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Thursday, 20 February 2020

Keeping up to date – The Man from the Pru

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The UK’s Prudential, now named M&G Investments, has a longer track record than most in infrastructure investing. An investor that financed a Scottish hydro project back in 1935 can claim a real heritage, compared with some of the more recent Johnny-come-Latelys. Staying competitive is, however, the key to success. By Adrian Murdoch and Rod Morrison.

To view the digital edition of this report please click here.

The said hydro project is the still operational – Carsfad Power Station, built by the Galloway Water Power Company and now run by Scottish Power. There is a plaque on the plant’s wall, saying “Funded by the Pru”. A minor coincidence, then, that PFI’s 500th edition’s birthday party will be in an old hydro power plant, the converted Wapping station.

The Prudential has dominated the UK investment management scene for a long time. It invests on behalf of its own huge life and pension funds, plus retail funds and direct investments for clients. The investment management division, backing “The Man from the Pru”, is now branded M&G Investments, another old City of London name. Within M&G, for strict compliance reasons, the debt and equity sides of the infrastructure business are split – Infracapital on the equity side and a Project & Infrastructure Finance team on the debt side.

Infracapital is not afraid to change with the times. It is one of the reasons that the asset management arm of the Pru remains a leading European infrastructure investor with more than £1.5bn of funds under management.

“Yield, yield, yield,” says Martin Lennon, head and co-founder of Infracapital, along with Ed Clarke, since 2005. “Our strategy is in part a reflection of where our investors are leading us and this is what the majority are saying.” He says that in the current low interest environment across Europe investors are looking for alternative ways to find yield.

Typical of Infracapital’s approach is its takeover last year of Veolia Water, now Affinity Water, a £1.24bn deal with Morgan Stanley Infrastructure Partners. At the end of January, and through HSBC, Lloyds, RBC and RBS, the company completed a whole business securitisation refinancing totalling £480m through a £250m 23-year bond, a £80m 10-year tranche and a £150m, 32-year linker priced at 132bp, 175bp and 157bp, respectively. To that it added a £95m 20-year inflation-linked private placement from the Universities Superannuation Scheme in mid-February.

Lennon explains the thinking behind the deal, which is similar in philosophy and variety to the restructuring Infracapital and what its co-shareholders did for Associated British Ports in late 2011. “For Affinity, we wanted to replace acquisition debt, which is limited in term, with tranches of longer-term debt. That reduces the financial risk profile of the business and with the different maturities, it reduces refinancing peaks.”

If the Prudential’s expertise with infrastructure investment goes back to the 1930s, nowadays, Lennon looks both more broadly across the spectrum – at social infrastructure, utilities, transport, energy and telecoms – but also more widely geographically too.

“Ten years ago, the landscape was generally dominated by the UK – there was the legacy of privatisation and the whole creation of the PPP sector,” he says. “That has changed across the European landscape; nowadays there is opportunity in infrastructure everywhere.”

But with new kids on the investment block snapping at their heels, it is not enough to look just broadly, it is essential to look more deeply too. “It is worth remembering that in terms of infrastructure assets one airport is not the same as the other and one toll road is not the same as the other. This is where the granular understanding of the markets is crucial,” says Lennon.

Typical here is Infracapital’s shrewd acquisition in summer 2011 of Dutch broadcast and telecoms provider Alticom Holdings from TDF Group, funded by Dexia Credit Local and ING with a €60m nine-year term loan, priced at around 325bp–350bp. Alticom’s high elevation towers provide a platform for national broadcast coverage of radio and digital television, as well as being a component of wireless networks for Dutch telecoms operators.

“It is a nice business – on the small side for many but nonetheless very important,” says Lennon. “Its network of broadcast towers is essential in the Netherlands. What we have done is to invest in the asset management capability of the company so that it can develop further.”

For the future, Lennon sees continued interest in renewables. Infracapital has several such companies in its portfolio: under Infracapital Solar it has a portfolio of six photovoltaic plants located across four sites in Northern Spain; and in 2007 it bought a 33.33% share in Zephyr Investments, the largest portfolio of wind farms in the UK, with JP Morgan Asset for £145m.

He is more measured about future investment in the sector. “It is a sector that to a certain extent divides opinion. We are seeing continued interest in the space, but behind the scenes there are important government policy drivers to be aware of. Time will tell whether the prices investors are paying now truly reflect the ongoing risk,” he says.

