Infrastructure As An Investment Class - Russell Investments Investment Forum 18 June 2020
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Infrastructure As An Investment Class
Russell Investments
Investment Forum 18 June 2020
Why? Infrastructure & Utilities
Over the last five years bonds have delivered incredible returns. That tailwind no
longer exists. Investors need alternative low risk/volatility fixed return assets
Starting Ending Ending Ending Ending
Yield Yield Yield 5 Year Return
Yield Yield
Govt Bonds Govt Bonds Shares Bonds 60/40
Japan 0.9%pa 0.2%pa. 0.3%pa. 3.5%pa. 1.6%pa.
Europe 1.3%pa. 0.7%pa. 1.3%pa. 4.2%pa. 2.5%pa.
USA 2.6%pa. 1.2%pa. 9.1%pa. 8.9%pa. 9.0%pa.
New Zealand 3.8%pa. 0.3%pa. 13.1%pa. 6.8%pa. 10.6%pa.
Bond returns calculated on the longest dated government bond in each market. All calculations to
May 2020.
2
Not Much Juice Left In Long Bonds
The Lower The Starting Yield The Lower
The Subsequent Returns (1976-2020)
Subsequent
5y return
US Treasury starting yield
(KKR Global Macro analysis)
3
Infrastructure Is A Broad Church
ELECTRICITY & GAS AGEING CONNECTIVITY AIRPORTS & WATER WASTE & SOCIAL FUEL
POPULATION TRANSPORT RECYCLYING INFRASTRUCTURE
o Integrated o Retirement o Data centers o Airports o Urban supply o Waste o PPPs o Refining
villages processing
o Generation o Mobile o Mobility as a o Irrigation and o Social o Distribution
and recycling
(peak, base o Aged care towers service water rights housing
load, o Waste to o Retailing
o Tech care o Fibre & o Public o Recycling o Student
capacity) energy o Alternative
platforms copper transport housing
o Retailing networks
o Rail
o Transmission o Integrated
telco o Ports
o Hydrogen
o Roads
o Batteries
4
Sector Target-Returns
Target-returns depend on
• Price/contracting risk
• Economic cycle/demand risk
• Capital/investing markets 20%
• Cost/availability of debt
• Regulation 16%
• Technology & cost curve 15%
14%
13% 13% 13%
12%
8% 8% 9% 9%
7%
8%
7%
5% 6%
4%
5
Infratil Portfolio: Risk & Value Diversity 6
Infratil Portfolio: Risk & Value Diversity
Sector Risk
Retirement NZ Electricity
Growth Core
Airport
Telco
Aust, USA
Electricity
Core +
Data
7
Infratil Portfolio: Long-term Return Expectations
Asset Expected
Category Return
Core 7-10%pa.
Portfolio Management Return To
Leverage Cost Shareholders
Core Plus 9-14%pa. 30% @ 4%pa. 1%pa. 9-14%pa.
Growth 13-25%pa.
8
NZ Utility Sector Performance (to 9th June 2020)
None was spared the value fluctuation associated with Covid-19
There have also been a wide range of one year returns
12 Months 3 Months 3 Month
Range
NZX50 14.9% 1.9% 30%
NZX Utilities average 4.6% 1.4%
Chorus 40.4% 4.7% 21%
Infratil 26.7% 7.5% 25%
Spark 25.6% (4.3%) 20%
Port Tauranga 24.8% 14.1% 32%
Gentailers 11.4% 6.3% 18-25%
Vector 7.9% 12.2% 17%
Auckland Airport (15.3%) (9.3%) 24%
Z Energy/NZR (50.4%) (20.1%) 37-42%
10 Year Govt. Bond 8.8% 2.0% 11%
9
US Equity Market Performance (to 1st June 2020)
The NZ market experience with utility stocks was consistent with what happened
in the USA. (the table shows changes in market capitalisation rather than indices)
% of Mid Feb to End Mid Feb to Early
Total March June
US Share Markets (29.1%) (12.3%)
Financial 17% (33.5%) (26.0%)
IT 15% (28.4%) (5.3%)
Consumer 19% (25.5%) (7.4%)
Industrial 11% (31.8%) (16.2%)
Health 10% (23.0%) 1.7%
Energy 7% (35.1%) (19.6%)
Real Estate 4% (33.2%) (21.7%)
Utilities 4% (27.3%) (14.7%)
10Infrastructure Sector: Risks-Return Lessons
• Interest rates are the underlying value driver
• Growth is a key source of differentiation:
• Between sectors: Secular decline (motor spirits) Vs. elevation (data)
• Within sectors: (e.g. gentailers, airports) there may be large risk-return
differences reflecting specific corporate or market features
• None of this addresses the lasting impact of C-19
11Risk Case Study: Two Airports Facing C-19 Restrictions
Wellington Auckland
81% domestic on domestic. 42% domestic on domestic.
