One by one, the claims made by modern finance have been tested during this crisis and usually found wanting. The merits of infrastructure investment are the latest to come under scrutiny. Infrastructure assets-roads, airports, utilities and the like-are supposed to provide stable if unspectacular long-term returns that are relatively immune to the peaks and troughs of the economic cycle.
That assumption is being tested by the severity of the economic downturn. On May 5th BAA, the main operator of British airports, reported a 10% fall in passenger volumes at its three London airports in the first quarter of the year, on a par with the drop it saw after the terrorist attacks on September 11th 2001. Ports on the west coast of America have suffered huge declines in volumes of container traffic. “Revenue is not as sticky as once thought,” says the head of a large infrastructure fund.
For long-term investors such as pension funds or sovereign-wealth funds, surely even the most precipitous short-term declines ought not to matter much? But pre-crisis enthusiasm for infrastructure assets created two vulnerabilities. One was that some investors strayed into areas that Colin Smith of PricewaterhouseCoopers, a consultancy, calls “infra-lite”assets that are more volatile and less protected by barriers to entry than essential infrastructure. Think of toll roads that can be bypassed, such as the gloriously empty M6 in Britain. Many expect investors to focus more narrowly in future on core assets where returns are heavily regulated (water companies, say) or based on availability rather than usage (for example, social infrastructure such as schools and hospitals).
The second weak link is the amount of leverage that many investors took on. Dips in revenue can be painful even for conservatively geared firms because infrastructure businesses tend to have high fixed operating costs. But they particularly hurt investors that levered up in the good times and now have to keep creditors at bay.
Crushing debts suffocated Babcock & Brown, an Australian investor that went into voluntary administration in March. BAA’s pre-tax first-quarter loss of £316m ($462m) resulted partly from increased interest payments after a refinancing last year. It needs to get a decent price for Gatwick airport, which it must sell on competition grounds, to reduce its debt burden.
This is not a seller’s market, however. Cheap money helped buyers to bid ever higher during the boom. Lenders are now pulling back. The planned privatisation of Midway airport in Chicago, which would have been the first such deal in America, collapsed last month after the winning consortium (whose members included Citigroup, which really ought to have known better) found that it could not finance its lavish bid. Many suspect that the deal will eventually be revived but at a much lower price. Macquarie, an Australian infrastructure pioneer that reported a steep fall in profits on May 1st and promptly raised more capital, is also feeling the effects of frozen credit markets. An independent analysis by Deloitte this month endorsed a lowish bid for Macquarie’s MCG communications fund from the Canada Pension Plan Investment Board because of MCG’s ugly refinancing burden.
Falling prices are good for investors who do not have to worry about creditors. Preqin, a data provider, reckons that infrastructure funds are sitting on $65.5 billion of uninvested equity. Record amounts of fund-raising-95 unlisted funds are on the road at the moment, targeting more than $100 billion of capital-would bolster the war-chest. Some government-stimulus money is earmarked for infrastructure, although it is unclear how the extra spending will feed through to private investors. The second-order effects of yawning deficits may prove more important, as governments unload assets in an attempt to balance their books. In infrastructure as in every other asset, cash is the best defence and the greatest source of opportunity.