Infrastructure sector anticipates stronger year ahead

Despite doom and gloom merchants predicting the onset of recessionary conditions across a number of industry verticals, reports of the demise of the infrastructure sector have been greatly exaggerated.

Over two-thirds of senior executives within the European infrastructure and transport industry expect the volume of deals and level of financial investment in European infrastructure projects for the next 12 months to either increase or remain consistent with the past year, according to a recently released survey by international law firm Freshfields Bruckhaus Deringer. The results follow a tough year so far for the industry, with the credit crunch contributing to activity dropping 40% in terms of number of deals completed during the first six months of 2008, compared with the same period in 2007.  

Activity levels for the next 12 months are expected to be concentrated on energy utilities (61%) and renewable energy (56%) with transport projects on roads (53%), rail (45%) and aviation (44%) also likely to feature. Social infrastructure projects, such as schools (33%), hospitals (28%) and prisons (22%) – which in recent years have experienced a boom – are, in contrast, expected to slow.

“With the credit crunch denting optimism across so many industries, the infrastructure and transport sector appears to be holding strong and pointing towards a decisive focus on traditional infrastructure, particularly energy and renewable projects but also rail, road and aviation,” says Nick Bliss, co-head of Freshfields’ Global Infrastructure and Transport team.

Among the reasons behind the industry’s focus on energy and renewables, Bliss cites the skyrocketing price of oil, the fact that governments worldwide are keen to improve energy security, dwindling energy reserves, nuclear plants coming to the end of their lifecycles, the unbundling of the European energy market, demand and growth of energy requirements in the emerging markets, as well as the regulatory and socially driven impetus for the energy sector to respond to climate change as major factors. “There’s a plethora of urgent issues stoking up demand for new, modern energy infrastructure,” he says.

Funding investment
A more detailed analysis of the results from specific respondent categories suggests investors being slightly more optimistic (80% expecting European deal volumes to increase or stay the same) than credit providers (60%) – a distinction far less discernible in relation to expected deal values (68% compared to 60%).

Despite a more positive outlook for the future, constraints within the market remain: the increasing cost of debt, continued downward pressure on individual credit providers’ exposure levels, the tightening of covenant packages and limited accessibility to the capital markets, particularly after recent monocline downgrades. “Market conditions are undoubtedly tougher, but recent deal closures and forward-looking announcements can give cause for optimism,” says Bliss.  

Recently completed deals include the Future Strategic Tanker Aircraft (FSTA) deal in the UK (which had a UK£2.2 billion senior debt requirement plus UK£105 million mezzanine and UK£180 million equity bridge facilities); and the UK£3.6 billion acquisition of Angel Trains. Future projects that have been recently announced include high-speed rail programmes in Portugal and Poland, the ongoing public private partnerships (PPP) road programme in Russia and India and PPPs in the USA – including the long-anticipated US$12.8 billion acquisition of the Pennsylvania Turnpike.

Longer-term view
The expected picture for the year ahead is consistent and, in fact even starker, when applied to the next 10 years where renewable energies (77%) and energy utilities (65%) are expected to provide the greatest opportunity for growth. These are followed by road (53%), rail (49%) and significantly, nuclear (45%) ahead of aviation (43%). Schools (32%), hospitals (25%) and prisons (23%) are not widely regarded as major growth areas.

“The continued strength of interest in transport infrastructure such as roads, rail and airports is not surprising given the attractiveness of the long-term stable returns that can be generated by such assets to a growing group of investors such as infrastructure funds, pension funds and sovereign wealth funds,” continues Biss. “However, over the long-term the highest levels of activity are, once again, expected to be in energy.”

Bliss warned that one of the main challenges for continued growth in infrastructure deals for the year ahead remains pricing and, invariably, funding. The large infrastructure deals of 2006, such as Ferovial’s acquisition of BAA and Macquarie’s acquisition of Thames Water, were supported by the availability of cheap and readily available debt. The debt markets have clearly undergone a radical change since August 2007, leading to higher levels of equity, vendor loans (to sustain, as far as possible, vendor exit price expectations) and an almost-total closure to infrastructure deals of the monoline wrapped bond market (exacerbated by the recent MBIA and Ambac downgrades). This has consequently led to an increased reliance upon bank debt, higher debt margins, reduced ticket sizes on the part of banks, tighter covenant packages and more conservative financial ratios.

“The overwhelming view from the survey’s respondents is that sellers’ price expectations are too high and remain at pre-credit crunch levels with only limited evidence to the contrary. The market is, in truth, expecting a price correction for infrastructure assets which has not yet come through,” concludes Biss.

Infrastructure financing impervious to credit crunch
Infrastructure project financing has largely escaped the credit crunch and growth prospects appear solid in most parts of the world, according to Standard & Poor’s. “The stability that typifies project finance around the world has remained eminent so far this year, even through the credit market turmoil, the economic downturn and the negative rating actions taken on monoline bond insurers,” S&P says in a new Industry Report Card for the sector.

Despite some downgrades, negative outlook revisions and CreditWatch placements for several projects related to this last factor, credit quality in the sector remained healthy. As of May 2008, investment-grade entities accounted for about 70% of Standard & Poor’s Ratings Services’ Global Project Finance portfolio. About 78% of those ratings have a stable outlook. Of the remaining projects, 33 have a negative outlook, 14 ratings are on CreditWatch with negative implications, nine have a positive outlook, and three ratings are on CreditWatch positive. The increased number of negative outlooks and Watch implications are largely due to a decline in financial and operational performance at several projects, as well as a reflection of the explicit actions on monoline insurers.

The project finance market remained active globally throughout the quarter. Since the last report card on this sector, Standard & Poor’s rated 12 new transactions. Seven of those have investment-grade ratings, demonstrating the strong credit quality associated with infrastructure projects and power facilities.

The North American public/private partnership (PPP) segment stands to flourish through the end of 2008, with several infrastructure projects reaching the financing stage and the expectation that power assets will continue to change hands. Hotel and stadium projects were forecast stable outlooks, while rising natural gas prices should further strengthen market conditions in the power sector.

Despite different issues that projects in different regions must tackle and common ones such as the monoline situation, global project financings continue to be an attractive means for economies worldwide to develop, maintain growth and provide resources. “Expectations are for increasing demand in infrastructure projects around the world. Although there will always be obstacles to overcome, the foundation for global project financings has been set with endless opportunities,” concludes the report.