Involving Private Sector Brings Benefits to Investing in Infrastructure

 

8- involving private sector brings benefits

#ActiveAllocator Opinion – We strongly advocate that where possible the private sector works hand in hand with the public sector to deliver infrastructure projects. Significant policy work still remains to be done in most countries to expand private sector involvement in infrastructure, although many governments are increasingly focused on advancing such policies.

Governments have historically used bond financing, custom lease structures, special tax districts, tax incentives and credits, as well as usage fees, to facilitate funding of infrastructure projects. They are now increasingly turning to private capital to supplement or replace public financing. This trend began in Australia and the U.K. and carried over to Canada and continental Europe. It is now becoming increasingly important in the U.S. Significant policy work still remains to be done in most countries to expand private sector involvement in infrastructure, although many governments are increasingly focused on advancing such policies. For example, in the U.S. a number of drivers are catalyzing increased private sector involvement. They include, among others, (i) funding shortfalls at each level of government caused by limits on tax increases and available debt; (ii) divestitures of existing infrastructure assets to raise capital for new investments; (iii) initiatives to obtain private sector management and technical expertise to improve service efficiency; (iv) enactments of favorable PPP legislation by federal and state governments; and (v) availability of debt and equity financing from private investment sources.

Development Banks Must Now Find a New Raison D’être

2- new raison d etre

Lets call a spade a spade. Development banks have done precious little to bring about meaningful development for their member states. Their members remain mired in poverty, their efforts have spurred little economic growth, and for the most part have done little to attract private capital or catalyze strides. These institutions have been parking places for bureaucrats, served as jobs programs for mediocre but well connected civil servants pursuing careers with cushy benefits, low expectations and job security with precious little accountability.

I did a back of envelop inventory of around 600 development banks worldwide. 40 are international, regional and sub-regional development banks and 560 national development banks.  To be relevant they need to do more than lend. They need to catalyze financial flows, beef up on new products, as well as mobilize newer resources.

And U.S. tax payer should stop funding such agencies.

 

Deals Resume in Sale of Risky Loan Funds

1- clo investors hit brakes

“Deals Resume in Sale of Risky Loan Funds” The WSJ, Tuesday June 30, 2020, B9.

CLO sales cross $34 billion YTD, $5 billion in June alone as investors re-enter the risky loans market. The Fed’s corporate debt buying program is catalyzing U.S. investor appetite seeking higher spreads ( AAA at LIBOR+1.65) , even as Japanese institutional investors curtail risk taking and have been pulling back.

In 2020 CLO investors need to be especially hands-on to understand the origination processes, servicers, borrowers and quality of underlying collateral. Quality and performance of the underlying collateral is worsening materially more than expected, suggesting that the underwriting process did not consider severity of coronacrisis induced slowdown. In many cases originators had created loans primarily for sale and retained little, if any, interest in ongoing performance. Investors also need to get more deeply involved in the information cycle where excessive reliance on lagging ratings doesn’t help. In the 2008 global financial crisis default and delinquency data was artificially low because of extend and pretend and refinancing. Reliance on historical performance data and statistical models and stress test is insufficient. Investors need to manage the risk that their models are becoming irrelevant to changing conditions in the underlying loans space.

Carl Icahn Case Study – Mylan Laboratories

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#ActiveAllocator Research – Companies are likely to become vulnerable to activist investors during the coronacrisis period. To explain transaction mechanics, activist hedge fund motives and criteria, we analyzed 15 Icahn transactions over the years. We present these in succinct case studies each day on our research blog.

Also, you can derive your own optimal portfolio allocation to activist and other hedge fund strategies on activeallocator.com

Debt From American Companies Lures Asian, European Investors

Wall Street Journal, June 29, B1 article “Debt From American Companies Lures Asian, European Investors”.

U.S. corporate debt  now much riskier as default rates rise, but Asian and European investor demand is very high. Fed backstop expectations prompts switch from holding low yielding treasuries to higher yielding corporate debt.

1-corporate debt

Carl Icahn Case Study – Lear Corp

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#ActiveAllocator Research – Companies are likely to become vulnerable to activist investors during the coronacrisis period. To explain transaction mechanics, activist hedge fund motives and criteria, we analyzed 15 Icahn transactions over the years. We present these in succinct case studies each day on our research blog.

