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

From 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 ways to cut expenses and realize cost 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:

• Philadelphia Gas Works, prepared by Lazard
• German Storage Tanks, prepared by Macquarie
• Chicago Parking Meter System, prepared by William Blair
• Minnesota Vikings Stadium Financing Discussion, prepared by RBC Capital Markets
• Ecuador Airports, prepared by UBS

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

• Central Parking Corp., prepared by Blackstone
• Standard Parking / Central Parking, prepared by Bank of America Merrill Lynch
• Standard Parking / Central Parking, prepared by Investor Relations

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 based on Unlevered Free Cash Flow 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.