Infrastructure Investing E-Book

Rajeev J. Sawant

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Serie: Wiley Finance Editions
• Sprache: Englisch

Seitenzahl: 412

Veröffentlichungsjahr: 2010

Beschreibung

Invaluable information regarding one of the biggest worldwide growth areas in investing-infrastructure assets Infrastructure investing is about to explode on the worldwide scene. The fact is that real money will need to be spent on real projects-which will present real opportunities for stable, long-term returns. But infrastructure assets have unique characteristics and the investments and funds that will likely rise up must be suitably structured to serve investor needs. Author Rajeev Sawant has been analyzing infrastructure investments, funds, and project financing programs for nearly five years, and with this book, he presents information that will be invaluable to lenders, pension funds, insurance companies, investment funds, rating agencies, and even governments. * Presents comprehensive data analysis on infrastructure cases worldwide * Analyzes the opportunities as well as the pitfalls of infrastructure investing * Focuses on the needs of pensions, insurance companies, and endowments interested in infrastructure investing For the next decade, worldwide economic growth and increased employment-as well as investment returns-will come from infrastructure projects. This book will help you understand today's dynamic infrastructure asset class and quickly get you up to speed on the unique risks and rewards associated with it.

Leseprobe

Table of Contents

Title Page

Copyright Page

Dedication

Preface

INFRASTRUCTURE INVESTMENT PATTERNS

OVERVIEW OF THE CONTENTS

IN CLOSING

Acknowledgements

CHAPTER 1 - Infrastructure Demand and Investment Funds

AN OVERVIEW OF INFRASTRUCTURE DEMAND

AVAILABILITY OF FUNDS

CONCLUSION

CHAPTER 2 - Infrastructure Asset Characteristics

DEFINING ASSET CLASSES

PORTFOLIO PERSPECTIVE ON ASSET CLASSIFICATION

LARGE UP-FRONT INVESTMENT

STRONG CASH FLOWS

STABLE CASH FLOWS

LONG LIFE

IRREVERSIBLE INVESTMENTS

LOCATION SPECIFICITY

GROWTH OPTIONS

VALUE UNDER DEFAULT

CONCLUSION

CHAPTER 3 - Equity Infrastructure Indexes

INFRASTRUCTURE INVESTMENT OPTIONS

EQUITY INFRASTRUCTURE INDEXES

MACQUARIE GLOBAL INFRASTRUCTURE INDEX

S&P GLOBAL INFRASTRUCTURE INDEX

CSFB EMERGING MARKETS INFRASTRUCTURE INDEX

INFRASTRUCTURE EQUITY INDEXES CORRELATION

EFFICIENT FRONTIER

CONCLUSION

CHAPTER 4 - Debt versus Equity Mode of Investment

THEORIES OF CAPITAL STRUCTURE

PECKING ORDER THEORY

FREE CASH FLOW THEORY

TRADE-OFF THEORY OF CAPITAL STRUCTURE

GOVERNANCE AND CAPITAL STRUCTURE

OPTIONS APPROACH

PRIVATE EQUITY MODEL OF INVESTING

CONCLUSION

CHAPTER 5 - Infrastructure and the Threat of Holdup

TRANSACTION COST ECONOMICS

SOLUTIONS FOR THE HOLDUP PROBLEM

CONCLUSION

CHAPTER 6 - Infrastructure Assets and Political Risk

POLITICAL RISK TYPOLOGY

SOVEREIGN HOLDUP

TYPES OF RISK

HEDGING SOVEREIGN HOLDUP

RISK MITIGATION STRATEGIES

CONCLUSION

CHAPTER 7 - Project Finance and Infrastructure

PROJECT FINANCE STRUCTURE

PROJECT FINANCE VERSUS CORPORATE FINANCE

RAS LAFFAN REVISITED

PROJECT RISK ANALYSIS

CREDIT RATING AGENCIES

USING THE PROJECT FINANCE STRUCTURE

ROLE OF GOVERNMENT

CONCLUSION

CHAPTER 8 - Infrastructure Asset Valuation and Bond Returns

AN OVERVIEW OF INFRASTRUCTURE VALUATION THEORY

BASEL II AND INFRASTRUCTURE LENDING

INFRASTRUCTURE BOND RETURNS

CONCLUSION

CHAPTER 9 - Case Studies

CASE STUDY 1: AGUAS ARGENTINAS S.A.

