3i infrastructure: accessing megatrends and opportunity

Long-term investment returns have been solid, and the shares have outperformed the FTSE 100 index over six months, one year and five years. Chief financial officer James Dawes explains how they do it, the trends 3i Infrastructure Ord (LSE:3IN) invests in and some attractive opportunities in the pipeline.

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Lee Wild, head of equity strategy at interactive investor: Hello. With me today I have James Dawes, chief financial officer at 3i Infrastructure. Hi James, thanks very much for joining me today.

James Dawes, chief financial officer at 3i Infrastructure: Hi.  

Lee: To start with, could you please tell viewers what 3i Infrastructure is, what it does and how it generates returns for shareholders?

James: Of course, yes. So, 3i Infrastructure is a London-listed investment trust. We invest in a diverse range of infrastructure companies, these are private companies, so you can’t buy them on the stock exchange. And we’re trying to deliver long-term sustainable returns to investors. So, we have a return target that is 8 to 10% per annum, over the medium term. About half that target comes through a dividend, so we have a progressive dividend policy, [and] it’s been increasing every year since IPO, and the rest comes through capital appreciation, so and including any outperformance that’s typically through extra capital return.

Lee: OK. So, how involved are you in the running of the businesses that you invest in, are you very hands-on or engaged less frequently? Do you send teams in or just one or two individuals?

James: So, we’re on the board of all the portfolio companies, so we’re very, very active managers. It’s a private-equity style way of running the portfolio. We’re backing exceptional management teams. We’re on the board, as I say, so we partner with those management teams to drive strategy for the companies. And we will add capabilities to the board as we see appropriate.

So, we’re meeting with them every week. Do we send teams in? Yes, there are about five or six people in our investment team working on each portfolio company, so it’s very intensive. We’re in touch with them every week, typically if there’s monthly board meetings. We have monthly management accounts. There is always stuff to be talking about with them.

Lee: The current portfolio is about 12 companies, is that about right historically or does that figure fluctuate at all?

James: It does vary, I’d say it’s about right. We don’t want double that size, equally we don’t want half that size. We want to maintain a diversified portfolio. And given the number of team members that are involved in working with each of the portfolio companies and the size of the team we have, that’s about right.

But it does change. We do sell assets, that’s a feature of our active management, is occasionally selling the right company at the right time, ideally through a competitive auction process. So, we get extra returns through doing that and then recycling the capital through new investments. So it will go up and it will go down a bit, but it feels about the right size.

Lee: It’s interesting about how you exit portfolio holdings because one might imagine it’s not easy to decide that, you know, you want to get out, who do you sell to. How does that process work?

James: Typically we’re selling to other private company investors. So, typically these are partnership funds, so infrastructure funds. Often they’re much bigger than 3i Infrastructure itself. And they’re building their own portfolios of private infrastructure companies. It takes a while to realise a company so you work with the management teams to construct a next-phase plan for the business, looking at how they’re going to grow into the future.

You have advisors appointed. You conduct due diligence exercises that you can give to potential buyers, and then you run a competitive auction process that typically are a number of rounds. And through that dynamic and because you’ve picked the time to sell the asset, you can get an uplift on where you’re currently valuing.

As an example, we sold our investment in Attero in July last year for about 30% more than we valued it just the previous March. That was through a proper exit sort-of auction process.

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Lee: OK. You report in your recent third-quarter performance update that things have gone better than expected over the past year and that you should beat your annual target return. Could you pick out some highlights that explain the outperformance?

James: Yes. We’re in the final quarter of the year now, so we’ve got good visibility on how the portfolio is performing and it’s performing very well overall. And, gratifyingly, some of the larger investments are particular highlights, so I can go into that in more detail in a second. But we had a very strong first half, so that gives us good visibility on outperforming for the year.

Lee: OK. Which ones would you pick out… [that] have pleased you?

James: Well, TCR is a good example. That’s our largest investment. That is a business that leases ground-handling equipment to airlines and ground-handling businesses. So, that’s all the kit that you see around an aeroplane when it’s about to move. It’s essential kit that’s providing an essential service [and] the plane won’t be able to take off if it doesn’t have all the stuff around it. So, fuelling and ground power, the steps on to the aeroplane, the baggage carts that load the bags on to the plane, all that equipment.

