Time to pause and reflect on private infrastructure valuations

It’s said that hindsight is 20/20, but perhaps, instead, 2020 will be a year of insight: or more precisely, a closer look into what some analysts suggest are too-high valuations and perhaps even signs of fatigue in the private market for infrastructure assets.

In their newly released “Top Infrastructure Trends for 2020,” strategists at UBS write that 2019 looks set to be a lagging year for infrastructure fundraising. Just over $58 billion has been raised to date, versus a record $94.1 billion in 2018, the year which saw the infamous accumulation of “dry powder:” huge, idle pools of money waiting to be deployed on ever newer, bigger deals.

But a Preqin report on the global infrastructure market released earlier this year, reflecting 2018 numbers, pointed to a downward trend in done deals despite the capital upsurge, with transaction volume down 22% between 2017 and 2018.

Bigger fundraises and fewer deals means average deal sizes have increased. Preqin’s research recorded an average deal size of $542 million in 2018 compared to $492 million the previous year. And capital has become increasingly concentrated in a small clutch of the biggest players. In 2018, they found, the world’s 50 largest global funds took home 98% of capital raised for infrastructure investment.

Mega-funds

This has given rise to a phenomenon well known in other parts of the alternative investments universe (to wit, venture capital): the rise of mega-funds. McKinsey’s latest Global Private Markets Review found that growth in real assets investing over the past few years, especially in the U.S. and Europe, has been driven largely by megafunds, defined as fund pools of $5 billion or more. Since 2013, eight such infrastructure funds have raised more than $68 billion collectively.

Against this backdrop, UBS found that the glut of capital flowing into infrastructure over the past two calendar years has brought about a broad shift in investment style, away from more conservative, income-oriented (core) strategies and into value-add and opportunistic strategies that more pursue growth more aggressively, but/and entail greater risk.

Something unexpected

The pivot to riskier investments has goosed valuations for private infrastructure overall, with average enterprise value to EBITDA multiples currently near pre-financial crisis levels. But while private infrastructure valuations have grown year-on-year in the interim, UBS notes that valuation multiples for listed infrastructure have actually stayed flat since 2016. This is not a commonplace divergence.

”In our view, what is more concerning is not where the multiples trade relative to history, but the fact that private multiples continue to trend above public market valuations, which is certainly not helped by the rising number of publicly-traded companies being taken private at a premium by mega-funds,” UBS writes. “The risk of further correction in public markets provides a potential headwind to private infrastructure valuations.”

Their concerns have been echoed by Partners Group, the Swiss-based investment firm with $91 billion in AUM and a client roster numbering 900 global institutional investors. In their own 2020 private markets outlook, the firm writes that “although higher asset valuations are justified by the low interest rate environment to some extent,” they have noted a “material decoupling” of valuations away from fundamentals.

“This growing disconnect is particularly problematic for core brownfield infrastructure assets, which have been trading at record prices across sectors and regions,” they write, adding: “Although generally perceived as safe and defensive, we argue that some of these assets are at risk in the current environment.”

Partners Group explains their concerns as twofold: first, any reversion of valuation levels to long-term averages could hurt returns, and, second, the lack of true operational levers in infrastructure investment makes them more susceptible to “disruption risk.”

Yeah, but…

So is it time to hide the china? Perhaps not yet. UBS concedes that, with interest rates stuck low, infrastructure premiums still look good, even as greater investment in the asset class has muted overall returns.

Moreover, they note, the private infrastructure market is four times larger than it was in 2007, with new investors in the mix, along with more widespread acknowledgement of infrastructure’s tendency to outperform in late-cycle and recessionary environments. All of the above could prop up private valuations in the near term, even amid rising ambivalence.

And so far, the investment community remains upbeat about the outlook. Preqin’s 2019 survey of institutional investors found 84% of respondents reporting that infrastructure as an asset class had met or exceeded their expectations. And roughly half said they were looking to increase their long-term allocation.