13% short haul 26% short haul.
6% related to long haul. 32% related to long haul.
Traffic Negligible freight. Freight.
2.5 airlines Multiple airlines.
Very stable growth at GDP. Asian growth exposure.
Each domestic pax “worth” Pricing and investment
Earnings PerWellington Five Year TSR To 31 December 2019 ~ 12.6%pa. Returns = dividends (which reflect operating cash flow and payout ratio) + the required dividend yield (which reflects the risk- free rate and the required spread over that rate). WIA’s 5 year return was 86% (12.6%pa.). The 86% comprised cash payments (36%) and equity appreciation (45%). 45% equity appreciation = 16% dividend growth (all higher free cash flows) + 29% yield compression (lower risk-free rates). 13
Infrastructure Provides Investment Opportunities
But it’s important to understand individual company risk-
return features
ELECTRICITY & GAS AGEING CONNECTIVITY AIRPORTS & WATER WASTE & SOCIAL FUEL
POPULATION TRANSPORT RECYCLYING INFRASTRUCTURE
o Integrated o Retirement o Data centers o Airports o Urban supply o Waste o PPPs o Refining
villages processing
o Generation o Mobile o Mobility as a o Irrigation and o Social o Distribution
and recycling
(peak, base o Aged care towers service water rights housing
load, o Waste to o Retailing
o Tech care o Fibre & o Public o Recycling o Student
capacity) energy o Alternative
platforms copper transport housing
o Retailing networks
o Rail
o Transmission o Integrated
telco o Ports
o Hydrogen
o Roads
o Batteries
14Presentation – Russell Investments June 2020
Highly Attractive Market Opportunity
New Zealand has a deep pool of potential private investment opportunities with limited local competition and competing
sources of capital
Stock Market Capitalisation (% of GDP) Significant Number of Potential Investment Opportunities
180% Annual Revenue
160% No. of
Employees
140% $0 – 10m $10 – 20m $20 – 50m $50 – 100m $100m+
120%
100% 0 – 49 427,131 1,698 615 165 99
80%
60% 50 – 99 1,104 594 402 102 42
40%
100 – 199 234 192 357 141 60
20%
–
200+ 63 63 153 195 294
New Zealand Australia United States OECD
Source: World Bank Source: Statistics NZ
• New Zealand has a relatively small public capital market in • Target universe consists of approximately 5,000 companies, plus
relation to its GDP an even larger universe of bolt-on acquisitions
• New Zealand’s economy is largely comprised of unlisted • Limited direct competition for assets in the mid market
companies
• Local exchange is not representative of the domestic economy
Strictly Private & Confidential | 2Approach to private market investments
The four primary routes for investment in New Zealand’s private company market are outlined below
1
• Direct investment in a private company via purchase of existing shares or newly issued shares for
growth capital
Direct investing in
• Examples within NZ Kiwisaver industry are Simplicity and Booster, who are making private equity
private companies
investments out of their Tahi Fund
• This approach removes the intermediary manager but requires significant in-house experience
2
• Direct investment in established, specialist private equity managers such as Pencarrow
Direct investing in • Requires an ability to assess managers and monitor them overtime. Some entities appoint an
private equity investment consultant to act as advisor
managers • Private equity managers in New Zealand typically take an active role in company strategy and growing
value
3
• Useful approach to build a global portfolio as it allows allocation to a range of different fund managers
Fund of fund
• Adds additional layer of fees
investing
• May need additional capability in house or can outsource
4
Hybrid of options • Direct manager investing in New Zealand and fund of fund investing for overseas private markets
two and three
above • Government Superannuation Fund/Annuitas is a proponent of this approach
Strictly Private & Confidential | 3The Private Equity Model
• Private equity firms raise “funds” with investment capital
(commitments) from financial institutions and high net worth
individuals
• Funds are usually structured as limited partnerships
- The private equity firm is the General Partner (GP) Fundraise
- The other investors are Limited Partners (LP)
- The GP-LP is a important distinction for both legal purposes
and also for understanding how the PE model works
Demonstrate
• Funds invest in multiple portfolio companies (6-12) acquiring a Invest
shareholding stake Gains
• Alignment between portfolio company management and investors
is important so management usually have an equity interest
alongside the investors
