Contains physical assets that you see in your daily life
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What is infrastructure investment?
Infrastructure investment is a type of “real asset” and includes physical assets that we see in our daily lives, such as bridges, roads, highways, sewers, and energy. These types of assets are very important for a country's development. Investors often invest in infrastructure because it is non-cyclical and provides stable and predictable free cash flow.
Financial characteristics of infrastructure
After learning about infrastructure, the question becomes, why invest in infrastructure and not just public companies? The answer comes down to the infrastructure's attractive financial characteristics.
1. Stable and steady cash flow
The possibility of stable cash flow is one of the main attractive features of infrastructure. Assets often come with regulated and contracted revenue models, resulting in stable and predictable cash flows.
For example, a newly constructed wastewater system may include a government contract to operate for the next 10 years. Therefore, cash flows are fairly predictable unless the government goes bankrupt (which is unlikely in developed markets).
2. Acyclical
A small Italian restaurant on the street corner may go bankrupt during a prolonged economic downturn, but the same risk does not apply to infrastructure assets. As mentioned earlier, infrastructure assets such as bridges and roads are critical to a country's development, and this also means that they will continue to be used heavily, regardless of what stage the economy is in. To do.
3. Low variable costs
The marginal cost per use of infrastructure is very small and completely negligible. For example, with a bridge, the variable costs of every car driving over it are very small.
4. High leverage
Leverage is that amount. Because infrastructure provides stable and predictable cash flows, it can leverage high levels of leverage, resulting in high interest costs.
Risks of investing in infrastructure
1. Leverage
Leverage is a common characteristic of infrastructure, but it still poses risks. The higher the leverage, the higher the interest paid. It is a great risk to an asset if it has enough earning power to generate a profit.
2. ESG risks
ESG risks (also known as environmental, social, and governance risks) have always been an important part of infrastructure. For example, building a large highway or bridge in a particular area can disrupt the local social community. Additionally, the construction phase can cause a number of pollution and environmental hazards that need to be addressed.
3. Political
Political factors have a more macro impact on infrastructure. Different governments have different stances on infrastructure development and how to regulate it. Assets in emerging markets such as Brazil and India will face higher political risks than countries like the United States.
Stages of infrastructure development
1. Greenfield (initial stage)
Greenfield early stage means that the developer has already decided to run the project, but only very basic plans have been drawn up. These types of projects face the greatest risks primarily in construction, regulation, and execution. Establishing relationships and agreements with various stakeholders is also important at this stage.
2. Greenfield (Late)
Greenfield (late stage) means the developer is further along than early stage. At this point, plans have already been developed and everything has been confirmed with the various stakeholders. The risks here are lower than in the early stages, but you still face construction risks and the potential for capital overruns.
3. Brownfield assets
Brownfield assets are assets that are already in operation and generating income. An example is a bridge that is completed and has cars on it. These types of assets are the least risky as they usually already have an established revenue stream.
take care of infrastructure
One of the financial characteristics of infrastructure is stable cash flow, so the discounted cash flow (DCF) valuation method is often used. However, when using his DCF for infrastructure investments, you should keep the following in mind:
1. Discount rate
A discount rate that reflects the approximate useful life of the asset is often used. For infrastructure that is built to last for a long time, he typically uses 30-year bonds. The discount rate should also reflect the illiquidity risk associated with investing in the asset.
2. Unleveraged free cash flow
Because most infrastructure has highly leveraged financial characteristics, it is common to use unlevered FCF to value infrastructure. When using UFCF, make sure that WACC is used for the discount rate to reflect both debt and equity in the capital structure.
additional resources
Thank you for reading CFI's Infrastructure Investment Guide. To continue learning and developing your financial analysis knowledge, we highly recommend the following additional resources:
