Private equity targets a risky stagflation bet

While leveraged buyouts struggle, one corner of private equity just keeps on going — the pursuit of infrastructure assets such as airports, gas pipelines and broadband networks. Combine strong demand for these inflation-proof businesses with rising borrowing costs, and the risk of overpaying for deals is rising.
The Italian billionaire Benetton family and Blackstone Inc clinched an agreement to buy out minority shareholders in listed toll-road operator Atlantia SpA, seeing off a rival consortium including construction tycoon Florentino Perez. Meanwhile, National Grid is offloading a controlling stake in its UK gas-transmission business to a Macquarie Asset Management consortium. Deal activity has held up, with debt financing still readily available.
The diverging views of private infrastructure investors from the stock markets are especially visible when it comes to the masts on which mobile phone operators hang their antennae. Deutsche Telekom AG’s strategic review of its towers business, worth a mooted $20 billion, has attracted significant private equity interest.
These assets are attractive in a stagflationary world, say analysts at Citigroup Inc. Mobile operators sign long-term contracts, typically accepting some indexation to consumer-price inflation (albeit often subject to a cap). There’s also growth potential from the rollout of 5G mobile networks and the opportunity to add more customers per mast as telecom owners cease to monopolise the real estate. Hence, towers command valuations well in excess of their current or former telecom parents.
And yet, for all their attractions in the current economic environment, the listed European towers companies have lost their shine. Sector bond yields have shot up not just in sympathy with higher government rates but also because investors see them as riskier credits.
In turn, higher bond yields have pummeled listed equity valuations since they reduce the theoretical value of future cash flows in today’s money. This is a particular problem for growth stocks, and the sky-high earnings multiples on which telecom towers trade have started to fall. This year, telecom companies themselves have performed better as investors have targeted value stocks.
The situation highlights the snag with listed infrastructure. As analysts at Barclays Plc warned in
November, the inflation-driven escalation in revenue may not completely offset the drag from higher financing costs when it comes to stock-market valuations. Indeed, long-run inflation expectations have not risen as much as bond yields, and the downdraft of higher finance costs on listed tower-company values may not be over, warns New Street Research. This all plays into the negotiating hand of private infrastructure funds looking to buy assets. Not only are public company benchmarks cheaper, but listed acquirers like Cellnex Telecom SA (also part-owned by the Benettons) are on the back foot. The plummeting valuation of the Spanish mast operator’s shares has deprived it of a helpful currency for funding deals on its own.

—Bloomberg