by Luis Miguel Ochoa Comments (18)

Infrastructure Investment Banking: How to Buy and Sell Airports, Stadiums, and More

infrastructure-investment-bankingFrom our coverage of public finance (Part One, Part Two), or “municipal securities” as it’s called at some firms, you learned all about issuing bonds and responding to requests for proposals (RFPs).

And if DCM and the capital markets are for you, public finance is a great place to be.

But if you’re more into advisory – working on actual M&A deals – then you should take a closer look at the infrastructure investment banking coverage group, which is what today’s feature is all about.

You still get to take your interest in government/political science and combine it with finance…

But now you’re running all the standard M&A analyses on airports, stadiums, power plants, highways, and more – rather than on industrial or commercial companies.

And you may even earn higher fees in the process (warning: fees not guaranteed, void where prohibited).

Here’s what lies ahead:

  • How to get into the business of public finance acquisitions.
  • How to think about the sector and the key valuation drivers.
  • How to value companies that specialize in public infrastructure: power / utilities, parking systems, bridges, hospitals, and more.
  • Where to go after giving back to the public sector in a finance role.

How to Get In: Fit for Government Work?

Q: A lot of people are more interested in traditional investment banking (read: mergers and acquisitions), but you chose to pursue a role in infrastructure acquisitions.

Why is that?

A: Similar to what you’ve written about public finance, I wanted to combine my interest in government and in corporate finance – really the mergers and acquisitions side of things.

It doesn’t hurt to take the relevant classes (e.g., ECON141: Public Finance & Fiscal Policy).

There is no required major for my infrastructure department, though it does see its fair share of political science majors and people who had interned / worked in government [treasury or finance] roles.

Some of the more senior professionals come from Leveraged Finance, or even from unrelated areas of sales and trading.

Debt analysis is more complex than equity analysis, and my group appreciates that skill set (although we have seen former sales specialists taking on acquisitions advisory responsibilities).

And you know the old saying: it’s more “who knows you,” rather than what you learned in school or where you went to school.

Q: So it seems like a pretty random mix in your group – how is your coverage universe divided?

Is everyone a generalist within infrastructure, or do you specialize?

A: Up to the Vice President level, we are all generalists.

Directors and Managing Directors cover sectors more or less in equal parts. Some will cover energy, others will cover hospitals/buildings, and a few will cover bridges, tolls, etc.

Broad and Vague? These Must Be Sector Drivers!

A: I love the title for this section. The drivers aren’t that broad!

Q: Let our readers decide on that…

So what are the key drivers in this sector?

A: The health of the economy, Federal Funds Rate, the treasury yield, taxes collected by the government vs. the construction budget, and even government programs such as unemployment benefits.

Of course, private companies’ profitability influences the level of taxes collected as well.

Q: You have to admit those do sound pretty broad and vague.

Let’s look at it from another angle: what motivates an acquisition, or what are the investment considerations?

A: For non-financial sponsors (i.e. normal companies) that want to acquire infrastructure assets, you’re mainly looking at strategic, operational, and financial aspects.

On the financial side of things, there’s a lot of focus on EBITDA generation; you can have a target with higher revenue growth, but it may also have much higher operating costs. And profits contribute more directly to value than revenue does.

On the operational side, you’re looking at cost cutting, the opportunity to reap synergies, and the ability to deploy common systems to provide a better customer experience.

Finally, strategy depends on how the product additions fit into the acquirer’s offerings.

We also take a close look at how cash flow generation is supported by additional locations or access to resources.

Q: OK… so what types of operating metrics and valuation multiples do you look at?

A: It depends on what we’re valuing.

Suppose you were to value a prison: the valuation would be driven by revenues received from taxes, and from the sale of goods produced at the prison; costs would be dictated by the number of prisoners and the terms of their sentences.

Similarly, the valuation drivers for something like an airport would depend on the broader health of the country. They might include export recipients, importers, GDP composition (services, industry, and agriculture), and composition of GDP (if a country’s major export is oil, then look at the non-oil exports and put that into a pie chart).

To be more specific, you’re looking at the number of passengers walking in and the cargo transported by air.

Tolls for roadways and bridges would follow the same logic: traffic flow. This is motivated by the health of commerce, and the competitiveness of public transport (rail, subway, etc.).

The supply of cars is also a factor since too many cars on the road leads to congestion and the pursuit of alternate transport modes.

Growth tends to be very tricky to assume / model for these types of assets because there isn’t necessarily much room to “expand” something like a highway, depending on its location.

