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Fed in driving seat for infrastructure M&A

M&A activity for infrastructure assets and operating companies is set to pick up in North America around mid-year 2023 as debt financing and buyers’ confidence return thanks to stabilized interest rates and supply chains, according to an informal poll of dealmakers by Infralogic.

Bold predictions for the second half of 2023 follow a year of two stories: 2022 started with robust activity reminiscent of 2021’s blowout in M&A activity only for dealmaking to slow down under the weight of soaring interest rates, ongoing supply chain challenges, the Ukraine-Russian conflict, and concerns the US economy would enter a recession, all of which hammered equity and credit markets.

Investors closed 100 deals worth close to USD 35bn in 2022 for infrastructure assets, excluding the power and renewables sectors, compared to 117 transactions worth over USD 59bn a year prior, according to preliminary Infralogic data. The telecom sector continued to see the most activity with 48 deals followed by 33 in transportation – industries that see the overwhelming preponderance in trading volumes annually for core and core-plus investors.

In the telecom sector, dealmaking in certain geographic regions fell dramatically from 1H22 into the second half, says digital investor GI Partners’ Managing Director Mark Prybutok.

“This speaks to the rapid change in the interest rate environment, which has impacted access to acquisition financing, especially for large deals,” he says, adding that despite the fall in activity GI Partners expects to see “strong flow” of investment opportunities in 2023.

Bid-ask spreads

Dealmakers says activity may not ramp up in the first half of 2023.

“The current disconnect between buyers and sellers has only been exacerbated by higher rates, which have increased borrowing costs and discount rates, and lowered purchase price expectations,” says Emmett McCann, co-portfolio manager for Oaktree Capital Management’s infrastructure strategy, in an email to Infralogic.

While January is historically a slow month for deals, sources predict 1H23 will lag because most market players will remain on the sidelines waiting for the Federal Reserve’s rate increases to finish winding their way through the economy.

Kyle Stage, the head of transportation and logistics in Credit Suisse’s investment banking unit, says that in his experience infra funds seeking 15% to 18% base returns will have to adjust their math for deals as debt financing costs, which once ranged from 5% to 6%, now stand at 10% to 12% on average.

“It makes the return profile challenging given the financing backdrop more broadly,” he says.

In the current environment, some funds have raised their internal IRR expectations for core-plus assets to the tune of 150 to 250 basis points, says Yorick van Slingelandt, the managing director and co-head of Europe at Moelis & Company, which covers infrastructure and telecoms in London.

If funds aim for higher IRR by bidding lower for assets, then this could compress returns for sellers and create challenges for sellside advisors trying to achieve 2021 valuations for clients.

Unfinished business

Hanging over 2023 is the question of what will happen to 2022 sale processes that were halted or outright cancelled – a product in part due to widening ask-bid spreads that grew as buyers and sellers dragged out negotiations.

In the transport sector, Macquarie decided to pause its sale of the Goethals Bridge P3, while the concession deal for Newark Liberty International Airport’s cargo facilities was called off with Amazon.com. The auction processes for Great Lakes shippers McKeil Marine and Rand Logistics did not result in announced deals.

In the telecom space, Altice USA
scrapped plans to find an investor for its affiliate Suddenlink. Rackspace Technologies
called off a potential sale of its business and QMC Telecom
canceled plans to sell its Puerto Rico-based tower company after receiving offers below expectations.

While sources declined to discuss specific companies and their stalled plans for sales, some predict that certain deals could come back to market.

“Many of these processes could stay on ice since they were trying to sell off inflated EBITDA levels and the buyer universe recognized that. The companies with solid fundamentals and stable capital structures will have a better chance of transacting in 2023, but only once buyer and seller expectations normalize,” Oaktree’s McCann says.

Given that the upward trajectory in interest rates is now slowing, dealmakers say they wonder at what point in 2023 will lenders loosen the purse strings for acquisition financing and buyers settle on recalibrated return expectations. While nearly all sources said 2Q23 or 3Q23 could see dynamics change, they left open the possibility that could be pushed into 4Q23.

A majority of dealmakers polled – those interviewed for this story together with polls taken on Infralogic’s social media accounts on Twitter and LinkedIn – felt optimistic about a sunnier scenario for overall M&A activity. About 42% felt 2023 will see relatively the same level of activity, while another 40% felt more trading would ensue than 2022. The remainder felt the number of transactions would be less than 2022.

