RARE Infrastructure director Richard Elmslie comments on the Intoll takeover bid in this Lateline news item:

Lateline interview: video & transcript >>

The Canada Pension Plan Investment Board (CPPIB) moves to buy Sydney-based infrastructure group Intoll.

CPPIB bid provides three options for Intoll shareholders including a cash offer equivalent of $1.53 per Intoll stapled security.

The offer represents a significant premium to Intoll’s recent trading price, according to CPPIB.

While CPPIB is doing due diligence on the firm, there’s no guarantee the pension fund will outline a formal binding proposal to buy Intoll’s stapled securities, according to a company statement.

“The directors of Intoll have not formed a view as to the adequacy of the proposal and accordingly recommend that Intoll security holders take no action at this time,” said Paul McClintock, chair at Intoll.

Intoll’s portfolio includes a 30 per cent stake in the 407 ETR in Toronto, Canada and a 25 per cent interest in the Westlink M7 in Sydney, Australia.

The firm’s share price rose more than 30 per cent to $1.45 per share after the announcement. Intoll hired UBS as its financial adviser and Mallesons Stephen Jaques as its legal adviser for the process.

Richard Elmslie, investor director and senior portfolio manager at infrastructure fund manager RARE Infrastructure, an Intoll shareholder, said the bid is reasonable.

“We bought in at around $1.06 [six months ago] so at $1.50 per share, it looks reasonably valued … we’ll just have to wait on the due diligence from CPPIB,” he said.

Intoll’s share price was $1.44 per share following today’s morning trading period.

In November, CPPIB and another pension fund bid for Transurban, which was rejected by the company.

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RARE Infrastructure has attracted $1.4 billion in investment mandates in nine months including one from the $67 billion Future Fund.

The global listed infrastructure fund manager has gained a number of institutional clients from Australia, Hong Kong, Canada, US and UK including several new clients in the past nine months.

Colonial First State awarded RARE a $200 million global listed infrastructure mandate in January this year.

It is not known when the Future Fund gave the fund manager an undisclosed investment mandate this year.

AvSuper, Canada’s Corporate Pension Plan, Russell OpenWorld and van Eyk Blueprint all awarded RARE Infrastructure mandates last year.

RARE Infrastructure was founded in 2006 and has more than $2.5 billion under management.

Nick Langley, investment director and senior portfolio manager at RARE, said the portfolio’s liquidity allowed the fund manager to reallocate to growth assets quickly early last year.

“[This] gave us the flexibility to transform the portfolio from a very defensive position, with significant utility exposure, in early 2009 to a more GDP leveraged position, with greater exposure to toll roads and rail,” he said.

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Volatility was heightened due to:

• the Greek debt crisis spreading to Iberia’s debt funding/refinancing needs and associated anxiety over the effectiveness of austerity measures introduced to help reduce debt

• mixed economic news as to the sustainability of global growth ; and

• to a lesser extent the temporary concerns created from volcanic ash spreading over Europe

There are many views on the economic outlook but in essence we need to see the European sovereign credit outlook stabilize, further evidence of cyclical improvement in the US and less volatility for confidence to return to the markets.

Infra Regulation. The NZ Commerce Commission released a draft decision on airport regulation which was viewed by the market as being favourable, establishing an appropriate regulated asset base for future price resets.

Infra M&A.
• Transurban (tollroads) rejected two further bids from major shareholders and proceeded with a $530m equity raising at $4.60 to fund the Lane Cove Tunnel acquisition. One of the shareholders subsequently sold their 12% stake at $4.44 after the raising.

• MAp (Airports) issued notices to certain foreign shareholders to dispose of their shareholdings because the 40% government imposed foreign shareholding threshold had been breached.

Infra Funding. Canadian government committed US$550m in loans for a Detroit River toll bridge. AdP (airports, Europe) announced a €500m bond issue at 80bps over swap (this is an attractive rate). Abertis has financed the R3-R5 tollroad in Spain with €370m from commercial lenders and €300m from the European Investment bank.

Other Infra News. The new UK coalition government announced its plans for the energy sector, in particular its support for nuclear generation and renewable energy.

