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Never assume the sun will rise

Morgan Stanley Infrastructure Partners’ Sadek Wahba may not have the rosiest outlook on the various scenarios that flow from investment analysis. But judging by the performance of his portfolio, it may be the best way to play the infrastructure game when you’re a global fund. By Cezary Podkul

Looking out of his office window on the 39th floor of Morgan Stanley’s global headquarters on New York’s famous Broadway Avenue, Sadek Wahba must spend a lot of time pondering whether the sun will come up the next morning.

“You have to go through counter-factual scenarios all the time – what if, what if, what if,” Wahba insists. “Because when the ‘what if’ happens . . . you can’t say, ‘oh my gosh – I didn't expect this could happen, let's maybe move jurisdiction. This way you are prepared for all scenarios, however unlikely they may occur.”

Infrastructure, Wahba makes clear, is an asset class where you need to think about the long-term consequences of your decisions. “I’m not manufacturing widgets,” he says. Such a process could be easily outsourced to another economy where labour costs are cheaper. But with infrastructure, “if you buy a port, you’re committed to that location. You can’t move it.”

Wahba: always prepared

For Wahba, an economist by training who heads up Morgan Stanley’s $4 billion infrastructure fund, that must translate to a lot of worrying. The fund has to date invested in 13 assets in Chile, India, China, Spain, the US, Italy, the UK and Canada and agreed a joint venture with a company based in Wahba’s native Egypt, Orascom Construction Industries, to invest across the Middle East and Africa. As recent world events demonstrate, just the Middle East alone can be enough to keep an investor worried for a long time.  

“I’m a pessimist by nature,” he admits, offering plenty of evidence over the course of a 70-minute interview.

Morgan Stanley Infrastructure Partners (MSIP), launched in 2006 as one of the first infrastructure funds in the US market to focus on deals globally, now finds itself in an investment environment where the fashion appears contrary to this global approach.

I'm not manufacturing widgets. If you buy a port, you're committed to that location. You can't move it

Sadek Wahba


As one limited partner in infrastructure, Richard Moon of Railpen Investments, wrote in a recent article, there is increasing demand on the part of investors for “more bespoke or targeted solutions” in infrastructure, which is “likely to take the form of more targeted sector or strategy focused funds” being offered by managers.

Already, institutional investors can take a punt on a fund that buys up water rights; one that invests solely in Mexico or Canada; or one that will develop renewable energy plants only in the Northeast and Mid-Atlantic states in the US. In other words, there are many niche infrastructure offerings in the market.

This is not the approach at MSIP, where Wahba believes unwaveringly that a global investment mandate is “absolutely critical in the investment strategy for an infrastructure fund”. As the discussion continues, he explains how MSIP, now nearly three-quarters committed on its $4 billion fund, has carried out its mandate.

‘Orthogonality’

If you wonder why MSIP ended up going the global route, Wahba’s economic training may provide a clue. His doctoral thesis at Harvard explored how to quantify cause and effect relationships in economics. For example: if one country experiences recession, will the contagion spread to a trading partner?

If your answer is “no”, chances are you believe in decoupling – the theory that world markets are becoming less and less dependent on each other. “In general,” Wahba believes, “there is a decoupling in the sense that…a couple of decades ago, the US would sneeze and everyone else would get a cold. That’s not the case anymore”.

A decoupled world makes for an interesting investment opportunity in infrastructure. Wahba points out that traffic on India’s roads is growing at 12 percent a year, while traffic in developed economies like the US is about 10 percentage points lower for reasons independent of India’s growth. Invest in one or the other and you get exposure to just that market and its specific risks. Invest in both and you get exposure to two uncorrelated markets, which lowers the overall riskiness of your portfolio: a recession might hit one market or the other from time to time, but probably not both at once.

“You want to have an ability to invest in those different cycles, meaning both economic cycles and developmental cycles for assets, and that naturally gives you portfolio diversification, and also provides orthogonality among the different risks”, Wahba says, selecting a word that perhaps gives away the fact he once considered a career in academia. Orthogonality, Wahba quickly explains, “is another way of saying that risks are not correlated – and that, I think, is very important”.