Most sources said mid-market deals will continue at their usual pace, unaffected by market and economic turbulence, mostly because such deals are easier to finance.

“We’ve completed three deals this quarter and we’ll announce two more in the first quarter - these are all below USD 1bn,” says Lazard Managing Director and Global Co-Head of Telecommunications, Media & Entertainment, Garrett M. Baker. “Those haven’t really slowed down.”

Multibillion dollar businesses and assets, however, will have tougher sledding in 2023, market players say. Investment banks largely halted leveraged financing in the waning months of 2022 after being stuck with billions of dollars’ worth of loans and bonds they couldn’t syndicate.

“There will likely be a greater bifurcation in valuations as intrinsic asset quality becomes more apparent in more challenging economic and financing conditions – particularly where business plans require significant access to external financing,” wrote Andrew Thomas, a senior managing director and head of communications, global ex-Europe at Stonepeak, in an email.

“The bigger deals - above USD 1bn just totally shut down in the last half of the year and it's going to be some time before they come back,” Baker adds. But once debt financing opens “there are several dozen in the US, broadly the digital infrastructure space, that are billion dollar-plus assets that are likely to come to market.” 

JV alternatives

Dealmakers may find ways to get deals done in the early parts of 2023 by using creative structures.

For sales that stalled in 2022 or those who decided to delay an official launch, executives and their advisors may find some measure of success in early 2023 by running bilateral or exclusive talks with only a few firms rather than relaunching a broad process, says KeyBanc Capital Markets Director Edward Hertz.

Baker says dealmakers could also consider alternative transaction structures such as minority stakes sales, preferred equity stakes and joint venture arrangements so that some liquidity is funneled to shareholders. These deals enable financial sponsors to take non-controlling stakes without having to worry about debt financing.

Telecom giants AT&T and T-Mobile in 2022 reportedly explored forming joint ventures with equity investors for fiber-optic businesses. Baker cites these talks as examples of one of the more interesting trends this year in dealmaking, something he expects to see more of in 2023. In December, AT&T signed a JV deal with BlackRock’s Diversified Infrastructure fund that will help finance an open access network outside of the incumbent’s 21-state footprint.

“Unique structuring is something that you could see, particularly as it relates to minority investments or people partnering up to make acquisition and expand platforms,” says Stage’s colleague at Credit Suisse, Doug Pierson, the head of Americas industrials.

Telecom opportunities

From an asset perspective, sources sounded bullish calls for various opportunities like fiber-to-the-home, wireless towers, airport cargo facilities and transportation logistics. Data centers are also expected to remain a hot commodity in the New Year.

“We expect data center and wireless tower assets to continue to have the strongest operational results, driven by continued robust demand and a more stable supply profile. This will be augmented by the more challenging market conditions encouraging wireless carriers and cloud players to outsource more of their network infrastructure deployment,” Thomas says, adding that higher rates will weigh on the assets’ valuation relative to over a year ago.

Both Stage and Slingelandt say that post-Covid recoveries in air passenger volumes bode well for airport assets. “Now that we have some stabilization in passenger numbers… it is easier for buyers and sellers to agree” on pricing, Stage says.

“For ports and airports I think people have gotten a little rosy in their value expectations,” cautions George J. Sampas, a partner with Sullivan & Cromwell, who practices in the firm’s mergers and acquisitions group.

Dealmakers say the bump in earnings that port terminal operators enjoyed during the pandemic is not sustainable once more normal commerce patterns take hold. Global shipping groups took advantage of high profits in 2021 and 2022 to acquire several US terminal assets owned by infrastructure funds at bumper valuations.

Rail too could see challenges rebounding from 2022 as a fair amount of industry consolidation has already taken place, and labor and operational issues continue to impact the sector, Stage says.

Overall, opportunities should emerge for the capital-intensive businesses that make up infrastructure.

“I think what benefits [infrastructure service companies] as they enter 2023 is that things have loosened up like supply chain issues and the earlier lack of available equipment and materials… these firms are going to be able to execute their backlogs a lot better in 2023 and are doing so right now at record highs,” says KeyBanc’s Hertz.