In fact, here’s what Central Parking states directly in its 10-K:

“Although some growth in revenues from existing operations is possible through redesign, increased operational efficiency, or increased facility use and prices, such growth is ultimately limited by the size of a facility and market conditions.”).

And if you’ve been to LA before, you know how little additional lanes help the flow of traffic in some locations.

So most companies and assets in this space grow through privatization, or through contracts that outsource elements such as parking structure management for hospitals, hotels, and especially stadiums.

With utilities and power companies, valuation drivers include regulatory factors, the ability to recover costs, the relatively low cost of capital, and the ability to leave tax-exempt bonds outstanding.

Revenue (and indirectly EBITDA) drivers depend on the demand for power, the season, and the presence of substitutes.

In some cities, people can choose to receive their electricity traditionally, through a gas/electric company, or through a firm that harnesses various forms of alternative energy (ex: wind, hydro) into a bundle.

Risks include higher operating expense, lack of tort protection, and of course the inability to leave tax-exempt bonds outstanding. Revenue detractors include anything that scares off customers.

Getting Technical

Q: Great – any example pitch books for this space?

A: Yup – here you go:

And if you want to learn more about parking complexes, these fairness opinions and presentations on Central Parking should prove interesting to you:

Deloitte has assembled a good white paper on valuing Australia’s water infrastructure.  Here’s a confidential information memorandum on some water pumps by BMO Capital Markets.

Q: And what are some of the common valuation approaches?

A: Sure. I’ll start with how the intrinsic valuation methodologies are slightly different, and the approaches not used in other sectors:

Held Approach: The infrastructure target in question does NOT get sold at the end of a 5-year (or 10-year or any other) period. You look at how the cash flow projection evolves as the per use charge changes over time.

This approach is a bit of a two-step discounted cash flow analysis, where you add a stream of growing cash flows to the cash flows that grow at a stable growth rate. Of course, you assume the first growth rate is higher than the “stable-state” growth.

You can, of course, use a standard DCF analysis with infrastructure assets as well – but there are some differences to be aware of:

Discounted Cash Flow: Sometimes you will skip over the changes in working capital and the addition of non-cash charges; for example, the William Blair presentation defines “Free Cash Flow” as operating revenue less operating expenses less CapEx less corporate tax liabilities.

But in other cases, FCF will be defined in more standard ways (see the other links above), especially for entire companies rather than individual assets.

A few other differences with a DCF for infrastructure:

Discount Rate: From school, you learned that the risk-free rate should reflect the cost of capital for a security with a lifespan that is close to the lifespan of the asset you’re valuing. In infrastructure, this risk-free rate is the yield on a 30-year treasury bond since assets here last a very long time.

The risk premium is set more abstractly, but you usually think of an investment-grade company or even a diversified portfolio for this part.

Because infrastructure targets are illiquid, acquirers require a higher return on investment; this implies a higher cost of capital.

As stated in the William Blair report, the cost of capital would reflect the interest rates of the bonds associated with the infrastructure asset.

Some think tanks, including Partnerships Victoria, have written about infrastructure cost of capital and have even divided the world into three categories based on the size and risk of the item in question.

Remember the broader valuation drivers in the corporate arena (read: private sector) include size, risk, and growth. While the parallels are logical, the conclusions are still up for debate.

Free Cash Flow to Equity (FCFE) (AKA Levered Free Cash Flow): From the UBS report on airport valuation, you’ll notice that FCFE is used because the assets’ target capitalization is much more geared toward equity than debt.

In other words, if capital structure is expected to change significantly than it may be important to factor it in by using FCFE rather than FCFF.

They define FCFE as: Net Income + Depreciation & Amortization – Capital Expenditures – Change in Working Capital + Changes in Debt.

Note from Brian: Yes, there are many definitions of FCFE, all of them slightly different. The basic difference is that you take into account interest income / (expense) and debt repayment – whether it’s just mandatory debt repayment or all debt repayment and whether or not you factor in additional debt borrowing is up for debate, and different sources use different methods.

Discount Rate for Free Cash Flow to Equity (FCFE): I know this is cheating, but there are some airports that are publicly traded. The discount rate here would just be Cost of Equity, so you would un-lever your peer group’s Beta and then re-lever it according to the target’s target capitalization.

Dividend Discount Model: Project dividends, calculate Terminal Value with a P/E multiple, and then discount everything at the Cost of Equity. This gets you the company’s Equity Value, and you can move from there to Enterprise Value if you want.