So is optionality, or the ability to invest in different sectors over time. “Had we been a narrowly defined infrastructure fund that focuses on US toll roads, we’d find ourselves in a position where you have a hammer and everything starts looking like a nail,” he says, because, contrary to market expectations in 2005 and 2006, there’s been “very little” opportunity to invest in that sector. A global fund, he says, “gives you what I think is extremely important optionality and ultimately the potential for higher returns”.

With that in mind, MSIP carved out an exposure of up to 25 percent for developing markets, or those countries that are not members of the Organisation for Economic Cooperation and Development (OECD), a club of developed markets such as the US, UK and Australia. In practice, that’s translated to an 8 percent exposure to India and 3 percent to China, but Wahba says he expects Morgan Stanley to invest more in both markets.

I think it's been a prudent approach from their side, getting emerging market and developing market exposure

Kasper Knudsen


“I think it’s been a prudent approach from their side, getting emerging market and developing market exposure,” says Kasper Knudsen, infrastructure and private equity portfolio manager at Danish pension PKA, which committed $178 million to Wahba’s fund in May 2008, its single largest infrastructure fund exposure.

“For core infrastructure, we target 10 to 14 percent [net IRR] to us as LPs and I would say it looks like at this point Morgan Stanley can deliver,” he adds.

Wahba declines to discuss the fund’s performance figures but says that MSIP is focused on building a diversified portfolio of assets that will deliver an attractive yield and overall return over a long-term investment horizon.

Exclusives and auctions

Two deals in the US help illustrate how MSIP has built out its portfolio. In 2009, the firm approached NSTAR, a Boston-based energy delivery company, about potentially buying Medical Area Total Energy Plant (MATEP), one of its subsidiaries that provides heating and cooling to hospitals around the Boston area.

“NSTAR was thinking of selling. They had it on their mind. It was an asset which was important to them but not necessarily core to their business,” Wahba says. MSIP knew some of NSTAR’s management and initiated discussions that ultimately led to a $320 million offer for the business – without a competitive auction.

“The sourcing I think is absolutely critical because it gives you the ability to look at investments in a different light than if you were purely going through a competitive process,” Wahba says. His team has done 13 transactions to date, of which ten have been deals exclusive to MSIP, such as MATEP.

Still, Wahba is not one to shy away from an auction. “I think there is nothing wrong with participating in a competitive process, if you perceive a relative advantage” he says, and points to the firm’s 2009 acquisition of a 75-year concession on Chicago’s parking meter system as an example.

Wahba: not afraid of the
occasional auction

“We looked at the concession agreement, which had already been fully written, and . . . we said it has all of the characteristics that we like in terms of an infrastructure asset,” Wahba says. It had stable cash flows, clear regulation, and price increases which were set in law by city council. The fact that it could only be acquired by auction was not an automatic disqualifier. But before entering into the bidding, Wahba first wanted to confer with his team.

MSIP’s office layout gives away the fact that he’s an avid information gatherer and wants to know what everyone on his team thinks. On a grand tour, he points out the open-air atmosphere devoid of cubicles, where Wahba can easily hear the chatter of the analysts behind him or chat with managing director John Veech to his right.

“When I am on the phone, I want my legal counsel to be able to hear what I am saying,” Wahba says. The same principle applies globally: the majority of people on the 43-strong team, from associates up to Wahba himself, have invested their own money into the fund, so they’re required to opine on every penny Morgan Stanley commits to an investment.

“When I make an investment in Chile or the UK or here in the US, the guy in Hong Kong comments. Why? It’s his money,” Wahba says. “When we looked at Chicago parking, it was the same thing.” And because MSIP thought it had more than a 50 percent chance of winning, it braved the competition, beating out a Macquarie consortium in a second round of bidding in which MSIP sweetened its offer by nearly $150 million to $1.16 billion.

MSIP was so comfortable with the transaction that it turned down the bank financing it had secured for the deal and financed the $1.16 billion entirely with equity, bringing in Germany’s Allianz Capital Partners and Abu Dhabi Investment Authority as its partners at financial close.