CASE STUDY 2: DABHOL POWER COMPANY

CONCLUSION

Conclusion

Notes

About the Author

Index

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Copyright © 2010 by Rajeev J. Sawant. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.

Published simultaneously in Canada.

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Library of Congress Cataloging-in-Publication Data:

Sawant, Rajeev J.

Infrastructure investing: managing risks & rewards for pensions, insurance companies & endowments / Rajeev J. Sawant. p. cm. - (Wiley finance series) Includes bibliographical references and indexes.

eISBN : 978-0-470-60234-8

1. Infrastructure (Economics)-Finance. 2. Public works-Finance. 3. Investments.

4. Financial risk management. I. Title.

HC79.C3S36 2010

332.6-1dc22

2009038770

S

I dedicate this book to my parents, Janardan and Charulata Sawant,whose encouragement, passion, and personal example made all thispossible; to Manisha for her patience, unwavering support, andunderstanding; to Rahul for constant and loyal support; and to Mehrand Manav, who are my personal attachment to the future.

Preface

Good roads, canals, and navigable rivers, by diminishing theexpense of carriage, put the remote parts of the country morenearly upon a level with those in the neighbourhood of the town.They are upon that account the greatest of all improvements.

—Adam Smith, Wealth of Nations

Future investment trends will be shaped by, among other things, infrastructure demand and spending. On the demand side of the market, the future looks rosy. As the BRIC economies (Brazil, Russia, India, and China) bring millions of people into the middle class, demand for better roads, electricity, telecommunications, airports, and clean water is expected to rise. Asia alone needs $1 trillion over the next five years to meet its infrastructure needs.1 Infrastructure also enables economic growth. BRIC countries as well as vast tracts of Africa, Asia, Central Europe, and South America need investments in development infrastructure. The developed economies of North America and Europe also need investments as they repair and replace their aging infrastructure assets. The 2007 rush hour collapse of the I-35W bridge in Minneapolis, Minnesota, was a stark reminder that infrastructure cannot be taken for granted.

What about the supply side? Governments have traditionally provided most infrastructure funds. The increasing demand on government resources and the sheer magnitude of the funding required to develop infrastructure ensures that private capital has a very important role to play in the future. This book focuses on private funds for infrastructure, invested with the aim of generating a return over investment for capital providers. As such, I do not examine flows of capital through developmental aid activities or any other form of investing that does not explicitly require a return on investment.

Although governments encourage private capital in infrastructure, governments regulate these assets severely and are liable to constrain returns because of infrastructure’s characteristics. Infrastructure asset characteristics also expose investors to other unique risks. The book examines these risks through a Transaction Cost Economics framework for which Oliver Williamson was awarded the Nobel Prize in Economics in 2009. The book suggests options for hedging and mitigating these risks. The book’s analysis shows that the private equity model of infrastructure investing that is followed by a vast majority of investment vehicles suffers from drawbacks that are likely to jeopardize infrastructure’s promise of long-duration, stable returns. While the private equity model possesses governance advantages, traditional private equity skills must be supplemented by political management skills to exploit these advantages. The book makes the case that investors pursuing high private equity type returns to compensate for political risk end up exacerbating those very risks due to a feedback effect in infrastructure investing. It is perhaps not surprising that infrastructure investing has been prone to boom and bust cycles.

INFRASTRUCTURE INVESTMENT PATTERNS

Investments flowing into emerging market infrastructure in the 1990s were an average of $185 billion per year.2 The investment boom of the 1990s collapsed as the multibillion-dollar Dabhol and Paiton projects in India and Indonesia went into default. New lending to emerging markets was close to zero from 1998 to 2002, and in 2001 the private lending total to emerging markets was negative $32 billion.3 The cycle reversed itself in 2004- 2005 and in 2006 reached $212 billion, which was an increase of 35 percent over 2005.4 Investors flocked to infrastructure funds, and the number of infrastructure funds and the amounts raised increased astonishingly. Seventy-two funds (not including funds focused on oil and gas) raised an amazing $160 billion in an 18-month period before June 2007.5 A large portion of these funds—approximately 60 percent of the number of funds and approximately 75 percent of dollars raised—remain focused on investing in U.S. and European infrastructure assets.

