The greenfield infrastructure investment opportunity

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Andy Matthews, Head of Greenfield Infrastructure, Infracapital

Andy Matthews joined Infracapital, the infrastructure investment arm of M&G, in 2015 to lead its greenfield infrastructure investment activities. He is an industry veteran with over 30 years’ infrastructure financing, development and asset management experience, most recently as a partner in 3i plc’s infrastructure team. He was responsible for origination in greenfield and brownfield PPP, renewable energy and core infrastructure sectors. Andy transferred to 3i plc following its 2013 acquisition of Barclays Infrastructure Funds, where he was Managing Director and Chief Investment Officer.

Since joining Infracapital, Andy has originated and executed several greenfield acquisitions, committing over £100 million across Infracapital’s greenfield mandate, and he holds directorships of Tidal Lagoon Swansea Bay and Bioenergy Infrastructure Group.

Andy’s early career included commercial roles at John Laing and Alfred McAlpine on major civil engineering projects in the roads, rail and utilities sectors. He holds an MBA from Manchester Business School and graduated from Nottingham Trent University with a BSc (Hons) in Quantity Surveying. He is a Fellow of both the Royal Institute of Chartered Surveyors and the Chartered Institute of Arbitrators.

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The vast requirement for new infrastructure across Europe is providing pension schemes, sovereign wealth funds and other institutional investors with an attractive investment opportunity.

Greenfield infrastructure investment finances new assets at the construction stage, in contrast to acquiring already-operational ‘brownfield’ infrastructure. It offers investors an early entry point to ownership of infrastructure, typically at a higher return than brownfield and with a steady yield over the very long term, in return for accepting a degree of execution risk. In this paper, Andy Matthews, head of greenfield infrastructure at Infracapital, M&G’s infrastructure investment arm, outlines the main investment considerations.

Infrastructure from schools and ports to power generation and housing is essential to our daily lives and vital to generating sustainable long-term economic growth. As economies grow, the requirement for new infrastructure increases and with it the need for investment to construct the assets. This is greenfield infrastructure investment – the provision of finance and expertise, either public or private, to essential infrastructure projects at their development or construction phase in order to create new working assets.

Development of new infrastructure has traditionally been the remit of governments and public sector agencies, yet the scale of investment required is now far greater than the budgets available to most national and supranational authorities. As a result, a wide range of investible projects is emerging for long-term investors to own and manage from the drawing board through to being fully operational.

Greenfield is often considered in contrast to brownfield infrastructure yet they are two complementary phases of an asset’s project lifecycle. Greenfield investments provide early access to opportunities that will ultimately develop into brownfield. Investments in the pre-construction or pre-expansion phases are considered greenfield, while brownfield investments take place in operational phases.

Greenfield is a relatively new market segment for institutional investors to invest in. Little capital has flowed into greenfield investment to date, yet pension schemes and other institutional investors have already proven to be effective owners and stewards of mature infrastructure assets, and both investment types share the long-term investment horizon required to own an asset from development to completion and beyond. Greenfield investment provides access to the early stage of an asset, where higher yields are created, and the later stage where they are received.

and social infrastructure, such as schools and hospitals – infrastructure that Western and Central Europe must build in order to meet the needs of a growing population and to lay adequate foundations for sustainable economic growth.

The scale of this requirement for new infrastructure is almost unprecedented. It is estimated that 75% of global infrastructure that will exist in 2050 has not yet been constructed.1 The Organisation for Economic Development estimates that US$30 trillion or more will be needed by the year 2030 across its 34, mainly European, member countries. In the near term, the European Commission’s Investment Plan, known as the Juncker plan, aims to unlock €315 billion investment in strategic infrastructure in the three years to 2017.

Many European national governments have responded to the challenge by developing their own plans to fund new projects, for which there is a crucial role for private sector finance. The UK’s National Infrastructure Plan assumes 64% of the UK’s £411 billion infrastructure pipeline over the next five years will be privately financed. In the Netherlands, major infrastructure plans include a €2.5 billion public-private partnership investment in roads and up to €5 billion invested in offshore wind projects. In the Nordic countries, plans include liquefied natural gas projects and around €10 billion investment for new roads and tunnels.

