How High Is Too High | Are Infrastructure Valuations Grounded in Reality?
Headline valuations associated with infrastructure transactions have, for years, been subject to mockery, skepticism or a more subtle roll of the eyes, with airports, data centers and towers considered usual suspects. Although the nascent asset class has more or less gone mainstream, higher rates and macroeconomic uncertainty haven’t allayed such oft-cited concerns. So, what do we make of infrastructure valuations in today’s environment?
To kick off, let’s consider the secondary market for private infrastructure investments. Surely, institutional buyers would apply a healthy discount to account for concerns around individual asset valuations, with the potential for an additional spread given favorable supply/demand dynamics observed in the secondary market more broadly, right? “So… why are we bidding x% of NAV for an interest in a leading infrastructure fund?” posed an unnamed HL executive at a recent IC discussion. The question was a good one considering the double-digit discounts observed for PE secondaries (and single-digit discount in question). The question could be addressed in a number of different ways, but at a very high-level, our bottoms-up underwriting analysis supported the price at hand in this particular example, as did (and does) the market.
Secondary Pricing % (Discount)/Premium
What does the market see in infrastructure to justify persistently healthy pricing? The essential and long-dated nature of infrastructure assets, paired with strong visibility into future cash flows, makes the asset class particularly well-suited for secondaries for both buyers and sellers, allowing sellers to secure strong value, and buyers to have confidence in what they are acquiring.
This still doesn’t solve for the visceral reaction elicited by any reference to infrastructure transactions trading at 25x+ pick-your-valuation-measure. After all, you may say, infrastructure centers around physical assets such as data centers – not chasing the unicorns that reside in the cloud. So, what do we think about acquiring a portfolio of cell towers for 30x tower cash flow (“TCF”) – is that cheap or expensive? How about 45x TCF? Like most things in life, the devil is in the details, although in the case of the latter, outliers can be easy to spot.
Tower Portfolio Valuation
TCF Multiple vs. Tenacy
Valuation Per Tower ($000) vs. Tenancy
Illustrative Tower Economics
| Tenancy Per Tower | 1.0x | 2.0x | 3.0x |
| Construction Cost | $350,000 | ||
| Revenue | $24,000 | $50,400 | $76,800 |
| Opex | $13,200 | $14,400 | $15,600 |
| Tower Cash Flow | $10,800 | $36,000 | $61,200 |
| Margin (%) | 45% | 71% | 80% |
| Yield-on-Cost | 3.1% | 10.3% | 17.5% |
| Build Multiple (xTCF) | 32x | 10x | 6x |
Source: Hamilton Lane adaptation of American Tower Corp illustration.
The redacted transaction comps shown above are a testament to substantial operating leverage associated with towers, as well as the significant value creation associated with increasing tenancy. How? Increased rents effectively flow directly to the bottom line, with higher cash flow multiples required to account for higher growth potential. Although simple to illustrate, towers are not unique in that headlines often obfuscate a more complex reality. Market commentary around data center take-privates such as QTS, Switch and CyrusOne are prime examples. Digging a bit deeper on each of these may or may not paint a different picture, depending on the example used.
Let’s instead turn to Hamilton Lane’s proprietary infrastructure dataset. Are higher purchase price multiples associated with lower returns? We’ve scrubbed and sliced our proprietary data set in a number of ways and can confidently say that higher headline purchase multiples (EV/EBITDA, in this case) are not correlated with lower returns on average, as illustrated in the exhibit below. This speaks to the market as a whole pricing infrastructure assets rationally.
IRR vs. Purchase Price Multiple
Are we buyers of infrastructure at any price? Absolutely not. After all, paying more for an asset upfront is a guaranteed way to reduce future returns, all else being equal. Likewise, although we’re excited about the opportunity set to invest behind key themes such as the energy transition and digitization, buyer beware: Not all opportunities are created equal. While the world migrates to the cloud, infrastructure as an asset class remains grounded in reality.
We cover more on this and other compelling areas within private infrastructure in our 2023 Real Assets Market Overview.Fill out the form below for an instant download of the deck.
2023 Real Assets Market Overview
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As of June 7, 2023