As more and more money chases fewer assets in these markets, rising asset prices puts pressure on returns.6 So far, emerging markets are some way off from these pressures and ought to play a role in investor portfolios, provided the returns are commensurate with the risks.

The growing appetite for infrastructure assets from pension funds, endowments, family offices, and high net worth individuals reflects a growing belief that infrastructure is a separate asset class, among other alternative asset classes like hedge funds, venture funds, private equity, commodities, credit derivatives, and corporate governance.7 Traditionally insurance companies provided over 70 percent of the funding for infrastructure. 8 The development of capital market instruments in the form of widely held bonds is also a relatively recent phenomenon, with about 10 percent of infrastructure funding coming through bonds.9 An analysis of these different forms of investment in infrastructure remains incomplete.

What differentiates infrastructure investing from other asset classes? Does infrastructure change the efficient investment frontier of a portfolio? How do investors break out of the boom-bust cycles and realize the promise of long-term stable returns that infrastructure promises? This book utilizes infrastructure asset characteristics as a focal point of analysis. These characteristics create distinctive risks, returns, and correlations with other asset classes. The book then analyzes the mitigation of these risks, particularly through the use of the governance and financing structure of project finance.

OVERVIEW OF THE CONTENTS

Chapter 1 breaks down the demand side of the infrastructure market, looking at sectoral and geographical demand. Chapter 1 analyzes pension fund liabilities and their traditional asset holdings, and makes the case that the long duration of pension fund liabilities matches the long duration of infrastructure returns.

Chapter 2 begins with an analysis of asset classes, but its main focus is on infrastructure asset characteristics. Infrastructure assets are lumpy (e.g., a half-bridge is useless), capital-intensive assets with large sunk costs, low variable costs, long lives, and in relative monopolistic positions. They generate cash flows without relying on growth options, unlike say biotechnology or high technology, and are relatively easy to manage. In short, they are boring and predictable from a business perspective. But they are also fixed to the ground and subject to holdup and political risks which assume far more importance than other types of risk.

Chapter 3 compares existing equity-based infrastructure indexes to broad indexes for equities, bonds, commodities, and real estate in terms of risk, return, and correlations. The aim is to ascertain whether equity-based infrastructure indexes provide the desired exposure to this sector.

Chapter 4 examines the characteristics of debt versus equity funding by applying the latest theoretical capital structure research to infrastructure funding. The chapter examines the advantages and disadvantages of the private equity model of infrastructure investing, utilized by over half the infrastructure funds formed in 2006-2007.10

Chapter 5 focuses on infrastructure risk factors, in particular the threat of counterparty holdup and the incentives this threat engenders. Chapter 5 uses a transaction cost economics lens to tease out those risk factors that most impact returns. The risk of post-investment holdup and political risk are among the most difficult to manage. Chapter 5 examines the transaction cost economics literature to lay out the governance structures designed to minimize threats of holdup.

Chapter 6 examines the literature on political risk and the mechanisms by which political risk is mitigated.

Chapter 7 examines project finance. Given the nature of risks facing infrastructure, this chapter examines the strategic use of capital structure as a risk mitigation tool. The chapter looks at how and why project finance incorporates mechanisms to deal with holdup and political risk. Chapter 7 lays out the implications for the various actors participating in the infrastructure market: institutional investors, commercial lending banks, rating agencies, multilateral funding agencies, infrastructure firms, and governments.

Chapter 8 examines infrastructure asset valuation issues and the return characteristics of a project finance infrastructure bond portfolio. The chapter also examines the Basel II rules for commercial bank project finance lending. Finally, the chapter examines the advantages and disadvantages of using a syndicate structure of debt versus capital market securities like bonds.