He is sanguine too about other changes affecting the industry. Perhaps the biggest debate remains that on long-dated lending, particularly important in the greenfield space. What is starting to be seen, as Lennon notes, is that institutional investors such as pension funds and insurance companies are increasingly seeking to wield greater influence over investment strategies collectively, an example being the PIP, or directly through segregated mandates.  

While he admits there is no “magic answer”, Infracapital has come closer than most to discovering one. “We are unique within the fund management community in that we have both closed ended funds and an evergreen vehicle, which is all about yield with no requirement to realise the assets,” he says.

Infracapital has been at the top for a long time and it intends to stay there. Its response has been straightforward. “You have to listen to the investors you are serving,” says Lennon.

The debt capability at the Pru goes further back. If the modern era of private investment in infrastructure dates back to deals such the Dartford (M25) and Second Severn Bridge projects in the late 1980s/early 1990s, the Pru was in at the start. It provided debt and equity for Dartford and debt for Second Severn.

It had built up the debt skills to take on these schemes and could fund in either fixed or floating rates on behalf of its funds. Deals such as the SELCHP waste to energy plant and the first Docklands Light Railway (DLR) expansion project followed. But then the credit boom took off and the Pru’s role and importance, in terms of the project finance market, receded. It continued to fund schemes, take part in syndications and buy bonds but the fact that commercial banks became so active, and the monoline insurers so predominant, limited the Pru’s visibility.

Inside the Pru, now M&G, life nevertheless continued. The M&G team now has five dedicated project finance professionals headed by Tim Huband, formerly of SG, CIC and Lloyds. The team built up a £2bn portfolio of private finance initiative (PFI) debt, £4bn in project finance debt and £20bn in infrastructure debt. Its last sole lead-arranged deal, before the global financial crisis, was the £70m Scottish Borders schools PFI deal, signed in February 2007.

It kept to its fund management roots, taking the role of investing on behalf of clients very seriously. On all its projects, it has a site visit once a year. The house style, even during the monoline wrapped bond days, was to analyse the underlying credit of a Triple A wrapped deal before buying the paper. When all the monolines lost their Triple A ratings, and indeed some went to junk, this analysis provided extremely useful. From 2008 to 2010, a source of new investment for the team was buying secondary monoline wrapped, now unwrapped, bonds.

The fund management business is all about return. The debt team originates deals on behalf of the managers of the various funds in the M&G group. Secondary trading in wrapped bonds after 2008 was good business, as the wrap fell away but the underlying credit was still in place. But buying secondary commercial bank loan portfolios was not such good business. The discounts available to the par value were not enough for M&G.

For Huband and his team, internal relationships inside M&G are vital. “It’s all about knowing your customer,” he says. Within M&G there are about 90 funds that invest in infrastructure debt, both public and private, as well as external clients interested in investing in the sector. The range of funds is an advantage. M&G has clients that can be served by short-term acquisition debt, as on the recent Stansted Airport deal, public funds, private funds, indexed linked, fixed rate and mezzanine.

External relationships matter too. The up-and-coming deal to finance the Alder Hey PFI children’s hospital in Liverpool will be originated on behalf of a client that is pleased to be associated with the project. “There are two big specialist children’s hospitals in England – Great Ormond Street and Alder Hey,” says Huband.

Alder Hey is a deal where the Pru/M&G has once again come to the attention of the market, as in the early 1990s. Governments all around the world are seeking to encourage the provision of long-term debt by institutional investors, and the UK government is particularly keen. The debt funding on Alder Hey was put out to a competition and eight institutions, including the commercial banks, bid. M&G, the oldest player in the field, won the first institutional investor PPP competition.

M&G offered a senior tranche to be placed with one of its funds, and a junior piece to be placed with another fund. In addition, it bid jointly with SMBC, which was responsible for the equity bridge loan and the ancillaries. As it turned out, the SMBC debt will not be needed. On the next deal, Glasgow college, M&G will have to bid against SMBC and a host of others.

Whether the latest fad for institutional debt is here to stay or not, the Pru/M&G will remain in the game. New areas for it, in the future, could be more investment and co-investment on behalf of other investors and a dedicated infrastructure debt fund.

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