In addition to follow on investments from existing clients, RARE has recently signed several new clients (weblink: RARE/About RARE/Our Clients). Investment Director and Senior Portfolio Manager Richard Elmslie said “we’ve been pleased by the strong take up of listed infrastructure amongst long term value investors. The genesis of the RARE strategy is to use a portfolio of listed utility and infrastructure companies to simulate the risk and return profiles of unlisted infrastructure. Investing in these companies in a listed form provides daily liquidity that has proved highly beneficial during the recent global financial crisis.

Investment Director and Senior Portfolio Manager Nick Langley said “the liquidity of the underlying global listed infrastructure stocks gave us the flexibility to transform the portfolio from a very defensive position, with significant utility exposure, in early 2009 to a more GDP leveraged position, with greater exposure to toll roads, rail and seaports as global trade recovered.

The total value of the assets of the companies RARE researches recently topped AUD5 trillion, representing approximately 25% of all of the infrastructure assets globally and more than 80% of the market of assets investors can invest in². Nick Langley said “with an expected USD20³ trillion to be spent on infrastructure over the next ten years, and with government finances under pressure, there are significant investment opportunities arising in the global listed infrastructure market.

About RARE:

RARE Infrastructure is a boutique investment management company specialising solely in the rapidly growing and increasingly recognised asset class of global infrastructure.

RARE invests in the securities of major infrastructure projects and developments such as airports, gas, electricity, water and roads, which provide essential ongoing services to communities in both developed countries and emerging markets.

Our small and dedicated team of highly experienced investment managers and securities analysts has 70+ combined years of experience in global infrastructure and 40+ combined years in funds management. We conduct our own infrastructure research using a rigorous analysis and hence we do not pay commissions to outside advisors.

RARE stands for Risk Adjusted Returns to Equity. It is our job to identify, analyse, invest and manage a wide range of global infrastructure securities with the aim of delivering stable, reliable dividends and capital growth for our investment clients.

RARE values its long term relationships with both retail and institutional investors. We provide a highly personalised service to wholesale clients and retail funds incorporating not only careful selection of global infrastructure securities and expert funds management but also reliable and relevant information and friendly assistance to all of our clients.

RARE (AFSL 307727) is not associated with any bank, broker or institutional investor. Treasury Group Limited owns 40% of RARE and is listed on the Australian Stock Exchange (Ticker: TRG). Its business is to invest in and support boutique fund managers, such as RARE Infrastructure.

For further information/comment:

Richard Elmslie +61 2 9397 7301, +61 419 203 360

Nick Langley +61 2 9397 7302, +61 407 936 037

1 As at 31 May 2010
2 RARE estimates, call for details.
3 RARE estimates

Important Information
While the information contained in this document has been prepared with all reasonable care, RARE Infrastructure Limited accept no responsibility or liability for any errors, omissions or misstatements however caused.

The risk/reward balance took a big step towards the defensive at the end of April as negative shock waves rippled throghout the developed world

• Investors are trying to digest the fall-out of a potential default by an EU nation and the resulting contagion
• The launch of civil securities-fraud case against Goldman Sachs by the SEC
• UK faces a hung parliament, and  as a nation, can’t get confidence that anyone is right for the top job

 The events of April bring home to us that the big theme of 2009 (delevering brought about by the developed market excesses of the last decade) is still in vogue with the focus now shifted from the corporates to the governments themselves. This has already proven to be a very painful experience as governments are forced to cut spending in order to attempt to establish fiscal credibility.

 Although the concept of cutting government spending in the midst of a crisis may be new to the developed world, the EM’s have been here before (1990’s and early 2000’s) and as many investors are forced to add a sovereign risk premium for Eurozone countries, they are rewarding the EM countries that have their fiscal house in order

• Russia issued US$5.5 billion in its first international debt sale since the 1998 default
• The extra yield investors demand to hold EM debt rather than US Treasuries sank to ~2.3% in April, the lowest level since Dec 2007
• Brazil raised it’s benchmark interest rate (up 75bps to 9.5%) to prevent an “overheating” of the economy
• Investors view the China risk to be a new bubble and want governments to intervene – very different to the no growth, high unemployement, sovereign balance sheet issues of the developed world

 We will likely continue to see volatility in the EM as contagion risk creeps into the picture but we remain focused on putting money to work in countries that are structurally focused on maintaining organic domestic growth and not reliant on the return of excess liquidity to fund demand.

