Infrastructure M&A Activities & Opportunities | Virtual Roundtable

In this week’s virtual roundtable we welcomed seven Axial members — both buy-side and sell-side deal professionals — across a variety of infrastructure M&A verticals to discuss where the industry stands today. In addition to discussing the industry more broadly, we took a deeper dive into construction, transportation & roads, telecom & data, and power. Topics of conversation included: government funding & regulation in the sector, infrastructure deferral, labor & unions, and opportunities in the sector moving forward.

Thank you to the following Axial members who participated in the discussion: 

Gregg Delcourt, Senior Vice President of Small Cap Investments, Alaris Royalty Corp.

Brandon Hinkle, Managing Director, Chicago Capital Partners

Bill Overbay, Managing Partner, Stone Road Capital

Ed Pallesen, Managing Director and Infrastructure Team Lead, H.I.G. Capital

Steve Smith, Vice President of Business Development, Tower Arch Capital

Rahul Suri, Founder & Managing Partner, Clariti Strategic Advisors

Pierre Villere, Managing Partner, Allen-Villere Partners

George Wedemeyer, Managing Partner, Downstream Energy Partners

Video

Audio 

Show Notes 

Introductions 00:00 – 9:00

Case study of an existing process – 9:00

• Clariti Strategic Advisors is in process on a business that is a corporate carveout, supports utilities, based in Canada with some emergency response in the U.S. — it was kicked off before COVID hit and a number of the parties who signed NDAs dropped off once the pandemic hit
• What resonated with buyers is that a business like this is recession-proof because they’re truly essential in order for the economy to continue to run
• Post-CIM, all management meetings needed to be done via Zoom, and with an expectation of closing in September, there will be in-person management meetings and site visits that will need to happen before close
• Contingent versus cash: a small percentage of the total percentage is on a deferred basis
• Without COVID you would have expected a more robust set of buyers but on the flip side, there is so much dry powder that investors are looking to deploy, and because this is a fairly low-risk opportunity in this climate, that is very helpful

Legal and Regulatory Factors – 15:18

• In past years, there has been lot of focus on getting the needed funding for “hard” infrastructure (roads, railways, etc.) so the government has put in place a lot of funding initiatives to allow the private sector to partner with them
• Through COVID, government initiatives will likely pick up steam
• Private/public partnerships most often fall into the “transportation infrastructure” category — roads, bridges, tunnels, seaports, airports
• Other areas of infrastructure that have a much lighter government hand on them are things like telecom, oil & gas, regulated utilities (these are things that are not impacted by things going on in Washington)
• Most infrastructure regulation (in the U.S) is at the state level, not on the federal level
• In the past couple of weeks, the Trump administration is thinking about a big infrastructure program, that would be very welcome — but how much incremental private investment does that open up? They could spend the money without public/private partnerships
• Data usage has been a hot topic since everyone has been working from home and the importance of a lot of areas within telecom has been accelerated with COVID
• A lot of telecom has been moving forward independent of what’s going on with the government
• Of the 612,677 bridges in the US over 54,000 opf those are considered structurally deficient
• The original Trump campaign discussed an infrastructure bill ($1.5-1.7 trillion) and what’s being discussed today is a bit less than that (closer to $1 trillion) and there are questions if it will pass

 Infrastructure Deferrals – 23:30

• There is close to $10 trillion of deferred infrastructure in the U.S. and it’s going to take a serious commitment from the government to face and fix this issue
• Responsibility breaks down into three sections: the federal level, the state level, and municipalities (depending on the state you’re in, different levels have different responsibilities when it come to repair)
• The Eisenhower Interstate System was announced in the mid 50s. The amount of money spent from the 1950s-1970s (this is when a good amount of the country’s interstate system was created) represented a much greater percentage of the government budget than it does today
• Entitlement programs have swollen in the past many years which has taken a lot of funding
• Texas probably leads the nation in developing new toll roads — this is very difficult to get passed in other states — and this is probably the answer long term 
• It takes a recommitment at all levels of government to get this done
• One of the stimulus discussions happening in Washington right now is a bill to help the states (who are hurting without their sales tax revenue & hospitality taxes) get loans which will allow them to meet the qualifications to get matching federal funds (a big part of this is to stimulate infrastructure spend)
• A lot of the decisions get made at a local level, but the money is coming from the federal level, which makes things hard to get moving
• A lot of the projects take a long time and the life of politicians are short, so that can be a problem
• Public/private partnerships are hard to put together, and a lot of local governments aren’t advanced enough to be able to put these together efficiently
• Governments have balance sheets with huge amounts of debt, so is there an opportunity for true privatization? There hasn’t been a lot of consensus around this in the U.S.
• It could be a win/win if there is an existing asset that needs a lot of capital and needs a lot of management (airports are an area where this has happened in Europe, and is probably the most likely place in the U.S.)
• Toll roads are a very successful example of privatization as well
• Infrastructure projects aren’t shiny, so when the government is given the option to spend their money in a place that will more tangibly or directly impact people’s lives, they do that