Q: Thanks for sharing all that. And what about the relative valuation approaches? Are there any differences to note?

A: Those are all fairly standard – you still use Enterprise Value, EV / EBITDA, EV / Revenue, and P / E and many of the familiar metrics you’ve seen before for both precedent transactions and comparable public companies.

A few additional metrics to look at: Book Value, Dividend Payout Ratio, Dividend Yield, Long-Term Growth Rate, Total Return, S&P Rating (other ratings are good too, it’s just that S&P is usually listed first), and credit outlook.

The main difference is that you may have to broaden your definition of what a true “comparable” is here: if you take a look at the acquisition of Central Parking by Standard Parking, for example, the comps group included anything that provided “on-site management services.”

This is because there often won’t be many publicly traded companies or recent transactions in the specific sector you’re analyzing – so you need to find common ground by broadening the selection criteria.

Where Do You Go After Giving Back to the Public Sector?

Q: So what do you like to read on the job?

Or what should our readers read if they want your job?

A: I would recommend reading articles or RSS feeds written by the various investment banks or consultancies.

You can also read Infrastructure Investor, Latin Infrastructure Quarterly, InfraNews, and Lloyds Bank’s articles on infrastructure.

Q: What about networking?

A: You can take a look at these two groups if you are in New York: Municipal Analysts Group of New York and the Municipal Forum of New York. You might also want to take a look at National Federation of Municipal Analysts.

Q: Great, thanks for sharing. So where do bankers in your group go after putting in their 2-3 years?

A: Similar to the divide between equity/equity-linked/debt/high-yield capital markets and investment banking coverage, you tend to have more options in other industries vs. what you would get in a pure public finance role.

I’ve seen people go into infrastructure private equity funds, investment banking coverage groups, trading desks that cover municipal securities… not to mention private equity funds that focus on industrials or even natural resources (power & utilities and oil & gas, really).

Q: Not to mention joining the “public” side of public finance…

A: Yes, exactly. You see senior professionals – say, the Treasurer of a major city – becoming the head of public works projects and the like.

As I mentioned at the beginning, some public finance professionals do go into the public sector, and might even return to the private sector in a later time.

Q: Thanks so much for your time.

A: Glad to be helpful. Looking forward to your comments.

M&I - Luis

About the Author

Luis Miguel Ochoa has facilitated a variety of strategic initiatives from corporate acquisitions to new market development. He earned his B.A. in economics from Stanford University where he was a member of the varsity fencing team.

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Comments

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  1. Hello Brian, I wonder how does the exit opportunity is like for an infrastructure IBanker to PE?

    1. Infrastructure PE is the obvious exit opportunity, maybe also Project Finance. Maybe also real estate and some energy-related PE firms.

      1. Hi Brian,

        Not sure if this is the right thread to post this question but, would it be possible to lateral back into the traditional M&A from an infrastructure investment gig at an IB? I read that infra is quite niche and once youre in youre gonna be pigeonholed in infra and the exit options are often limited to infra pe/pf.

        1. Yes, you could probably do that if you make the move quickly (within 1-2 years). It would be harder to move around once you’re already on the buy-side or in project finance.

  2. Brian/Nicole,

    Hi,

    I am from India. I have completed Masters in Economics. I am currently working with Citigroup as Operational Risk Manager and also perusing CFA (level III candidate). I am planning to go for MBA (targeting top 15 schools in US) to make a career shift into finance side of Infrastructure. I aim to get into Infrastructure IB role right after MBA and leverage this experience to eventually shift into Infra PE profile.

    Even though I have good modeling and financial valuation skills, I lack work experience in IB role and in infrastructure related industries. With this in mind, I wanted to know how much difficult it would be to break into infrastructure investing after MBA from a good school?

    Also I am planning to take an internship in infra financing company before I leave India for my MBA. What more can I do to get relevant work experience/industry knowledge before my MBA?

    Your advice and suggestion would be highly appreciated. Thanks. Keep posting such enlightening interviews.

    1. M&I - Nicole

      Yes an internship at an infra-financing company can potentially help. If you can gain some valuation experience or even experience at a buy-side infrastructure firm this can increase your chances.

  3. Given that a lot of the work is with puic entities how does deal flow and bonuses/hours compare to other industry groups?