Despite what appears to be strong US economic recovery markets are very focused on Greece and peripheries, possible indictment of Goldman Sachs and potential Chinese property bubble. From an infrastructure perspective stocks have held up well, with the exception of southern Europe.

 Infra Regulation. The Italian energy regulator AEEG issued a draft review for gas storage regulation. This document confirmed the attractive incentives available for investments that develop new storage capacity within the country, a 4% premium on top of the base returns (currently 7.1% pre-tax real WACC) for a period of 16 years. This draft is seeking consultation prior to the final determination being issued.

 Infra M&A. E.ON (German, Utility) sold their US power and gas business to PPL Corporation (US, Utility) for US$7.6 billion, which was higher than market expectations and at an EV/EBIT multiple of about 15 times. This transaction pushed E.ON’s disposals above their target for €10 billion by the end of 2010. Edf received offers for its UK electric business, with an announcement expected in the next few months. TCL (Australia, toll road) was cleared by competition authorities to bid for the failed Lane Cove Tunnel project. A Vinci (France, toll road) led consortium reached financial close on the first Russian toll road (Moscow to St Petersburg) valued at ~US$2b.  Forth Ports (UK, ports) rejected a third takeover bid that valued the company at 14.8x consensus EV/EBITDA.

 Infra Funding. Many Unlisted funds closed their capital raisings, with US11.7b raised YTD compared to US9.4b raised in all of 2009. ASF (France, toll road) issued €500m 10yr bonds @ ~4.1% (around 80bps over swap) and EdF (France, electricity) issued €1.5b 20yr bonds @ ~4.6% (around 95bps over swap).  The rating agency S&P unexpected downgraded Abertis (Spain, toll road) from A- to BBB+.

Companies in our universe continue to have access to the capital markets.

 Other Infra News. IATA indicated that the volcanic ash disruption will cut ~4% of April passenger traffic. RARE expects 0.5-2% expect impact on annual traffic.

INVESTORS should be looking at infrastructure for one very good reason: it is where the growth is.

Globally, according to Canadian Imperial Bank of Commerce World Markets, $US35 trillion will be spent on infrastructure over the next 20 years.

The Organisation for Economic Co-operation and Development puts the figure at $US41 trillion — but its timescale for that investment is 2005-2030. And while most people would assume the burgeoning growth of the emerging markets is behind this surge — with China’s mind-boggling infrastructure statistics at its heart — that is not wholly the case. The OECD’s figures have the infrastructure spend in North America and Europe at $US15.6 trillion, almost matching the $US15.8 trillion slated to come out of Asia/Oceania.

“That’s the beauty of infrastructure as an investment theme,” says Andrew Cassar, senior investment analyst at Zenith Investment Partners. “The attraction is not just the massive amounts of spending projected to build infrastructure in the emerging markets, but also the similar size of spending that the developed world has to do, to refurbish and upgrade existing infrastructure.”

A case in point is that while China plans to spend $US128 billion on water-related investments by 2014, the US requires $US1 trillion in water infrastructure investment over the next 20 years.

Cassar says global infrastructure securities funds, which invest in listed infrastructure stocks around the world, are the best way for a retail investor to hold infrastructure in their portfolio in a properly diversified way. “We view global listed infrastructure as a lower-risk international shares option [relative to the MSCI World Index] in a well-diversified portfolio.”

The professional managers are best-placed to choose an infrastructure portfolio, he says. “In infrastructure it’s very important to get a broad range of exposures across the different kinds of infrastructure assets. For example, you’ve got `regulated assets’ [eg. water and sewerage utilities, distribution pipelines and transmission wires], `user pay’ assets [eg. toll roads, airports, ports and railways] and `competitive assets’ [communications, power generation and energy providers]. “The appropriate weightings of these kinds of assets depends very much on the economic cycle. For example, defensive assets like utilities come into their own when economic growth is flat, but user-pay assets will generally outperform utilities in periods of strong growth,” he says.

Zenith has a `highly recommended’ rating on the RARE Infrastructure Value Fund, and a `recommended’ rating to four others, the CFS Global Listed Infrastructure Securities Fund, the Macquarie International Infrastructure Securities Fund, the Magellan Infrastructure Fund and the RARE Series Emerging Markets Fund. These five funds have annual fees of 1-1.3 per cent of invested assets), with all except the CFS fund also having a performance fee.