• Lifetime of the Fund is typically evergreen but investors can agree
wind-up from 10 year point Value-add
Strictly Private & Confidential | 4Private Equity Example
• Consider a business generating EBITDA of $5m, valued at $25m, no debt. Current management want to buy out existing owner but do not have
the capital to do so themselves
• MBO, management contribute $2m, PE contribute $8m equity and $8m sub debt, bank debt of $7m
• On exit, business is generating EBITDA of $10m, valued at $50m, ignoring interest
Entry Exit Returns
$7m Bank – interest
Bank (not shown)
Implement $8m
PE debt – interest
PE
growth Debt (not shown)
strategy,
expansion, $50m
$7m acquisitions 5x
Bank $28m PE equity $28m on
etc. EBITDA
PE $8m (3.5x cash)
$25m $8m Equity
PE
5x Debt
EBITDA $8m
PE $10m $7m Management $7m
Equity
$5m Management on $2m (3.5x cash)
$2m Management
EBITDA Enterprise MBO EBITDA Enterprise
value Funding value
Strictly Private & Confidential | 5The Private Equity Process
Private equity firms have a hands-on approach to building value, following a 5 step process through the investment cycle:
1. Fleshing out the investment thesis
• Having a clear understanding of how the company makes money and why we’d want to invest in it
• Thesis is developed and refined alongside management and sets strategic objectives and financial targets
2. Drawing up a blueprint for action
• Thesis outlines broad picture – to execute successfully requires more detail (e.g. a 100 day plan)
• A good plan should be clear what needs to be done to achieve the company’s strategic objectives
3. Supporting strong management teams
• Private equity should provide an environment where the company can take advantage of opportunities they may not be able to
achieve on their own
4. Measuring what matters
• Identifying the key metrics that drive value and monitoring through an operational “dashboard”
• Helps monitor progress toward operational goals before they show up in financial results
5. Plant the seeds for a future possible liquidity
• Understanding how a company makes money at each stage of the business cycle and engineering performance improvements
helps create a strong business positioned to perform well in future
Strictly Private & Confidential | 6What makes a company a good candidate for private equity
investing?
• Track record of positive earnings and growth
• Strong management teams looking for a partner to provide strategic and governance expertise
• Attractive industry dynamics and strong and differentiated market positions – focus on emerging global players and leading domestic
businesses
• Strong growth propositions (offshore scalability, roll-up, roll-out)
• A well defined investment thesis
• Expected to provide a target IRR of 30% per annum (net 20% to investors)
• Attractive to future purchasers (if decide to realise value)
Strictly Private & Confidential | 7Capabilities Provided to Firms
Private equity provides both capital and skills and expertise in:
• Strategy development
• Governance
• Acquisition, divestment and IPO experience
• Extensive networks
• Key personnel and external service providers
• Financing and balance sheet structuring
• Active Board input
• Risk management / ESG
• Long experience of successful input into development and execution of company strategies and plans
• Acting as a “sounding board”, aided by investee company management network and wide industry experience
Strictly Private & Confidential | 8Domestic Private Equity Fund Performance
The mid-market is the sweet spot for New Zealand private equity investments
Gross IRR by Size of Invested Capital (n = 131) = number of investments
40% 80
74
35% 70
30% 60
25% 50
20% 40
31 35%
15% 30
18
10% 20
8
5% 15% 10
8%
– –
-1%
$0 - 5m $5 - 50m $50 - 100m $100m+
(5%) (10)
Source: Cambridge Associates
Strictly Private & Confidential | 9Pencarrow has been helping New Zealand businesses achieve
their goals for over 25 years
History
Founded Fund II Fund III Fund IV Bridge Fund Fund V
Fund I $25m $138m $75m $124m $80m $250m
1993 1998 2005 2011 2016 2018
11 portfolio 11 portfolio Six portfolio
companies in companies in companies in
Fund I Fund II Fund III
Investment Approach Investment Themes
• Pencarrow partners with outstanding management teams & • We invest in a broad range of industries.
existing shareholders to realise a company’s full growth potential. • Particularly attracted to emerging global champions, leading
• Returns are derived through earnings growth, not excessive levels domestic players potentially expanding into Australia, roll ups and
of leverage. roll outs.