And customers we’re finding would rather lease, or increasingly, [would] like to lease that equipment from TCR. TCR is the largest provider of this leasing service. So, it owns the kits and it makes sure that it’s available, it maintains it and so the customers don’t have to worry about that. And it had a good Covid, so whereas the customers were having a difficult time, [and] obviously the air travel industry was largely shut for a little while. But TCR, given the nature of what it does, the customers expected that they would require this kit when they were able to fly again, so they hung on to the TCR service.

And then since then, those customers are very keen to rent the equipment rather than own it themselves because they obviously had a difficult time during Covid. So, it’s having a very strong time since Covid.

Lee: OK. James you’ve talked about TCR, are there any other companies that you think viewers might be interested in?  

James: Well, I think they’re all interesting. These are real businesses with real employees that do very interesting things and we encounter them in day-to-day life. But thinking of a UK example, we’ve got a portfolio company called Infinis, again it’s one of our largest portfolio companies. That generates electricity from methane gas that comes out of landfill. So, it operates over a large number of landfill sites across the UK. In the corner of the plot they’ll have some gas engines [and] they burn the gas to generate electricity.

We’ve changed that company since we bought it back in 2016, so it’s now more of a balance renewable power developer and it’s rolling out solar power, so solar cells across the landfill sites. And alongside that it’s implementing some battery storage, which is a good balance against the solar for when the sun is not shining. So, I think that’s a fascinating company.

Lee: The shares have generated significant returns for investors since launch in 2007. They currently yield about 3½%. Are you comfortable with recent performance? What are conditions like for the business currently and have target companies become more or less expensive?

James: So, the performance has been very strong since IPO, so it’s been about 12% per annum since the company started. The FTSE 250, which we’re a member of, has done about half that return, so around 6% in the same time period per annum. So, yes, it’s been a strong performance.

When the interest rate cycle changed and interest rates started going up, we moved from trading at a premium to net asset value (NAV) to trading at a small discount. So over the last year, for example, the share price has been broad and flat. So, you know, we haven’t seen the NAV performance translating into share price performance recently, but we would expect to see that much more strongly correlated in the near future with [us being] close to the turn in the interest rate cycle now. So, that change is in the past now.

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Lee: So, you expect that once rates do start to fall, possibly from mid-year, around that sort of time, you expect that to reflect more positively on that discount?

James: Possibly. That’s what happened on the way up, but even if they stayed flat, we should see the NAV performance translating into share price performance.

Lee: And when you’re looking at target companies, how are evaluations at the moment? Are target companies looking more expensive, or are there some bargains to be had? 

James: So, we still see that for high-quality infrastructure businesses with the sort of characteristics that we like, so essential services, sort of good downside protection, these trends that can support them across economic cycles, these mega-trends that I mentioned.

But businesses like those are still very attractive. There’s a lot of money in the private fund world looking to buy businesses of the sorts that are in our portfolio. So, that’s helped our valuations hold up in the last year and our sale of Attero in July was evidence of that.

I think the market has slowed down, so it doesn’t necessarily mean pricing has changed, but there may be fewer bidders at the moment. We’re fully invested, in fact we’ve drawn into our credit facility at the moment, so we don’t need to make new investments, and indeed we don’t need to make new investments to deliver our return target as well of 8 to 10% per annum.

It’s more of a buyer’s market than a seller’s market at the moment, but we don’t have to buy things to hit what we’re trying to achieve.

Lee: So you’re invested in companies driving the energy transition from fossil fuel to renewables, among other mega-trends as well. Will that particular trend become an even greater focus over time do you think?

James: We want to maintain a diverse portfolio, so lots of different risks balanced across the portfolio, so we’re not trying to become a renewable power fund, for example. But if you think over the next couple of decades, a lot of investment needs to go into the energy transition. A lot of investment needs to go into digitalisation, so those are the two biggest themes today, so I do see that that will continue.

Lee: You talked in the third-quarter update about a number of attractive opportunities. Now you said you don’t have to invest at the moment, you are fully invested. But when you mentioned the attractive opportunities, does that mean at some point in the future you’ve got your eye on some businesses that you would like to bring into the portfolio?

James: Well, we’re always looking for things. But the focus on our portfolio at the moment is potentially realising one or two companies that will help us pay off our credit facility. But the attractive opportunities are particularly through the existing portfolio companies. So TCR that I mentioned just now has bought an equipment services business off KLM, so based in Schiphol Airport. So that sort of thing, the bolt-on acquisitions particularly through the current portfolio company is an area of focus for us.

Lee: James Dawes, chief financial officer at 3i Infrastructure, thanks very much for joining me today.

James: Thank you very much.