post-crisis investing: how global investors employ new models

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InduStreams.com & Port-Investor.com

POST-‐CRISIS INVESTING:

HOW HUTCHISON AND OTHERS EMPLOY NEW MODELS

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Introduc>on

It used to be all about the markets, well, mostly at least. Which markets are hot and which are not (and “picking the winners”). Whereas this is s>ll something the global port investors clearly obsess about, a clear difference is possible to spot for those who have been around some years in the sector. In short, they are star>ng to focus much more on the models they use to invest and extract value from their porColios. And as part of that they employ models that assume much more vola>lity in the markets than previously. In this short piece we will be illustra>ng this trend with a few samples and uncover some of the key things the best in the market are doing differently.

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What Hutchison and others are doing (1)

One of the most notable cases was the Hutchison Port Trust IPO in Singapore. In one single move Hutchison Port Holdings (HPH) transformed their return exposure completely for all their Pearl River Delta (PRD) assets when they IPO’ed them on the Singapore Stock Exchange. Not only did they secure a substan>al part of the poten>al future cash flows they also placed themselves in a role that gives them many >mes the upside compared to the stake they have leP in the game. In 2010/11 when HPH was faced with decisions concerning their PRD porColio, including their very profitable Hong Kong and Shenzhen ac>vi>es, they probably looked at something resembling the spread of poten>al returns shown on next slide.

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Note: The figures used are just samples, they do not reflect specific es>mates (and we are only talking about HPH here rather than the wider set of owners behind the assets for simplifica>on).

Market drivers

Return (NPV)

-‐$5bn

+$5bn

Market drivers

Return (NPV)

-‐$5bn

+$5bn

The diagram displays a spectrum from the least op>mal to the most op>mal market condi>ons and a corresponding value of the HPH PRD assets (in NPV) when matched against a poten>al sale (or in this case proceeds from an IPO) at $5bn.

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In the diagram to the leP (previous slide), HPH would be assuming that under reasonable market condi>ons they would enjoy the same future cash flows as what they would gain in proceeds from a sale and obviously would gain more by retaining their holdings under more favorable condi>ons (and vice versa). Whether HPH saw more downside than upside has been speculated on and it is of course en>rely possible that they might have been looking at a fla]ening of the upside poten>al as illustrated in the diagram to the right given the market supply/demand situa>on and associated rate environment. That however is not so relevant to the issue at hand. The interes>ng part is the constella>on they put in place as part of their divestment. Had they just divested the majority of the holdings you could argue that they would have simply reduced up-‐ and downside. But instead they made a managing role for themselves, not en>rely different from the more tradi>onal PE structures, in which they receive bonus based on performance. BUT this was done without adding to the down side (see next slide).

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In short HPH substan>ally reduced their down side and instead put in place a structure that would allow them exposure to a poten>al upside many >mes that of the capital deployed.

Market drivers

Return (NPV)

-‐$5bn

+$5bn

Market drivers

Return (NPV)

-‐$5bn

+$5bn

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What Hutchison and others are doing (5) A more recent example would be the China Merchant Holdings Interna>onal (CMHI) acquisi>on of part of the CMA terminal porColio for a reported amount of €400mn. Very simplified the return exposure might have been as outlined above in the diagram to the leP. But it is possible, as was rumored, that CMHI nego>ated a guarantee providing them with a minimum return for the first 7 years of 7-‐8%, substan>ally reducing the poten>al downside of the investment (as outlined in the diagram to the right).

Market drivers

Return (NPV) +€400mn

-‐€400mn

Market drivers

Return (NPV) +€400mn

<€250mn

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The general trend

The stated examples are just a few snippets of what is visible to the public when looking at press releases and other such sources. From direct deal involvement it is clear to us that in par>cular the more established operators and investors are star>ng to behave very different in their investment and porColio management approach. It does, however, not look like an across the board change in the way these organiza>ons work internally. Governance and procedures seem to remain the same. As example in the form of some one-‐line projec>ons to support a business case that goes to the board. But in these organiza>ons are people who have been through many investment cases and today sit with what is oPen a mixed bag of assets. These decision-‐makers are not relying on predic>on accuracy anymore. So what are they doing?

