by Aaron Levitt | July 2, 2012 12:46 pm
After conquering the world of leveraged buyouts (LBOs) and acquisitions, private equity firm KKR (NYSE:KKR) has now set its sights on the various toll roads, bridges and pipelines that dot the country. Following the lead of competitors like Blackstone (NYSE:BX) and Carlyle (NYSE:CG), KKR has begun raising money for investments outside the traditional world of LBOs. These transactions have become increasingly hard to finance and undertake as the 2008 financial crisis froze the critical credit markets needed to conduct these dealings.
To that end, infrastructure assets — with their boring yet stable cash flows — have been targeted as A way to diversify from traditional private equity fare. That could be a great long-term strategy. As the developed world has grappled with budget and austerity worries, crumbling infrastructure continues to take a back seat to more “important” matters.
However, despite government budget cuts, maintaining and improving vital infrastructure is still a paramount issue. For cash-strapped governments, selling public assets could mean the difference between insolvency or staying viable.
For retail investors, following KKR’s lead into the infrastructure world could ultimately be a smart move and lead to both big portfolio payoffs now as well as future growth.
To tap infrastructure’s potential, KKR recently raised $1 billion for investments in the sector, plus an additional $1.25 billion for natural resource-based infrastructure. That follows up recent separate fund-raising from KKR affiliates of $1.3 billion for infrastructure and $350 million for natural resource investments. The firm plans to plow these newly raised funds into public and private assets in need of repair as well as alternative-energy efforts.
Already, it has invested in several public works projects, including wind farms, parking lots and a 23% stake in the eastbound Colonial Pipeline. Ultimately, KKR plans to profit from the stable cash flows these assets can throw off. However, KKR isn’t alone with making the infrastructure leap.
Mega-pension fund, the California State Teachers’ Retirement System, or CALSTRS, has already moved into infrastructure. Earlier this year, it announced that it shifted nearly $500 million of its giant $145 billion portfolio into utilities, roads, ports and pipelines across the globe, through a partnership with Australia’s Industry Funds Management.
More recently, embattled natural gas driller Chesapeake Energy (NYSE:CHK) reported it would sell its entire 45% interest in Chesapeake Midstream Partners LP (NYSE:CHKM) to private equity firm Global Infrastructure Partners for $2 billion. That deal would strengthen GIP’s nearly $10 billion worth of worth of gas conduits, electricity plants and airports.
Overall, a variety of institutional investors have poured over $700 million into infrastructure investments during 2011, and the number of infrastructure-specific funds has doubled since 2008.
These funds, however are just a start when looking at the long-term picture. According to the Organization for Economic Co-operation & Development (OECD), both developed and developing market governments will need to spend at least $53 trillion on infrastructure projects by 2030. That’s no small sum, especially for already stretched public budgets.
That’s where private investors come in. Infrastructure improvements can be ignored for only so long. Sooner or later, bridges will crumble and pipes will burst. Privatizing infrastructure assets and spending could be the wave of the future as governments prepare for lower tax receipts and dwindling public spending.
Already, we’re seeing such transactions. Chicago’s $1.8 billion, 99-year operating concession deal with private investors and Macquarie (PINK:MQBKY) for its Skyway Bridge is just a taste of what’s to come.
Plenty of rewards await for private investors who take on this challenge. First, the sector’s low correlation with other asset classes provides diversification while boosting returns and curbing risk. Second, these assets often provide stable cash flows as the payments for assets such as cellular tower or highway tolls roll in.
More important, this income is often inflation-resistant because many infrastructure businesses use pricing formulas that change with economic conditions and are generally linked to measures of economic growth such as GDP and the CPI. Add this to the long-term or even permanent contacts operators typically get, and you have a recipe for predictability and stability.
Private equity’s rising interest and the coming surge of public-to-private infrastructure transactions could be a great opportunity for retail investors, who can gain many of the same benefits. And now could be a great time to do it.
However, that can be a daunting task because of the sector’s large breadth. So, Wall Street has attempted to quantify the theme into several broad exchange-traded funds (ETFs).
One that really stands out is the iShares S&P Global Infrastructure Index (NYSE:IGF). This ETF provides a great global take on the theme, tracking 76 different operators of toll roads, airports and parking lots including Spain’s Abertis as well as pipeline superstar Enbridge (NYSE:ENB). Aside from being a global bet — only about 30% of the fund’s stocks are domiciled in the U.S. — IGF isn’t “too heavy” on utility firms.
One of the major criticisms and drawbacks for many broad infrastructure funds is that they end up looking like proxies for the utility sector. IGF has only around 40% of assets in the sector. That compares to a nearly 80% weighting for its chief competitor, the SPDR FTSE/Macquarie Global Infrastructure 100 (NYSE:GII). That smaller weighting should allow IGF to outperform its peers during good times.
The iShares ETF can currently be had for roughly where it was in 2009, and it offers a strong 4.42% dividend yield. Expenses run a cheap 0.48%.
For investors who really want to focus on the transition of public to private operations, both Canada’s Brookfield and Australia’s Macquarie Bank are two great examples. Both have several private equity funds that are open to qualified investors and that invest in infrastructure assets. Luckily, both offer several publicly traded options as well. Brookfield Infrastructure Partners (NYSE:BIP) owns assets including timberlands, ports, transmission lines and social infrastructure (hospitals, prisons). It yields around 4.5%.
Macquarie Infrastructure Co. (NYSE:MIC) includes airport services, bulk liquid-storage facilities and natural gas distribution. It recently reinstated its dividend after cutting it during the credit crisis to pay down debt. MIC now yields a healthy 2.4%.
These three ideas just scratch the surface of this investment theme, but they’re all strong long-term leaders in the sector and should be given serious consideration.
As of this writing, Aaron Levitt is long IGF and MIC.
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