• Later stage investor – companies are typically cash flow positive or
have a clear pathway to profitability. Funding
• Active investor bringing complementary capability to the board.
• Pencarrow raises funds from its investors every 3-5 years.
• We seek to grow the value of its investments and provide dividend
income stream over the long term. • Funds raised represent a binding commitment and are “called”
when Pencarrow makes a new investment.
• Typically provide expansion capital to effect growth, but also
provides replacement capital where founders wish to de-risk their • Investors comprise large institutions, iwi groups, trusts,
investment, either through majority or minority stakes. foundations and individuals, mainly from New Zealand.
Strictly Private & Confidential | 10Pencarrow Investment Themes
Identifying competitive advantage that is underpinned by clear economic, demographic, social or technological factors
Emerging Global Champions Leading Domestic Players Industry Consolidation Rollouts
• Companies addressing a • Market leaders in New • Industries with attractive • Industries with attractive
niche segment in a global Zealand in attractive dynamics and no clear dynamics and proven
market industries market leader business models
• Differentiated market • Strong and stable cash flows • Potential acceleration of • First-class management
position and strong growth scale and growth through teams with the ability to
• Potential international
propositions consolidation capture market share
expansion, particularly
• Companies leveraging New Australia, which is seven • Opportunities for significant • Scalability
Zealand’s small economy times larger than New cost synergies
and characteristic of an Zealand
experimental test bed to
attain rapid global
expansion
Strictly Private & Confidential | 11Current Situation
• Covid-19 forced PE managers to actively work with their portfolio companies to undertake scenario planning, ensure contingency plans were in
place and ensure adequate funding and liquidity.
• Merger & acquisition (M&A) deals were cancelled or put on hold (eg, Metlife) and origination largely ceased.
• Certain sectors (eg, travel, tourism, leisure, hospitality, education, retail) were much more dramatically affected than others. Different to the GFC
which more broadly impacted across a range of sectors.
• With Covid-19 now eliminated in NZ, we are much more likely to experience a “V’ shaped recovery apart from certain sectors like tourism. This
will also reflect in boosted M&A activity and valuations.
Strictly Private & Confidential | 12Conclusion
• Private Equity represents an asset class almost completely unrepresented in many NZ portfolios and yet has been shown over the long term to
deliver among the highest risk-adjusted returns of any asset.
• Virtually all large institutional investors in NZ have now embraced the asset class including NZ Super, ACC, iwi groups, community trusts and
high net worth individuals yet many other investors (such as Kiwisaver investors) are missing out.
• As a proportion of the NZ economy, private companies and markets are a much bigger opportunity set than those represented on the NZX.
• Illiquidity does not represent a good reason for fund managers to remain uninvested in this asset class. Illiquidity can be managed through the
greater scale that many funds now have and the known stickiness of most underlying investors.
• Pencarrow would welcome investment into our next fund (Fund VI), likely to be raised in 2021. Likely parameters are:
- 6 -10 investments
- Target enterprise values of $20m to $200m
- Evergreen fund but the ability for 25% of investors to call a two year wind-up notice at Year 8
Strictly Private & Confidential | 13Appendices
Case Studies – Fund IV
Pencarrow Investment Team
Strictly Private & Confidential | 14BrewGroup Investment
Ownership
$16.8 million
79.0%
Leading New Zealand tea and coffee business (Fund IV – 47.8%)
Invested October 2013 (Co-investment – 31.2%)
Deal Overview Investment Thesis Value Added
Leading position in the domestic tea and Leading player in attractive markets with Achieved revenue and earnings uplift
coffee markets number one or two brands and from increased sales to Progressive,
diversification across all key distribution expansion into Australia and acquisitions
channels
Portfolio of strong brands, including Bell,
Jed’s, Hummingbird, Gravity, Twinings Launched a number of new products,
and Burton’s Incremental and highly profitable including Jed’s Bean Bags
business available through increased
sales to Progressive Enterprises
Operates in all major channels in New Secured a number of major coffee
Zealand including grocery, hospitality, accounts