These governments recognise that for private sector investors, namely pension schemes, sovereign wealth funds and insurance companies, to be attracted to greenfield infrastructure, governments must support greenfield investment by providing certain incentives and support networks – such as guarantees or subsidies for some renewable energy development.

While private sector investment has in some cases been substantial – it averaged £4.6 billion per year from 2000 to 2015 in the UK under the government’s private finance initiative2 — these sums pale relative to what will be needed during the coming decade based on official projections.

1 Ecos, Sustainable Infrastructure as an Asset Class, January 20142 National Audit Office, The choice of finance for capital investment, April 2015

European infrastructure demand far exceeds greenfield funds raised since 2010

350300250200150100500 400 21€ billion

Juncker plan

Greenfield funds raised since 2010

European Commission

€ trillion

Source: From top: The European Commission estimates that the EU may need €2 trillion of infrastructure investment by 2020; the European Commission Investment Plan 2014 (Juncker Plan) aims to mobilise €315 billion investment in 2015-2017; Preqin, infrastructure funds raised since 2010 with Greenfield and Europe focus. Where no greenfield allocation was specified, 50% has been assumed.

The greenfield infrastructure investment opportunity

Building a modern Europe

Greenfield projects encompass communications, transport, energy generation (including renewable energy generation)

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Greenfield today, brownfield tomorrow

The greenfield lifecycle begins with plans drawn up by a project developer and moves through several phases before it becomes operational. Early stages are design, planning and obtaining of consents and licences, while later stages include contractual structuring, finance raising, financial close and construction. After construction and/or expansion, investments enter ‘steady state’ commercial operations, which can last for 25 years or more due to the long term nature of infrastructure assets.

Late-stage development can take one to two years and there may be three to five years more of construction and expansion after it, but greenfield assets typically take around three years from late-stage development to end of construction.

Source: Infracapital, proprietary Infracapital transaction information. As at 25 January 2016. Target returns have been estimated by Infracapital using assumptions based on market conditions and anticipated investment opportunities. One or more of these assumptions may prove to be inaccurate. Consequently, such target returns are not indicative of future results and there can be no assurance that the fund will achieve comparable results.

Investment in the unlisted equity of a greenfield project can help solve challenges facing pension schemes and other institutional investors, alongside answering the conundrum of economic growth for governments.

As each asset moves from building site to operational, it starts to create revenue and thus reward its equity investors with a comparatively higher yield than brownfield, often linked to inflation. Predictable cashflows are generated throughout the typically 25-year investment term post the construction period.

Over the long term, investors are compensated for the gap in yield between a project’s financial close and its operational launch with access to long-term yields well in excess of equivalent brownfield infrastructure to meet their liabilities and commitments. Institutions seeking long-dated income, for future pension payments, for instance, are typically willing to forego yield for a short period in order to access high-quality cashflow for many years ahead.

Alternatively, investors can dispose of assets early in the operational phase with the aim of crystallising a significant capital gain, as there is a ready brownfield market keen to acquire assets when they are fully in operation.

Indicative returns throughout the project lifecycle

Greenfield as a solution

Expected average return: operational brownfield

Higher volatility of returns reflecting higher risk Expected high teen return to end of construction period

Expected average return: later development / construction

Operational (brownfield) stage10-25 years

Later development / construction stage

Early development stage1-2 years

Expected average

return

Lifecycle

Sweet spot: later stage greenfield potential to deliver premium returns and opportunity to mitigate a number of risks

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Returns and risks

It is possible to invest at any stage of an infrastructure project’s lifecycle, but returns reflect the risk: returns increase the earlier you enter the lifecycle, as compensation for the higher risk of those returns. An asset’s value grows with every phase successfully achieved, typically accreting significant value during late-stage development, construction and expansion.

