Investment managers at three private equity funds talked at the Chadbourne global energy & finance conference in June about where they see the best opportunities currently in the market. The panelists are John Breckenridge, managing director and chief operating officer of Capital Dynamics, Christopher Hunt, managing director of Riverstone Holdings, and Drew Murphy, senior managing director of Macquarie Infrastructure and Real Assets Inc. The moderator is Noam Ayali with Chadbourne in Washington.
MR. AYALI: Drew Murphy, start us off. Tell us your current focus.
MR. MURPHY: We have a global business platform at Macquarie Infrastructure and Real Assets or MIRA, as we call it, but our funds are all pretty much regionally focused, so what we do out of the New York office is really focused primarily on North America.
Our traditional infrastructure funds look at core infrastructure: utilities and regulated assets, public-private partnerships, contracted power and some mid-stream oil and gas. We have access to capital for new funds to the extent we see opportunities.
In terms of dollar size, we are generally looking for larger investments, so $200+ million. We might go a little below that, but $200 million to up to $1 billion where we have co-investors alongside of us is our sweet spot. We have one vehicle in the US that is a publicly-traded fund or infrastructure company that has invested in smaller transactions where the equity checks have been $10 or $20 million as part of a portfolio approach to investing.
MR. AYALI: John Breckenridge?
MR. BRECKENRIDGE: Capital Dynamics Clean Energy and Infrastructure Fund is basically a mid-market power fund. We have invested in Australia, the UK and North America primarily, although we have some current vehicles that have broader geographic focus. Our sweet spot is a late-stage development asset. We do the last mile of development work, financing construction and then owning the assets. I probably represent the smaller end of the equity check bite size on this panel, probably about $50 to $100 million per transaction. We have invested in gas-fired generation, done a significant amount of wind, solar, biomass and landfill gas, and have done a number of other transactions across the power generation gamut with the exception of coal.
MR. AYALI: Chris Hunt?
MR. HUNT: Riverstone has assets under management of about $30 billion. That extends across the energy spectrum, everything from E&P to pipelines to refineries, service companies and, of course, power.
We are slightly different than other private equity firms in the sense that we set up a dedicated fund to do clean energy work that is in large part solar and wind, but also includes natural gas-fired generation.
We are currently investing a $3 1/2 billion fund that we call Renewable and Alternative Energy II. That fund has done several transactions that are probably relevant to this conference, one of which is Pattern Energy, which was one of the early yield co companies. We also did a lot of the solar assets that led to the formation and initial public offering of TerraForm Power. We also recently listed one of the first renewable master limited partnerships, which is a company called Enviva Biomass that sells wood feedstock to coal producers. We have also done a number of service-type investments for the power industry. Generally, it has been a favorable fund, but it is not without its daily challenges.
MR. AYALI: A few numbers might give us all a sense of perspective. According to Bain’s Global Private Equity Report, 2014 was a record year for private equity exits, $450 billion worth across the private equity spectrum, so the figure is not solely energy and infrastructure. It was also a very strong year for new fundraising: $1.2 trillion was raised across the private equity spectrum and, out of that, $400+ billion is earmarked for buyouts alone. In terms of private equity returns, 2014 produced returns that exceeded the S&P index. Obviously it was a very strong year for the sector.
What do 2015 and beyond hold? What are the challenges?
MR. HUNT: This year and next year, I would rather be a seller than a buyer. I am currently selling several businesses and am finding the interest levels quite high. There are a lot of buyers for well-structured wind and solar projects. The pricing is great. A comment was made yesterday that you are probably never going to find a time when there are better valuations.
Once we sell this current wave of assets, we then have to create the next wave and that is going to be a bit more of a challenge. I am a little nervous about what happens when my cupboards run bare and I do not have anything else to sell and have to go out and fill them up again.
MR. AYALI: John Breckenridge, what keeps you awake at night?
MR. BRECKENRIDGE: There are two ways to look at the overall market today for power assets. You have an overall low growth environment, low power price environment, low cost of capital environment. It has been hard to find a way to make money in the solar sector. It is easy to have a negative outlook currently as an investor.
On the flip side is there is a tremendous amount of change underway in the industry. Gas is cheap. You have a huge amount of coal. We talked about numbers yesterday, that even for me sounded like big numbers, for coal retirements. You have a big change in the cost of capital that is spurring lots of development.
