P R I VAT E E QU I T Y

Investing in Infrastructure
G LO B A L

In many countries, economic development is hampered by the lack of modern

infrastructure. India, Indonesia, Thailand and Vietnam have all witnessed
shortfalls in infrastructure funding, which have in turn threatened to undermine
their growth. In many cases, these deficits could be met in part or in full from
private sector sources, including private equity.

If China faces an infrastructure deficit, On the face of it, PE funds seem a

it does not seem to have inhibited its
GDP growth, which has regularly
topped 10% per annum. Such
spectacular growth could however be
hampered in the future, if infrastructure
fails to keep up. In the next five years,
China and India alone are expected to
make a total investment of around
US$2trn on development and
regeneration of core infrastructure.
China’s recent infrastructure
China’s recent investment has been driven by internal
infrastructure and government-related sources of
capital, but that supply of funding
investment has cannot be assured forever. With
been driven by improvements to standards of credit
evaluation at China’s key banks and the
internal and increasing calls on government funds
government-related for social needs, China may need to
rely more on private investment.
sources of capital Malaysia’s situation is somewhat
similar. It has to date been able to
supply its infrastructure needs largely
domestically, but it may need to turn
to the private sector and to foreign
investment in the future.
poor match for these infrastructure
requirements. Typically infrastructure
pays back investment steadily over
its lifespan. These returns are often
constrained by a project’s quasi-public
nature (and the consequent oversight
of government). PE funds however
generally demand short term, above-
market returns. Further, PE funds
typically lack the resources to operate
the relevant assets, as opposed to the
industry players who have a much
longer track record of investing in this
asset class in emerging markets.
Despite this fact, PE funds are already
surprisingly active in the infrastructure
area. PE funds (sometimes under
the banner of Infrastructure Funds)
have taken on different kinds of
infrastructure risk at a number of
stages throughout the infrastructure
life cycle.
A common challenge for PE
participation arises at the point of
bidding, through construction and early
stage operation. Once this high-risk
segment of the life cycle of the project
is safely passed, the PE fund would
typically increase the debt leverage of
the project and/or sell out its equity
interest to, for example, a pension
fund, which requires lower risk,
predictable, returns and is willing to
sacrifice rate of return to obtain these.
A special, but potentially useful case
of this paradigm is the Public Private
Partnership (PPP).
3 Investing in Infrastructure
The critical success parameter in
helping build PPP in infrastructure as a
potentially attractive asset class for
private equity investors is to reconcile
the twin objectives of efficient project
delivery with reasonably attractive
returns over the long term. The desired
value for money could be achieved by
way of better risk management, more
efficient life cycle cost management,
introduction of better technology
and management practices without
compromising on return expectations.
PPPs have seen limited take-up in
developing countries, but their success
in the UK and Australia, and more
recently in Continental Europe, North
America and Singapore, suggests that
PPP could be an effective vehicle for
the introduction of PE funds into
developing country infrastructure
investments. A significant portion of
PPP projects in these countries relate
to social infrastructure, for example,
schools, universities, hospitals and
non-front line facilities for the military.
PE funds have resolved the challenges
of the early risk phase here by
assuming the bidding, construction and
early operation risk (along with suitably
qualified industry partners) and selling
their interests in the secondary market
at a (sometimes very large) premium.

PE houses might properly claim that
such super returns are justified by their
superior ability to accurately analyse
the detail of the risk of (initially
unfamiliar) PPP structures, and by the
fact that returns sometimes turn out to
be sub-normal. It is also true that the
presence of major PE houses in an
investment consortium may give
confidence to lenders to increase debt
leverage and so enhance the returns
of the equity (including that of the
PE funds).
PPP could be an effective vehicle for the
introduction of PE funds into developing
country infrastructure investments
The PPP model may be particularly
applicable in some developing
countries where public investment
in infrastructure is constrained by
lack of available public funds. The
governments of certain developing
countries (in certain instances
supported by multilateral agencies)
could nevertheless be credible
‘guarantors’ of certain non-commercial
risks to which private investors are not
prepared to take exposure. PE and
other private fund sources currently
see a shortage of these kinds of
investment opportunities. The process
of bringing together governments and
PE (and other) funds in an allocation of
risk and reward which both can accept,
which to date has had limited success,
may be facilitated by independent
advisors. KPMG’s global Advisory
network can draw on a wide range of
experience in developing economies.
A large amount of infrastructure
investment by PE funds has been
by bidding for government assets at
privatisations by way of trade sale
(rather than IPO), not investment at the
construction stage. Some have been
by way of secondary market purchases
from ineffective private operators,
sometimes by way of supporting
management buyouts. In this case
there is a tendency by the PE investor
to maximise leverage (aided by the
confidence given to the bank lenders
by the reputation of, and often
relationships with, the PE house) to
increase equity returns in the short run.
Investing in Infrastructure 4
kpmg.com

Contacts:

David Nott
Partner, Head of Private Equity – Asia Pacific
KPMG in Australia
Tel: +61 (2) 9335 8265
dnott@kpmg.com.au

Satya Ramamurthy
Executive Director
Global Infrastructure & Projects Group
KPMG in Singapore
Tel: +65 6213 2060
sramamurthy@kpmg.com.sg

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Publication name: Investing in Infrastructure
Publication no: 312-831
Publication date: April 2008