Select Committee on Treasury Written Evidence


Memorandum submitted by the Macquarie Bank Group

SUMMARY

  1.  Within the context of this Treasury Committee inquiry and the broader debate on the role and impact of private equity funds in the UK, Macquarie seeks to present the merits of what we believe is a unique form of private equity that brings a number of potential benefits—that is long-term infrastructure funds.

  2.  One of the challenges of the current debate around private equity lies in demystifying the term to establish an understanding of what private equity is and does. In the broadest sense private equity is defined as money invested in companies that are not public ie not quoted on the stock market. Within that broader definition, the focus has been on investment funds used to buy a company out of public ownership or out of a larger entity[74]. Such funds are therefore commonly referred to as buy-out funds. Within that subset, the common perception of private equity relates to funds characterised by a short investment timeframe and a need to generate comparatively high returns over that period, which can lead to aggressive cost-cutting practices and a focus on short-term profitability at the expense of long-term growth and investment.

  3.  In reality, however, there are a range of investment "models" that can be classed as private equity, many of which share none or only few of the characteristics typically associated with the term. Macquarie's aim in putting forward this submission is to present the merits of one such model—long-term infrastructure funds—and to demonstrate the potential benefits this form of investment fund can deliver not only for investors but for investee companies and the broader community.

  4.  Long-term infrastructure funds are typically characterised by:

    —  Long-term commitment—a long-term investment horizon of typically more than 10 years

    —  Partnering with management—as opposed to replacing existing management as per the "management-buy-in" model.

    —  Investing for capital growth—a desire to maintain or grow exposure to a successful investment via capital expenditure.

    —  Profitability with responsibility—the interests of a long-term investor are not served by disregarding the needs of other stakeholders, including employees and their trades unions, users/customers, regulators and local communities.

  5.  In addition to the benefits this approach can deliver for the stakeholders of individual investee companies—including investors, employees and customers—Macquarie believes long-term infrastructure funds will also play an increasingly important role in helping to bridge the gap between the growing need for investment in essential infrastructure services and facilities and the ability of governments around the world to fund such investment.

  6.  With reference to the Committee's invitation to provide evidence to the inquiry, this submission deals primarily with the area of economic context, while also touching on regulation and transparency. However we feel it is important to also articulate Macquarie's long-term infrastructure fund model, so that our comments on these areas are understood in the appropriate context.

ABOUT THE MACQUARIE BANK GROUP

  7.  The Macquarie Bank Group is a diversified international provider of specialist investment, advisory and financial services, with over 10,000 employees in 25 countries. The Group has total assets of £44.8 billion with a further £61 billion in assets under management. Macquarie Bank is listed on the Australian Stock Exchange.

  8.  The Group has been actively involved in the UK and Europe since the late 1980s. Today Macquarie has over 900 employees in Europe, regionally headquartered in London and with offices in Dublin, Frankfurt, Geneva, Milan, Munich, Paris, Rome, Vienna and Zurich.

  9.  Macquarie's approach is to focus on select sectors where our particular skills and expertise deliver real advantages for clients and investors. This has enabled Macquarie to developed highly specialised skills, establishing itself as a market leader in a range of business sectors internationally. Macquarie's infrastructure funds management business is one such example.

  10.  The Macquarie Group's European activities include:

    —  Infrastructure and specialised funds management.

    —  Corporate finance and advisory services.

    —  Financial products.

    —  Lending and asset financing.

    —  Institutional stockbroking and research.

    —  Treasury and commodities activities.

    —  Equity structured finance and derivatives.

    —  Real estate structured finance.

    —  Real estate capital.

    —  Residential mortgages.

  11.  Further information about Macquarie is included in Appendix 1.

LONG-TERM INFRASTRUCTURE FUNDS—A UNIQUE FORM OF PRIVATE EQUITY INVESTMENT

The economic context—bridging the infrastructure investment gap

  12.  Long-term infrastructure funds have the potential to play a meaningful role in addressing the widening gap between the demand for better infrastructure and the ability of communities to pay for it.

