Opportunities in Infrastructure
Thursday , February 22, 2007
By Jonathan Hoenig
Infrastructure businesses are the skeletons of economic activity — the essential things we use everyday but don't think much about. Generally, they're assets where a natural or near-natural monopoly exists, such as a toll road or power grid. Parking lots, water utilities, roads and airports, even cell phone towers are all considered infrastructure assets. Over the last few years, it is an area of the capital markets that has undergone unprecedented growth.
The appeal of infrastructure investment is obvious. High barriers to entry make direct competition difficult. Imagine the cost of building a new airport to compete with an existing one. Plus, the assets are all physical and localized — you can't outsource a toll road to India, or use the Internet to offer cut-rate pricing on a gas pipeline. This makes infrastructure assets much less susceptible to the natural competition faced in almost every other industry.
Because infrastructure assets are economic necessities, have highly predictable revenue streams and require huge capital expenditures to build, they can provide excellent long-term income with reasonably low volatility. Although infrastructure assets are usually highly regulated, user fees for businesses such as toll roads or airport parking can be raised, making the asset class comparatively well insulated from inflation. This has prompted billions of income-seeking investment dollars to pour into infrastructure investments, as everybody from large pension funds to small retirees have sought attractive income streams to supplement low yields on bonds and real estate.
In almost every country besides the U.S., there has been a move toward government privatization of big-ticket infrastructure assets. Oddly, however, in the U.S., most infrastructure assets are still owned by government-related entities. LaGuardia Airport, for example, is owned and operated by the Port Authority of New York and New Jersey. In contrast, Auckland Airport, New Zealand's largest, is owned by a public company that's actively traded on the New Zealand stock exchange.
Two Mexican airport operators, Grupo Aeroportuario del Pacifico, S.A. de C.V. (PAC) and Grupo Aeroportuario Del Sureste SA de CV (ASR) actually trade on the NYSE. Yet American investors are relatively unaccustomed to the notion that, from toll roads to hydroelectric dams, large infrastructure assets can be attractive investment vehicles. In the States, we think about investing in airlines…but not in the airports themselves.
Slowly, that’s changing. The political trend has been shifting in the U.S. towards the privatization of more government-owned assets, a reality due largely to stretched state and municipal budgets. For example, in 2005, a group of investors paid the city of Chicago $1.83 billion for a 99 year lease to the Chicago Skyway, a toll road just 7.8 miles long. Last year, 150 miles of Indiana’s Interstate 80 was auctioned off to a group of Spanish and Australian investors who will operate the road for 75 years. The benefit to the local government? A cool $3.8 billion dollars.
These sorts of arrangements are commonplace across much of the world, with toll roads in Italy, Portugal, Spain, Australia and many others either owned or operated by private, for-profit companies…even in semi-socialist France.
Supporters of such plans often cite how private companies are significantly more effective operators. For example, one of the main criticisms of state toll authorities is that they engage in “earthquake pricing” — long stretches of no rate bumps, then suddenly a large increase, or “earthquake,” where toll prices might jump 40% or more. Private firms tend to change prices more regularly, but in smaller and less disruptive fashion. Private firms also tend to make better improvements and investments in the assets themselves, such as installing electronic toll collection systems that make it easier to pay fares.
The international leader in infrastructure investments is Macquarie Bank, a fast-growing, Australian company that has almost single-handedly spearheaded a major market expansion of infrastructure as an asset class. Typically, Macquarie buys a collection of infrastructure investments, bundles them into a fund, and sells them to yield-hungry investors anxious for predictable dividends, stable returns and a relatively diversified risk.
A few examples of its funds include the A$7.1 billion Macquarie Infrastructure Group (ASX: MIG), one of the largest private developers of toll roads in the world with 11 of them across six countries. Macquarie Airports (ASX: MAP), also listed in Australia, owns interests in airports in Sydney (Australia), Rome (Italy), Copenhagen (Denmark), Brussels, Birmingham and Bristol (both U.K.). Macquarie Communications (ASX: MCG) invests in communications infrastructure such as satellites, broadcast and wireless towers. These investments have been among the best performing asset classes worldwide in recent years.
Unfortunately, the vast majority of the
firm's infrastructure funds trade only in Australia, making them
essentially unavailable for U.S. investors. Responding to increased
demand, the bank has listed a few funds in the U.S. that domestic
investors might find of interest.
Macquarie/First Trust Global Infrastructure/Utilities Dividend and Income Fund (MFD) invests primarily in utilities and pipelines, both of which have been exceptionally strong amid an environment of rising energy prices. Foreign assets are emphasized, with less than 10% of the fund's holdings domiciled in the U.S. Many holdings, such as the U.K.'s AWG plc and Kelda Group plc, are unavailable to U.S. investors as American depositary receipts. The fund currently yields 6.2% and has risen almost 20% over the past 12 months.
For a true pure-play on infrastructure assets, U.S. investors can investigate Macquarie Infrastructure (MIC), a trust that owns a diversified group of infrastructure businesses worldwide. Launched in December 2004, the company pays quarterly dividends and currently sports a yield of 5.6%.
Like other infrastructure assets, MIC
tends to be uncorrelated to major U.S. stock indexes, making it an ideal
diversification for portfolios heavy on equities and short on income.
The company also owns The Gas Company, a producer and distributor of natural gas and propane to over 36,000 customers in Hawaii. Shares are up over 15% over the last 12 months.
The Macquarie Global Infrastructure Total Return fund (MGU) holds primarily electric and gas distribution assets, along with natural gas pipelines, water utilities and an approximately 12% allocation to airports and toll roads. The vast majority of holdings are foreign, and in an effort to increase total return, the fund can also write call options against existing positions to generate premium income, a strategy that can work well in relatively trendless markets.
Investors should do their own due diligence. But given recent returns, it’s hard not to imagine more money speeding down the road of investing in infrastructure…the very mechanisms that make a global economy work.
Jonathan Hoenig is managing member at Capitalistpig Hedge Fund LLC and markets editor for Smartmoney.com. At the time of writing, Hoenig's fund held no positions in the securities mentioned.