FUNDS: Macquarie Renaissance seek out Russia infrastructure deals

By bne IntelliNews April 2, 2013

Ben Aris in Moscow -

"We invest in infrastructure and industries with a strong alignment to infrastructure, as there is a very strong rising demand for these assets in Russia," says Pavel Nazarov, director of Macquarie Renaissance Infrastructure Fund (MRIF).

That huge demand comes from the shoddy state of much of Russia's infrastructure today. Inflation is much in the news at the moment following the proposed appointment of former economy minister Natalia Nabiullina as the new central bank governor and what this means for the fight against it, and it's Russia's two-decade-long bout of high inflation that is main the reason for this situation.

In its battle to bring down inflation from an historic peak of 2,333% in December 1992, the Russian state kept tariff increases to the bare minimum, starving everyone from utility companies to grid operators of investment. Russian infrastructure has rotted in the meantime, and after almost 40 years with no investment it desperately needs to be renovated and replaced.

The inflation battle was finally won in the spring of 2008 when the rate fell to single digits for the first time in modern history. Almost immediately, the government drew up a $1-trillion investment programme, but by the autumn of that same year the global economy went into meltdown and all these investment plans were shelved.

To the government's credit, the plans were not forgotten. Inflation continued to fall to an all-time low of 5.5% in July 2010 and despite a rise again to the current 7.3% on the back of a poor harvest last year, the investment programme was relaunched anyway.

The main recipient so far has been the state-owned rail monopoly Russian Railways, which has received an average of $32bn a year since 2008, and the government has managed to pump $100bn a year into the infrastructure sector as a whole over the last four years.

New targets for investment are constantly being introduced. A road fund was set up and went into operation this year and the number of airports in Russia has been cut from 1,000 to 300 through a process of closure and privatizations in the last four years. All this activity is creating opportunities for investors, but private investment into infrastructure is still stepping off square one.


Set up in 2008, MRIF is a pioneer in the field. The fund has a total of $670m under management that has been invested exclusively by bodies related to governments: the Eurasian Development Bank; the European Bank for Reconstruction and Development; the World Bank's commercial arm, the International Financial Corporation; the Kazakh sovereign wealth fund, Kazyna Capital Management; and the de facto Russian development bank Vnesheconombank, which is the largest investor with $200m in the fund.

Currently, the fund has four investments: a stake in Brunswick Rail, Russia's leading commercial freight operator; a stake in Russia Towers, the leading provider of telecommunications infrastructure to Russia's burgeoning mobile phone providers; and stakes in two utility companies. "We have invested in both projects related to state-backed companies like in the power sector, and into private companies, including Russia Towers and Brunswick Rail," Nazarov tells bne.

But Nazarov notes that while there is a strong need for private capital investment in many infrastructure sub-sectors, few of these areas are actually easy to invest into. "There are not many 'packaged' transactions in the market, and we typically need to do a lot of work with our partners to craft well-structured deals that can become stable, long-term investments," says Nazarov.

The problem is that while companies are becoming increasingly interested in selling off their non-core assets and optimising their balance sheets by concentrating on what they are good at, this doesn't automatically mean there are a lot of deals to do. In Soviet times, companies were built up into complexes: a steel producer could well own the power facilities that it needed to run its plant. "We believe there are opportunities to invest in infrastructure assets currently held on the balance sheets of large companies, but are not core to their business. These investments can be structured in the form of sales of existing assets with the subsequent lease-back arrangements or in the form of commitments to fund future capex against either lease-back or off-take agreements."

This makes it difficult for the investment bankers to put together a deal in which they can invest. Nazraov says there are three criteria that define an investable infrastructure deal.

1. the object has to have predictable revenues, such as a take-off agreement, decades-long toll arrangement or long-term leases;

2. there need to be high barriers of entry so that the object enjoys close to monopolistic control over its business;

3. and a low correlation to economic growth, so the revenues won't tank if economic growth slows mildly.

In many ways, Russia Towers is a perfect example of the coming infrastructure projects that MRIF wants to find. As mobile telephony develops in a country, companies invest heavily in building transmission towers and opening up a region to their services as the only provider in the local market. However, after a few years their competitors arrive and also build towers. At some point, it makes no sense for everyone to build towers in the same place, so rivals agree to share the towers and in doing so cut costs. Eventually, the mobile operators give up on even this and sell their towers to a company like Russia Towers to run, moving the cost of towers from their capital investment column to a much more predictable operating cost. Russia is just reaching this last stage now, and Russia Towers was founded in 2009 to take advantage of this change and is already by far the biggest player in the game.

Other sectors like power, bridges, roads and rail need to move to similar models. "We are constantly looking at new sectors," says Nazarov, who adds that the fund has money to make several more investments. "We continue to like energy and we are looking at things like ports, airports and toll roads."

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