Our firm’s founder Brian Jones and me have participated in over $40 billion M&A transactions , so we hope you find some of our insights useful. Also, you can derive your own optimal portfolio allocation to activist and other hedge fund strategies on activeallocator.com.

Governments Face Significant Issues in Infrastructure

7-governments face significant issues

 

With few exceptions, under investment in infrastructure has been a global secular trend. In some instances the true economic cost is not passed on to consumers. In these situations, under-pricing tends to be subsidized by the government, which results in pressure on government finances. The cumulative adverse impact is under investment, lagged maintenance and inadequate infrastructure replacement. This in turn slows development, erodes productivity, and in some cases results in shifts of populations and industries to more infrastructure efficient geographic areas. Estimations and methodologies to determine infrastructure funding needs differ due to varying definitions of infrastructure as well as the level of subjectivity involved in assessing the need to renew, maintain or to add to existing assets. The market for private investment in public infrastructure is expected to continue to grow in size, sophistication and opportunity. Private investors recognize this trend and have begun to raise dedicated infrastructure funds to address these opportunities. These infrastructure funds bring together capital from a variety of investors and allow for efficient deployment of equity capital.

Is There a Common Root Cause for Financial Crisis?

This week’s large banks stress tests by the Federal Reserve project losses in pronounced downturn at $700 billion. This scenario is likely in the event of a widespread and prolonged economic downturn.

Are we headed into one with attendant risks of a financial crisis? Looks unlikely. I examined financial crisis over the last 3 decades and was quite unable to come up with common root causes that trigger these events – necessitating different tools each time . Here is a visual I update that speaks to this.

2-previous crisis1

Fed Sets Caps on Bank Payouts Amid $700 Billion Loss Threat

The Wall Street Journal  Fri, June 26, 2020 reports Federal Reserve writedown estimations after it conducts stress tests on leading banks. It orders banks to cap dividends and suspend share buy backs.

We contrast June, 2020 write down estimations with reconstructed numbers from October 2008 estimations.  Federal Reserve stress tests June 2020 project large bank losses in pronounced downturn at $700 billion on soured loans and writedowns.  In 2008 this loss was estimated at double the amount, suggesting that the global financial crisis was twice as  severe as far as the banking sector is concerned.

20 estimated writedowns

Carl Icahn Case Study – Kerr-McGee

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#ActiveAllocator Research – Companies are likely to become vulnerable to activist investors during the coronacrisis period. To explain transaction mechanics, activist hedge fund motives and criteria, we analyzed 15 Icahn transactions over the years. We present these in succinct case studies each day on our research blog.

Also, you can derive your own optimal portfolio allocation to activist and other hedge fund strategies on activeallocator.com.

Retain Appropriate Infrastructure Project Risks with Public Sector

6-retain appropriate risks

We strongly advocate appropriate sharing and retention of risk between the private and public sectors in infrastructure projects. PPPs can take a wide variety of forms with varying involvement of the private sector and with varying degree of risk transfer from government to the private sector. Properly implemented, PPPs and PFIs transfer risk from the public sector to entities that may be better qualified to bear it as well as be better qualified to reduce costs and create better service delivery outcomes. It also frees government resources and public funds to address pressing social problems or to develop projects that are less attractive to private investors. Issues that inevitably feature in policy discussions relate to economic transfers and distributional effects, e.g., who benefits and at what costs to others, rents, accountability, regional development, jobs, prices and tariffs.

Carl Icahn Case Study – General Motors

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ActiveAllocator Research – Companies are likely to become vulnerable to activist investors during the coronacrisis period. To explain transaction mechanics, activist hedge fund motives and criteria, we analyzed 15 Icahn transactions over the years. We present these in succinct case studies each day on our research blog.

Also, you can derive your own optimal portfolio allocation to activist and other hedge fund strategies on activeallocator.com.

Infrastructure Funds Buy Leasing Rights for Abu Dhabi Pipelines in $10 Billion Deal

9-Abudhabi Leasing

WSJ June 24, 2020 article “AbuDhabi Gets $10 Billion Deal”

We see this infrastructure deal as midstream transportation and hydrocarbon handling and transportation. It is a typical gas  pipeline deal that uses a “toll-road” or “fee-for-service” business model to handle, process, and trans-port oil, gas, gas liquids, and refined products.