How do private investors feel about government involvement? 34:10

• Any new public dollars are usually used on longer-term projects, and since PE firms usually have a focus on hold periods and exit opportunities, a lot of times these are not the best deals to look at, even if public dollars are attractive
• The U.S. spends 2.3-2.5% of GDP annually on infrastructure
• If you roll something out this year, you’re going to see the impact on the financials next year and the year after, so the concern is around paying a high multiple now, only to sell for a lower multiple a few years down the line — this is something you want to avoid, even if the EBITDA is higher regardless

Labor – 40:15 

• One of the biggest challenges in infrastructure businesses is labor and safety
• A lot of the labor in the infrastructure sector is unionized
• If you have great safety protocols and a good track record, it is much easier to have a good relationship with the labor unions
• Retention is a big deal because a lot of jobs in the infrastructure market are not glamorous or fun, so it’s important to keep morale of workers high
• Unions can be viewed as beneficial from a buyer because of the safety-culture that comes along with it, and also because there tends to be more employee stickiness

Infrastructure of the future – 44:50

• There’s a lot of opportunity across the industry
• Some of the trends that are happening outside of transportation: smart city development, 5G, the development of data centers
• There are a lot of private dollars flowing into those spaces
• De-urbanization in a post-COVID world is fueling things as well
• Power is also an interesting space: Tesla’s impact, fossil fuel reduction, upgraded power grids, etc.
• There are also some interesting considerations within the transportation sector: what impact will autonomous vehicles have? Changes to logistics and shipping will also have an impact on transportation
• As you move further away from “hard infrastructure” where the government is holding a lot of things up, you come across all of these privatization opportunities

Revisiting unions – 50:26

• Historically, private equity hasn’t loved union businesses
• That said, if you look at deals on a case-by-case basis, the relationship with the union actually can help you get a sense of the culture of the company
• If there has been a tempestuous relationship with unions, that’s a red flag and can be a reflection of the overall culture
• On the flip side, if there is a really good relationship with the union, that makes it more likely that there is a healthier, more collegiate attitude within the business
• Some projects won’t be awarded to non-unionized businesses, so if you don’t want to invest in those businesses, you need to accept that you’re ultimately giving up potential revenue opportunities
• If a company employs union workers, they need to be treating them well and to a standard where they know that there won’t be union blowback
• Training, benefits & employee welfare are places where unions make sense
• However, it’s the cases where it’s an “us versus them” mentality that makes unions less attractive
• In the metropolitan Chicago area, all construction/concrete/asphalt is unionized, and this puts everyone on an even playing field — from the big corporations to the small family businesses — in terms of their labor costs; it’s done a lot to stabilize the market there
• Safety in the infrastructure world is probably the most important thing, so the safety culture that comes along with unions really should be valued

The resiliency infrastructure & entrance into the market – 58:45

• In a post-COVID world, does the resiliency of the infrastructure market ultimately make it a lot more competitive (either for entrepreneurs or investors)?
• From the entrepreneurial perspective: now is not an ideal time to be starting any business, regardless of the market
• Over the past five years, you have seen a lot more interest in the space and more people wanting to be involved
• This is both good and bad from an investment perspective, because you’d like to have a strong market, but you’re also increasing competition & price
• One place that is a standout vertical post-COVID is telecom
• Telecom has historically been on the fringe, but it was beginning to pick up steam, even prior to the pandemic; now, judging by multiples, you can see that it’s at the forefront
• It will be interesting to see what happens to commercial real estate, because that will ultimately have an impact on hard infrastructure

Downstream power considerations – 1:02:45 

• What is Tesla’s impact on gas stations?
• The bigger concern is actually around retail demand versus gas demand. A lot of gas stations have evolved to be major retail stores, so that is what the owners need to be concerned about
• If people only need to charge their cars at a service station on a road trip, will there be enough consumers to warrant keeping those retail centers open? 
• COVID immediately killed almost all downstream energy M&A, but it’s now back

Deal activity & travel post-COVID – 1:11:40

• More than half (4/7) participants have ventured out and been on the road related to deals
• Pierre Villere (Allen-Villere Partners, based in New Orleans) has scheduled fairly extensive business travel over the next month for both existing deals as well as just general marketing; wears a mask the entire trip unless in a socially-distanced conference room
• Eating out — especially eating in airports — is still tough
• Hotel occupancy is still poor but it’s definitely picked up and is coming abc slowly
• Tower Arch has been traveling to portfolio companies over the past month; getting ready to travel for two platform opportunities in the next couple of weeks; they’re a bit more cautious about having people in the office 
• The major obstruction to deals closing over the past few months was that people wanted an in-person meeting before finalizing things, so this is a positive step
• Downstream Energy Partners is back to their normal pre-COVID deal travel
• Debt still seems to be an issue, but if equity players are back on the road, the dam will likely break for lenders in the very near future