* Nordic power grid sales among few potential 2014 deals
* Pension funds, others compete with equity funds to invest
* Force 'core' deal returns to slip to single digits
* TenneT, EDF, Urenco privatisations scrapped or delayed
By Simon Jessop
LONDON, Dec 6 Power distribution systems may not
sound like trophy assets, but for investors seeking higher
returns in a low interest rate world, such European
infrastructure is gold dust.
Established infrastructure assets - defined as "core", from
wind parks in France to gas pipelines in Norway - generally
offer less risk than "greenfield" projects and higher returns
than those available from schools or hospitals.
And while government stakes in companies such as Nordic
utilities Vattenfall and Fortum could come
on the market in 2014, these alone won't satisfy
"Assets are not coming to market as freely as they have done
in the past or as they had been expected to come in relation to
government privatisation," said Hamish de Run, Infrastructure
Partner at Hermes GPE.
A lack of political appetite for state sales, a decline in
the number of forced corporate sellers thanks to a buoyant debt
market and a shortage of reinvestment opportunities for funds
that already hold some of the assets are all playing a part.
Reasons vary from country to country, and while some of the
debt-hit southern euro zone countries have been more active
sellers, higher-quality assets in the more politically secure
and economically stable countries of northern Europe are scarce.
In October, the Dutch finance ministry scrapped plans for an
IPO of grid operator TenneT, while talk about a sale of part of
the French state's stake in electric power utility EDF
has gone quiet.
There is little political inclination in Germany to endanger
a government coalition with an unpopular sale of 'Crown Jewel'
assets, while the UK, which pioneered the sale of state
infrastructure, has little left to sell.
British and German plans this spring to sell a stake in
government-controlled uranium enrichment firm Urenco, estimated
to be worth up to 10 billion euros ($14 billion), hit resistance
from the Dutch government, which owns a third. Sources say a
sale or IPO may be revisited in early 2014.
"We see an overhang in demand for core infrastructure assets
- operational, very well-regulated or long-term contracted
assets, with inflation protection and very predictable cash
flows," said Markus Hottenrott, chief investment officer of
Morgan Stanley Infrastructure, which manages $4 billion.
Pinning down the size of the infrastructure market as a
whole is difficult, given the varying definitions. Taken as
assets with government involvement at some level, such as price
setting or regulation, JPMorgan Asset Management said the UK
alone, Europe's most mature market, has $1-$1.5 trillion of
The slice of that figure considered "core" is much smaller,
however. An asset is generally defined as such when it has been
running well for a number of years and the income is steady and
reliable - qualities that make them more expensive and reduce
the payout attraction to equity funds.
PENSION FUND POACH
The entry of investors such as pension funds, insurers and
sovereign wealth funds to the market has challenged the
dominance of traditional infrastructure funds, which are having
to take on more risk to bag the returns they seek.
"They are being forced to take more operational risk,
financial leverage, looking at opportunities in an earlier stage
of that life cycle such as greenfield, etcetera, because the
core assets are being bought by long-term, direct investors,"
said de Run of Hermes GPE, which at the end of September was
managing 2.6 billion pounds ($4.25 billion) in the sector on
behalf of clients including pension funds.
In October, for example, two funds managed by Goldman Sachs
and two Danish pension funds said that between them they
would buy 26 percent in Danish state-owned oil and gas group
DONG Energy, a European market leader in offshore
wind, for 11 billion Danish crowns ($2 billion).
For funds looking to invest in core assets, the internal
rate of return - a preferred measure of value by many
infrastructure investors - has slid.
"Investors used to expect 10-12 percent returns on core
assets, but in today's environment, when interest rates are so
low and there is ever-increasing demand for these assets,
getting that is almost impossible," said Serkan Bahceci,
Infrastructure Strategy at JPMorgan Asset Management, which
manages $3.5 billion in its various infrastructure funds.
Serkan said he expected the Fortum and Vattenfall assets to
return "single digits", but still more than the returns on offer
from safer government bonds, with benchmark German Bunds, for
example, yielding 1.75 percent.
Falling returns has not stopped the number of equity funds
in the market from growing, industry data tracker Preqin said in
a November report, flagging a record 58 Europe-focused funds
looking to spend a combined 24 billion euros.
"While there is a significant amount of capital being raised
to invest in European infrastructure, the fundraising market is
very competitive, with a record number of Europe-focused funds
on the road," the report said.
That pales into insignificance, however, when compared with
the many billions more gearing up to be deployed by pension
funds and insurers, which have a cheaper cost of capital and
more flexibility in financing than equity funds.
While no firm Europe-wide data exists, de Run said European
and U.S. pension funds allocated around 2-3 percent of managed
assets to infrastructure. While that is increasing, it is still
some way behind the figure for pension funds in market leaders
Canada and Australia, which can be as high as 10 percent.
Reduced supply and increased competition have meant that the
bulk, 58 percent, of deals done by equity fund managers between
2011 and the year to date in 2013 were valued at less than 100
million euros, with just 10 percent above 500 million euros,
For Jason Clatworthy, a member of the infrastructure team at
consultants Deloitte, which recently undertook a survey of
infrastructure investors, the scarcity of deals built up a head
of steam for pricing battles when sales do appear.
"Core deal values will remain strong as there is still,
ultimately, a shortage of high quality assets with established
yielding profiles in the market. Therefore when they do come,
they get quite aggressively bid and prices remain high."