Measured by press coverage alone, it has been a busy 12 months for the UK infrastructure sector. The proposed high-speed rail link from London to Birmingham (HS2) has proved a reliable headline generator, as has the announcement of a stream of infrastructure initiatives and programmes by the coalition government.
Meanwhile the opposition Labour Party has done its bit to keep the subject in the public eye with the publication in September of the results of a review by Sir John Armitt that recommended the establishment of an independent infrastructure commission to take the politics out of infrastructure planning.
Despite all the noise, however, actual dealflow — particularly on the greenfield side — has been mostly notable by its absence.
Transportation, in particular, saw an almost complete dearth of progress on new build projects until this summer, when contracts were finally awarded on a pair of road concessions and the next stage in the overdue upgrade to the Thameslink rail network.
The latter — a £1.6bn contract to provide new carriages and depots — was won by a consortium led by Siemens. It was financed by an innovative hybrid private finance initiative (PFI) and public private partnership (PPP), which included a debt facility provided by a syndicate group of 19 banks led by Lloyds Bank, Sumitomo Mitsui, KfW and Bank of Tokyo Mitsubishi UFJ.
Meanwhile, a pair of Spanish-led consortia were named as preferred bidders for the road concessions — a £415m project to complete the M8 motorway between Glasgow and Edinburgh and the £2bn Mersey Gateway toll bridge.
Elsewhere, the social infrastructure sector saw a handful of smaller projects get underway in the student accommodation, social housing and waste sectors, as well as the announcement of a further round of funding for school refurbishment.
Activity in the greenfield sector remained decidedly muted however, and the picture was only slightly more positive on the operating assets side.
There, the majority of interest centred around the airports sector, where Heathrow Airport Holdings — formerly BAA — finally caved in to pressure from the Competition Commission and sold Stansted to Manchester Airports Group for £1.5bn.
That was followed in August by the €502m transfer of the Luton airport concession from a consortium led by Abertis to one comprised of fellow Spanish player Aena, and Axa’s private equity arm.
The sector also saw the sale last October by Copenhagen Airports of its 49% stake in Newcastle airport to Australian fund manager AMP Capital Investors, as well as a successful refinancing by London City Airport owners Global Infrastructure Partners and Highstar, which secured £465m of five year funding from a 12 strong group of lenders.
According to Giles Tucker, managing director and head of infrastructure at Royal Bank of Canada, which acted on both the Luton and Newcastle deals, the airport sector is likely to remain one of the most active in infrastructure over the next 12 months.
He points to the possibility of further disposals by Heathrow parent Ferrovial from its UK airport portfolio — comprising Aberdeen, Glasgow and Southampton — as well as the anticipated potential disposals of whole or part stakes in London City, Bristol and Leeds-Bradford.
For Emmanuel Goldstein, co-head of transportation and infrastructure for EMEA at Morgan Stanley, however, the tentative nature of the UK recovery to date suggests asset holders will likely sit on their hands for at least another 12 months.
“Sellers want to optimise the conditions of their exit so if they have a choice they will prefer to wait for the wider economic recovery to translate into operational figures,” he says.
Finance not a problem
What most bankers do agree on, perhaps surprisingly, is that the recent muted levels of activity — and the thin pipeline across nearly all sectors — has little or nothing to do with the availability of finance.
This is slightly at odds with received wisdom in the post-crisis era, which holds that infrastructure funding is facing near insurmountable challenges as looming capital restrictions force banks to pull back from long term lending and refuse to leave themselves open to refinancing risks, while the anticipated wave of institutional money coming into the sector refuses to take construction risk on its balance sheet.
Partly, the answer to the conundrum lies in the current very low — by historical standards — levels of activity in the sector.
The big contraction in the long term bank lending market has been matched, for the most part, by the lack of projects, while the handful of banks that have remained active — primarily from Germany and Japan — have sufficient capacity to mop up most of the smaller deals that have emerged.
There has also been a trend for increasing innovation by market participants to explain the continuing availability of funding. As an example, Tucker picks out a pair of student accommodation deals undertaken by RBC this year, both of which ended up in the bond market.