Cassar says infrastructure should be in the portfolio as a defensive/income asset. “Infrastructure is not Australian equities where you’re going to get 8-10 per cent a year. It’s not meant to be a high-octane security, it’s meant to generate a consistent capital growth return of 3 per cent a year, plus income of 3-5 per cent.

“In some cases it has been considered as an inflation-protected defensive hedge against down markets — but as we saw in 2008, nothing really was a defensive position, everything correlated with everything else, and no asset was considered a defensive asset, infrastructure included. We would say that investors should view infrastructure as what it was always supposed to be: a stable, defensive, long-term cashflow generator,” says Cassar.

Asset manager Goldman Sachs JBWere Asset Management says the strong case for a significant allocation to Australian infrastructure within a balanced portfolio is based on the following attributes: high level of earnings certainty; the inherent inflation hedge, which protects purchasing power for long-term superannuation investors; the consistent and attractive, tax-efficient yield; the diversification benefits (low correlation with other major asset classes); and the strong growth expected in infrastructure investment by both the private and public sectors.

Goldman Sachs JBWere Asset Management says the earnings certainty comes mainly from the monopoly positions in markets — either from natural monopoly characteristics where the economies of scale make it irrational to replicate existing infrastructure (such as in airports or transmission lines), or through contracts/concessions (such as an exclusive right to operate a tollroad).

Second, says the firm, infrastructure assets show inelastic demand — that is, because they provide essential services such as providing power, transport and water, demand is very stable and tends to grow with time. Goldman Sachs JBWere Asset Management says the combination of these two features provides infrastructure assets with significant pricing power; earnings can continue to grow even in the infrequent circumstances where volumes contract.

As the asset manager points out, Australian infrastructure assets look very attractive to long-term investors, in particular overseas pension funds. That is evident from the raid by the Canadian Pension Plan Investment Board, which bought out Macquarie Communications Infrastructure Group in June 2009; and the Canadian institution’s second foray to the Australian Securities Exchange (ASX) in November 2009, in conjunction with compatriot Ontario Teachers’ Pension Plan, with a $6.8bn bid for tollroad operator Transurban, of which the pair already owned 28 per cent. Transurban immediately rejected the offer, saying it undervalued its assets.

In December 2009, Australia’s sovereign wealth fund, the Future Fund, announced that it was talking to the Canadian funds about supporting their proposal, but it ended those talks last month. Andrew Chambers, infrastructure analyst at Austock Securities, says the Canadian pair would probably have to lift their bid from $5.25 a stapled security to $6 to be successful — but adds that on a one-to-two-year view, Transurban is likely to be above that price regardless of the current takeover offer.

For their part, Australian superannuation funds are interested in infrastructure, because the steady long-term cash flows it provides suit their needs. In particular, says Alex Dunnin, head of research at research group Rainmaker Information, industry super funds have been much keener on investing in alternative assets — a category that includes infrastructure, private equity and hedge funds — and typically have 18 per cent of their investments in with about half of this allocation in infrastructure. In comparison, he says, retail master trusts on average have 4 per cent allocated to these types of assets and only very low exposure to infrastructure.

The biggest super funds in terms of infrastructure allocations are mainly industry funds: MTAA Super has $1.5bn (28 per cent of its assets) in infrastructure, CBUS has $1.6bn (12 per cent of assets), Australian Super has $1.8bn (6 per cent of assets) and UniSuper has $1.5bn (4 per cent of assets). New South Wales government employees’ super fund State Super NSW has the largest funds allocation to infrastructure in dollar terms, at $2.2bn invested, or 7 per cent of assets.

MTAA Super has been investing in infrastructure for more than 12 years. Dunnin says the major reason for its very high allocation is that the fund uses infrastructure as its “de facto fixed interest allocation” because infrastructure has almost all of the characteristics of bonds.

Chris Trevillyan, senior consultant and head of infrastructure research at Frontier Investment Consulting, says infrastructure should not be viewed as a straight bond replacement, because it has more risk than bonds.3

But he says this means that super funds can expect a premium for owning it. “These are generally operational assets, and even with regulated assets you can still get volatility in the cashflows from time to time, so it’s not a direct substitute for fixed-income. But that risk gives it a touch of growth. At a very minimum we see infrastructure earning 4 per cent above long-dated bonds — so at current rates, you’re looking at 10-11 per cent as a return expectation. That’s a minimum hurdle rate of return, and then if you introduce development risk, or more exposure to GDP growth you’re looking for an additional premium,” he says.

