Promoting investment in American infrastructure

Posted by MIRA Funds

April 01, 2017



01   Overview

Overview

Karl Kuchel is chief executive officer of Macquarie Infrastructure Partners, which manages more than $8 billion in US and Canadian infrastructure assets, including regulated utilities, toll roads, ports, renewable energy, midstream oil and gas, power, waste, and telecommunications. In this interview with McKinsey, Kuchel discusses the future of private investment in US infrastructure.

 

This article was first published in Voicesglobalinfrastructureinitiative.com.


McKinsey: What are the barriers to increasing private investment in US infrastructure?

Karl Kuchel: In the United States, private-sector investors have invested significant capital in many infrastructure sectors, including energy (regulated utilities, power, midstream oil and gas, renewables), ports, rail, wireless towers, and fiber networks. These investments may be held via listed companies or unlisted vehicles. The primary consideration for these investments is generally whether they are able to deliver reasonable risk-adjusted returns

There are a number of additional challenges for private capital looking to invest in US infrastructure, relating to toll roads, airports, and social infrastructure that traditionally have been developed, owned, and managed by the public sector. In many cases, there is political and public skepticism over public–private partnerships (PPPs), privatizations, or other innovative solutions involving the private sector. This can make it tough for governors or mayors to convince their constituencies of the merits of taking this route to deliver major infrastructure assets. Questions can arise regarding how the project will be operated, the level of risk-transfer benefits, and the profits that will be earned by the private sector. It is incumbent on the private sector to assist in educating politicians and the general public on these matters.

Also, in many cases, the lack of a systematic approach to procurement, negotiation, and implementation of potential transactions involving the public sector can increase execution risk and may reduce the private sector’s interest in a given project. These challenges are not new. There has been progress in addressing them over the last 10 to 15 years. The Trump administration’s focus on infrastructure investment could help to accelerate private participation in traditionally publicly owned infrastructure assets.

 

McKinsey: Interest rates have risen recently in the United States. How will that affect infrastructure pricing, development, and acquisitions?

Karl Kuchel: In general, the broad infrastructure asset class performs better on an absolute basis in a stable and improving macroeconomic environment. This is because the operating performance of many infrastructure assets is correlated with major macroeconomic trends. This can be due to revenue being linked to consumer-price-index escalators; regulation that allows higher costs to be passed on to customers; or simply from higher demand for the services provided. These higher earnings offset the debt service costs and required returns on equity associated with higher interest rates—and help to support asset valuations.

Higher interest rates will most adversely affect the valuation of infrastructure assets that have bond-like characteristics. These kinds of projects typically have very stable, low- growth cash flows. Given that these assets look like bonds, they should trade like bonds—that is, inversely with interest-rate expectations.

The public sector has missed an important opportunity to improve infrastructure through borrowing over the past five to seven years, when interest rates were at record lows. Higher interest rates, alongside current public-sector funding constraints, should help drive a greater degree of private-sector collaboration and more opportunities for infrastructure investment.


McKinsey: Will global currency volatility affect capital flows into infrastructure?

Karl Kuchel: Global capital flows into the infrastructure asset class have been robust over the past few years, with investors seeking assets that provide stable returns and long- term, dependable cash flows. Clearly that underlying investment performance can be materially influenced by currency volatility.

Infrastructure investors must consider the impact of currency when investing outside their home jurisdiction and consider using suitable hedging, either on an individual investment basis or across their entire investment portfolio.

We have seen this with recent US dollar strength and the impact it has had on the relative valuation of overseas infrastructure assets held by US investors on an unhedged basis. We also continue to see very strong interest from global investors in US infrastructure, as many are underweight and also because of the dollar’s role as the world’s primary reserve currency.

 

McKinsey: Are there new financing approaches that the United States should consider?

Karl Kuchel: Yes. One is a variation on Australia’s successful Asset Recycling Initiative, which provides incentive payments for state and local governments to fund infrastructure growth. In the United States, the federal government could offer state and local governments incentives to sell or lease their brownfield assets on the condition that the proceeds are reinvested in new infrastructure. This type of incentive would help politically “de-risk” public–private deals for state and local governments. The federal government could also expand the use and availability of private activity bonds for public projects.

The US has 31 large hub airports with a combined asset value worth billions of dollars. This untapped equity could be used by cities and states to fund other infrastructure needs. The US Federal Aviation Administration’s Airport Privatization Pilot Program and related tax provisions could be altered to encourage local officials to pursue these concession transactions.

Finally, as part of implementing its grant or incentive programs, the federal government should also encourage states to include PPPs in their approach to delivering infrastructure.