A £190m project for University of Hertfordshire, which closed in May, was sold as an unwrapped instrument, the first unwrapped UK project bond for around 15 years, while a similar £62m 35 year bond for University of Edinburgh, launched in July, featured a rare wrap from monoline insurer Assured Guaranty.
Simon Allocca, head of loan markets at Lloyds Bank, agrees that innovation will likely be the key theme in infrastructure financing for the next 12-18 months. “Indeed,” he adds, “I strongly believe that, because of the challenges we’re facing, we’ll see more innovation on financing in this space than in any other.”
This conviction stems partly from the view, shared by most infrastructure market participants, that the appetite for UK assets among institutional investors is strong.
As Lloyds Bank’s head of infrastructure and energy Guillaume Fleuti notes, UK infrastructure assets are as popular with international investors as with domestic pension funds and insurers.
“Non-European based investors and sponsors are comfortable with investing in the UK, both in infrastructure and in other asset classes,” he says. “They see it as a very stable investment destination and they see the recovery coming up faster here than in the rest of Europe.”
Goldstein at Morgan Stanley agrees. “International investors love the UK, which they see as a very safe and sound investment destination,” he says. “If they were offered the right opportunities they would be very happy to increase their exposure to the country.”
However, the lack of dealflow in the UK — and particularly the shortage of the type of investment grade assets required by institutional accounts — is currently forcing many investors to look instead to continental Europe for places to put their money to work.
Similarly, sponsors are look beyond the UK for opportunities. “Many of the construction companies are actually re-gearing outside of the UK due to the lack of a sufficiently strong pipeline,” says Tucker.
Breaking the deadlock
As to what could get the UK infrastructure market moving again, market participants are less certain.
The coalition government, which has outlined plans for more than £300bn of spending by the end of the decade, is hoping that new initiatives in the PFI sector and a high profile guarantee scheme — as well as the appointment of the man responsible for the successful delivery of London’s Olympic Games, Lord Deighton, to oversee them both — can break the deadlock.
The new PF2 format for public private partnerships, which allows the government to take an equity stake in new infrastructure projects and also to aggregate debt for financing, is being trialled in the next £150m tranche of the Priority Schools Project and has received a positive response from the private sector.
Meanwhile, in June, Treasury Secretary Danny Alexander announced that the £10bn Hinkley nuclear plant project and the Mersey Gateway would be the first to receive a guarantee under the government’s new scheme to accelerate infrastructure construction.
As he admits in an exclusive interview with EuroWeek(see page 16). however, Lord Deighton is in agreement with other sector participants that the availability of finance is not the main barrier to UK infrastructure development.
Indeed, he notes that a key aspect of his new role involves “pulling together projects and getting them in the right shape to take them to market” — including assisting with the UK’s notoriously laborious planning processes.
According to bankers, this remains a stumbling block for both investors and construction companies.
“All investors want to map out their pipeline in terms of future investment,” says Allocca, “and equally sponsors looking to build projects need to get investment approval and capital allocation approval — and clearly both parties will prioritise in those jurisdictions where the speed of planning permissions and licences is quicker.”
He agrees with Lord Deighton, however, that this alone would not be sufficient to deter investors, given the strength of demand for UK assets.
“There is no doubt that between the various market participants — the banks, the insurance companies and the pension funds — all the infrastructure requirements of this country can be met,” he says. “There is sufficient liquidity through construction and post-construction to meet all the requirements, but at the moment the missing piece is just bringing everyone together.”
Tucker also notes that, when the pipeline does start to build, the mismatch between the risk requirements of investors and sponsors may start to become more apparent.
“Unlike the banks, which used to provide the long term funding for infrastructure, institutional investors need projects to be investment grade,” he says. “The government is aware of that but they haven’t necessarily had to confront it as they might have done if the pipeline had been as strong as it was historically.”
Much clearly depends on whether the government and Lord Deighton can deliver the pipeline it has promised over the next 12 months. Investors both at home and abroad will be watching closely.