The era of deleveraged resilience

As a recent move by Quebec’s La Caisse demonstrates, resilience has become a reason to deleverage infrastructure assets and enjoy their inherent stability. Times have clearly changed, writes Cezary Podkul.

In the alphabet of infrastructure investing, “r” stands for “resilient”: the theory that, because infrastructure assets provide essential services that underpin the very functioning of the economy, they should be less affected by economic downturns than other, non-essential businesses and services.

But while you may hear the “r” word as often as you might have in the go-go days of 2005 or 2006, there’s been a subtle change in the context in which investors are touting the resilience of their infrastructure portfolios these days: namely, that higher levels of leverage are no longer desired.

Cezary Podkul

First, a trip down memory lane. When debt was plentiful and asset prices were high, the resilience of infrastructure assets served as a convenient marketing point in negotiating for higher leverage levels – and razor thin debt service coverage ratios (DSCR). Why settle for a 2x DSCR if the asset is resilient in the face of a downturn? Indeed, if an asset is resilient to economic and industry downturns it can afford to bear increased levels of debt and lower DSCRs – say for example a 1.5x DSCR. That, at least, was how the conversation went a few years ago.

Resilience, in other words, went hand in hand with the leveraging-up of infrastructure assets. Post financial crisis – and the many workout situations that undoubtedly happened and are still happening behind the scenes – the resilience thesis has not been abandoned. But these days it goes hand-in-hand with the de-leveraging, not the leveraging, of infrastructure assets.

Just ask Macky Tall, vice president for infrastructure investments at the C$151.7 billion (€112.3 billion; $155 billion) La Caisse de dépôt et placement du Québec, one of Canada’s largest institutional investors. Tall manages a portfolio of 16 infrastructure assets which “confirmed” their resilience by growing their earnings before interest, tax, depreciation and amortisation (EBITDA) despite the downturn.

He points to Heathrow, the UK’s largest airport, as one example. Caisse owns 21.2 percent of BAA, the British airport operator that owns Heathrow and five other airports. In 2010, the airport weathered a shutdown of air traffic due to the explosion of an Icelandic volcano, strikes by airline employees and a massive snowstorm that paralyzed major airport across Western Europe. “Despite all these events, BAA still met its EBITDA objectives and actually was in slight increase compared to the previous year,” Tall says, (late last month, BAA declared a 9.2 increase in its EBITDA to £966.9 million for 2010).

Yet since Caisse’s investment in BAA in 2006, the company has also been chopping away at its debt load, which has gone from about £15 billion as of the end of 2008 to £9.9 billion at the end of 2010. BAA’s sale of Gatwick Airport in 2009 for £1.5 billion and an equity injection by the company’s shareholders helped contribute to this downward trend.

The deleveraging trend reached the shareholder level as well. In 2010, Caisse eliminated C$6.7 billion of debt on its private equity and infrastructure portfolios, leaving them completely debt-free. Tall credits this “significant” deleveraging to the fact that it “reduces the risk profile of this portfolio and globally of the Caisse”. This despite the resilient nature of his infrastructure portfolio .

To be sure, infrastructure portfolios aren’t out of the woods yet. Tall is keeping a close eye on the price of oil, which could indirectly impact his portfolio if it rises to such levels that airlines begin to raise ticket prices to make up for increased fuel costs.

But it’s safe to say that if infrastructure assets are to experience another major test of their resilience in the near future, they will likely do so with a much lower debt load than in years past. Resilience, infrastructure investors seem to have concluded, is a reason to de-risk the portfolio and enjoy stability, rather than to lever it up for the sake of juicier returns.