But while super funds are attracted to infrastructure, they are wary of how best to enter it. Spectacles such as UniSuper blowing up $50m on infrastructure investments in NextGen fibre optic cabling and Loy Yang Power, and toll-roads going into receivership because not enough vehicles used them, have made them gunshy — not to mention their experiences in the GFC. However, they are more than willing to do it: UniSuper, for example, is involved in the Victorian Government’s desalination plant project, as a bond holder.

And earlier this month, retail industry fund REST joined with the UBS International Infrastructure Fund to buy the Collgar wind farm in Western Australia.

“Super funds are still certainly looking for infrastructure investments: it’s just that they’ve now got a much better understanding of illiquidity,” says Trevillyan. “Our clients typically have up to 10 per cent allocations to infrastructure. Nearly all would prefer to be doing it in the unlisted space: the smaller funds are going through wholesale funds, but the larger funds are looking more direct.

“A lot of that’s more to do with being able to have control of the overall portfolio, and what they’re allocating into; they want to be able to manage their total portfolio and also hopefully have more input into the buy and sell decision.

Really, the funds are trying to get the best of both worlds: we certainly see infrastructure as playing a more defensive role in the portfolio, but with still some upside,” says Trevillyan.

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Despite on-going concerns over the developed European sovereign balance sheets, we believe the market became more comfortable with our February view that they wouldn’t default and relief would be found locally – supported by successful bond offerings in Greece in late March. In our view this, together with better than expected macro stats from the developed world, were the largest drivers of the stronger markets in March. We believe EMs will continue to track their developed peers over the short to medium term, as risk appetite again dictates investment decisions and not stand alone EM fundamentals. As such we may see on-going EM market volatility.

From a longer term fundamental stand point, the news flow for the EMs and the infrastructure stories within the EMs in March was positive with

• A reduction in the severity of the “currency manipulation” comments coming from Washington
• No major concerns regarding rising inflation as yet – postponing need for monetary tightening
• Strong FY results – many of the stocks beat expectations and announced bullish 2010 targets
• A number of new offerings were announced and positively received by the market
• Governments reaffirmed their infrastructure programs – Mexico to tender USD50bn in projects in 2010, Brazil announced dates for major capacity auctions

On a low note, Chile suffered a devastating earthquake which we believe will take them some time to recover from. However, we would positively note the strong domestic and global response to the disaster and that for the infrastructure investors with Chilean assets, insurance is expected to cover much of the damage.

We remain positive on EMs with their strong fundamentals and attractive growth profile and would use any weakness associated with developed market volatility to buy real value (EM infrastructure).

Over the last 9 months RARE has consistently commented that investors will observe rising Treasury yields and increased employment, pointing to a stronger than expected recovery. These signposts received economic support in March (continuing into April) and were the primary reason for strong equity markets. Treasuries felt the weight of the more robust economic climate, of heightened global inflation fears, of rising crude oil prices (to $87 per barrel) and of substantial worries about sovereign debt. Of course looking forward this creates tension for equity markets with an improving economy on one hand and rising rates on the other.

Infra Regulation. The independent electricity pricing regulator in NSW (Australia) followed moves elsewhere in Australia approving price hikes of 20-42% for the 2010-13 period and warning of another 24% increase in energy costs.

Infra M&A. There were a number of M&A announcements in the sector including:

•        Mexico announced plans to tender US$50b of projects during 2010
•        Forth Ports (UK, Port) has rejected two takeover offers
•        Ferrovial announced it will dispose of 10% of the 407ETR tollroad in
         Toronto

Infra Funding. March proved to be a very active month for equity and debt financings in the infrastructure space. IPO’s included Chongqing Water  US$511m (China, water); Ecorodovias US$764m (Brazil, tollroad), Avantha Power (India) announced plans to float while the UK Government announced plans to seed a  green infra fund with up to £1b. In the debt capital markets, Wales and West Utilities (UK, utility) launched a £5b bond program and Transurban (Australia, tollroad) raised A$250m at 180bps over swaps.

Other Infra News. It is expected that damage sustained to infrastructure from Chile’s earthquake will be covered by insurance.