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With money so easy why is infrastructure so hard?
2019 closed out an amazing decade for capital markets, as they continued to rebound from the 2008 global financial crisis.
This decade ahead will leave a lasting mark on future generations as interest rates hit record lows, assets hit record highs and populist governments thrive due to the inequality those two things in combination create. The enormous wealth created has significantly altered investor behaviour and expectations.
Over the past decade, with both debt and equity capital becoming so cheap, we saw many investors chase higher risk, hoping to get returns by funding loss-making or barely profitable businesses, sometimes for very long periods of time.
Some of these businesses have fundamentally changed our lives and are reshaping our economies, and they have been some of the biggest benefactors of an unusual decade. In a different decade these businesses would have been forced to focus on margins, profitability, accountability and governance, as opposed to growth. It would be hard to argue that Uber, Netflix and Tesla haven’t fundamentally improved consumers’ lives, but those same companies (by our estimates) have collectively lost US$21 billion since 2008. Amazon, the poster child of growth, only made US$28 billion in total profit over that period. Compare that to Apple which made US$424 billion, Microsoft which made US$252 billion or Google which made US$142 billion.
Some of these business models wouldn’t have survived in a different cycle. The near failure of WeWork was a very public statement from capital markets that suggests they do in fact have a limit, and that some of these businesses now need to prove they can be sustainable.
So as we look to the decade ahead, investors are confronted with new challenges of how and where they deploy capital. After decades of under-investment, one of those areas will be building the infrastructure needed for future generations.
Better infrastructure benefits everyone
Infrastructure investment is a critical part of any successful economy because infrastructure is a tool that improves our lives. Less congestion, better schools, better hospitals, increased safety, cheaper electricity, and cleaner air all contribute to a better way of life and enable us to deal with future issues such as climate change. Governments and corporates are equally responsible for building the world of tomorrow and we all share the same desire to get it right because the benefits are for everyone - better quality of life for our citizens, higher tax takes with less cost for our governments, and higher returns for corporates.
Despite everyone benefitting from it, infrastructure around the world is aging and in some cases is no longer fit for purpose, primarily because the usage of our infrastructure has grown at a faster rate than both the maintenance of existing and building of new infrastructure. The issue is that infrastructure involves long term planning for an unknown future, and therefore it is easy for governments and corporates to kick decisions down the road. Governments face the problem of short election cycles, corporates face the challenge of short term returns expected by shareholders on investment, local councils can’t directly tax the users of infrastructure and the consumer wants it as cheap as possible, and they want it today.
So where you end up is election promises, band aid solutions, projects being built too late and no coherent plan. The worst form of spending is governments playing Santa to win votes and corporates making ego statements.
In the past, we planned roads because we knew there were going to be cars, and we built railways to move goods from A to B. Rapid technological changes and rising environmental demands are now factors that also weigh into the debate, which means that infrastructure investment requires more careful thought and long-term planning than ever.
It Takes Two To Tango: Public & Private Money Have to Partner
To put it into context for New Zealand, to build the infrastructure we need to support our future requires 5G networks, charging networks, light rail, heavy rail, bigger ports, drone stations, new office buildings, better roads, more bridges, more hotels, better housing, modern schools, modern hospitals, bike lanes, electric scooter parking and lanes, more airport runways - and the list goes on. The amount of investment required is in the hundreds of billions and therefore it is not a task that the Government can undertake alone.
Successful infrastructure investment requires:
- A clearly communicated vision with a detailed plan spanning decades
- An incentive structure to align the right behaviours between private and public investment
- An autonomous body that is accountable with clear, measurable criteria and real governance
- A funding model that attracts the capital from both public and private sources
Prioritising infrastructure spend requires projects to be measured in terms of value (including both social and economic factors), targeting capital towards those with clear regulation which provide a fair return for risk and have a social obligation enforced on the owners, proportionate to the value they are receiving.
The good news is that over the years we have experimented with various models that have given us great infrastructure, sharing the burden between private and public investment fairly. Yet we don’t seem to stick to one model.
The mixed ownership model for the gentailers listed in the government share offer programme saw the government retain control, receive billions of dollars and today their holdings are worth more for their majority stakes than when they owned 100%
- Napier Port got the funds to build a new wharf and their 55% stake is nearly worth the same as when they owned 100%
- Crown fibre holdings delivered a world class fibre network to New Zealand at minimal cost to the Crown
- The retirement sector is building part of the infrastructure required to provide care to our population, at zero cost to the government by aligning the investment model to the outcomes desired
- Kiwishare required the telecommunications industry to service non profitable parts of the network in return for the right to earn from the profitable parts
So, we have many good examples of how models can work to effectively align private and public capital to deliver on the infrastructure potential. What capital markets and investors will be looking for in 2020 will not be promises of money being spent randomly over a decade, but rather a clearly articulated plan that is measured with a fair incentive structure that balances social requirements against the returns the public and private capital require.
The positive takeaway from the past decade is that the cost of funding is so low today that capital is readily available from private and public markets. If a government can get the model right, they will deliver the infrastructure for years to come.
James Lee is CEO of investment and advisory group Jarden. With 20 years’ capital markets experience he is involved in all Jarden’s equity capital transactions from IPOs to secondary sell downs, mixed ownership models and bespoke capital solutions. James leads the firm’s relationships with corporate and institutional clients across Australasia. James was a member of the steering committee for Capital Markets 2029, and the investment committee for Cystic Fibrosis New Zealand.
A version of this article was published on the New Zealand Herald on 20 January 2020.
This article reflects the opinions and views at the time of publication, and is not to be relied upon as a basis for making any investment decision. Please seek specific investment advice before making any investment decision. Jarden is an NZX Firm, a broker disclosure statement is available free of charge at www.jarden.co.nz. Jarden is not a registered bank in New Zealand.
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