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Growth of ‘core plus’ infrastructure investing puts spotlight on diligence and deal terms

The evolution from core to core plus investment is changing the asset class. Over the past ten years the types of assets that infrastructure investors have been willing to buy has been steadily widening, with the race to Net Zero, the war in Ukraine and the pandemic only accelerating this trend.

These assets provide interesting opportunities for investors but their higher risk profile means that investors need to take a different approach to due diligence as well as consider new financing terms.

Market transformation

Before the financial crisis, infrastructure investing was dominated by pension funds and institutional investors who tended to only purchase ‘core’ assets, such as gas or electric providers, water companies, top-tier airports and seaports. But in recent years a new generation of investors has entered the space, pushing up prices and forcing investors to look at more unconventional infrastructure plays. Investments in assets such as motorway services stations, data centres, fibre optic networks, stadiums and hospitals are now far more common, with the industry terming these ‘value add’ or ‘core plus’ infrastructure investments.

In Asia Pacific in recent years we have seen Canadian pension funds, Middle Eastern sovereign wealth funds and alternatives players, like KKR and Stonepeak, building out their infrastructure teams, while in the U.S. and Europe, we have seen a rise in the number of Australian superannuation funds on the hunt for deals, with Aware Super saying that it would spend AUD16bn on assets in these regions in the next three years.

Rising awareness about the impact of climate change as well as the pandemic is furthering this trend. Global lockdowns reduced revenue streams from core infrastructure assets like airports and toll roads, encouraging investors to diversify their strategy and look to digital infrastructure assets. As such, we have seen a race for data centres across Europe and Asia Pacific, with a scarcity of land and power supply remaining issues for further growth in Europe. We have also seen rising interest in fibre optic networks, which in parts of Europe, including Germany, is lagging behind the U.S. and Asia.

Over the past two years we have also seen a huge increase in interest in solar and wind assets, as well as for other assets that will be crucial to the energy transition, such as transmission, storage, distributed energy and clean mobility. We have seen a rising interest in platform deals from a range of investors in this area, with developers and utility companies now bundling together portfolios of these assets to entice larger infrastructure investors to invest. As Europe attempts to wean itself off Russian oil and gas, we expect ever more demand for these sorts of infrastructure investments over the coming years, particularly given that a record USD26bn was raised for renewables strategies last year, according to Infrastructure Investor magazine.

Due diligence

This market transformation requires buyers to take a different approach to due diligence. While a core infrastructure asset might rely on regulated contracts with a government agency for its income, a core plus asset might instead be dependent on long-term contracts with private sector organisations. As such, buyers will need to adopt a more holistic approach to due diligence, ensuring that contracts in place are robust and will provide reliable revenue streams. In some instances this will involve surveying a small percentage of thousands of contracts that may be in place. In other instances, it will involve lawyers doing a deep, granular dive of all the customer contracts. The requirements will depend on the situation.

Changing financing terms

The entrance of more private equity players into the infrastructure market has also encouraged many investors to take advantage of more flexible financing arrangements that are typically seen on leveraged buyouts.

Over the past two years we have seen a wide range of more investors pushing for:

  • Increasingly borrower friendly lending terms, such as the ability to increase debt levels or reschedule payments with the permission of only one lender.
  • Greater flexibility when it comes to the financing of bolt-on acquisitions, with fewer restrictions on how much and when they can borrow money for follow-on M&A.
  • More restrictions on whether debt can be sold on to a third party, such as a hedge fund or other private equity firm, in the event of default.

In Asia Pacific, new entrants to the market are also bringing more sophisticated funding approaches, increasing the desire for warranty and indemnity insurance coverage.

Changing leverage levels

In addition to these more private equity style financing terms, we have also seen a change to the leverage levels on some core plus deals. For instance on large cap deals, where the investor is essentially buying a company with a balance sheet and track record, we regularly see leverage levels of five to six turns of EBITDA - similar to a traditional private equity deal. On a traditional project finance deal it is not uncommon to see up to ten times of leverage.

These changing market dynamics mean that investors now have more flexibility than ever when it comes to the types of assets they buy and financing available to them. But those changes also carry risks, requiring careful consideration from both buyers and sellers.

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