New EDHECinfra research documents the factors behind the evolution of unlisted infrastructure prices over past 15 years.
Common risk factors found in numerous asset classes explain the evolution of unlisted infrastructure secondary market prices. That’s the finding of a new paper drawn from the EDHECinfra /LTIIA Research Chair. Interestingly, the paper also shows that that, after a long period of prices increases, “peak infra” may already be behind us.
Unlisted infrastructure prices have increased considerably over the past decade. Was it a bubble or a normal phenomenon? In a new ground-breaking paper, EDHECinfra shows that systematic risk factors can largely explain the evolution of average prices but also that valuations have shifted to a higher level.
No, it’s not a bubble
Author and Director of EDHECinfra Frederic Blanc-Brude said: “The worries about a bubble were driven by the constant increase in prices since 2008. In fact, the process of price discovery happened in slow motion. Infrastructure businesses are expected to deliver steady and predictable cash flows and, to the extent that this is the case, they should be expensive. In a very illiquid market, it took 10 years for investors’ views on fair value to express themselves.”
In a a very illiquid market where assets seldom trade, such as infrastructure, just looking at average reported prices can give insufficient and biased data. The paper uses actual transaction prices and advanced statistical techniques to estimate unbiased factor effects. It then applies these to a much larger group (the EDHECinfra universe). Our selections are based on criteria that investors actually find useful, and provide excellent representation of the investable market.
Research has identified six factors that explain the market prices of unlisted infrastructure investments over the past 15 years; size, leverage, profits, term spread, value and growth. To these usual suspects, one can add sector and geographic effects. The result is an unbiased view of the evolution of prices (price-to-sales and price-to-earnings ratios).
Current valuations make sense
Thierry Déau, Chairman of LTIIA said: “This new research shows that infrastructure valuations make sense today but also that focusing on systematic risks is an important aspect of value creation for investors in infrastructure. The existence of “value” effect for greenfield projects is good illustration of this fact.”
Blanc-Brude highlights the similarities – and important differences – between listed and unlisted assets. “Unlisted infrastructure prices should continue to be driven by common risk factors, some of which are relevant across asset classes. Unlisted infrastructure equity is actually found to be somewhat correlated with public equities, but also to have a different profile. Higher dividend pay-out ratios make future revenues more valuable today, while higher financial and operational leverage make future profits more uncertain.”
The paper concludes that average valuations have reached a plateau since 2016. Two key drivers of the slowdown are the impact of the leverage factor and interest rates on discount rates.