  13.  Traditionally, governments have facilitated investment in infrastructure assets either by directly financing and building roads, railways, electricity grids and telephone lines, or by subsidising others to do so. The need for ongoing investment remains a pressing concern for governments globally.

  14.  A major OECD Futures Project Report[75] to be released in May 2007 provides the following estimates for global infrastructure costs:

    —  Electricity demand is predicted to double by 2030 and the OECD estimates the cumulative investment required at $10 trillion.

    —  Surface transport needs will be more modest—$50 billion a year for new railways; perhaps $200 to $300 billion annually on roads, which is about twice the present spend.

    —  The need for investment in water supply estimated at $1 trillion a year by 2025.

  15.  But while demand continues to rise, governments are spending less due to political pressures to reduce taxes and balance budgets. In OECD countries, infrastructure spending as a share of government outlays has fallen from 9.5% in 1990 to approximately 7% in 2005.

  16.  However while public investment shrinks and the infrastructure gap grows, private investors are increasingly keen to transform this once staid sector into a vibrant new asset class.

  17.  Macquarie played an active role as a private sector partner alongside the eleven countries on the OECD Project Steering Group. Copies of the report "Infrastructure to 2030" are enclosed for distribution to members. The full report can be made available on request.

Background—Development of infrastructure funds

  18.  While infrastructure funds have gained prominence of late, it's only in the last two to three years that the sector has gained recognition as an alternative investment class in its own right.

  19.  Macquarie is widely recognised as a pioneer in the development of infrastructure investment globally. The development of the sector, and Macquarie's role at the forefront, resulted largely from an accident of history—the fortuitous timing of unrelated events. In the early 1990s, the Australian Government gave a major boost to retirement savings by introducing a compulsory pension contributions scheme. The subsequent growth in pension fund assets coincided with both a significant push from government towards private sector funding of existing and new infrastructure and a global downturn in equity market returns that resulted in a search for new, alternative investment opportunities.

  20.  As early as 1990, Macquarie recognised the appeal of infrastructure as an investment class, offering a unique combination of attractive, long-term investment characteristics. A key attraction of well-managed infrastructure assets is their ability to generate stable yields that are sustainable over the long-term—the result of their essential and long-term nature, combined with strong competitive position. This in turn appeals to investors with a long-term time horizon, in particular pension funds.

  21.  As a result, for more than 15 years Macquarie has focused on infrastructure funds management, investing in and actively managing quality infrastructure assets on behalf of investors, via a range of specialist listed and unlisted funds. Macquarie's approach has been to establish long-term investment funds which aim to identify, acquire and actively manage quality infrastructure assets over the long term.

Defining infrastructure—essential drivers of an economy

  22.  Infrastructure assets including roads, water utilities, railways, airports, ports, electricity and gas transmission and distribution networks, provide the foundation of basic services on which the growth and development of a community depend. Reliable transport corridors, communication networks and energy distribution systems are as essential to the health of an economy as robust legal and political systems.

  23.  Broadly, infrastructure assets fit into three categories. The first, economic infrastructure, includes those assets which provide services that are used in production processes and final consumption in the economy. Such assets are required for economic growth and involve high initial cost outlay. They usually have a long operational life and show monopolistic characteristics. Typical assets would be transport, telecommunications and utilities such as electricity, gas and water.

  24.  The second category is social infrastructure, which includes the system of networks and facilities that support people and the community. These assets are often operated within the private sector and are used to support and provide public services such as hospitals, education, housing, recreation and leisure. The public/private mix will vary in different countries and private sector participation needs to be responsive to the objectives and approach of individual situations.

  25.  Finally, a recent offshoot of the asset class is commercial infrastructure, which comprises assets for which the benefits of sharing infrastructure outweigh the competitive advantage of owning and operating one's own infrastructure. Characterised by a high degree of competition, this category includes assets such as satellites, cable networks, and mobile phone towers.