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A. Avoiding predic>on failure (1)

It used to be the general belief that by pulng enough resources to work you should get a fairly precise es>mate of a poten>al set of market drivers. Drivers that in turn could be used to make a business case and in general form a business model around to op>mize returns for the specific investment in ques>on.

Market drivers

Return (NPV)

Market drivers

Return (NPV)

-‐$500mn

+$500mn

-‐$500mn

+$500mn

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A. Avoiding predic>on failure (2)

But with a market now li]ered with projects that in the worst case have no cargo or prospects of gelng any material such, this is changing. As men>oned for some reason it s>ll seems to be the norm in terms of the actual governance and process surrounding decision-‐making for inves>ng and asset management but the experienced execu>ves are not buying it. And so they simply assume a much larger poten>al fall-‐out range (see right diagram versus leP diagram above). For a more in depth look at market vola>lity in the port markets, please see: www.port-‐investor.com/market-‐vola>lity

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B. Thinking in business/inv. models (1)

With that backdrop it becomes important to dis>nguish between market drivers and the model you employ to transform these into return. Another way to think of this would be to consider the market drivers as the variable “x” and the business or investment model employed as “f(x)” and the returns generated from these as “y”.

Market drivers (or x)

Return (or y)

Business/investment model (or f(x))

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A few examples given below on what cons>tutes the aspects considered in terms of drivers versus model.

Market (drivers) Model (inv./business)

§  Volume §  Rates §  Unit costs §  Tax §  Interest rates §  Etc.

§  Concession terms §  OperaOng model §  Expansion, phasing and

other opOons §  Funding and ownership

model §  Deal structure §  Etc.

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And of course the goal for these operators and investors is to create a model that looks like the model to the right and avoid the one to the leP (or transform it). In other words working to employ a model that provides most possible upside and least possible downside when considering a wide range of possible market scenarios.

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This is in stark contrast to what most are s>ll doing today, which is op>mizing factors in the model around a decision base or single point rather than the whole spectrum. Working with increased focus on the model itself also has the benefit that through the full cycle from pre-‐ to post-‐investment, you have control of the model, you make the decisions that govern it. Not so for the market drivers which you can at best try to impact. Or to put it another way, you may not be able to dictate the terms for e.g. a specific concession but ul>mately you decide whether or not to take it. Ironically despite this, mistakes by investors in terms of the models employed have previously at large been ignored (although they have been in full control of these). This as opposed to market predic>on mistakes that have been discussed in great detail (despite the obvious limita>ons cons>tuents have in this regard).

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C. Using “real op>ons” (1)

In a world that is fully predictable op>ons have no value. But in a world with plenty of variance they are tremendously valuable. And what is more, they permeate all walks of the models we employ and thereby our return exposure. As very simple illustra>on we can use put op>ons and expansion op>ons (or exclusivi>es that secure upside) to illustrate how real op>ons impact return exposure (see next slide). In the leP diagram restric>ons or lack or op>ons or en>tlements is curbing the upside, whereas a put op>on is used to limit the downside in the diagram to the right.

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C. Using “real op>ons” (2)

Real op>ons or flexibili>es and en>tlements come in all shapes and forms. Some are very obvious and easy to spot whereas others are more complicated and hidden in legal terms or inherent in e.g. the chosen opera>ng model.

Market drviers

Return (NPV)

Market drivers

Return (NPV)

-‐$500mn

+$500mn

-‐$500mn

+$500mn

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What comes next?

In the next ar>cle on this topic we will look at some of the big implica>ons this development is having on the sector. This ar>cle is part of our “Real Payoff” ini>a>ve, which you can read more about on: www.industreams.com/real-‐payoff We encourage anyone who wants to share specific views or cases to reach out and explore the challenges and possibili>es of this topic with us. You can reach us directly on: [email protected]

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