Infrastructure Investing On the Job: Private Equity Lite, or Modeling Like a Mega-Fund?
We pick up today with Part 2 and do a deep dive into what you do on the job, a day in the life at an infrastructure fund, what modeling and deals consist of, and yes: the pay, hours, and all the stuff you actually care about.
Besides just being a “hot” sector, infrastructure investing has other attractive attributes as well: the ability to earn PE pay with improved hours, for one.
Read on to find out why and how that’s possible and what you can expect after you land your offer and start working:
A Day in the Life
Q: So how close was the job description to what you’ve actually been doing at the fund?
A: Pretty close. Just like traditional PE, it’s a mix of deal execution and managing existing assets. Since it’s a smaller fund, everyone here does a bit of everything.
On the sourcing side, there hasn’t been any cold calling so far and all the opportunities come to us through the senior team here.
I’ve spent a fair amount of time reviewing investment memos, submitting bids for good opportunities, reviewing data room documents, and modeling cash flows from assets, but I haven’t cold called managers of power stations or anything like that.
Occasionally, we’ll participate in banker-run auction processes but we try to avoid them when possible because they tend to drive up prices and make it more difficult to hit our targeted IRR.
If we decide to pursue an investment, there’s still an internal approval process and investment committee just like at traditional funds.
So the deal execution process is not that much different, even though the technical work can be.
One difference is that we use a lot of external advisers on everything from verifying that the asset we’re investing in is functional to whether the compliance requirements are met to the insurance on the asset.
Cost overruns on these projects can easily wipe out returns, so it’s important to carefully review and understand the clauses in the project documents to make sure those are covered.
As one example, a wind farm in Australia that we invested in ran into problems because the company responsible for the concrete foundation did a bad job and the project has been delayed – but under the engineering/construction contract, we can claim damages on that and at least get some money back.
Q: So you do also develop new assets (“greenfield”), similar to Project Finance?
A: Occasionally, but it’s rare due to the higher risk associated with them. Just like with real estate development, building new assets is always riskier but the returns and your own compensation won’t necessarily go up in proportion to that risk.
We also need to get Engineering Procurement & Construction (EPC) contracts in place to reduce some of this risk and protect ourselves from scenarios like what I just described.
Q: I see… so you’re still very focused on acquiring existing assets, but occasionally you’ll do a greenfield project.
What do juniors at your fund do in terms of “portfolio management”?
A: Everyone here gets assigned a few assets to monitor, and we estimate cash flow distributions, update the financial models on the assets, and prepare quarterly updates for investors.
We also run an independent valuation process every 6 months, which involves giving some of our data over to an external firm to “audit” our portfolio and make sure our assumptions are reasonable.
Almost all the assets we purchase have a debt financing component as well, so part of the job involves monitoring that and deciding if debt needs to be refinanced or if there’s a danger of the covenants being breached.
Q: Great. And what about the fundraising side?
A: We’re actually in fundraising mode right now and we’re going after new LPs, preparing pitches, and responding to requests from investors and asset consultants for more information on our performance and strategy.
Not too much is different process-wise, but, as you’ll see soon, the presentation of deals and the quirks of the Australian market make for some differences in working with LPs.
Infrastructure Modeling: Crazy for Cash Flows
Q: OK, I know you wanted to mention a few points about that at the end, so we’ll skip it for now and move onto technical skills and modeling.
I have to admit that I know very little about the sector, so…
A: Wait a minute, don’t you teach modeling courses?
Q: Hey, I can admit when I don’t know something. I’ve seen a few Project Finance models before, but do not know enough about it at the moment to create a course.
My understanding: similar to real estate, infrastructure investing is cash flow-based and the actual “modeling” is fairly simple. True or false?
A: Mostly true. It’s very cash flow-focused since there are so many fixed, long-term contracts and you know what the asset will look like 10-15 years in advance.
Also, you don’t care about the distinction between expensed vs. capitalized costs as much, so full-fledged 3-statement models are rare.
Free Cash Flow to Equity (Levered Free Cash Flow) is the key metric, because that tells you how much you’re earning after interest and principal repayments on the debt.
Revenue and expense projections are fairly simple and you usually just assume they increase at the rate of inflation or some other low percentage.
Most of these assets have operating & maintenance (O&M) contracts that spell out the key terms and tie costs to inflation as well.
There’s a bit more modeling involved on the debt side because we look at different demand / inflation / interest rate scenarios, and how IRRs and cash flow yields change under all of those.
Q: OK, so let me stop you right there to clarify something. You mentioned in Part 1 that your targeted IRR is 10-15%, but you also just said that revenue and expenses only increase at a low percentage each year (maybe 3-4%?).
How is it possible to get a 10-15% IRR under that scenario? Operational improvements? A very high amount of leverage?
A: Hah, good question. There could well be “turnaround infrastructure funds,” but there’s limited room for operational improvements with most of our assets because of the fixed, long-term contracts in place.
If you can’t reduce the expense profile or increase revenue, the returns have to come from either multiple expansion or additional leverage – in Australia specifically, there have been cases of multiple expansion due to the commodities boom and increased demand for infrastructure (though that obviously won’t last forever).
NOTE: Based on some of the comments left on the previous article, the answer here seems to be “a high amount of leverage.” Summary of comments left by other readers:
- Investments can be highly leveraged (e.g. 80:20 Debt:Equity ratio, far above what you see in most non-bubble leveraged buyouts).