  26.  However in determining attractiveness from an investment perspective, Macquarie focuses on key characteristics rather than types of infrastructure. Certain features of particular infrastructure and related assets provide stable, long-term revenue streams that are a good match for the long-dated liabilities of pension funds and other investors. For example, from an investment perspective, regulated infrastructure assets are attractive because they provide essential services to the community in which they operate, they tend to enjoy robust and stable demand and their revenue and charges are regulated. On the other hand, certain electricity and gas generation and production assets compete for sales and are exposed to market risks, making them far less attractive for our investors.

Long-term infrastructure funds—the Macquarie model

  27.  Over the past 15 years Macquarie has developed and refined an infrastructure investment model that we believe is unique, and that is well-suited to the important nature of infrastructure businesses. Today, Macquarie manages £22.7 billion in equity across a global portfolio of over 100 infrastructure and essential-service investments including water, electricity & gas transmission, renewable energy, toll roads, airports, broadcast towers and social infrastructure. Approximately 60% of this portfolio is in Europe. Of the total amount, £7.8 billion is invested via unlisted, or private equity funds.

  28.  In creating and managing long-term infrastructure funds, Macquarie's approach is based on the following core characteristics:

Long-term commitment

  29.  Macquarie's investment model is based on a long-term investment horizon. This is core to our investment philosophy, and reflects the fact that investors in our funds, primarily pension funds, insurance companies and other large institutions, are seeking stable and predictable returns over a similarly long-term time horizon. From an investment management perspective, this has a fundamental impact on our approach—when we invest in an asset we look at its business prospects over the next 30 years. One of the most significant differences between Macquarie's infrastructure investments and a traditional private equity approach is that our business plans do not assume that we will sell the businesses we buy, whereas the typical private equity approach depends upon the ability to resell an asset within a period of three to five years.

  30.  For example, when Macquarie funds in 2004 acquired 70% of Brussels Airport from the Belgian Government, which retained a 30% stake, we made a commitment not to sell our shares for a minimum period of 10 years. When two Macquarie funds recently acquired Airwave, the UK public safety communications service, we also committed to retain our investment for a minimum of 10 years and declared our intention is to remain for the longer term.

Partnering with management

  31.  Unlike the "management buy-in" approach typical of many private equity funds, Macquarie is attracted to companies with a strong, established management team. We seek Board-level positions where we can provide strategic input and direction, in order to complement the skills of existing management teams, working with them to provide support and enhance overall performance. Consistent with our long-term focus, Macquarie's model places a high priority on recruiting, retaining and rewarding quality staff.

Investing capital for growth

  32.  Long-term infrastructure funds are willing to commit to significant capital expenditure programmes. Our investors generally want to maintain or grow their exposure to a successful investment, and further capital expenditure enables them to do that.

  33.  The Macquarie-managed funds that are lead investors in Thames Water have agreed to an investment programme of £2.5 billion over the next three years.

  34.  On a smaller scale, following Macquarie's acquisition of the UK's renewable energy provider Energy Power Resources Limited (EPRL) in March 2005, over £3 million was invested at Eye power station to ensure that it was Waste Incineration Directive (WID) compliant from December 2005. Since then another £4 million has been invested at Thetford power station. EPRL's budget assumes further capital expenditure of £5 million for 2007-08.

Profitability with responsibility

  35.  For a long-term investor, it is essential that businesses are managed in a way that is both profitable and responsible. Macquarie appreciates the need to satisfy a range of stakeholder groups—employees and their trade unions, users/customers, policymakers, regulators, local communities—because these groups will impact the long-term viability and prosperity of the business. As a long-term investor, it is not in our interests to ignore or seek to compromise the interests of these stakeholders.

  36.  Macquarie has extensive experience in balancing the needs and priorities of different stakeholder groups, including:

    —  the need to facilitate efficient linkages within broader infrastructure systems;

    —  the need to work with employees and their trades unions, local councils, business and community groups to achieve well-informed, consensual solutions;

    —  the need to provide users with value for money;

    —  the need to deliver on performance objectives for investors;

    —  the need to minimise social and environmental impact on surrounding communities;

    —  the need to maintain the overarching priority of safety and security.