 

McKinsey: Where are the brightest prospects?

Karl Kuchel: In North America, energy infrastructure is likely to continue to provide the largest number of investment opportunities, by deal quantity and dollar value. This should include supply-related midstream assets as well as gas-fired power plants and renewables to replace the retirement of coal-fired power plants. Investors’ risk appetite will determine which opportunities within this sector are most attractive.

The sale of high-quality, low-risk infrastructure assets in the United States is expected to continue, although in some cases, considerations such as regulatory approvals will affect the level of competition for assets.

In general, for investors looking to build a diversified infrastructure portfolio, patience and discipline will be required to find projects across different sectors that meet their risk-return requirements.

For more information about our infrastructure capabilities, please contact us.

This market commentary has been prepared for general informational purposes by the authors who are part of Macquarie Infrastructure and Real Assets (MIRA), a business division of Macquarie Group (Macquarie), and is not a product of the Macquarie Research Department. This market commentary reflects the views of the authors and statements in it may differ from the views of others in MIRA or of other Macquarie divisions or groups, including Macquarie Research. This market commentary has not been prepared to comply with requirements designed to promote the independence of investment research and is accordingly not subject to any prohibition on dealing ahead of the dissemination of investment research. Nothing in this market commentary shall be construed as a solicitation to buy or sell any security or other product, or to engage in or refrain from engaging in any transaction. Macquarie conducts a global full-service, integrated investment banking, asset management, and brokerage business. Macquarie may do, and seek to do, business with any of the companies covered in this market commentary. Macquarie has investment banking and other business relationships with a significant number of companies, which may include companies that are discussed in this commentary, and may have positions in financial instruments or other financial interests in the subject matter of this market commentary. As a result, investors should be aware that Macquarie may have a conflict of interest that could affect the objectivity of this market commentary. In preparing this market commentary, we did not take into account the investment objectives, financial situation or needs of any particular client. You should not make an investment decision on the basis of this market commentary. Before making an investment decision you need to consider, with or without the assistance of an adviser, whether the investment is appropriate in light of your particular investment needs, objectives and financial circumstances. Macquarie salespeople, traders and other professionals may provide oral or written market commentary, analysis, trading strategies or research products to Macquarie’s clients that reflect opinions which are different from or contrary to the opinions expressed in this market commentary. Macquarie’s asset management business (including MIRA), principal trading desks and investing businesses may make investment decisions that are inconsistent with the views expressed in this commentary. There are risks involved in investing. The price of securities and other financial products can and does fluctuate, and an individual security or financial product may even become valueless. International investors are reminded of the additional risks inherent in international investments, such as currency fluctuations and international or local financial, market, economic, tax or regulatory conditions, which may adversely affect the value of the investment. This market commentary is based on information obtained from sources believed to be reliable, but we do not make any representation or warranty that it is accurate, complete or up to date. We accept no obligation to correct or update the information or opinions in this market commentary. Opinions, information, and data in this market commentary are as of the date indicated on the cover and subject to change without notice. No member of the Macquarie Group accepts any liability whatsoever for any direct, indirect, consequential or other loss arising from any use of this market commentary and/or further communication in relation to this market commentary. Some of the data in this market commentary may be sourced from information and materials published by government or industry bodies or agencies, however this market commentary is neither endorsed or certified by any such bodies or agencies. This market commentary does not constitute legal, tax accounting or investment advice. Recipients should independently evaluate any specific investment in consultation with their legal, tax, accounting, and investment advisors. Past performance is not indicative of future results.

 

This market commentary may include forward-looking statements, forecasts, estimates, projections, opinions and investment theses, which may be identified by the use of terminology such as “anticipate”, “believe”, “estimate”, “expect”, “intend”, “may”, “can”, “plan”, “will”, “would”, “should”, “seek”, “project”, “continue”, “target” and similar expressions. No representation is made or will be made that any forward-looking statements will be achieved or will prove to be correct or that any assumptions on which such statements may be based are reasonable. A number of factors could cause actual future results and operations to vary materially and adversely from the forward-looking statements. Qualitative statements regarding political, regulatory, market and economic environments and opportunities are based on the authors opinion, belief and judgment.

 

Other than Macquarie Bank Limited ABN 46 008 583 542 (MBL), none of the entities noted in this document is an authorized deposit-taking institution for the purposes of the Banking Act 1959 (Commonwealth of Australia) or banking legislation in other jurisdictions. The obligations of these entities do not represent deposits or other liabilities of MBL. MBL does not guarantee or otherwise provide assurance in respect of the obligations of these entities.