How COVID Reshaped the Infrastructure Market

As demand for data, renewables, and ESG-minded assets accelerates, Philippe Camu and Scott Lebovitz of Goldman Sachs explore the opportunities available for private capital infrastructure investment

The past year has been one of unprecedented change. The COVID-19 pandemic, economic shutdowns, work-from-home, increased social awareness, and a continued focus on sustainability have all led to a significant acceleration in pre-existing trends in infrastructure, most notably a focus on renewables and energy transition, as well as the continued digitization of economies.  

As both these trends have accelerated, the pandemic-induced economic deterioration has resulted in economic pressure. Nevertheless, the US Government continues to work toward meaningful public infrastructure initiatives. We believe that even with increased fiscal stimulus, the combination of aging public infrastructure and the new infrastructure requirements needed to support tomorrow’s economy will create vast opportunities for private capital to supplement – and in many cases drive – infrastructure development.

Government Debt and Public-Private Partnerships
According to research by McKinsey, global infrastructure will require $3.7tn of new investments by 2035 to keep pace with projected GDP growth. President Biden’s recently announced infrastructure package could begin to close this funding gap should it become a reality, but there are still plenty of details to work through and spending choices to be made.  

Against the backdrop of rising public debt and the need for increased infrastructure investment, the size, cadence, political considerations, and ultimately the structure of the private capital required to aid this fiscal shortfall are difficult to forecast. Furthermore, the return expectations for what will be the next generation of public-private partnerships is equally difficult to assess. We believe it is reasonable to assume that most public-private partnership returns will be more in line with ‘core’ infrastructure, which are typically less than 10% levered rates of return.  

Private Capital Opportunity
The investment opportunity set beyond immediate public-private partnerships is expected to be broad. Nascent sub-industries, greenfield projects, and ‘old-to-new’ transformation opportunities continue to be available to those with deep infrastructure and private equity investing experience.  

We believe the richest opportunity set resides in mid-market companies. Although many of these companies may not be perceived as ‘infrastructure’ assets under a traditional definition, they may ultimately hold the key infrastructure characteristics that make them tomorrow’s core infrastructure assets. We believe the infrastructure label should be applied to asset-intensive businesses that have defensive and contractual cash flows, exhibit resiliency throughout the economic cycle, are critical to society, and enjoy incumbency advantages.

At a sub-sector level, the key drivers of infrastructure investment include strong secular growth in digital services and data consumption, as well as the need for decarbonization. The growth of new sub-sectors and the need to transition assets toward a more ESG-centric mandate requires greater domain expertise, in addition to the experience of being an active owner-operator. The ‘set it and forget’ ownership mindset of the past is unlikely to survive in a more dynamic infrastructure market.

Digital Infrastructure Opportunities
Digital infrastructure primarily includes data centers, fiber networks, and wireless assets and their related ecosystems. These types of infrastructure assets are generally subject to lower levels of economic regulation than utilities and are characterized by long-term contracts with large creditworthy customers. The rising use of data, communications, and technology has resulted in relatively inelastic and resilient demand through economic cycles. Digital infrastructure also benefits from growth tailwinds associated with an increasing prevalence of data-oriented solutions, the proliferation of devices, and the ubiquity of digital communication channels.  

Barriers to entry are relatively high, particularly for the more capital-intensive forms of digital infrastructure. However, given significant recent growth, this space has been subject to greater competition and a rapidly evolving regulatory regime. Overall, the increasing importance of data, communications, and technology solutions for enterprises is expected to continue driving significant growth and meaningful investment opportunities.

Energy Transition Opportunities
Energy transition is a structural change that will require meaningful investment for decades to come in order to meet national, regional, and corporate decarbonization objectives. Key megatrends driving the energy transition include the continued penetration of renewable energy, the rise of hydrogen as a new source of power, the proliferation of electric and hydrogen-fueled vehicles, the addition of meaningful renewable fuels and chemicals to the energy mix, as well as carbon capture and sequestration as a critical element in reversing carbon emission trends. Energy transition infrastructure provides the backbone for the future energy system, which will be adapted to meet critically important decarbonization objectives.  

ESG and Government Stimulus
Policymakers have widely recognized the economic stimulus’s importance in the road to recovery. In the US, President Biden has reached a tentative agreement with a bipartisan group of lawmakers on an infrastructure plan in excess of $1tn. While details are still being finalized, it is likely to further accelerate pre-existing trends. Most notably, Biden’s initial proposal included $100bn to expand broadband access to 100% of the US population and a further $100bn to improve the energy grid, including targeted tax credits for transmission systems.  

From a return perspective, the plan will likely result in increasing valuations and compressing yields for infrastructure assets, with the greatest compression likely to be in core assets, given their direct exposure to public funding. ‘Value-add’ companies will see some price appreciation, but we believe it will be less pronounced since many of the opportunities will be outside of the scope of direct public funding.

Market Dynamics
The present economic climate is ripe for infrastructure investment and requires significant private capital. We believe the opportunity set is richest in mid-market and ESG-considered companies. That said, the owner of infrastructure assets, be it a private equity sponsor or a sovereign/state entity, will need deep domain expertise, especially in the emerging sub-sectors, and to adopt a value-add, owner-operator approach.

In this environment, public-private partnerships should remain a viable funding model, but the return expectations will likely remain subdued as valuations remain elevated for most core assets. It should also be noted that Biden’s plan could displace some of the opportunities for core private capital.

Perhaps most importantly, we believe we are at a rare point in time when both private and public capital can strategically reposition legacy assets and invest in the infrastructure assets of the future, all while having a deliberate focus on ESG and sustainable considerations.

About Philippe Camu
Philippe Camu is global Co-Head and Co-CIO of the Infrastructure Investment Group for Merchant Banking within the Asset Management Division. He joined Goldman Sachs in 1992, and became a partner in 2010. He is a member of the Merchant Banking Infrastructure Investment Committee. He also serves on the board of directors of CityFibre and on the Supervisory Board of HES International. Philippe received an MSc. from École des Hautes Études Commerciales (HEC) Paris.

About Scott L. Lebovitz
Scott L. Lebovitz is global Co-Head and Co-CIO of the Infrastructure Investment Group for Merchant Banking within the Asset Management Division. He joined Goldman Sachs in 1997, became a managing director in 2007, and became a partner in 2012. He serves on the Merchant Banking Sustainability Council as well as the Merchant Banking Corporate and Infrastructure Investment Committees. Scott serves on the board of directors of Lucid Energy Group. He received a B.Sc. from the University of Virginia.