Large pension funds aren’t normally known for being fleet-footed mavericks, but desperation can force even such institutions to skip past market norms.
Just look at AustralianSuper and Melbourne-based fund manager IFM Investors. In October, the two organisations succeeded in an audacious bid for a controlling stake in electricity company Ausgrid, without going through a formal sale process.
The pair put forward a A$16.2 billion ($12.2 billion) offer to buy 50.4% of Ausgrid after an earlier attempt to sell the stake to Chinese investors was blocked by federal treasurer Scott Morrison for national interest reasons. The company supplies power to 1.7 million customers in New South Wales.
AustralianSuper and IFM had tabled their unsolicited proposal while other interested parties were waiting for the state government to relaunch the auction process. The unconventional move worked – the New South Wales government accepted the bid on October 20.
As the race to secure infrastructure assets becomes more competitive, fund managers are thinking creatively.
“There’s no shortage of capital chasing large-scale regulated assets with existing cash flows, but when the financials on a project become more ambiguous, there is a need for inventiveness,” said Sam Sicilia, chief investment officer at superannuation fund Hostplus.
The Ausgrid deal was unusual in that it involved the privatisation of a brownfield asset – one where development has already been done. Most other unsolicited proposals have been for new projects or to expand assets already in private hands.
Greenfield projects – new construction on unused land – have long presented pension funds with barriers to entry. They carry construction risk and the prospect of spending months on a bid with no guarantee of success. But unsolicited proposals offer pension funds the chance to enter via the backdoor by suggesting an idea that may not be on the government’s to-do list. These suggestions include upgrades and add-ons to existing infrastructure.
“Ideally we don’t want our ideas being put out to general tender, so we only put forward unsolicited proposals that we think have a special angle and will fly,” said Michael Hanna, head of Australian infrastructure at IFM Investors. “We have a lot of front-running conversations with government before we put together a firm pitch.”
Construction on two unsolicited add-on projects in the transport sector is under way, and both are backed by asset owner support.
One is the A$5.5 billion Western Distributor project in Melbourne that will provide an alternative to the West Gate Bridge (pictured right) and direct access to the city’s port. The other is the nine-kilometre NorthConnex tunnel in Sydney linking the M1 Pacific Motorway to the Hills M2 Motorway. The new roads have attracted capital from institutions such as Canada Pension Plan Investment Board and Queensland Investment Corporation (QIC).
In deals of this type, asset owners typically team up with an operating company to form an equity consortium, which then tenders the construction of the project to an engineering firm. Debt funding is usually arranged via bank syndication.
Investors need to be compensated for taking construction risk by achieving higher rates of return, said IFM's Hanna. His firm has recently submitted an unsolicited proposal to spend A$300 million upgrading its Southern Cross train station in Melbourne.
The hurdle rate – that is, minimum acceptable rate of return – on new projects averages about 250-350 basis points above brownfield assets, he said.
But not all unsolicited bids are created equal. And while asset owners seek new means of gaining exposure to the assets, governments have the luxury of being pickier when choosing whom to sell new or existing projects to.
Australia’s state governments are proving quite pragmatic about the increasing desire of asset owners to take unsolicited stakes in infrastructure assets. They have been willing to give concessions, but only if proposed price rises aren’t too ambitious and the project being put forward is unique.
Any hint of competition for a project, however, and this mindset quickly changes. “If there is even a possibility that two different parties could provide the same outcome the onus is on the government to go to competitive tender,” said Karl.
Moreover, when it comes to unsolicited bids, it isn’t always easy for governments to determine whether they are getting value for money or that communities will benefit, said Paul Kenny, a partner and public- sector lead at law firm Allens. “Even though we now have a framework for unsolicited bids in most states, it is still too early to tell if it is going to be a total success.”
In New South Wales, where unsolicited bids have been most successful, the government has made a point of hiring executives from the finance industry to assess the validity of proposals. Another common approach is to appoint external advisers to stress-test projects.
Kenny believes governments can help appease concerns about the closed-shop nature of unsolicited bids from asset owners by farming out civil infrastructure contracts. “Major civil and capital works should be run through a transparent market process and hopefully awarded to unrelated parties,” he said.
Look out for part two of this report in the coming days, which will focus on infrastructure debt, another way to play this asset class.