It is hard to have a thematic view of the market, but, because of all this change, there is tremendous room to be opportunistic. I have been surprised about the number of middle-market transactions that we have coming into our office given my overall view that the market as whole is not so exciting.
MR. AYALI: Drew Murphy, your challenges?
MR. MURPHY: The first panel yesterday of investment bankers talking about new trends sort of pulled me up short. I came here thinking I would talk about the fact that we are looking at PJM assets and the unique idea of paying for a development pipeline and buying a management team, and then it turns out that other people are willing to pay for that, too. That is a challenge.
There is a lot of money looking for a home. There are new entrants in the space looking for opportunity. You have to pick your spot. There is a tremendous number of assets available for sale.
You need to have a thesis-driven approach to each opportunity, to whether it fits the thesis and there is room to optimize it. That means going deep and doing more work on assets than you might otherwise have had to do previously.
This is also a market undergoing rapid change. We heard yesterday about at what pace section 111(d) might drive coal retirements. Those types of regulatory changes could mean more renewables and transmission opportunities for us. While it is a sobering time for us because of the amount of capital and the need to be careful what you buy, it is not market without opportunities.
MR. AYALI: One of the themes of the past year has been “shadow capital.” The term refers to the competitive position of the fund versus its limited partner investors who are now looking to chase the same transactions and assets in which the fund is interested, not so much through the private equity but alongside the private equity or in competition with the private equity. Is this a challenge or an opportunity?
MR. MURPHY: It is a definite trend. The larger investors are looking for ways to deploy more capital and reduce the fees they pay. It is a reality that we have to recognize.
We view it as more opportunity than challenge. We are focused on giving our investors the opportunity to come in alongside us on interesting deals. For example, we announced last fall the acquisition of Cleco, the electric utility company in Louisiana. That was a deal that required about $2.2 billion of equity, more than our infrastructure fund in the US can do on its own. A large part of it came in as co-investment with relationship investors who are also in the fund and they appreciated that we led them to the deal and did a lot of the work for them. We hope to continue that pattern and avoid getting into a competitive head-to-head situation.
MR. HUNT: Most funds have a concentration limit. Usually it is in the 20% range, so if you just do simple math, it means that any fund is going to cap out on the size of transaction it can do. If you take the right perspective on co-investment and, as you call it, shadow capital, it just means that you can look at more deals. You still have to do the administrative work of getting your co-investors into the deal, and negotiate the governance rights and fees or no fees that go with it. It is a bit more work, but it opens up a whole new set of transactions that you can do. I mentioned Pattern earlier. That was large check, and the only way we could do it was by having direct investment from some of our investors.
MR. AYALI: I have seen reports that private equity has started to narrow its focus to sub-segments of the renewable energy space. For example, I read that one private equity fund is exiting the wind sector to focus on solar. How common is this, and is the direction toward solar?
MR. BRECKENRIDGE: We are still agnostic about technologies. I am surprised to hear that direction because I would have said the movement is in the other direction.
It is hard to make money on utility-scale solar. Obviously, residential rooftop solar is another business, and we are not in that business. We still think wind is interesting and, for a late-stage development investor, wind fits us very well.
We tell our investors that it is important for them to be invested with people who are agnostic about the technology because the opportunities move around rapidly, so you have to be nimble and be able to move from one to another.
MR. AYALI: The last couple years have seen a tremendous focus from the private equity sector on natural gas, mid-stream assets, a lot of shale opportunities and then culminating in some headline-grabbing LNG investments, Blackstone and Cheniere, IFM and Freeport, and GIP and EIG now in Corpus Christi at Cheniere’s new terminal. Prices of oil have obviously been plummeting and are affecting opportunities in these sectors. Chris Hunt, how do you see low oil price affecting both your current holdings?
MR. HUNT: Did the oil price go down? [Laughter.]
MR. AYALI: There was a rumor.
MR. HUNT: Those of us who are 30-year veterans of this industry have seen this cycle before. This is not the first time we have seen oil prices drop, and it will not be the last time.
The good private equity companies that have made investments in this space do it in a manner in which you can sustain cyclical movements.
The oil price drop will affect those who got over extended and did not set up capital structures to allow them to weather a difficult period. And there are many of those. Their travails will create opportunity for further investment by other private equity companies. You should see a lot of good and a lot of bad come out of this period. It will show who was properly prepared and who was not.
