US infrastructure: Mind the gap

US infrastructure investment has a powerful advocate in Larry Fink, chairman and CEO of BlackRock. "Infrastructure in the US is dismal - whether it's crumbling roads, underfunded public transportation networks, or less visible things like power grids and sewer systems," he wrote last September before coming up with a shopping list of suggestions.

Fink wants cash-strapped local governments to partner with the private sector to get projects funded. He wants governments to aggregate assets in order to attract private investors. And he likes the idea of a federal infrastructure bank that would offer central leadership.

Despite the White House seeking to provide impetus with the Build America Investment Initiative, political risk - the fear that a tender issued by one administration will be withdrawn by the next - is the sector's most pressing problem. The US needs an infrastructure upgrade and investors, including Asian institutions building out their portfolios, like low-yield, long-term, cash-generative projects in developed markets. But they don't like uncertainty.

"Many investors want to diversify their holdings in North America and it is logical for them to be interested in US infrastructure, but the opportunity set is still quite skewed towards energy and utilities," says Kerry Ching, Asia managing director at AMP Capital. "Some telecom deals have come up in the last few years, and we think there will be more, but compared to a full-spectrum market like Australia, the US is still relatively confined to specific sectors."

Public problems

Energy appeals because public sector involvement is rare and it potentially offers higher returns than traditional core infrastructure. Global Infrastructure Partners' entire US portfolio comprises energy assets, while IFM Investors four out of five US projects are in energy and power. Nine of Brookfield Asset Management's 16 projects in the country are energy-related.

While praising the ethos behind the Build America program, one executive with a leading infrastructure player says that his objectives include developing partnerships with likeminded investors on deals. "Typically, those investments do not include governmental entities."

A US Department of Treasury report released last year emphasized the trying byproducts of underinvestment in public infrastructure: drivers annually spend 5.5 billion hours in traffic, resulting in $120 billion of losses in terms of fuel and time; businesses pay $27 billion in additional freight costs because of poor roads; and there as approximately 240,000 water main breaks per year due to deteriorating supply infrastructure.

At the same time, governments are directing less capital at these problems. Public spending on drinking and wastewater projects, for example, declined 23% between 2006 and 2013. The American Society of Civil Engineers estimates that the country's cumulative infrastructure needs will total $2.7 trillion by 2020, and public funding will cover only 60% of the cost.

They took this deal right through to almost signing on the dotted line and it has basically died. Consortia have spent several million dollars in bid costs and an awful lot of time to get to that stage and it's just pure politics going against the project - Andrew Garbutt

Public-private partnerships (PPPs) have not achieved the same critical mass as in other developed markets, largely because local governments have been able to rely on the municipal bond market to finance infrastructure. With bond issuance declining in recent years and governments reducing commitments to infrastructure, there are calls for more innovative forms of funding. Adopting private market solutions, such as PPPs, is one option.

However, private investors have in the past struggled to secure privatizations of assets. The fragmentation of the market is one challenge - municipal and state authorities have the greatest say in how projects are allocated - and it exacerbates the other: political uncertainty. "There have been a couple of high-profile examples of bids going pretty late in the process and then cancelled. We see that less in some other jurisdictions," says Julio Garcia, head of North American infrastructure at IFM.

Andrew Garbutt, a principal at KPMG who advises on US infrastructure deals, points to the debacle over the $500 million Indianapolis city courthouse project that unfolded over the course of the last 18 months. He blames the decision by Mayor Greg Ballard not to seek a third term in office with removing impetus for the project.

"They took this deal right through to almost signing on the dotted line and it has basically died. Consortia have spent several million dollars in bid costs and an awful lot of time to get to that stage and it's just pure politics going against the project," Garbutt says. "It is buyer beware."

The courthouse was a greenfield project, but industry participants are united in the view that brownfield is the real problem. Although the private sector already accounts for a lot of US infrastructure, there is residual discomfort in privatizing assets and transactions can escalate into points of political contention.

Privatizations therefore remain relatively rare and Garbutt says he often reminds sellers that it is not all about getting the highest price: money has to be left on the table for investors must sign off on certain pricing and service quality requirements in order to protect public users.

Hope in Indiana?

IFM's Garcia sees hope in the form of the Indiana Toll Road Concession Company. The asset was privatized in 2006 with more than 80% debt and went bankrupt last year. IFM acquired it in March for $5.7 billion - and with much lower leverage - bringing in a string of US pension funds as investors alongside other global institutions.

There is more investor interest in core infrastructure and US pension funds are no exception. Whether acting with fund managers or independently, these groups may be seen as more acceptable buyers and US infrastructure privatizations can deliver on their potential.

"That is where the industry is thinking things will go, it really depends on how quickly," says Garcia. "The demand has always been there but dealing with political cycles and different levels of government is a problem. Maybe it is easier to get comfortable about a bunch of local pension funds coming in and backing critical infrastructure than traditional private capital."

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