Managers with the specialist expertise and experience to manage projects through financial close, structuring, tendering for contractors, and construction can protect value and take advantage of the extra returns that can be earned from participating in these phases.

Expected returns on greenfield projects vary since every asset is a different size and shape; however, developers, which like venture capitalists assume the risk that some projects will not reach completion, can target a payoff of several times the original investment on assets that do

become operational. A manager that participates in project structuring prior to construction of assets (typically a year) will usually expect an IRR in the mid to high teens, depending on project life, while coming in at construction phase could result in returns in the region of a few hundred basis points lower than this. Both would deliver a return well in excess of that expected on an equivalent brownfield portfolio.

Cashflows on a portfolio of assets typically follow a J-curve, with cash outflows after financial close as capital is deployed in the construction and expansion phases, which turn rapidly upwards to accumulated cashflows significantly higher than the starting point as assets become operational.

The impact of this initial downward curve can be mitigated by constructing diversified portfolios of assets (in the context of unlisted infrastructure) from the full breadth of sectors available with different development times, to ensure positive cashflows even while other assets are still in development.

Greenfield infrastructure in action: Bioenergy Infrastructure Group

The Bioenergy Infrastructure Group (BIG) platform launched in October 2015 to invest in the construction of biomass and Energy from Waste (EfW) plants.

BIG has been established to invest in greenfield renewable energy projects that will support jobs and economic growth across the UK. Supported by government subsidy, it will help satisfy growing demand for reliable and environmentally sustainable power generation and waste management, which reduces landfill.

Its first project is a new £87 million 21.5MW biomass plant in Cheshire in the UK’s largest resource recovery park to provide enough electricity to power 40,000 homes. Infracapital, M&G’s infrastructure investment arm, initially acquired a 70% stake in the platform providing access to future development projects, and has already made a second investment in a project in Hull.

This platform offers investors exposure to a diverse set of greenfield projects that can offer high long-term yields and predictable, often inflation-protected cashflows.

Construction has commenced on Bioenergy Infrastructure Group’s 24MW energy from waste plant, Hull

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Risk mitigation is crucial

A seasoned greenfield manager will view construction and other risks as known entities to be mitigated through measurable risk management techniques. These management techniques include the strict selection and incentivisation of construction partners; the structure of contracts, with specific risks transferred to partners where possible; effective cost management and identification of economies of scale; and appropriate insurance. Handling construction contractors, managing budgets and ensuring a project is delivered on (or ahead of) time are core skills for a greenfield fund manager.

It is also critical to pay close attention to the regulatory and political environment when assessing a project’s prospects. Industry sectors such as renewable energy, utilities and transport infrastructure typically involve price contracts, concession agreements, subsidies or government guarantees. Most greenfield developments additionally require permits, licences and leases from government entities. Where the environment for securing these is transparent and stable it creates favourable conditions for private sector investment, but changes in government policy can create uncertainty.

Contractual and counterparty risk of this kind is of course present in brownfield assets too, so experienced infrastructure managers will typically have the expertise to mitigate the impact of regulatory or political change. Rigorous stress testing prior to investment can evaluate whether an asset is financially viable and an attractive investment should the level of government support change. Conservative assumptions in the structuring process can also help to ensure the resilience of assets.

Diversification is another effective risk mitigation strategy in greenfield portfolios. Infrastructure sectors have different characteristics and varying degrees of risk, based on factors such as barriers to entry and relative sensitivity to economic cycles. Combining assets such as utilities (consistent income stream and low correlation with GDP growth) with energy (high growth potential, less inflation linkage) and transport (strongly correlated with economic growth and high level of indexation) can create a diversified portfolio with a reduced and balanced risk profile.

Greenfield investment in action: Gigaclear

Gigaclear provides ultrafast broadband connectivity to rural communities in the UK, offering consumers a download speed 50 times faster than the national average. It meets the need for reliable communications infrastructure that can support consumers, local businesses and local economies. It is a growing company, partly backed by UK government grants, which provides an essential product to an underserved market.

