Infrastructure

Ports in a storm

May 7th 2009
From The Economist print edition

Heavy debts and light volumes test a supposedly stable asset class

ONE by one, the claims made by modern finance have been testedduring this crisis and usually found wanting. The merits ofinfrastructure investment are the latest to come under scrutiny.Infrastructure assets—roads, airports, utilities and the like—aresupposed to provide stable if unspectacular long-term returns that arerelatively immune to the peaks and troughs of the economic cycle.

That assumption is being tested by the severity of the economicdownturn. On May 5th BAA, the main operator of British airports,reported a 10% fall in passenger volumes at its three London airportsin the first quarter of the year, on a par with the drop it saw afterthe terrorist attacks on September 11th 2001. Ports on the west coastof America have suffered huge declines in volumes of container traffic.“Revenue is not as sticky as once thought,” says the head of a largeinfrastructure fund.

For long-term investors such as pension funds or sovereign-wealthfunds, surely even the most precipitous short-term declines ought notto matter much? But pre-crisis enthusiasm for infrastructure assetscreated two vulnerabilities. One was that some investors strayed intoareas that Colin Smith of PricewaterhouseCoopers, a consultancy, calls“infra-lite”—assets that are more volatile and less protected bybarriers to entry than essential infrastructure. Think of toll roadsthat can be bypassed, such as the gloriously empty M6 in Britain. Manyexpect investors to focus more narrowly in future on core assets wherereturns are heavily regulated (water companies, say) or based onavailability rather than usage (for example, social infrastructure suchas schools and hospitals).

The second weak link is the amount of leverage that many investorstook on. Dips in revenue can be painful even for conservatively gearedfirms because infrastructure businesses tend to have high fixedoperating costs. But they particularly hurt investors that levered upin the good times and now have to keep creditors at bay.

Crushing debts suffocated Babcock & Brown, an Australianinvestor that went into voluntary administration in March. BAA’spre-tax first-quarter loss of £316m ($462m) resulted partly fromincreased interest payments after a refinancing last year. It needs toget a decent price for Gatwick airport, which it must sell oncompetition grounds, to reduce its debt burden.

This is not a seller’s market, however. Cheap money helped buyers tobid ever higher during the boom. Lenders are now pulling back. Theplanned privatisation of Midway airport in Chicago, which would havebeen the first such deal in America, collapsed last month after thewinning consortium (whose members included Citigroup, which reallyought to have known better) found that it could not finance its lavishbid. Many suspect that the deal will eventually be revived but at amuch lower price. Macquarie, an Australian infrastructure pioneer thatreported a steep fall in profits on May 1st and promptly raised morecapital, is also feeling the effects of frozen credit markets. Anindependent analysis by Deloitte this month endorsed a lowish bid forMacquarie’s MCG communications fund from the Canada Pension PlanInvestment Board because of MCG’s ugly refinancing burden.

Falling prices are good for investors who do not have to worry aboutcreditors. Preqin, a data provider, reckons that infrastructure fundsare sitting on $65.5 billion of uninvested equity. Record amounts offund-raising—95 unlisted funds are on the road at the moment, targetingmore than $100 billion of capital—would bolster the war-chest. Somegovernment-stimulus money is earmarked for infrastructure, although itis unclear how the extra spending will feed through to privateinvestors. The second-order effects of yawning deficits may prove moreimportant, as governments unload assets in an attempt to balance theirbooks. In infrastructure as in every other asset, cash is the bestdefence and the greatest source of opportunity.