Infrastructure private equity (PE) is a specialized sector within the broader private equity industry that focuses on investing in infrastructure assets.
The last few decades have witnessed rapid growth in infrastructure PE across the globe. Indeed, interest in this sector is predicted to continue growing, with one 2023 survey of investors finding that up to 58% plan to increase their allocation to infrastructure strategies in the next two years.
In this guide, we’re going to delve deep into the world of private equity infrastructure. We’ll look at how it works, its key characteristics, the main players involved, how PEs evaluate infrastructure assets for investment, and the main exit strategies for PEs in this sector.
Table of Contents
What Is Infrastructure Private Equity?
As the name suggests, private equity infrastructure is simply private equity that invests in infrastructure assets — that is, real assets that provide essential utilities and services.
The basic process is similar to that of traditional PE equity —a PE fund or private equity firm raises capital from investors, uses this capital to buy real assets, tries to improve the value of these assets, and then sells them at a profit.
The key difference between traditional and infrastructure PE lies in the nature of the underlying investments. As mentioned, infrastructure PE exclusively targets infrastructure assets.
Common examples of assets that infrastructure PE funds or firms will invest in include:
- Utilities: Gas, electricity, water distribution, and telecommunications
- Energy: Power plants, oil terminals, pipelines, and renewable energy assets (like solar and wind farms)
- Transportation: Airports, seaports, and railways
- Social infrastructure: Hospitals and schools
Key Characteristics of Infrastructure Private Equity
Almost all infrastructure private equity assets or investments share the following characteristics:
- Low volatility and stable cash flow: Infrastructure assets are less sensitive to economic cycles and tend to generate stable cash flow. That’s because they provide essential services that remain in demand even during economic downturns.
- Low risk: Infrastructure assets are typically seen as low-risk compared to traditional private equity. For example, people will always need power and running water. Therefore, the possibility of the entities behind these utilities shutting down and ceasing to operate is low.
- Linked to macro indicators: Macro factors or indicators like GDP, inflation, and population growth can affect the demand for infrastructure. As a result, an infrastructure investor usually views infrastructure private equity as a good hedge. For example, during periods of economic turmoil (when the value of other investments might be going down), governments might choose to invest in infrastructure to stimulate economic growth and employment creation. The returns from an infrastructure investment could therefore help offset or limit any losses a PE fund or firm might make on its other investments.
- Strong cash yield: Unlike traditional private equity investments, where investors often need to wait for exit opportunities to get returns, infrastructure asset investors can enjoy dividend yields from their investments during the holding period.
- Low correlation with other asset types: Infrastructure assets are uncorrelated with other asset classes, including fixed income, stocks, and even real estate. As a result, they provide an excellent way for an infrastructure investor to diversify their portfolios.
The Process of Infrastructure Private Equity Deals
The process of executing private infrastructure deals involves the following stages:
Deal Origination
In this stage, PE firms or funds source potential investment opportunities through various channels or methods. For example, they can use a targeted screening process or leverage their industry relationships or proprietary networks to identify infrastructure assets that could be worth investing in. (P.S.: Looking for some tips on how to be a better deal originator? We’ve got you covered.)
Preliminary Screening
Identified assets or opportunities undergo a preliminary evaluation where key factors such as financial performance, growth potential, regulatory environment, and competitive landscape are assessed to determine their suitability for further consideration.
Due Diligence
If an asset passes the preliminary screening, detailed due diligence is conducted. Due diligence is one of the most critical stages in the infrastructure PE investment deal-making process.
The goal of due diligence is to thoroughly assess and evaluate the target asset to gain a comprehensive understanding of its strengths, weaknesses, risks, and opportunities. With this information, the PE can decide whether to move forward with the deal or abandon it.
PE firms can perform due diligence themselves or engage specialized consultants to assist with the process.
To ensure optimal outcomes, PE due diligence should include the following considerations:
- Financial due diligence: This involves examining the target’s financial condition. It might include an analysis of its financial statements, assets, cash flows, debts, and projections.
