Thursday, 17 January 2019

Dalmore Capital - Broadening its horizons

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Dalmore Capital, the UK-based independent fund manager, has had a busy year in acquisitions and fund raising. Following the final close of its third fund and a flurry of deals, it is now looking towards consolidation. By Peter Collins.

With the completion of a £1.5bn, syndicated debt-backed acquisition of the UK’s Riverside energy-from-waste (EfW) plant, Dalmore Capital capped a productive year that saw it continue the AUM growth of 2017.

The group’s third fund, DCF3, along with consortium members Fiera, Semperian and Swiss Life, together provided about £950m in equity for Riverside while raising £550m in debt underwritten by BNP Paribas.

The loan was quickly syndicated at the end of October, split into a 20-year, £340m institutional tranche from Aviva, Sun Life, Scottish Widows and BNPP, and a 12-year, £210m commercial tranche that was picked up by Credit Agricole, HSBC, Santander and Siemens. The two tranches were priced at 190bp and 140bp, respectively.

The project currently stands at 72MW of generation capacity, with the potential for a doubling in size. The deal, originally agreed in June, saw the consortium take full ownership of the project from Cory.

Its strong operational track record and contracted revenues – on both gate fees and energy generation – stood out to Dalmore, which had identified a number of opportunities in the waste sector before deciding on Riverside.

History and structure

Dalmore was formed in March 2009 following the sale of the Infrastructure Investors (I2) fund. Its sale saw two of I2’s senior investment partners Michael Ryan and John McDonagh take the opportunity, along with then Merrill Lynch director Alistair Ray, to create a long-term fund for low-volatility infrastructure assets with predictable, inflation-linked cashflows.

COO McDonagh, prior to four years at I2, had been project finance director of a Carillion subsidiary and assistant director with Banco Espirito Santo on the financial advisory side.

Ryan, Dalmore’s CEO, had worked as director of Noble PFI, Edison Capital, and KPMG’s PFI advisory unit before joining I2.

Since its founding, the group has since grown to become one of the UK’s leading infrastructure investors, managing a number of investment vehicles with £5bn of total assets under management.

Its team now counts 33 investment professionals and support staff.

Dalmore Capital Fund 1 (DCF), was raised in 2012 and 2013 with 13 investors providing £248.6m in commitments and three co-investment vehicles combining for £128m alongside it. Within 12 months of final close it had been fully committed, with investments in 46 underlying PPP projects.

PPP Equity PIP, known as Fund 2, was raised in 2014 and 2015 with a focus on operational UK PPPs. It reached a final close of £534m, with two co-investment vehicles raising £135m.

Raise and invest

For Dalmore, 2018 was focused on completing the DCF3 fundraising and deploying the capital on a diverse range of assets. Through all its transactions, the fund has managed to raise and deploy an additional £1.7bn in co-investment.

As well as Riverside, the fund signed the last tranche of its Cadent acquisition, the UK’s largest gas distribution business with a regulated asset value of £8.8bn

Following a March 2017 investment in 61% of the business, a put-and-call option for a further 14% was exercised and a subsequent put-and-call for 25% was agreed.

Once the final put-and-call option is exercised in summer 2019, DCF3 will own 100% of the business. The fund, which is providing £140m of its own capital, is being supported by its co-investors to the tune of £300m.

Also notably, Dalmore led the acquisition of a 49% stake in EDF’s portfolio of UK wind farms. The 24 projects – all of which are operational bar one in the final stages of construction - combined for a total capacity of 550MW.

Dalmore’s £700m bid will see it take 75% of the acquired stake while consortium member PIP will take the remaining 25%. Santander provided £350m in debt, priced at 145bp.

The deal was targeted for its low risk opportunity, an experienced and reliable partner in EDF, and strong operational performance, as well as the reliable returns received via the UK’s ROC and CfD programmes.

Dalmore’s acquisition strategy is to create a diversified portfolio of low volatility assets with limited exposure, “which is exactly what we’ve done”, said CIO Alistair Ray.

Generally, the group will avoid overly competitive auctions, which can end up threatening the level of returns. The EDF deal, while acquired through a bidding process, was an example of an asset that the company believed would be overlooked by most bidders.

The large operational portfolio was said to appeal less to traditional investors, while the ticket size would be below the radar of larger, direct investors. Notably, the returns would be lower than what larger funds would wish to target.

As a result, Dalmore was able to fill a gap in the market, and win the portfolio without having to outbid too many competitors.

But perhaps the biggest highlight for Dalmore this year was its first public-to-private deal when, in October, in consortium with Equitix, it acquired a 100% interest in John Laing Infrastructure Fund (JLIF).