MR. AYALI: Shifting toward opportunities in the OECD countries versus emerging markets, Drew Murphy, how do you decide whether to look beyond the safe OECD investments? What kind of hurdles do you need to hit in emerging markets?
MR. MURPHY: Our funds are generally focused on specific regions. For example, we have a specific Mexico fund. It was set up with the kind of return thresholds that we thought we would need to show investors in Mexico. We are launching a LatAm fund for which we are in the process of fundraising now. It will focus on Mexico, Brazil and maybe one or two other countries. Returns will have to be at a level that compensates for the additional market risk in these countries.
We have stayed away from what we would consider the true emerging markets. We have had a presence in Africa, but we are not very active there right now as it is pretty challenging. Our Asian funds have mostly focused on the more developed countries: Korea is very active for us, Australia, India is a bit challenging, Japan and China, but we are more focused on the more developed countries because we are better able in such countries to get our arms around the risk and return.
MR. AYALI: Chris Hunt, does Riverstone use dedicated country funds?
MR. HUNT: We tend really to have only three kinds of funds. We have a conventional energy fund and a renewable energy fund, and we started a credit fund that we are in the process of raising now. We tend to go global. We do not put geographic restrictions on where we can go.
If you look at where we have actually placed most of our capital, it has been in North America with some Europe. We are now doing a fair amount in Mexico and are looking at some things in Japan.
It is an obvious question to ask a private equity guy whether he goes to the emerging markets given how full the market is in the United States. I can only speak for my specific area, which is power and renewables. I started in the emerging markets. You will remember the infamous Dabhol project. So many of us have lived through some very difficult scenarios in the emerging markets, and it is hard to see a viable case for investing in such markets at the current return levels on offer. I see people doing deals with relatively low yields in places like South Africa and Brazil and now even India, and it is hard to imagine that is an appropriate risk-reward ratio, so we plan to wait and watch.
MR. AYALI: Let’s talk some details. Are you looking for control positions? Are you looking for significant minority positions?
MR. BRECKENRIDGE: We do not have a preference. It does not matter whether we are the lead investor or a partner. It is a matter of who the team of equity investors is and whether their goals are aligned. Sometimes we do better by having a co-investor with whom to talk out issues.
MR. AYALI: Chris Hunt, you are shaking your head.
MR. HUNT: If you are going to have a partner, you want a partner that you get along with and that brings something to the table. I have been involved in investments where things sour and you sometimes make bad decisions if you have a partner with whom you do not get along and who has different objectives. I have also been in situations where our partners see things that I missed and bring a lot to the table. However, recognize that in every private equity company relationship, you have a partner by definition in your management team, and sometimes if you add another partner on top of that, you get into exponential partnership management issues, which can be tough.
MR. AYALI: Drew Murphy, how important is control?
MR. MURPHY: It depends on the situation. Our general view is that we want to be in a position where we have significant influence and that could include a significant minority stake where you have the right to control major decisions.
MR. AYALI: There is a lot of liquidity, a lot of money-chasing opportunities. Chris Hunt, you mentioned that there are lots of new entrants. How do you stand out in such a crowded market?
MR. HUNT: It is not easy, but I learned some things in the course of doing this that seem so obvious now, but did not seem so obvious at the time.
When you raise a fund, it is a five- to 10-year fund. The first thing I learned is you take your time. A lot of people are in a rush to spend the money immediately and get it out the door in the first year. I have learned that my best investments are those investments that I make over an extended period of time. You wait, you watch, you study and you pounce at the appropriate time. If someone were to give me $1 billion today and say where would you spend it, I would say I will get back to you in six months and we will talk about it. There is so much money out there that you really have to be circumspect, sit back and do not get forced into an investment solely for the sake of doing an investment, particularly now when valuations are so high.
MR. MURPHY: Each deal is not just an investment. It is not doing a deal and then putting it into a portfolio. You are going to live with it for a long time, so it is critical to take the time up front to have a deep view of the business plan. That is the only way you can actually add value because things change the minute you buy the project, and you know that the business plan will evolve and you have to be able to follow along. Make sure that you can commit the time and resources to it on an ongoing basis. That is what will differentiate you from the other funds for the investors.