Chapter 9 looks at two case studies that did not live up to the promise of infrastructure and applies the frameworks developed throughout the book: the Aguas Argentinas concession in Argentina and the Dabhol electricity project in India. Aguas Argentinas examines the perils of increasing tariffs for users and the political sustainability of indexing tariffs to a rapidly devaluing currency. The Dabhol electricity project in India draws lessons about the management of risk from a single buyer, especially when the buyer is a government entity.

IN CLOSING

In closing, the book analyzes the options available to investors seeking exposure to infrastructure. The book examines for the first time the return characteristics of equity infrastructure indexes and infrastructure bonds and their suitability as part of investor portfolios. By pointing out the areas of concern in the private equity model of investing and the rating methodology followed by the rating agencies, the book hopes to contribute to improving the returns that investors can expect from infrastructure assets. Ultimately, by illuminating the precise nature of infrastructure risks and focusing on their mitigation, the book hopes to improve the returns that investors are able to obtain from their infrastructure investments while increasing the physical stock of infrastructure in the world and thereby improving the quality of millions of people’s lives.

Acknowledgments

This book would not have been possible without the dedication, advice, encouragement, and passion of my teachers. In particular, my Ph.D. committee at the Fletcher School at Tufts University supported the research from which this book grew. Professor Laurent Jacque has been unstintingly generous with his time, knowledge, insights, and support. I have learned immensely from Professors Paul Vaaler, Patrick Schena, Bruce Everett, Jeswald Salacuse, Richard Shultz, Carsten Kowalczyk, Joel Trachtman, Ravi Sarathy, Sanjiv Das, and Julie Schaffner. I am indebted to the Hitachi Center for Technology and International Affairs at the Fletcher School for providing me with a writing infrastructure, and to the Edwin Ginn Library for a research infrastructure. I am also grateful to Alok Srivastava, Felton “Mac” Johnston at Robert Wray PLLC, Swaminathan Venkataraman at Standard and Poor’s, and Burkhard Schrage at Singapore Management University for sharing their experience and insights and for giving their time so generously. The book also benefited immensely from the dedication, support, and painstaking review from my editors, Pamela Van Giessen and Emilie Herman. All errors, of course, remain entirely my responsibility.

Rajeev Janardan Sawant Medfield, Massachusetts

CHAPTER 1

Infrastructure Demand and Investment Funds

Bijli, sadak aur paani (Hindi for “Electricity, roads and water”)

—Election slogan in India, 2004

Roads probably constitute the earliest human demand for infrastructure, and the earliest known constructed roads have existed in Ur in modern-day Iraq since 4000 BC.1 Indeed, the pyramids couldn’t have been built without the roads on which the giant limestone blocks were dragged around between 2600 and 2200 BC. Civilizations advanced or declined around the quality of their road networks. The ancient Roman, Persian, Indian, and Chinese civilizations all built road networks that allowed them to rapidly transport military units while simultaneously encouraging commerce and trade. Trade routes joined the empires of China, India, Asia Minor, North Africa, and Rome. The next major infrastructure development came from the great discoveries of electricity and its applications by Benjamin Franklin, Nikola Tesla, André-Marie Ampère, Michael Faraday, Thomas Edison, and many others in the eighteenth and nineteenth centuries.

In the modern era, the term infrastructure refers to a wide array of industries with different characteristics. Traditionally, infrastructure refers to the following sectors of the economy: transportation, energy, telecommunications, water, and sanitation. Transportation refers to road, rail, airports, and ports. Energy refers to oil, gas, petrochemicals, and electricity generation, transmission, and distribution. Telecommunications refers to fixed lines and mobile telephony. Recently, information technology infrastructure that refers to the physical hardware used to connect computers and users is sometimes grouped with traditional infrastructure.a

Commentators have also grouped social infrastructure like schools, prisons, hospitals, and courts under the rubric of infrastructure.2 Grouping fundamentally different industries like mobile telephony with schools and prisons obscures the fact that the risk and return profile of these assets is very different. Consequently these assets demand different investment strategies. We therefore need consistent criteria for classifying infrastructure industries.