Working with Equitix – traditionally a competitor – was “unusual” for Dalmore, said Ray, but ultimately “worked quite well”.

“Raising capital to take over a listed opportunity is very difficult; the takeover code severely limits the number of parties that can be approached, which is quite different to private market transactions,” he explained.

The cooperation with Equitix, then, was an example of intelligent opportunism by the fund’s partners – a key theme in the fund’s strategy and investments.

The LSE-listed FTSE 250 company was valued at nearly £1.5bn and holds stakes in 67 PFI and PPP opportunities. While nearly three-quarters of those assets are UK-based, significant chunks are located in Europe (15%) and North Americas (13%) too.

The deal included a 12-month debt financing of a £964m tranche and an additional €40.7m facility, each with two six-month extension options. It is priced at 125bp, increasing to 175bp following the first extension and to 225bp after the second.

Going forward, the investment strategy will be to divide up most of the assets between the sponsors, with Dalmore focusing on the education, justice and emergency sectors.

Larger assets in transport and health will see investment from both itself and Equitix, while one non-core asset is likely to be sold.

After the dust had settled from these deals, DCF3, which reached a £950m final close in August, was 85% committed after nine transactions, leaving circa £140m left for a potential final investment. Ryan confirmed to PFI that it was still looking at opportunities.

This could come sooner rather than later, as the fund is understood to have made a joint bid with GLIL Infrastructure for a 49% stake in two SSE wind farms, building from its experience from the EDF deal.

The deal, for the 225MW Stronelairg scheme and the 94MW Dunmaglass project, could be worth up to £500m. First bids were due by December 12.

Going forward

While a fourth fund launch is planned for some time in 2019, CEO Michael Ryan told PFI that there were no immediate plans to get the ball rolling.

“If we wanted to we could have commenced fundraising for a successor fund earlier this year,” said Ryan, but cited Britain’s current political turmoil and the recent close of its last fund as why it has paused any plans for a number of months.

Ryan pointed out that the group had only just finished raising a lot of money and didn’t want to go right back to fundraising.

“Between now and the fourth fund there will be new appetite.”

Regarding the UK’s Brexit situation, Ryan said we “we’re seeking greater [political] clarity than there is now”, before any new launch, adding that “we felt putting our investors under pressure to re-up now would not be fair”.

In addition, the amount of work needed on the JLIF portfolio post-acquisition means not fundraising will give Dalmore and Equitix the chance to focus on splitting up and consolidating the assets.

In terms of the investor’s acquisition focus in the short term, it will be “more of the same” for the group, which continues to look at the opportunities available.

Some changes, consistent with adapting to an ever-evolving market, are to be expected, however.

Dalmore’s fund mandates have previously allowed investments outside of the UK, though it has rarely employed it. The JLIF portfolio, featuring a number of US and EU assets, could be a sign of things to come as the group looks further afield.

“Next year we will be a bit more focused on what [non-UK] options are out there,” said Ray, who added that while the option is there for consideration, the company will continue to take “an opportunistic approach”.

This modest but notable shift, while at this stage still hypothetical, would be nothing new to Dalmore, which has not been afraid to open up its pipeline opportunities in the past.

“Each time we launch a fund, we consider tinkering with the strategy,” said Ray, pointing to its Thames Tideway deal and the first Cadent transaction as catalysts for broadening the horizons of DCF3.

Its previous funds had taken a pure PPP focus, but Dalmore’s partners identified opportunities that fit the low-volatility mandate and were comfortable adjusting to the new market layout.

Despite this previous success, Ray cautioned that “it is important that we evolve over times and don’t change too much too quickly” as Dalmore, reflecting on the political and economic climate, does not see any significant indicators that a new direction is needed.

Regarding the impact of Brexit and its associated issues on its existing portfolio, Ray said that “we’re in quite a nice place”, primarily due to the lack of GDP exposure on any of its investments – a key condition for a low-volatility investor such as Dalmore.

“We feel quite comfortable that whatever the scenario there won’t be a significant impact,” he said.

Asked about the future attraction of UK renewables – which has seen the end of subsidies for onshore wind and solar PV – Ray reiterated the focus on opportunism over a commitment to a sector or technology.

If the range of returns are too broad, Dalmore will not pull the trigger. In addition, yield is something that is important to investors as well, meaning uncertainty over an asset’s long-term viability would serve as a red flag.

Co-investment, which has worked so effectively for all its funds, will continue to be an important factor in Dalmore’s strategy, as it looks to deploy into individual assets.

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