In early 2015, the company operated 23 rural networks but needed equity finance to accelerate the build of 31 more, so its management team turned to long-term institutional investment. The finance has enabled Gigaclear to push ahead with the physical construction and operation of these planned networks, and help bridge the gap between rural and urban broadband access.

In return for making investments such as this, institutional investors gain access to businesses providing essential services, in well-regulated environments, that can deliver relatively higher total returns over the lifespan of the investment when compared to investment made at a later, operational stage.

A Gigaclear engineer lays broadband cables to underserved UK communities

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Infracapital and greenfield

Infracapital, the infrastructure investment arm of M&G, is one of the first fund managers to offer long term institutional investors a sector-wide, dedicated greenfield strategy focused on delivering access to core infrastructure assets at an earlier stage and a strong yield over a long-term investment horizon that can match liabilities. It can do so because its experienced team invests on a buy and hold basis, having experience in the financing, construction and the ‘steady state’ asset management associated with a time horizon of 25 years.

Infracapital draws on a long heritage of infrastructure investment at Prudential Group, which includes a 1935 investment in the Carsfad hydroelectric dam in Scotland, investments in the Severn and Dartford river crossings in more recent decades and a £300 million commitment to Infracapital’s greenfield platform from Prudential Assurance Company.

Head of Greenfield Infrastructure, Andy Matthews, is supported by a greenfield team including Director Michele Armanini, who has spent over a decade financing and structuring greenfield infrastructure investments across Europe. The team is further supported by existing greenfield expertise and cross-sector transaction execution and asset management capability within the wider Infracapital team.

Contact

Infracapital Team

Carolyn Pearce, Director Tel: +44 (0) 20 7548 2972 Email: carolyn.pearce@infracapital.co.uk

M&G Team

John Atkin, Director Tel: +44 (0) 20 7548 3466 Email: john.atkin@mandg.co.uk

Henry Barstow, Associate Director Tel: +44 (0) 20 7548 3469 Email: henry.barstow@mandg.co.uk

Stefan Cornelissen, Director Tel: +31 (0)20 799 7680 Email: stefan.cornelissen@mandg.co.uk

Sunita Dey, Associate Director Tel: +44 (0) 20 7548 3393 Email: sunita.dey@mandg.co.uk

Annabel Gillard, Director Tel: +44 (0) 20 7548 3258 Email: annabel.gillard@mandg.co.uk

Robert Heaney, Director Tel: +46 8 5025 6529 Email: robert.heaney@mandg.co.uk

Billyana Kuncheva, Director Tel: +358 9 4159 0488 Email: billyana.kuncheva@mandg.co.uk

Andrew Swan, Director Tel: +44 (0) 20 7548 2375 Email: andrew.swan@mandg.co.uk

Luuk Veenstra, Director Tel: +31 (0)20 799 7685 Email: luuk.veenstra@mandg.co.uk

For Investment Professionals only.

This guide reflects M&G’s present opinions reflecting current market conditions. They are subject to change without notice and involve a number of assumptions which may not prove valid. Past performance is not a guide to future performance The distribution of this guide does not constitute an offer or solicitation. It has been written for informational and educational purposes only and should not be considered as investment advice or as a recommendation of any particular security, strategy or investment product. Reference in this document to individual companies is included solely for the purpose of illustration and should not be construed as a recommendation to buy or sell the same. Information given in this document has been obtained from, or based upon, sources believed by us to be reliable and accurate although M&G does not accept liability for the accuracy of the contents.

The services and products provided by M&G Investment Management Limited are available only to investors who come within the category of the Professional Client as defined in the Financial Conduct Authority’s Handbook.

Infracapital is a division of M&G Investment Management Limited and is used by other companies within the Prudential Group. M&G Investment Management Limited is registered in England and Wales under number 936683 with its registered office at Laurence Pountney Hill, London EC4R 0HH. M&G Investment Management Limited is authorised and regulated by the Financial Conduct Authority.

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