European Infrastructure Finance Yearbook - Investing In Bonds ...

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COMMENTARY Publication Date: Sept. 7, 2007 Primary Credit Analyst: Michael Wilkins, London, (44) 20-7176-3528 Leveraged Finance & Recovery: Taron Wade, London, (44) 20-7176-3661 THE CHANGING FACE OF INFRASTRUCTURE FINANCE: BEWARE THE ACQUISITION HYBRID Bank lenders and institutional investors have traded favorable debt terms against the management of credit risk during the infrastructure finance boom of the past 18 months. Now, with the cycle turning in the global credit markets, loosely structured and highly leveraged acquisition loans are looking far less attractive. As a result, it is estimated that up to $34 billion of leveraged infrastructure loans may be left paralyzed under current market conditions. Cheap debt with relatively generous terms has been the order of the day among infrastructure sponsors. To meet market demand, banks have combined project finance structuring techniques with covenants prevalent in leveraged finance facilities--allowing sponsors to acquire infrastructure assets at record-breaking debt multiples. Despite the advantages for borrowers, Standard & Poor’s Ratings Services believes that this new form of acquisition hybrid poses a significant credit risk to the infrastructure sector. Many assets recently purchased for eye-watering acquisition multiples have failed to boast the operating and cash flow strengths assumed typical of infrastructure assets. Such risks are likely to be exacerbated as credit markets become increasingly volatile and investor confidence fragile. With $332 billion in leveraged loans currently sitting on banks’ balance sheets globally, bankers are unlikely to be keen to lend to infrastructure assets in the current climate without comfort that credit risks are well mitigated. Investors and lenders alike therefore need to examine the risks associated with each individual transaction, and if necessary seek more credit protection than is currently being provided within the hybrid structure to ensure that the level of debt can be supported by the underlying asset. This is particularly pertinent as new assets are brought under the infrastructure umbrella--with car parks, motorway service stations, and motor vehicle certificates now claiming to be strong infrastructure assets. Breaking New Boundaries: Hunger For Infrastructure Drives Development Over the past few years the boundaries of infrastructure finance have been increasingly pushed, with investors hungry for new types of assets and financing techniques. Consequently, the lines between project finance and leveraged finance have become evermore blurred, with 8 ■ NOVEMBER 2007 STANDARD & POOR’S EUROPEAN INFRASTRUCTURE FINANCE YEARBOOK investors marrying together structuring techniques from both financing classes to acquire infrastructure assets. Crucially, the high debt multiples usually associated with project finance transactions have been adopted in conjunction with the relatively flexible controls, hurried due diligence, and weak security packages more common in LBOs. As a result, increased debt multiples are often coming at the expense of necessary risk mitigants. Since 2006 a phenomenal appetite for infrastructure assets has spread worldwide. This, in turn, has fuelled a surge in the number of acquisitions within the sector, making it a significant area of growth for the syndicated loan market. Landmark deals include the purchase of U.K.-based airport operator BAA Ltd. (BBB+/Watch Neg/NR) by a consortium led by Grupo Ferrovial S.A. in February 2006 for $30.2 billion, the acquisition of the Indiana Toll Road for $3.8 billion by Macquarie Infrastructure Group and Cintra Concesiones de Infraestructuras de Transporte, and Goldman Sachs’ Admiral Acquisitions consortium’s £2.8 billion acquisition of Associated British Ports (ABP). Fusion Of Project Finance And Leveraged Finance As for the financing of “greenfield” infrastructure assets, investors have turned toward project finance to raise funds when acquiring mature infrastructure assets--securing high leverage multiples due to the stable cash flows and monopolistic environment. They have then incorporated leveraged finance structuring techniques instead of carrying out an LBO of the asset as would traditionally have been the case for the acquisition of mature infrastructure assets (see table on next page for the various structuring techniques typically associated with leveraged finance transactions and project finance transactions, respectively). Of key concern for Standard & Poor’s is that, in combining techniques, investors have been trading favorable debt terms against the management of risk. Often we are seeing new infrastructure acquisition financing structures employing structural features, such as short shareholder lock-in periods, that are weaker than those of traditional transactions, coupled with a very aggressive financial structure. ABP, for example, was purchased for £2.8 billion with an enterprise value (EV)-to-EBITDA ratio of 16.6x.
