Institutions heed the call(2)

The Australian PPP market has been the target of international developers and development funds, but now local and international institutional investors are being increasingly attracted to this core infrastructure investment segment. Duncan Taylor discusses opportunities and nuances

Lend Lease is a leading property and infrastructure group with operations in Australia, Asia, the Americas, Europe and the Middle East. Its investment management platform currently has A$11.8 billion (€9.5 billion; $11.9 billion) in funds under management supported by over 150 institutional pension funds and sovereign wealth funds through a number of unlisted wholesale managed funds and separate mandates. With an established infrastructure capability in Australia, and following the success of its UK Infrastructure Fund, it is now looking to partner with institutional investors in its pipeline of Australian and New Zealand PPPs which offer long-term, low-risk cash returns.

Institutional investors will be familiar with Lend Lease’s investment management business in real estate, but how is Lend Lease participating in infrastructure investment?

DT: Over the past few years Lend Lease has significantly bolstered its infrastructure capabilities, both through the acquisition of the Australian-based infrastructure construction and service businesses of Valemus (AbiGroup, Baulderstone Hornibrook and Conneq), as well as the development of the Capella Capital subsidiary, which is a leader in the origination and development of PPP infrastructure assets in Australia. In the Investment management segment, Lend Lease raised the UK-based £220 million (€275 million; $344 million) UK Infrastructure Fund with Dutch pension fund PGGM as the majority investor. With our strong end-to-end capability spanning the entire infrastructure asset value chain, as well as Lend Lease’s successful investment management platform, the logical next step is to provide opportunities for long-term investors to partner with us for investment in the strong pipeline of these assets in Australia. 

PPPs in Australia have been the subject of some criticism in the press. How does this relate to the risk involved in the current projects? 

DT: There are two aspects to discuss, the most significant of which is the experience of the ‘patronage’ toll road assets and, secondly, perceptions around construction risk.

Firstly, the criticism of PPPs has been largely focused on the high-profile patronage toll road assets where investors have experienced significant losses, primarily due to material underperformance of traffic forecasts. This is very different to the ‘availability’ style PPP assets in which we are focused – typically hospitals, schools, non-patronage risk transport and other social assets – where the equity and debt investors receive revenues from the AAA/AA-rated government body based on the facility being ‘available’ and meeting established operational standards.  This ‘availability’ risk profile is therefore significantly lower, often being considered a ‘core’ infrastructure asset. Lend Lease is focused on these ‘availability’ PPPs and is engaged with various bodies in developing an appropriate model for future ‘patronage’ PPPs.

The second point is the perception of the degree of construction risk the equity holder takes in a PPP. In a PPP the primary risk for construction is taken by the contractor (builder), which is taking the major risks of cost overruns and delays in completion. The construction issues we have seen in Australia have resulted in few cases of an ultimate material impact on equity. We are subsequently seeing that investors are becoming comfortable with construction risk, but are seeking to deal with more experienced PPP development and delivery teams to better assess and structure consortium risk allocation, and ultimately, the strength and capability of those counterparties taking the lion’s share of the risk (i.e. the contractor).

At Lend Lease we are able to demonstrate both attributes; with project sponsorship, the highly experienced 20-member strong team from Capella Capital developing the project, our investment management team providing a management and governance framework for investors, and Lend Lease construction and delivery having a strong balance sheet with an investment grade credit rating, with alignment further demonstrated by our equity co-investment.

Investors are increasingly comfortable with greenfield PPPs. Why then are we not seeing widespread pension fund investment in the sector?

DT: While we are continuing to see many pension funds becoming increasingly comfortable with the risks associated with the construction stages in PPPs, particularly recently, it has been other factors in regard to the bidding process that have left many pension funds on the sidelines, particularly high bid costs, long bid timeframes, and the perception of insufficient size of investment to justify the time and resource to manage the process and understand the asset class.

Is there a solution?

DT: These issues are difficult to solve by a pension fund on its own, which is leading to partnerships being formed between long-term investors and delivery and principal groups like ourselves which can offer solutions to these issues.

Lend Lease’s solution is based on our ‘best practice’ corporate governance model, our leading market position across the value chain and our PPP pipeline. Australian PPPs are on average larger than in the UK, resulting in larger absolute equity positions becoming available – for example projects can be greater than A$2 billion in size. As a significant participant in the PPP sector, Lend Lease considers it likely it will be able to provide a sizable aggregate equity investment to investors over a two-year period – for example, Lend Lease is currently short-listed on all PPPs in the bid-stage in Australia at this time. Lend Lease will take the bid cost and resource risk and assist the investor based on our significant experience in infrastructure in Australia and internationally. 

Corporate governance and management of conflicts of interest are major concerns for pension funds; have you found this to be the case?

DT: It certainly is. The focus we have placed in developing the governance model and managing our potential conflicts mean that corporate governance has become one of our strengths. Of course the very reasons that make our proposition attractive are the same that cause the potential conflicts – the value derived from extensive involvement in the project. We examined the nature of the asset, the bid process, the roles we take and our target investors. The model was then designed to manage potential related party issues by providing transparency, evidence of third-party market pricing, independence/investor participation in decision making and to align the interests of Lend Lease and the investor.