  4. Brian/Nicole

    I’ve worked in the infrastructure industry as a Civil Engineer (on the construction side) for nearly a decade and am currently enrolled in a part-time MBA program from a local school. When I began the program I had planned to stay within my industry, thus I went with the local MBA that is paid for by my firm. Had I any intention of moving into finance, I would have targeted a top 10 school, but alas I came to this realization a few years late. As I’m nearing the end of my MBA program I’ve come to the conclusion that I would like to move into the finance side of the infrastructure industry, in particular in PE. I am looking into part time internships (I have at least one prospect), but am looking for any other advice about getting into PE with no finance experience at my age (31). Is this completely unrealistic, or would getting my foot in the door with a small firm open up other opportunities?

    Thanks

    1. M&I - Nicole

      Yes, there’s still a chance. I’d network with smaller firms and see how that goes https://www.mergersandinquisitions.com/private-equity-recruiting/

  5. Brian, you now I am a sucker for all things infrastructure. And yet M&I presents us with another interesting piece on it. So thanks to Luis and you for your efforts.

    However I still have some questions. To my understanding most banks have Power & Utility teams and might deal with airports and within in their Transport & Logistics team (which again might be part of the broader industrials group). Same for PPP projects, which might be handled by construction teams. Just wanted to know whether you have any insight regarding which banks combine the above in an infrastructure team? Your input is greatly appreciated.

    1. M&I - Nicole

      Thanks for your support. I am not 100% sure though I believe there aren’t too many firms that fit what you’re asking for.

      From online sources, I believe these two firms maybe close to what you specified.
      http://www.greenhill.com/index.php?option=com_content&task=view&id=62&Itemid=155
      http://www.menainfrastructure.com/about-us/

  6. BBQ Shape

    Luis, excellent interview. I’d say this topic interest me pretty heavily. Taking financial skills and using them to achieve an end-result that is visible and develops society. You can see the product of your work in motion and its impact. There has to be no better feeling than to be a part of infrastructure projects that improve the lives of residents in the geographic area.

    Running analysis is fun, but it’s even better when you can see the impacted end result and say “I helped upgrade the energy infrastructure in Southern California,” or “See that airport? We worked the deal to make that happen.”

    Please ask the interviewee if we can bring the Raiders back to Los Angeles. We need a team and by definition, we need a stadium.

    On a serious note, thank you to the interviewee for the work you do. It has a positive impact on us all.

    1. Thanks! Yes, there is definitely more “societal good” in infrastructure.

      I’ll see about the Raiders, but I think the asking price might be a bit higher than the capital I have available…

  7. I always wanted to know, how do these groups find clients? For example, it’s not everyday that a mayor decides to build something big like a bridge or an airport. What is their marketing strategy/how do they capture clients?

    1. Good question… I think a lot of it is maintaining relationships with longstanding clients, such as cities / states / countries that are likely to build new projects. So it’s even longer-term than what you usually see in IB with normal companies.

      And then there are some traditional bake-offs / contests where banks are called in and have to compete for the business as well, but likely more for companies in the space as opposed to governments.

      Would be curious to hear from anyone else who knows more about this point.

      1. Rodrigo B. Cortez

        I will share my experience from a Project Finance team with a European Bank. We work on advisory mandates to help clients finance, as well as participate in the lending syndicate for the construction and operation of infrastructure assets. Therefore, I will speak more to the private sector.

        Corporate Clients: Most corporations that want to build an asset, let’s say, a transmission line, will know who are the main banks that have particular expertise in the area and will invite them to submit proposals and maybe do a presentation. Most companies that construct infrastructure assets have done before in the past and will therefore have a handful of advisors who have done good work in previous projects.

        Financial Sponsor Clients: There has been an increase in infrastructure funds that special in emerging countries, such as Latin America which we cover in my group. Some funds want to get in since the beginning of construction phase, while others only want in at the operation phase or when construction risk is very minimal due to the level of completion. Those that want to get in early, tend to form partnerships with corporations that do not want to put all the equity into the deal or are want to have some subordinated debt in the project structure. Those that want to get in after the construction phase will buy a stake or the whole project from other funds or companies willing to sell, either because they want cash invest in other projects or they want to rid of bad performing projects.

        1. Thanks for adding all that! Very helpful.

    2. I don’t know how it is in the US, but in Europe there are pretty strict laws as to which extent public sector entities can award advisory contracts free-handedly. Obviously advisors keep in touch with the public sector in order to scoop up smaller assignments which can be assigned without a public tender and to be kept in the loop in regards to new tenders and what are the key elements an entity might look for in a company’s tender documents. This can lead to an advantage, but most of the time pricing of the offer is the critical point since criteria for awarding projects have to be objective and transparent, which is easiest with price. Also, the public sector is a notorious cheapskate.

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