Leveraged Finance And Project Finance Structuring Techniques Leveraged finance Project finance Despite the asset’s strong monopolistic position and stable cash flows, these terms are unlikely to fully mitigate risk arising from the high level of debt. Nor are they likely to mitigate market risks such as the increasing environmental and regulatory hurdles limiting ABP’s ability to expand capacity in the future. Infrastructure--An Ever Expanding Asset Class? For the past 18 months, sponsors have also been using the hybrid structure to acquire assets not traditionally considered as infrastructure. These assets do not benefit from the significant track record of other sectors such as ports and airports and therefore may not be suitable to support high debt multiples, lacking the necessary long-term stable cash flows or a strong monopoly position in the market. The recent refinancing of Autobahn Tank & Rast Holding GmbH, a German motorway service area operator, is a clear example of the market opening up to new assets and financing acquisitions that would not previously have been recognized as infrastructure-style deals. Indeed, the initial acquisition of Tank & Rast by privateequity investor Terra Firma for €1.1 billion in November 2004 involved traditional leveraged finance techniques. The acquisition was financed using an all-senior debt facility, with a debt multiple of 6x debt to EBITDA. As little as two years later, in June 2006, Terra Firma was able to refinance the debt, obtaining greater leverage at a cheaper price. The refinancing transaction involved a €1.2 billion seven-year senior loan with a cash sweep, and COMMENTARY Corporate entity in competitive environment Asset with stable cash flows over the long-term, monopolistic environment Debt capacity dictated by market-driven multiples Debt capacity dictated by discounted cash flows Medium-term maturity, lower leverage, bullet repayment Long-term maturity, higher leverage, amortizing repayment, lower margins Standardized due diligence Detailed due diligence Key ratio: debt to EBITDA Key ratio: loan to project life coverage Flexible financial undertakings Fixed financing structure, monitored/ updated Capital expenditure lines accounted for, but not Future expenditure (i.e., restoration of assets) accounted for mandatory future capital expenditure Standardized security interest charges Ring-fencing security and "cash waterfall" controls leverage was about 8x. Significantly thinner margins were attained via the refinancing--with pricing falling to a range of 125 basis points (bps) to 150 bps in 2006, from a range of 212.5 bps to 262.5 bps in 2004. Importantly, the arrangers of the refinancing--Royal Bank of Scotland, Barclays Capital, Société Générale, and West LB--marketed the transaction as infrastructure play, highlighting the asset’s 90% market share and stable, predictable cash flows. Investors and lenders need to be aware of the credit risk of applying significant leverage to a new asset type. The experience of U.K. motorway service operator Welcome Break Group demonstrates the pitfalls of assuming that this asset class can support significant levels of debt. Standard & Poor’s believes that applying infrastructure-style financing techniques to less mature asset types could serve to undermine the sector’s reputation for strong, long-term revenue flows if appropriate risk mitigants are not employed. The Origins Of The Acquisition Hybrid Hybrid acquisition financing structures are fairly new to the infrastructure sector, with the South East Water deal in 2003 heralding the first transaction of this kind on a large scale. It was the subsequent flurry of French toll road deals in 2005 and 2006 that brought infrastructure acquisition transactions into the mainstream--with Eiffarie’s purchase of Autoroutes Paris-Rhin- Rhone (APRR) providing a template for future transactions. Techniques from both leveraged finance and project finance were evident in the APRR STANDARD & POOR’S EUROPEAN INFRASTRUCTURE FINANCE YEARBOOK NOVEMBER 2007 ■ 9
Page 1 and 2: November 2007 Infrastructure Financ
Page 3 and 4: CONTENTS Introduction STANDARD & PO
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CONTACTS KEY ANALYTICAL CONTACTS Fr
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ARGENTINA AUSTRALIA BRAZIL CANADA C
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