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Trendy before the fall (of premiums)

Just as LBO firms are invading infrastructure, established infrastructure players are invading the emerging markets, writes Cezary Podkul.

A memorable passage from Barbarians at the Gate reminds us that history has a funny way of repeating itself:

“’So this is what it’s come to,’ he thought. Every investment banker with an extra nickel in his pocket thinks he ought to go into LBOs. After five years of steadily mounting competition, Kravis was sick of it.”

Cezary Podkul

Now that Kohlberg Kravis Roberts is targeting $4 billion for its debut infrastructure fund, veteran infrastructure managers are probably thinking to themselves that every LBO guy with a nickel in his pocket thinks he ought to go into infrastructure.

“How would they like it if we invaded their space?” joked Global Infrastructure Partners’ Adebayo Ogunlesi at PEI’s recent Infrastructure Investor forum in New York.

But the entry of global buyout funds into infrastructure isn’t the only example of the unstoppable urge GPs have to expand empires. Case in point: established Western infrastructure pros are hungrily eyeing the emerging markets.

The migratory pattern begins in Australia in 2004. Infrastructure investors there eager to open up new frontiers set their sights on Europe, where there was still no significant investment by infrastructure funds. Macquarie launched the Macquarie European Infrastructure Fund I and soon a flurry of European country-focused OECD-funds followed. Before long, the 400 to 500 basis point spread between investing in Australian and European infrastructure got competed away.

Fast-forward three years. LPs who had become comfortable with infrastructure as an asset class began to look for ways to diversify their exposure beyond the OECD countries. As they began to ask their GPs whether they had emerging markets-focused products, a flurry of GPs made plans in 2007 to crack open the next frontier.

Despite the global financial crisis, a lot of those funds began or finished fundraising in 2008. Placement agent Probitas Partners counted no fewer than 25 emerging market-focused infrastructure funds in the market or about to go to market at the end of the year collectively seeking $16.9 billion.

It is a development that is bound to make established emerging market-focused infrastructure investors, such as New York-based Conduit Capital, think, “every infrastructure guy with a nickel in his pocket thinks he ought to go into emerging markets”.

On the bright side, the opportunity is still immense: the IFC estimates that emerging markets will require $21 trillion for their infrastructure between 2008 and 2017 alone.

But on the flip side, don’t expect premiums in emerging markets to last.

“The premium is going to get competed away fairly rapidly”, says Deepak Bagla, a director at the $1.2 billion 3i India Infrastructure Fund.

He predicts that government de-risking of projects and the entry of new competitors will soon wipe-away the estimated 3 to 5 percent premium for investing in Indian infrastructure.

Other countries will follow, and its sure to make some GPs experience déjà vu in 2009.