Asia’s infrastructure needs have long attracted interest from private equity firms but drawn-out development and construction timeframes and eroding returns have prompted some investors to look at smaller projects, particularly in energy.
Data from Dealogic shows that the number of private equity deals in the oil and gas, energy and utility sectors in Asia ex-Japan fell to 7 in 2013 from 21 in 2010.
Further illustrating the tough times, 3i Infrastructure said in May that its $1.2 billion India Infrastructure Fund will not make any new investments as it has not delivered on its expected returns, blaming a deterioration in the political, market and economic climate since its launch in 2007.
Greg Karpinski, co-head of energy, resources and infrastructure at SCB Principal Finance, a unit of Standard Chartered Bank, said there is a growing interest in smaller infrastructure investments, with his firm now targeting projects of less than $500 million, where they are able to make equity investments of $20 million to $200 million.
“As [private equity] investors, large scale energy and infrastructure projects, especially if they are greenfield, are not always as good an opportunity as they seem at first, given our return thresholds and typical hold periods,” Karpinski said.
The Asian Development Bank has predicted the infrastructure needs of Asia will double to about $800 billion a year in the 2011-2020 period, from around $400 billion a year in the preceding decade. However, banks and private equity funds are losing their appetite for large-scale infrastructure projects. Banks are facing capital restraints, making long-tenure debt lending more difficult, while private equity funds have become disillusioned with the lengthy development periods and lower-than- expected returns.
Smaller-scale infrastructure and energy projects allow private equity funds an easier entrance, while ensuring that Asia’s infrastructure gap is being addressed, albeit in small steps. Investors reap favourable returns while Asian communities get the electricity generators and municipal waste treatment plants that they badly need.
Greenfield projects have long gestation periods, both in terms of the development process and construction period prior to achieving operation, a problem particularly well documented in markets such as India and Indonesia, where permit delays have become daunting.
That makes those investments more suitable for energy majors, national companies and state-owned enterprises, which have lower costs of capital and longer investment horizons than private equity funds, who are often expected to return capital to their partners in five years.
“We’re interested in distributed infrastructure companies that target niche markets where there is an absence of reliable existing infrastructure,” Karpinski said.
Distributed power generation relies on small generators near the energy demand versus large-scale generation that must then be distributed via a grid network. This makes distributed energy more attractive in remote markets with underdeveloped grid networks.
Standard Chartered, which has about $4 billion worth of investments in mid- to late-stage companies in Asia, Africa and the Middle East, invested $25 million in Navigat in December of last year to finance its power-generating business MAXpower. Navigat, a Jakarta-based gas-to-power group, specializes in distributed energy across Indonesia, with plans to expand in Southeast Asia.
Standard Chartered also invested $75 million last year in Energy World Corporation, a Hong Kong-headquartered energy company with gas and power operations in Indonesia, Philippines and Australia.
Karpinski said he’s looking particularly at situations where remote communities, such as on islands, cannot efficiently be connected to the grid, so renewable solutions such as solar and gas power, with some investment, can replace more costly energy such as diesel-powered generation.
“To a village in the middle of India or on a small island somewhere, a distributed power solution such as a stand-alone micro solar plant can provide electricity at grid parity or close to parity on a fully costed basis. Location matters significantly when you price infrastructure development,” Karpinski said.
He said that at current oil prices diesel power costs approximately 30 cents per kilowatt hour, versus natural gas, which, even if priced at the high end of the market, can be converted to electricity at around 12 to 15 cents per kwh.
Big returns on small deals
Investors and advisors said that, while large-scale infrastructure investments deliver returns on equity of 9% to 14% — falling to the lower end of that range in recent years due to the worsening economic climate — smaller infrastructure returns can be 15% and higher, driven in part by increased cash flow and the technical risks associated with smaller projects that use non-conventional fuels and technology.
Smaller deals may still come with support from multilaterals such as the Asian Development Bank and the International Finance Corporation.
Steve Payne, partner and head of the energy, infrastructure, project and asset finance practice in Southeast Asia, White & Case assisted IFC in making a $25 million pre-IPO equity investment in Shenzhen Zhaoheng Hydropower’s offshore holding company and $50 million in first round debt financing to its onshore subsidiaries to finance the construction and operation of small-to-medium hydropower plants in China.
“We’ve done several deals in this range in the clean water sector as well, with the IFC investing in companies with the technology to provide clean municipal water as well as municipal and industrial wastewater treatment. We’re seeing lots of investments like that in the $20m to $25m range,” Payne said.
Johan Bastin, chief executive officer of private equity firm CapAsia, headquartered in Singapore, which invests in medium-sized infrastructure in emerging Asia, said they are taking a close look at several smaller gas-fired power plants around the region, but have not yet made an investment decision. CapAsia has already invested in projects such as Indonesian and Thai toll roads and Pakistani wind farms.
“There is a trend towards smaller gas-fired power plants, where there are sufficient gas reserves, and in several cases they replace more expensive bunker fuel power,” Bastin said. “Technology has changed and smaller-scale turbines are more feasible than before but the availability of gas is always a key question.”