UK: Developments In The Infrastructure Sector

IN THIS INTERVIEW TIM SHEDDICK, PARTNER AT SHEARMAN & STERLING, HIGHLIGHTS THE KEY THEMES HE BELIEVES WILL DOMINATE THE MARKET FOR INFRASTRUCTURE ASSETS IN 2020.

WHAT WERE THE KEY DEVELOPMENTS IN THE INFRASTRUCTURE MARKET GLOBALLY DURING 2019?

Increased focus on foreign investment controls - investors saw an increased focus on the control/scrutiny of foreign investment into critical infrastructure assets in both the U.S. and Europe, through increased regulation as well as "softer" controls applied from a public relations/political perspective.

Level of returns on regulated assets - for regulated assets in Europe, the regulators have been looking to tighten the level of allowed returns that investors are entitled to as part of the regulatory pricing settlements, as seen recently in the U.K. water sector. We expect this will increasingly also affect other European regulated assets.

Infrastructure is maturing as an investment class - infrastructure is maturing as an investment class so the allocation of capital by investors to infrastructure continues to grow, and consequently, the amount of available capital to be deployed in the sector continues to grow. The result is that there is ever increasing competition and pricing pressure for quality assets. Investors are also having to think laterally about what constitutes an "infrastructure-like" asset. The scope of "core plus" infrastructure (assets that were not traditionally seen as infrastructure but have the characteristics of infrastructure - high barriers to entry, asset heavy, stable cash flow generative assets) continues to expand. Digital infrastructure for example has become a growing asset class for infrastructure investors in both the U.S. and Europe over the last few years.

WHAT MIGHT INVESTORS NEED TO BE AWARE OF IN 2020?

How to invest - the optics of how investors do deals and how they invest will be increasingly important. Reputation management and public/political perception can be a crucial element to getting deals through successfully. For example, when it comes to responsible and sustainable investing, investors need to ensure they have the right policies in place as well as proof that they have applied them to the management of their existing investments. This is particularly true in privatisations. while government/municipality vendors are keen to get the highest price they must also show the public that they have sold to a suitable type of investor who is a sustainable and responsible new long term owner of the asset.

Climate change - this is likely to become increasingly a tipping point in the way people evaluate opportunities. For example, if there are two relatively similar assets, but one asset is better at managing its carbon emissions or is seen to promote the "green agenda", that asset may be seen as having a premium in terms of valuation and/or ongoing regulatory environment which tips the balance in its favour.

Geopolitical (un) certainty - finally, an overriding issue over the last year in the global infrastructure sector has been political uncertainty, particularly in the U.K.. However, following the result of the recent general election, the nationalisation risk in the U.K. has been significantly reduced and therefore we may see a number of transactions in the U.K. regulated utility sector.

ARE YOU EXPECTING TO SEE GROWTH IN CERTAIN AREAS AND SECTORS? WHY DO YOU THINK THIS MIGHT BE THE CASE?

Digital - digital infrastructure and the continuing investment into fibre and data centre assets is one area we expect will continue to grow. Europe has not caught up with the U.S. in terms of its focus on data centre investment as part of infrastructure and equally the U.S. has had less of a focus on fibre as an infrastructure asset. In both cases, this is largely due to the way these business are currently owned and operated.

"Core plus" - investors are generally exploring what assets they can fit into the "core plus" bucket, as mentioned above. During 2019, we saw a number of deals in assets not traditionally considered infrastructure (e.g. healthcare, care homes and nursery schools) and expect this creative expansion of the definition to continue in 2020.

LOOKING AT THE SPECIFIC AREA OF AIRPORT INVESTMENT, HOW IS IT EVOLVING AND GROWING? IS THE PACE OF CHANGE INCREASING AND IF SO HOW DOES THIS IMPACT DEVELOPMENT STRATEGY, FINANCIAL PLANNING AND RETURN EXPECTATIONS?

In Europe, there is currently a smaller pipeline of brownfield airport transactions following a fair amount of activity in the airport sector in previous years (although there is still the potential for a number of significant transactions).

In terms of growth, we expect to see this coming from emerging markets including Brazil, Latin America, Africa, Asia, India and Indonesia. This is due to a developing middle class in these markets resulting in people wanting to travel more and take more flights, and therefore a need for more airport capacity.

This is therefore where the airport operators are currently focussed in terms of growth. However, these can be challenging jurisdictions to do deals in.

In the long term, climate change could have a huge impact on airport investments. There is a growing trend, particularly in the developed world, of people seeking to fly less frequently (or at least until aircraft manufacturers can develop lower carbon emitting aircraft).

In Europe, there is potential for a carbon tax to be applied to every flight (which would increase the cost of flying and therefore could impact passenger numbers). Some airline operators are likely to try to take the lead on the reduction of carbon emissions from aircraft rather than having a carbon tax or similar imposed on them but others seem willing to wait and see what happens. Airport operators are already making great strides to make their airports carbon neutral and this trend will continue.

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