Dell Explores Spinning Off $50 Billion VMware Stake

As coronacrisis progresses expect companies to separate portions of business. Such actions will be typically driven by strategic decisions to divest businesses and/or valuation creation opportunities. Often there is a valuation drag on due to ownership of lower valuation businesses. Spin-offs often have potential for shareholder value creation when investors have higher valuation expectations of the new separate public company.

ActiveAllocator Research – Re. WSJ Wed, June 24, 2020, A1 article ‘Dell Explores Spinning Off $50 Billion VMware Stake”. I see at least three options for Dell – an outright spin-off, a carveout, or a total sale. All of these will unlock Dell’s $50 billion, 81% VMware stake, boost stock-price which has been near static while tech indices have surged past year, and reduce its debt burden. We have a fair bit of experience in the investment banking space and I will keep you posted as the deal progresses.

spinoff-1

Carl Icahn Case Study – CSX

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ActiveAllocator Research – Companies are likely to become vulnerable to activist investors during the coronacrisis period. To explain transaction mechanics, activist hedge fund motives and criteria, we analyzed 15 Icahn transactions over the years. We present these in succinct case studies each day on our research blog.

Also, you can derive your own optimal portfolio allocation to activist and other hedge fund strategies on activeallocator.com.

Vital Importance of Risk Management in Infrastructure Projects

5-vital importance of risk management

#ActiveAllocator Opinion – We strongly advocate  both greater upfront as well as ongoing risk analysis to catalyze infrastructure development. The fundamental drivers of infrastructure revenues are changes in macroeconomic factors such as GDP and demographic trends. Growth in these factors increases usage-based revenue and positive cash flows for these assets. Infrastructure assets typically feature a set of common attributes which provide for defensive investment characteristics.

There are three key criteria that dictate the risk/return characteristics of infrastructure to a large extent:

Stage of Maturity

Investment in assets under construction is riskier than completed assets; investment in newly completed assets with no operating history (including usage) is riskier than investment in mature assets with established operations and usage history.

Geography

Political risk in developing countries is a key consideration given the essential nature of the assets to the local economy, the long life of the assets and the fact that they cannot be moved, making them vulnerable to expropriation. To mitigate this risk, many investors target only developed countries or developing countries with robust legal frameworks, particularly with respect to property protection and contract enforcement. The long payback period also increases the probability that an investment may be adversely affected by a period of severe economic instability (e.g., government default, hyperinflation). In compensation, many emerging markets are enjoying significant economic growth, which has strong direct benefits for infrastructure businesses.

Sector Scope

All else being the same, infrastructure businesses whose revenues are not subject to price and/or volume variations are less risky than those that are. Some social infrastructure PPP companies (e.g., for hospital facilities) may be paid by the government on an “availability basis,” e.g., revenue is independent of usage and the service is compensated at a fixed price, with deductions only for poor service. Where there is volume risk, this may be mitigated by the nature of the service (e.g., provision of water to a given area) and/or by the monopolistic nature of the asset (e.g., being the only airport for a major city). Price risk may be mitigated by regulation that periodically determines price to provide a certain return on capital (e.g., for utilities) and/or by fundamental demand (e.g., for a toll road for a major corridor). To the extent that price and volume risk is not significantly mitigated, the asset may not be considered to be “infrastructure” for investment purposes. For example, power generators that sell electricity into a market at spot prices (e.g., it is “merchant” generation with no long-term power purchase agreements) is considered ineligible by many infrastructure investors.

Carl Icahn Case Study – Blockbuster/Hollywood Entertainment

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#ActiveAllocator Research – Companies are likely to become vulnerable to activist investors during the coronacrisis period. To explain transaction mechanics, activist hedge fund motives and criteria, we analyzed 15 Icahn transactions over the years. We present these in succinct case studies each day on our research blog.

Also, you can derive your own optimal portfolio allocation to activist and other hedge fund strategies on activeallocator.com.

 

Which Companies Likely to be Targeted by Carl Icahn During Coronacrisis?

