competition for assets

Page 12: Long Term Investors: Needs, Opportunities and Open … · Development Phase Brownfield (operational history) vs Greenfield (new development). Construction and technology risks for

Illustrative Infrastructure Debt Financing Terms

• Illustrative debt financing terms

shown for infrastructure assets

with varying risk profiles

– From lower risk “core” assets

to higher risk infra/PE “cross-

over” assets

Asset Class Types.pptx\03 JUL 2017\11:40 AM\2

Notes

1. Debt Service Coverage Ratio

CORE CORE-PLUS CROSS-OVER GREENFIELD

e.g. regulated utilities, toll roads,

airports

e.g. partially contracted plants,

power, oil & gas processing plants

e.g. infra-like assets, asset-heavy

services businesses

contracted / regulated (i.e.,

construction of core assets)

Debt-to-Cap (%)60% up to 75-80%, if under

securitization structure50% 40-50% 60%

Tenor 5-20y; up to 30-50y 5-7y 3-7y 15-20y

Debt Amortization Limited to no amortizationPartial, scheduled + cash-flow

sweeps

Full, scheduled + high cash-flow

sweepsYes, scheduled + cash-flow sweeps

Rating Investment Grade Borderline Investment Grade Sub Investment Grade Sub Investment Grade

Structure Pari passu Pari passu Senior & Junior Pari passu

Margin +100-200 bps +250-400 bps +300-500 bps +200-400 bps

Sizing Ratios / Credit

Metrics

1.3-1.4x DSCR (1)

Net Debt / EBITDA: 3.5-5.5x

1.6-1.9x DSCR (1)

Net Debt / EBITDA: 3.5-5.5x

Net Debt / EBITDA: 4-5x senior; 1-

2x additional junior1.3-1.4x DSCR

(1)

Dividend Distribution Yes Yes, generallyGenerally not until significant

deleveraging occursYes, after construction

Illustrative Debt Financing Terms

12

Page 13: Long Term Investors: Needs, Opportunities and Open … · Development Phase Brownfield (operational history) vs Greenfield (new development). Construction and technology risks for

Disclaimer

June 2015_Infrastructure as an Asset Class_vF.ppt\05 JUL 2017\10:43 AM\14

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