Investors have clamoured to deploy capital in both asset classes, buoyed by record distributions to investors over the past two years, pushing levels of unspent capital to record highs. With more money chasing deals, valuations have surged, making it tougher to hit targeted returns.
According to Preqin’s Global Infrastructure Report 2016, more than half of infrastructure investors found it more difficult to identify attractive investment opportunities in 2015 than in the previous year. Rising valuations for infrastructure assets drove the average deal size to an all-time high of $ 528 million in 2015.
In an effort to boost deal-flow, infrastructure funds have started competing with private equity for riskier, higher-yielding assets, which are the type of investments private equity firms usually make.
Tom Whelan, head of private equity at law firm Hogan Lovells, said: “We’re seeing infrastructure funds effectively doing private equity-style investments, so called infrastructure plus. These are typically service-type businesses for infrastructure assets or where the assets have ‘infrastructure-like’ characteristics but fall outside the traditional areas for infrastructure investing.”
These hybrid assets include car parks, electricity meter businesses and mobile telephone masts.
Jay Yoder, head of real assets at North American investment group Pavilion, said: “The definition of infrastructure is being stretched because returns have been compressed in traditional infra and managers are looking at any alternatives that they might be able to squeeze into the definition.”
Private equity firms also invest in pseudo infrastructure assets. On December 6, KKR announced that it was buying smart meter financing firm Calvin Capital from infrastructure investor Infracapital. CVC Capital Partners-backed metering business Ista is slated to come to market in the first quarter of 2017 and is likely to attract interest from infrastructure and private equity.
The added competition from infrastructure funds for these assets is placing increased pressure on private equity houses that are already struggling to do deals amid a climate in which trade buyers and foreign investors are competing for deals, pushing prices up even further.
Jonathan Wood, a partner at law firm Weil, Gotshal & Manges, said: “[Some of these infra funds] are pushing the boundaries of what might be considered infrastructure and entering markets historically occupied by the classic private equity funds, with the obvious impact on pricing. Some of these infrastructure investors have very substantial funds to call on.”
Not only do some of the infrastructure funds have significant reserves of capital to call on, they also have a natural advantage when competing against private equity as they are typically targeting lower returns over the same or longer hold periods.
Whelan said: “Private equity sponsors are typically looking for a much higher IRR than infra funds. When they’re both bidding for the same assets, even if the funds have the same 10-year structures, infrastructure funds can pay more than private equity and still hit their target returns.”
But the increasingly blurred line between infrastructure and private equity assets can also be an opportunity for private equity firms looking to put capital to work.
David Higgins, partner at law firm Freshfields Bruckhaus Deringer, said: “It’s a problem as much as it’s an opportunity and some private equity houses have tapped into investors looking to play into the space. CVC has done its strat opps fund, while Carlyle and Blackstone have also raised longer-life funds.”
Yoder said that in today’s low interest rates environment “everyone is stretching for good returns and most funds are looking for attractive investments wherever they can find them”. He added that while there will always be some overlap between asset classes, for instance in the energy space, firms should be careful not to push the boundaries too far. “We certainly don’t think a dental business can be described as infrastructure. We are concerned about strategy drift in any asset class.”