  37.  For example in the case of our proposed investment in NRE, a gas and electricity distributor in the Netherlands, we have committed to put the public interest before our commercial objectives. If our municipal co-shareholders judge that our business plans are counter to the public interest, then our plans must change.

  38.  When Macquarie acquired the East London Bus Group (formerly Stagecoach London) from the Stagecoach Group, £60 million was injected into the staff pension plan scheme (which includes a final salary component) as part of the transaction to bridge an existing funding gap and safeguard employees' future benefits.

Regulation and transparency

  39.  Due to the nature of infrastructure assets, many of the companies in which Macquarie-managed funds invest are regulated entities in their own right. Examples of such companies include Wales & West Utilities, Thames Water, Arqiva and National Grid Wireless. In these examples, the regulatory framework provides a range of controls and assurances in relation to pricing, service levels and investment. In addition, regulated entities are required to make public reports to the regulator, ensuring an appropriate level of transparency and public accountability. Other assets such as Bristol and Birmingham airports are not subject to formal price controls however their activities are subject to specific sector regulation to ensure that their behaviour is in line with the public interest.

  40.  Other infrastructure businesses operate under long-term concession agreements or customer contracts, often issued by government or public agencies, with relevant service standards, pricing mechanisms and other controls built into the concession agreement. Examples within Macquarie's portfolio include East London Bus Group, Moto, M6 Toll and Airwave.

  41.  In relation to transparency, many Macquarie-managed infrastructure funds are publicly quoted companies and, as such, provide detailed financial and other reporting on a regular basis, including information about investee companies.

  42.  For example:

    —  Midland Expressway Limited, the company which operates the M6 Toll, is owned by Macquarie Infrastructure Group (MIG), which is listed on the Australian Stock Exchange (ASX).

    —  Bristol and Birmingham Airports are both partly-owned by Macquarie Airports (MAp), which is also ASX-listed.

    —  Airwave, Arqiva and National Grid Wireless are all partly-owned by Macquarie Communications Infrastructure Group (MCG), also listed on the ASX.

    —  Red Bee Media is controlled by ASX-listed Macquarie Capital Alliance Group (MCAG).

Leverage

  43.  One of the key attractions of investing in infrastructure assets is their ability to generate predictable, stable cashflows over an extended time horizon. As a result they are able to support a level of debt that may be greater than for other types of businesses where there is higher volatility of earnings and dividends. Macquarie's approach is to structure a debt package that is appropriate to the nature of the business and to our long-term investment horizon and as a result the level of leverage in different businesses can vary substantially. Each proposed debt structure is rigorously stress-tested against a range of worse-case scenarios to ensure robustness. This analysis is further tested and ultimately endorsed by the range of banks that participate in the debt funding for each asset. Consequently debt is typically investment grade.

  44.  Where appropriate, the capital structures used by Macquarie provide further funding to meet the investment and expansion plans of the Company, as well as accommodating liquidity needs. Protection against adverse changes in the cost of borrowing is readily available via a liquid interest rate swaps market. In addition, Macquarie applies hedging to the majority of debt carried by our assets/funds for further protection.

CONCLUSION

  45.  Broadly defined, private equity funds are now a significant component of the UK economic and financial landscape. Within the broad definition of private equity funds there is a wide range of investment models and approaches. Long-term infrastructure funds, a model largely pioneered by Macquarie, is one such approach which we believe offers substantial benefits not only for direct stakeholders but in contributing to the broader need for ongoing investment in important community infrastructure assets.


74   Inside the dark box: shedding light on private equity, The Work Foundation, March 2007. Back

75   Infrastructure to 2030: Main Findings and Policy Recommendations, OECD Futures Project on Global Infrastructure Needs: Prospects and Implications for Public and Private Actors, May 2007 Back


 
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