Growth of global infrastructure funds poses problems for investors and lenders

Both investors and lenders need to be fully aware of the credit risks arising from the recent breathtaking rise of global infrastructure funds, with credit quality suffering across the sector as infrastructure assets adopt aggressive balance sheets in an attempt to fend off private equity players. This is according to a new report published by Standard & Poor's Ratings Services titled "The Amazing Growth Of Global Infrastructure Funds: Too Good To Be True?"

"The rise of funds in the sector has led to banks, private equity groups, and investment managers alike struggling to buy suitable assets in the sector. Simultaneously, infrastructure deals are becoming increasingly highly leveraged, reflecting what we believe to be a pricing bubble caused by the wave of new funds chasing limited assets," said Standard & Poor's credit analyst Michael Wilkins. "Despite this increased appetite, however, full risk analyses of assets should always be carried out, because not all will boast the strong, stable features assumed typical across the global infrastructure sector."

Credit quality is coming under downward pressure as a growing number of infrastructure assets--especially utilities, airports, ports, and toll-road operators--are being privatized or sold or auctioned by existing owners that wish to take advantage of the voracious appetite of infrastructure funds. It is estimated that $100 billion-$150 billion of fund money has been raised globally and is waiting to be placed in suitable assets in the infrastructure sector. So far in 2006 we have seen more than $145 billion of M& A activity in the sector, representing a stunning 180% increase since 2000.

There are no signs that 2007 will be different. Valuation and debt-to-EBITDA multiples in infrastructure M& A deals have been soaring, while equity contributions have generally been decreasing. As a result, credit quality is suffering across the sector as infrastructure assets adopt aggressive balance sheets in an attempt to fend off private equity players. This was recently demonstrated by the defense of U.K. airports operator (BBB+/Watch Neg/A-2) against a takeover by the Airport Development And Investment Ltd. consortium in the spring of 2006.

With debt-to-EBITDA multiples in recent deals ranging from 12x to 30x, it is clear that, as a result of rampant demand, the infrastructure sector is in danger of suffering from the dual curse of overvaluation and excessive leverage--the classic symptoms of an asset bubble similar to the dotcom era of the last decade. When that particular bubble burst many investors lost out. Those who cannot remember the past are condemned to repeat it: Due diligence and robust credit analysis of assets should be undertaken in the infrastructure sector to prevent similar mistakes occurring again.

"We believe the current creation of infrastructure assets and projects will remain strong and many more assets are likely to come to market as privatization spreads and regulatory regimes become increasingly stable throughout Europe," added Mr. Wilkins. "As infrastructure owners come under escalating pressure to sell their assets, however, due diligence processes and whole risk analyses become paramount--otherwise the credit risk involved in each transaction will not be fully appreciated. If risk parameters weaken, the infrastructure sector will increasingly lose its key attractive feature of relatively strong and stable yield returns."