- Regulatory due diligence: Evaluation of the asset’s regulatory risks (this is especially important for heavily regulated infrastructure industries).
- Tax-due diligence: Assessment of the target company’s compliance with tax laws. This can include analysis of the target’s tax returns, audits, and agreements.
- Legal due diligence: An examination of the target’s legal liabilities (for example, are there any pending lawsuits?).
- Information technology (IT) due diligence: Assessment of the target’s IT infrastructure and cybersecurity risks.
- Human resources due diligence: Evaluation of the target’s workforce, including elements like benefits, salaries, and bonuses.
- Commercial due diligence: An assessment of the target assets’ industry and its position in the marketplace.
- Operational due diligence: An assessment of the target’s operational risks and opportunities.
Find out how CapLinked can help streamline your PE’s due diligence process for optimal outcomes.
Valuation and Structuring
Based on the findings of due diligence, the target asset is valued and the deal is structured.
The purpose of a valuation is to determine the intrinsic value of a target. Some of the key factors that infrastructure PEs should consider when valuing infrastructure assets that they are thinking of investing in are:
- Asset revenue and cash flow
- Market demand and growth opportunities
- Regulatory environment and contracts
- Asset condition and lifecycle
- Asset operating expenses
- Environmental and sustainability factors
Once the valuation is done, the next step is to structure the deal. Structuring infrastructure private equity deals involves designing the optimal framework for the acquisition and management of assets.
For example, the parties to the deal may agree to:
- An asset sale — where the PE acquires some or all the assets of the target (e.g., its physical or intellectual property).
- A share sale — where the PE takes over or purchases the entire business, including its assets and liabilities.
- A merger or acquisition — where the two become one entity, either under the name of the target firm, the PE, or a completely new name.
Financing
With valuation and structuring done, the next step is to secure financing for the acquisition of the target infrastructure asset.
Financing a PE infrastructure deal can take many forms. Usually, private equity infrastructure funds or firms will just use the money raised from their limited partners (investors) to finance the transaction.
In some cases, the PE might combine investors’ funds with debt financing from banks or other lenders.
Negotiation and Documentation
Once the PE firm has come up with a valuation of the target, settled on an appropriate deal structure, and secured financing, the next step is to initiate negotiations with the owners of the target infrastructure asset.
Here, the terms and parameters of the transaction, including the purchase price, warranties, representations, and other key provisions, are discussed and documented in legally binding agreements.
Closing
After negotiations and agreeing on terms, the transaction is finalized. This involves the exchange of funds, the completion of legal formalities, and the transfer of ownership and control of the asset to the infrastructure PE firm.
Asset Management
Once the deal has been closed, the infrastructure PE firm takes an active role in managing and optimizing the asset’s operations and performance. Asset management may involve implementing operational improvements, expanding the asset’s capacity, optimizing cost structures, improving environmental sustainability, and monitoring regulatory compliance.
The goal is to enhance the value of the asset over the long term and, depending on its nature, generate stable cash flow for investors.
Key Players in Infrastructure Private Equity
The infrastructure private equity space consists of several key players. Here are the most important ones, together with their respective roles and duties.
Infrastructure Private Equity Firms and Funds
Private equity infrastructure funds or firms are basically entities that specialize in investing in infrastructure assets. These firms will typically have great industry expertise and relationships, as well as dedicated teams responsible for sourcing, evaluating, and managing infrastructure investments on behalf of their investors.
Investors
Investors in infrastructure private equity include institutional investors, pension funds, sovereign wealth funds, and high-net-worth individuals. These are the people who provide the capital necessary for private equity firms to invest in infrastructure assets.
Sponsors and Project Developers
Sponsors and project developers play a crucial role in originating and developing infrastructure projects, often partnering with private equity firms to bring projects to fruition.
Government Involvement in Public-private Partnerships (PPPs)
Governments can also sometimes be involved in infrastructure PE. This is usually in the form of public-private partnerships (PPPs).