- And these investments are far from “risk-free” – a cost overrun, construction delay, contract cancellation, etc. could all cause problems down the road. So a potential IRR far above bond yields is not unreasonable.
- One reader also mentioned that for some “low risk profile” assets such as standard schools or hospitals, leverage of up to 95% is possible, even post-ongoing-financial-crisis.
Q: Great, thanks for explaining that one.
Can you tell us about the culture at your fund?
A: It’s much more relaxed than in banking, where you see a lot of high-stress situations and people running around constantly catering to clients’ needs.
We have several offices in Australia, and everyone sits together in the same area with no separate offices or glass doors or anything.
It’s almost eerily quiet in the day because everyone is just doing their own thing. They encourage you to share ideas and speak up if you want feedback, but just like with traditional PE or VC, you’re off working on your own most of the time.
No one here stays very late, so you don’t see the kinds of “late night socials” that are common in banking when everyone is there working until 2 AM.
Q: Right, so much better hours overall … 50-60 per week?
A: Closer to 50 I’d say – the average day starts at 8:30 AM and goes until 7 PM or so. I haven’t worked a single weekend since I’ve been here.
When deals heat up we can get busier, but we haven’t done any massive deals since I’ve been here – mostly just smaller investments that haven’t involved killer hours.
NOTE: Again, based on comments left on the previous article, hours can creep up toward IB hours when a deal is near the finish line – one reader from Canada also mentioned that he works more like 10-14 hours per day on average.
So this one depends on the region as well, and the hours in other markets may be worse overall.
Q: And do you get to travel and see any of these toll roads / bridges / power plants in-person?
A: Sometimes you’ll do site visits, but it’s very difficult to really evaluate these types of assets unless you’re an engineer.
In traditional PE, you can go visit a company, speak with management, observe customer interactions, and get a sense of how the company operates even if you don’t have an operational background.
But here, we usually have an engineering firm look after assets, send us monthly operational reports, updates, and so on, so we’re more removed from the operational side.
Q: You also mentioned that your firm hasn’t done many big deals lately.
Any reason why? It seems like “mega-deals” are making a comeback in the traditional LBO market.
A: For one, the capital raising environment has been tough lately and lots of pension funds here are increasingly doing their own investment work in-house.
They look at infrastructure funds and say, “Well, why bother investing in your firm and paying the fee when we could just build our own internal team instead?”
Over time, they’ve gradually shifted from putting money into infrastructure fund managers to co-investing to now bringing everything in-house. And in Australia, because of the mandatory pension contributions across the population, they have the resources to do large deals.
Another trend lately has been Canadian pension funds entering the market and doing big deals here, sometimes bidding up the prices on assets.
I am not 100% sure of the specifics on how it benefits them, but I believe they get a tax advantage or have a cost of capital advantage or something like that and can therefore afford to out-bid local firms.
So, bottom-line: when fundraising is increasingly difficult and valuations keep getting bid up, you don’t do too many large deals.
Getting Paid and Moving Up
Q: Yeah, that makes sense. Now I have to ask about the compensation – is it in the same range as traditional PE?
A: Actually, yes. Base salaries here are in the $100K USD range, with matching bonuses, so all-in pay can be around $200K for junior associates, with more than that if assets perform well and we get higher performance fees.
The fee structure here is more like “1 and 20” rather than the 2 and 20 you see at other PE funds, so you’d think that pay would be lower, but that hasn’t been the case so far (pay at the senior levels may be lower, but I’m not sure about that).
Base salaries have actually gone up a bit since I started working here.
One difference is that it’s very difficult to achieve our IRR hurdle to earn carried interest because of the problems I mentioned before.
Also, our fund is currently indexed to something that’s completely inappropriate (i.e. an index that has returns much higher than 10-15%), so that limits our additional bonus / upside from performance.
But if that ever changes, or if there’s a true “boom year” where you earn much higher returns, there’s potential for even higher pay.
NOTE: Again, based on the comments left on the previous article, the pay in Australia seems to be different from other regions.
One reader in Canada mentioned that bonuses there were more like 30-60% of your base salary rather than 100%, but that you might get some carry starting at the Associate level depending on the fund.
So don’t walk in expecting your bonus to be 100% of your base salary, as it depends on the region and fund.
Q: PE pay with even better hours, at least in certain regions… I like the sound of this.
I’m guessing that most people don’t even move on or want to go elsewhere, since it sounds like a great opportunity.
A: Pretty much. Turnover is very low here – some people have been here for 5+ years, which is almost unheard of in investment banking and is pretty rare even in traditional PE or hedge funds.
There isn’t a strong incentive to leave because there’s good work-life balance and the pay is solid.
If you did want to move on, another infrastructure fund, a power / utilities group, or even Project Finance might be possibilities.
Q: Great. So what are your future plans?
A: It’s difficult to move around in the Australian market because there aren’t that many funds here, and I’ve been happy so far so I have no real reason to leave.
Pension funds might be interesting in the future, especially if they continue to build out their in-house teams.
I’ve also thought about going overseas to work in the US or UK since they’re both much bigger infrastructure markets.
But all of that is a long ways away – for now, I need to focus on completing the CFA!
Q: As I cringe in horror at what you just said.
A: Haha, yeah, I realized it’s not particularly useful in this sector but I already signed up… so might as well follow-through on it.
Q: Fair enough. Thanks for your time and insights!
Infrastructure Investing / Infrastructure Private Equity – Series:
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