June 2016

Australia in Transition: Disruption breeds new infrastructure investment opportunities

Tom Butcher, Managing Director, Transport, Infrastructure, Power and Utilities, and Linda Blore, Director, Corporate Banking, explain the risks and opportunities that disruptive technologies present to investors in Australian infrastructure assets.

From roads to power stations, Australia’s infrastructure sector has proven a reliable safe haven in recent decades, offering steady returns for investors and attractive capital recycling opportunities for state governments. But the environment is changing. Over the next few years, traditional infrastructure investments in Australia – and elsewhere for that matter – will continue to confront the reality of technological disruption.

Governments and communities continue to work on identifying what infrastructure should be developed and where, but predicting the impact of technology on these requirements is not straightforward. What is the changed nature of the infrastructure that Australia needs and will technology ultimately reshape the country’s requirements?

Future demand for Australia’s infrastructure will be directly affected by growth in population, developments in global economies, technological change, the need for environmental sustainability, and changing consumer preferences. Australia’s population will grow by five million in the next ten years and is expected to reach 39.7 million by 2055*. This growth will see additional demands placed on urban infrastructure, which in many cases is already subject to high levels of demand. Significant investment to increase Australia’s agricultural productive capacity is also expected.

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Economy-wide spending attributable to infrastructure services in Australia was estimated to be 13% of GDP in 2011. This spending is expected to grow proportionate with the economy through to 2031. The transport, ports, telecommunications, gas pipeline and airport sectors are all projected to grow faster than GDP in coming years. In contrast, the water, petroleum, electricity, non-urban road and non-urban rail sectors are all projected to grow at a slower rate than GDP.

The rise of disruptive technology is by now a well-worn topic for savvy investors around the world. Yet, despite the phrase’s ubiquity in the global business lexicon, only a few technological developments turn out to be truly transformational. For infrastructure investors, driverless vehicles, 3D printing, energy storage, renewable electricity, the internet of things (IoT) and maintenance drones are all examples of disruptive technologies that will meaningfully impact demand and supply dynamics for Australian infrastructure.

These disruptive technologies have become a source of innovation and growth for the industry. Infrastructure exists to provide services and the quality and cost of these services is in constant focus. Technological disruption can provide many benefits, such as improved asset utilization, lower operating costs, reduced environmental impacts and increased employee safety rates.

As well as the potential for improved service and lower cost, disruptive technology is expected to result in new emerging patterns of demand. Examples include changing traffic patterns resulting from driverless vehicles; changing demand from centrally generated electricity to distributed generation and energy storage; and changes in labor requirements as technological mechanisms are employed for activities like check and maintenance.

Given these inevitable supply and demand side changes, disruptive technologies have the potential to challenge existing regulatory frameworks, finding ways to supply consumers with infrastructure that is easier to duplicate and open to competition.

The Australian infrastructure sector has historically required significant funding, being highly capital intensive. The current level of public sector expenditure, especially in sectors that remain largely funded by government rather than employing user pays models, may be unsustainable in the face of increasing budget pressure to fund welfare and health services. Given this, ensuring strong conditions to facilitate private sector investment in Australian infrastructure is fundamentally important.

Most Recent Private Sector Investments into Australian Infrastructure

Source: Bank of America Merrill Lynch * BofAML acted as sell-side financial advisor

* Source: Australian Bureau of Statistics

Nov 15 TransGridHasting, CDPQ, Tawreed,

Wren House, Spark10,258 14.5x

Feb 16 Mortlake Terminal Station* AusNet Services 110 12.9x

May 16 Mortlake Pipeline* SEA Gas 245 14.4x

Dec 15 Pacific Hydro* China State Power Investment Corp. / /

June 16 Cullerin Range Wind Farm* Energy Developments Pty Ltd. 72 11.6x

Date Infrastructure Asset Buyer EV (A$m) EV/EBITDA

June 2016

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Economy-wide spending attributable to infrastructure services in Australia was estimated to be 13% of GDP in 2011. This spending is expected to grow proportionate with the economy through to 2031. The transport, ports, telecommunications, gas pipeline and airport sectors are all projected to grow faster than GDP in coming years. In contrast, the water, petroleum, electricity, non-urban road and non-urban rail sectors are all projected to grow at a slower rate than GDP.

The rise of disruptive technology is by now a well-worn topic for savvy investors around the world. Yet, despite the phrase’s ubiquity in the global business lexicon, only a few technological developments turn out to be truly transformational. For infrastructure investors, driverless vehicles, 3D printing, energy storage, renewable electricity, the internet of things (IoT) and maintenance drones are all examples of disruptive technologies that will meaningfully impact demand and supply dynamics for Australian infrastructure.

These disruptive technologies have become a source of innovation and growth for the industry. Infrastructure exists to provide services and the quality and cost of these services is in constant focus. Technological disruption can provide many benefits, such as improved asset utilization, lower operating costs, reduced environmental impacts and increased employee safety rates.

As well as the potential for improved service and lower cost, disruptive technology is expected to result in new emerging patterns of demand. Examples include changing traffic patterns resulting from driverless vehicles; changing demand from centrally generated electricity to distributed generation and energy storage; and changes in labor requirements as technological mechanisms are employed for activities like check and maintenance.

Given these inevitable supply and demand side changes, disruptive technologies have the potential to challenge existing regulatory frameworks, finding ways to supply consumers with infrastructure that is easier to duplicate and open to competition.

The Australian infrastructure sector has historically required significant funding, being highly capital intensive. The current level of public sector expenditure, especially in sectors that remain largely funded by government rather than employing user pays models, may be unsustainable in the face of increasing budget pressure to fund welfare and health services. Given this, ensuring strong conditions to facilitate private sector investment in Australian infrastructure is fundamentally important.

Competition for infrastructure investments is increasingly global, from superannuation and pension funds, as well as international corporates who are looking for geographical diversification within the sector. The majority of infrastructure investors prefer to make their investments directly, typically as part of a consortium, as it gives them greater flexibility and enhanced control. This adds complexity to investment processes.

Investors identify Australia’s long track record in infrastructure, stable economic, fiscal and legal frameworks as key features driving interest in the market. Demonstrating that Australia can navigate technological disruption effectively by global standards, in terms of policy, planning and regulation, will be critical to maintaining this interest.

Even in this era of technological disruption, there will be an ongoing requirement for significant capital investment in Australian infrastructure over the coming decades. This provides an opportunity for the financial sector to play a role in creating innovative solutions to meet the changing market needs.

Australian population growth

Source: Australian Bureau of Statistics

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