corporate/workplace and food service Multiple opportunities for growth
Acquired Hummingbird in early 2016
Vertically integrated business model
Sold to global beverage leader JDE in
November 2016
Strictly Private & Confidential | 15Icebreaker Investment
Ownership
$15.0 million
38.0%
Global leader in merino outdoor apparel (Fund IV – 19.0%)
Invested November 2015 (Co-investment – 19.0%)
Deal Overview Investment Thesis Value Added
Leading designer and marketer of merino Differentiated position in a large and Restructured North American operation
outdoor and sports apparel growing market by closing US regional office and
consolidating functions to Canada
Diverse offering of natural and Historical track record of growth and
Instigated a comprehensive review of the
sustainable fibre products profitability
product supply chain
Primary markets are North America, Robust plan to grow revenue and Closing a number of underperforming
Europe, and New Zealand and Australia improve profitability with a focus on stores in the US and opening new smaller
accelerating consumer demand and format stores in Canada and Australia
reducing supply chain costs and
Products are ranged in more than 4,500
overheads Restructured management team with
premium outdoor, snow-sports and
new head of strategy / marketing, CFO
sporting goods stores across 44 countries
and COO appointed
Partnering with a high quality
management team
Sold to global apparel and footwear
leader VF Corporation in April 2018
Strictly Private & Confidential | 16Seequent (previously ARANZ Geo) Investment
Ownership
$15.3 million
40.5%
Global geological software solutions and services business
Invested July 2014
Deal Overview Investment Thesis Value Added
Leading global provider of 3D geological Leading player in a niche global software Completed the internalisation of third-party
modelling software for mining and market distributors
exploration geologists
Made several hires to strengthen the senior
Track record of rapid and profitable
management team
Customer base encompasses more than revenue growth, with annual recurring
400 mining and exploration companies licence renewals over 90% Increased investment in new product
development and made two significant
Strong recurring subscription-based Multiple growth dimensions acquisitions in 2016
licence revenues, with direct distribution
Significantly expanding the company’s
and sales into most international markets Backing a high quality CEO and
addressable market by entering new verticals
management team
Sold a majority stake to US private equity
investor Accel KKR, alongside Pencarrow
Fund V, in August 2018
Completed the acquisition of Canadian
geoscience software company Geosoft for
CAD43.5 million in December 2018
Strictly Private & Confidential | 17Pencarrow Investment Team
Rod Gethen Managing Partner Nigel Bingham Managing Partner
• Joined Pencarrow in 1994 • Joined Pencarrow in 2005 after 20 years in investment banking
• Previously worked for Deloitte and PwC in corporate finance in • Previously worked for Cameron Partners as a partner and Fay,
Auckland, Sydney and London Richwhite
• Currently on the boards of BeGroup, Umbrellar, Mix and The • Currently on the boards of MMC, Seequent, Netlogix, RedShield
Collective and New Zealand Frost Fans
• Previously a director of BrewGroup, Icebreaker, BJ Ball and • Previously a director of BrewGroup, phil&teds, BJ Ball and
Methven Rishworth Aviation
Jonathan Goldstone Managing Partner Philippa Weston Investment Director
• Joined Pencarrow in 2013 • Joined Pencarrow in 2012
• Previously worked for Morgan Stanley and UBS in investment • Previously worked for Kiwibank and AMP Capital
banking in New York, Auckland and Sydney • Currently on the boards of MMC, Mix, BeGroup and Solarcity
• Currently on the boards of Umbrellar, Netlogix, The Collective,
Avanti Finance and Skin Institute
• Previously a director of Icebreaker and Seequent
Hazel Martin Investment Manager Geoff Romijn Investment Manager
• Joined Pencarrow in 2017 • Joined Pencarrow in 2018
• Previously worked for PwC in corporate finance, a mid-market • Previously worked for Deloitte in corporate finance in
European PE fund in London and the Walt Disney Company Wellington, Z Energy, and Colt and United Biscuits in the UK
• Currently on the board of Umbrellar
Alex Perry Investment Analyst Contact Details
• Joined Pencarrow in 2018 Wellington
Rod Gethen 04 917 0118 Level 14, Pencarrow House, 1-3 Willeston Street
• Previously worked for PwC in their corporate finance team in
Nigel Bingham 04 917 0116
Wellington
Auckland
Jonathan Goldstone 021 656 345 Level 5, 33 Federal Street
Hazel Martin 0204 123 2482
Strictly Private & Confidential | 18You can also read