“At the end of the day we got comfortable with the underlying asset itself, we got comfortable with Chicago and we got comfortable with the sanctity of the contract,” he says. That comfort arose from a due diligence process Wahba describes as “drill and drill” for information, “and when we finish drilling we try and drill even more”.

There is no such thing as too much information being bad

Sadek Wahba



“There is no such thing as too much information being bad. Especially when you make an investment that will stay with you for a long, long period of time,” Wahba adds.

After the transaction closed in early 2009, though, some of the meters began to malfunction. Just as rates were increased across Chicago, there was a problem with the meters’ different coin capacities, while others gave customers less time than they’d paid for. A flurry of parking tickets ensued, fueling public anger, vandalism and, needless to say, bad PR. Did MSIP just not know about the different meter technologies scattered around the city?

“It wasn’t a question of information that wasn’t available. I think it was principally a question of implementation,” he says, acknowledging there was a hiccup in the way the transition was handled. Equally importantly: “We were able to correct in a matter of two weeks,” he adds. Since then, 99 percent of the system has been functional “at any moment in time”. Chicago’s Mayor Daley, who took a lot of criticism for the malfunctions, told this publication in an interview last year he thinks the meters are now “a much better, efficient system” under MSIP’s ownership.

Investors have likewise vindicated MSIP’s original thesis on the transaction. In November 2010, the firm sold $600 million of bonds backed by revenues from the parking meters, finally infusing debt into the meter concession company’s structure, as originally planned. “It was worth the wait,” Wahba says, pointing out that the bonds were 169 basis points less expensive and three years longer in tenor, with no amortization requirements compared to the facilities than the banks had offered up to his team during the original bidding in 2008.

Franchise value

Not all of MSIP’s success is due to his team. Wahba also credits the institutional support received from its parent, investment bank Morgan Stanley. Contrary to the oft-cited criticism of bank affiliation as a potential for conflict, Wahba sees it as an important part of how he was able to grow a global team so quickly.

“There is a whole infrastructure behind it that effectively supports us in making these decisions, when we make investments in these different jurisdictions, whether in the US or outside, we have support from legal, from tax, from compliance, who gives us their insights,” he says. “I think being part of an institution like Morgan Stanley gives you also the kind of support, the kind of franchise value, that gives you a stamp of quality,” he adds.

He admits there’s times when Morgan Stanley’s Wall Street connection makes it more difficult to do business in an area as closely connected with Main Street as infrastructure. “But at the end of the day what we do is we always remind people that we focus on our objective and our fiduciary responsibilities toward our LPs,” he says – not toward Morgan Stanley the investment bank and its activities. During the financial crisis and the ire that was directed at all storied Wall Street names, drawing that distinction was crucial.

The financial crisis also ensured that Wahba will not be able to count on Morgan Stanley’s franchise value indefinitely. As part of his effort to fix the problems that led to the crisis, President Barack Obama signed into law a financial regulatory reform act that includes the so-called “Volcker Rule” – a provision named after former Federal Reserve Chairman Paul Volcker that limits the amount of capital a bank may invest in its captive infrastructure and private equity funds. Might that not prevent Morgan Stanley from someday seeding another infrastructure fund and force his team to spin out?

It goes without saying we will implement the Volcker Rule

Sadek Wahba


“It’s very difficult for me to answer that question because I’m not familiar with the Volcker Rule,” Wahba says. Before jaws drop, he quickly adds: “That’s a joke.”

“It goes without saying that we will implement the Volcker Rule. We’re waiting for some of the regulation to be clarified and implemented over the coming months and, frankly, years, so we have plenty of time to understand and absorb and effectively do what is necessary to comply with the Volcker Rule,” he says.

For now, though, Wahba is concentrating on deals, which have been flowing at a brisk pace in 2011. At press time, Indian media were reporting the firm would be buying a stake in the Indian subsidiary of Spanish developer Isolux Corsan for $200 million. And Spanish utility Gas Natural confirmed that Morgan Stanley had just agreed to buy a 300,000 connection point gas distribution network for €450 million, a deal poised to make MSIP owner of the third-largest gas company in Spain.

“For me it’s a very symbolic and emblematic deal of who we are,” he says, projecting a sense of accomplishment that makes one briefly question whether he’s really the natural pessimist that he claims to be.