2-Typical Carl Icahn Target Criteria

 

Many companies are likely to become vulnerable to activist investors during the coronacrisis period, though strong performance can help insulate from advances.

To understand typical companies targeted, motives and criteria, I analyzed 15 Icahn transactions over the years. These also include Hollywood Entertainment, CSX, Kerr-McGee, Lear Corporation, Mylan Laboratories, Nabisco, Temple-Inland, Time Warner, USX, VISX. Here are some of my take aways.

 

How Does Carl Icahn’s Activist Hedge Fund Make Money?

1- activism_icahn

ActiveAllocator Research – Activist hedge-funds have been largely opaque and mysterious and have acquired a certain myth. Whether they are seen as corporate raiders specializing in hostile takeovers and asset stripping of publicly listed businesses or activist investors is very much in the eye of the beholder? To understand typical strategies,  I analyzed 15 Icahn transactions over the years. These also include Hollywood Entertainment, CSX, Kerr-McGee, Lear Corporation, Mylan Laboratories, Nabisco, Temple-Inland, Time Warner, USX, VISX. Here are some of my take-aways.

Remember you can derive your own optimal portfolio allocation to activist and other hedge fund strategies on activeallocator.com.

Climate Change, Government and Role of Banks

2- role of banks

The Economist June 20, 2020 article is an interesting one “How much can financiers do about climate change?”.

Having been a banker on Wall Street in a previous life, I have been giving this matter some thought. Here are some ideas where I see banks play an important role in supporting government climate and environmental policy.

 

Critical Climate Vulnerabilities of Developing Countries

1-developing

ActiveAllocator Research – I came across an informative BBC article ‘Who is really to blame for climate change?” by Jocelyn Timperley 18th June 2020. I for one am much more concerned with climate vulnerabilities of developing countries. In ordering my thoughts many critical vulnerabilities come to mind including geographic exposure, low incomes and greater reliance on climate sensitive sectors. Dependence on agriculture, poor health infrastructure, inadequate water related infra, a growing urban populations, poor public services and underdeveloped financial markets further exacerbate the issue.

 

Europe Should Learn from the U.S. & Take Steps to Block Chinese Bargain Hunters

The NY Times Fiday, June 19, 2020, B6 “Europe Takes Steps to Block Chinese Bargain Hunters”.

Europe is doing too little too late to block Chinese investors (backed by government that provides financial support and subsidies) to snap up distressed European companies at bargain prices. It can borrow much from the U.S. which has been way ahead.

We draw attention to changes in US regulatory environment for foreign deals in the Trump presidency. The national security landscape has shifted in recent years, and so has the nature of the investments that pose the greatest potential risk to national security. Recent amendments to the Committee on Foreign Investment in the United States (CFIUS) process now brings significant hurdles to foreign investment in ‘sensitive’ sectors. The Foreign Investment Risk Review Modernization Act of 2018 (FIRRMA) was signed into law after receiving broad bipartisan support in Congress and new regulations are expected. We provide historical context, highlight recent evolution and provide color on consummating such transactions.

Prioritizing Infrastructure Requirements

3- prioritize

We strongly advocate that government needs to develop a complete portfolio level picture of infrastructure needs rather than one off projects driven by political interests. It needs to figure out financing sources and funding. It also needs to bring in granular project management expertise and put in place appropriate structures, practices , systems, accountability and controls to ensure prioritized execution.

 

Governments Should Enhance Best Practices for Infrastructure Investments

2- best practices

Governments have historically used bond financings, custom lease structures, special tax districts, tax incentives and credits, as well as usage fees, to facilitate funding of infrastructure projects. They have also increasingly turning to private capital to supplement or replace public financing.  Multiple drivers are catalyzing increased private sector involvement. They include, among others, (i) funding shortfalls at each level of government caused by limits on tax increases and available debt; (ii) divestitures of existing infrastructure assets to raise capital for new investments; (iii) initiatives to obtain private sector management and technical expertise to improve service efficiency; (iv) enactments of favorable PPP legislation by federal and state governments; and (v) availability of debt and equity financing from private investment sources. Government has a huge role to catalyze infrastructure development that goes far beyond traditional projects and financing.