Long Term Investors: Needs, Opportunities and Open Issues The Case of Infrastructures Domenico Siniscalco and Corrado Celestre 12 July 2017
Long Term Investors: Needs, Opportunities
and Open Issues
The Case of Infrastructures
Domenico Siniscalco and Corrado Celestre
12 July 2017
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
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Key Drivers for Investing in Infrastructure Increased Attractiveness of Infrastructure in a Low Yield and Uncertain Environment
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• The attractiveness of
infrastructure as an asset class
has increased in recent times
– Diversification
– Cash yield
– Attractive historical risk-
adjusted returns
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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.
Examples of Infrastructure
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• 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
Key Infrastructure Risk Factors Understanding Nuanced Nature of Individual Asset Performance Drivers
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• 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
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
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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
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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
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%
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
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
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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
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
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