Public-private partnerships (PPPs) are collaborations between public sector entities (like the government) and PE funds and firms. These collaborations can be used to finance, build, and even operate projects or infrastructure like public transportation networks, parks, and convention centers.
Typically, the private entity contributes capital and expertise to the project while the government provides certain financial guarantees or support. For example, a PE fund may construct a toll road on behalf of the government in exchange for some of the operating profits of the completed project.
PPPs offer an opportunity for PE investors to participate in infrastructure projects that have a significant impact on society while still generating good returns.
Evaluating Infrastructure Assets for Investment
When evaluating infrastructure assets for investment, PEs can categorize them into the following four buckets, depending on the level of risk that each poses and the possible returns.
Core
Core infrastructure investments are characterized by low-risk and stable incomes. Typically, these are well-established, income-generating assets with long-term contractual agreements and predictable cash flows.
The downside of these assets is that they have zero to limited growth, plus their internal rate of return (IRR) is usually low — below 10%.
The stable nature of these assets means that they are mainly targeted by investors who have low return targets and whose priority is consistent, long-term income. An example is regulated electricity distribution assets like power lines.
Core-plus
Core-plus infrastructure investments incorporate slightly higher-risk assets than core investments. However, they tend to generate higher returns. They also tend to have some room for growth.
The IRR of these assets is usually in the lower teens, with returns coming from both cash flow and capital appreciation.
Value-add
Value-add infrastructure investments involve even higher risk but have the potential for high returns. They require active management, operational improvements, or significant capital expenditures from the PE fund or firm to enhance their value.
During the holding period, the majority of potential returns are from capital appreciation rather than cash flow.
An example of a value-add investment is a PE fund or firm buying a small local airport and expanding it into a regional airport.
Opportunistic
Opportunistic infrastructure investment strategies carry the highest level of risk and potential reward. These investments involve assets that may be distressed, underperforming, or have significant development or operational complexities.
While the potential IRR can be as high as 15%+ (mainly from capital appreciation), these assets usually come with a huge downward risk since things may not always go as expected after the buyout.
Opportunistic assets are typically pursued by experienced investors with a higher risk appetite and the ability to navigate complex situations.
Exit Strategies and Opportunities in Infrastructure PE
At the moment, there are two main exit routes for infrastructure private equity.
Sale to Strategic Buyers
Private equity investors may sell their infrastructure assets to strategic buyers, such as other infrastructure companies or industry participants seeking expansion or synergies.
Secondary Buyouts
This involves PE infrastructure funds or firms that are invested in different categories of infrastructure assets selling their ownership stakes or interests to one another.
For example, a private equity firm that has invested in core infrastructure assets may sell it to another one that has invested in core-plus infrastructure. Alternatively, a core-plus invested fund may sell to a value-add fund, and so on.
Wrapping Up
Infrastructure assets can provide steady and predictable cash flows for private equity investors and also act as a good hedge.
That said, infrastructure PE is not completely risk-free. In fact, before investing in any infrastructure asset, it’s important to carry out sufficient due diligence to make sure that there are no major risks or liabilities.
One important tool to have when conducting due diligence is a virtual data room (VDR). This is a secure online vault that allows you to store, manage, and share sensitive documents and data.
There are many virtual data room providers out there, but not all are worth their salt. That’s why you should consider a reputable and proven provider like CapLinked.
With enterprise-grade security and advanced features like digital rights management, collaboration tools, and customizable permissions, CapLinked Virtual Data Rooms are specially built to keep you organized during the due diligence phase of your transaction for a fast, streamlined process.
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Sean LaPointe is a freelance writer with experience in finance. He has previously written for several well-known brands and publications, including The Motley Fool and Angi/HomeAdvisor.
Sources
Investopedia: Public-Private Partnerships (PPPs): Definition, How They Work, and Examples
Pitchbook: Due diligence checklist for VC, PE and M&A investors
InformaConnect: “Infrastructure can also exit”
Nuveen: Nuveen’s EQuilibrium Global Institutional Investor Survey
