Elsevier

Utilities Policy

Volume 21, June 2012, Pages 59-65
Utilities Policy

Impact of private equity investments in infrastructure projects

https://doi.org/10.1016/j.jup.2011.12.001Get rights and content

Abstract

Private financing of infrastructure projects is commonly seen in many countries today. In recent years, many private infrastructure projects have also attracted investment from Private Equity (PE) firms. Though there have been instances of PE investment in infrastructure even in the past, the growth has been substantial in recent years. This paper analyses the role of PE investments in infrastructure financing. The findings are based on an analysis of 2821 infrastructure projects that were announced during 1990–2009. It was found that projects with PE investment were larger when compared to projects that did not have PE investment, indicating that that PE investment helped in successfully financing larger projects. Our analysis also indicated that PE investment in infrastructure is more frequently seen in developed countries as compared to developing countries. In developing countries, the number of sponsors is higher in projects with PE investment without any corresponding increase in project size. This indicates that PE investors have helped in sharing the project risk among a larger group of investors, thereby reducing the risk faced by the individual sponsors.

Highlights

► We find the impact of Private Equity (PE) investments on infrastructure projects. ► Projects with PE investment were larger than those without PE. ► Large projects that have PE investment successfully achieve financial closure. ► PE investment in infrastructure was more frequently seen in developed countries. ► In developing countries PE helps in sharing project risk between the sponsors.

Introduction

Private financing of public infrastructure projects has increased considerably in recent years. Project finance is now recognized as the most common method used in the financing of private infrastructure projects (Gatti, 2008). In a project finance transaction, the creditors share much of the project risk and financing is obtained largely on the strength of the project cash flows. In a project financing structure, the lenders do not have access to the cash flows of the project sponsors. The lenders receive their interest and principal payments from the cash flows of the project and the assets of the project are used as collateral to secure the loan (Kleimeier and Megginson, 2001, Esty, 2006). Since the lenders do not have recourse to the cash flows or the assets of the sponsor, such type of financing is called as limited or non-recourse financing (Finnerty, 1996).

Traditionally, in a project finance transaction, the sponsors are often organizations that are connected with the project development or operations in some way, viz., construction companies, equipment suppliers, maintenance agencies, operating companies, or even the host government. Having a group of sponsors where the partners share a product market relationship creates more value (Allen and Phillips, 2000), and more importantly helps to prevent hold-up by related parties in sectors such as infrastructure (Esty, 2003).

However, in recent years, purely financial investors such as Private Equity (PE) firms, who do not share any product market relationships with the infrastructure project, have been picking up equity stakes in infrastructure projects (Gatti, 2008). Investment from PE firms differs from other sponsors in terms of the timing of cash flows rights from their investment. Promoter sponsors can potentially get access to project cash flows as they get compensated for executing project contracts or supplying equipment to the project (Chemmanur and John, 1996). PE firms, on the other hand, get access to only the residual cash flows after all operational expenses, vendor payments, and debt holders have been paid. PE investors would be able to recover their investment as well as achieve a return on their investment only upon the successful completion of the project.

Although PE firms have been investing in the infrastructure sector from the 1990s (Lorenzo, 1996), it is only in recent years that they have begun to actively invest in infrastructure. The purchase of Chicago’s Skyway Toll Bridge by Cintra of Spain and Australia’s Macquarie Infrastructure Group in 2004 is a well known example of how PE firms have contributed to financing of infrastructure projects.1

Private sector investment commitments to infrastructure totaled approximately US$ 62 billion between 1990 and 2002 (Silva et al., 2006). In 2006, the value of infrastructure deals backed by PE investors was approximately US$ 73 billion, a figure significantly higher than in 1988 when PE firms represented only 2% of this value. Given that requirements for infrastructure development are steadily rising and presently about $4 trillion annually,2 PE investments in infrastructure are also estimated to rise.

Since the trend of PE investments in infrastructure has been recent, there has been limited research so far on the effect of this funding source on infrastructure. This paper is an attempt to address this gap. Specifically, this study has the following objectives. The first is to identify whether there are any differences between projects that have PE investment as compared to those that do not. In addition to an overall analysis, we also do a separate analysis for developing and developed countries. The second is to understand the impact of access to PE on the size of the projects. The third is to understand the determinants of PE investments.

The rest of the paper is organized as follows. Section 2 gives a short review of research on private investment in infrastructure. Section 3 describes the main data source used in the study. Section 4 presents the results of the comparative analysis of projects with PE investments with those that do not. Two types of comparison have been done: first at the overall level, and the second, separately for developed and developing countries. A comparison of projects between developed and developing countries that have PE investments has also been done. Section 5 presents the results of the regression analysis. Discussion and policy implications are presented in Section 6 and Section 7 summarizes the paper.

Section snippets

Private sector involvement in infrastructure

The most common reason for private participation in the development of infrastructure is the lack of available public funding (Page et al., 2008). Quiggin (1996) noted that the past 25 years began witnessing a decline in public spending on physical infrastructure as a proportion of GDP. Respective governments began to self impose constraints on public borrowing capacity and the capacity of the public sector to undertake new [infrastructure] investments. They decided to diversify the sources of

Data source

Project level data used in this study has been obtained from the Global Project Finance (GPF) database, provided by Venture Xpert. This GPF database provides details on projects that have successfully achieved financial closure on project financing basis. Project information available in the GPF database included sector, cost, gearing ratio, date of financial closure, type of private participation, and the sponsors of the project. The sample period chosen for this study was from 1990 to 2009.

Overall sample

Table 1 gives the overall comparison of projects with PE investment with those that do not. The comparison has been done on three parameters: project size, debt ratio, and number of sponsors. Project size is the total cost of the project in million dollars. Debt ratio is the percentage of debt capital used in financing the project. Number of sponsors is the number of main shareholders in the project.

The comparison has been done for the entire period (1990–2009), as well as for two 10-year

Project size and private equity

The preceding section indicated that in the overall analysis, projects that had PE investment were bigger. An OLS multivariate regression analysis has been done to identify whether a relationship could be established between project size and the presence of PE investment after controlling for other factors such as time, project sector (oil and gas, power, transport, water and petrochemicals), number of sponsors, and the risk level of the host country where the project is being implemented.

Discussion and policy implications

The study provides several interesting insights. First, PE has emerged as an additional source of capital for financing infrastructure projects. So far, equity for private infrastructure projects was contributed only to the promoter sponsors. Financial investors largely invested only in project debt. With the emergence of PE, equity contribution is also being seen from financial investors. This has expanded the pool of capital that infrastructure projects can get access to.

However, PE

Summary

This study analyzed the impact of PE investments in infrastructure projects. A comparative analysis of projects that received PE funding to those that did not revealed that projects that received PE funding had larger average project size and more number of sponsors than those projects that did not receive PE funding. There was no significant difference between in debt levels between the two categories.

The results of the analysis of the projects in developed countries were in line with the

Acknowledgments

The authors have benefitted from the insightful comments of Professors Jose Gomez Ibanez, Akash Deep, and Henry Lee of Harvard Kennedy School, on the initial drafts of the paper. Financial assistance from the Fulbright Foundation that enabled the corresponding author to visit the Harvard Kennedy School for this research is acknowledged. We are grateful to the helpful comments from the anonymous reviewer that helped us to improve the paper.

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