Why Private Equity Alone Cannot Speed the Pace of US Infrastructure
Infrastructure investing has become increasingly mainstream over the last decade, most recently highlighted by the noticeable influx of private equity money into the sector.
Infrastructure investing is nothing new, but The Blackstone Group’s announcement of a $40 billion infrastructure fund in May 2017 was definitely the biggest splash made in this space to date among private equity firms, with overall infrastructure fundraising likely to continue.
Why has infrastructure investing become more prominent? A pivotal reason is the increased global need for infrastructure spending to support ageing or expanding facilities, and public sector interest in using the private sector to enhance efficiency and taxpayer value. Another reason is that the persistently low interest rate environment has increased investor appetite for alternative investments, such as infrastructure.
Will the significant capital available from private equity firms be enough to finally move the needle on many of these projects and renovations? The short answer is ‘no’
This raises an interesting scenario of increasing institutional participation in a heavily politicized sector. The need for updated/expanded infrastructure, particularly in the US is without question. But the relative public sector inertia surrounding commencing renovations and making new asset investments throughout the country raises questions around how project timing would coincide with the investment horizons and return targets of private sector debt and equity investment vehicles. On the positive side, global needs are in the trillions of dollars so these funds can potentially find investment opportunities in other countries pursuing new and improved infrastructure, although weaker operating environments in certain countries may introduce additional risk considerations.
Will the significant capital available from private equity firms be enough to finally move the needle on many of these projects and renovations? The short answer is ‘no’, as private sector investors will need to ultimately be repaid, and sustainable longer-term sources of infrastructure funding remain elusive.
The US remains stuck in the debate on whether taxes or user fees are the solution
Identifying sufficient sources of repayment has yielded mixed results historically. In developed markets, it has been harder to convince the public to pay for rehabilitation when there is little perceived added benefit. In developing markets, the benefits of improved infrastructure are more perceptible and consequently subject to less opposition.
In the US, for over a decade there has not been clear federal policy on what infrastructure goals are important, who is responsible for pursuing these goals and how it will be paid for. Instead the US remains stuck in the debate on whether taxes or user fees are the solution. While the proverbial doctors argue, the patient is in critical condition.
In contrast, many European, Asian and Latin American countries have identified central government resources to keep funding a core, but not fully-sufficient, level of infrastructure to pursue policy goals. This is despite the ongoing debate about tax levels, how to most effectively spend tax dollars and whether user fees would be more equitable.
The challenge for private equity funds then is timing and risk tolerance. The US could be a significant component of the global infrastructure investment opportunity set were political obstacles abate. Despite geopolitical challenges, Western Europe is on a positive economic trajectory that should support more reliable infrastructure investment. The emerging market economies in Latin America, Asia and Africa have varying degrees of stability that hold promise for infrastructure. However, currency risk will remain a hurdle.
While private equity firms continue to raise meaningful capital to deploy in infrastructure investments, it is a still relative drop in the bucket compared to the overall infrastructure universe. Regardless of the dollar amounts, local politics remain a key influence which infrastructure investors of all types will need to navigate.
Cherian George is a Managing Director and Head of Fitch Ratings’ Infrastructure Group for the Americas
Meghan Neenan is a Managing Director and Head of Fitch Ratings’ Non-Bank Financial Institutions Group in North America