One Man’s Trash | Evaluating Environmental Infrastructure Assets
The concept of something having contradictory qualities depending on the eye of the beholder can be traced back to the first century B.C. Whether the Roman poet and philosopher Lucretius coined the expression, or merely repeated it, his is the oldest known reference: "Quod ali cibus est aliis fuat acre venenum" (what is food for one man may be bitter poison to others). You may be more familiar with the modernized adaptation: "One man's trash is another man's treasure."
At Hamilton Lane, we've noticed an interesting trend over the last five years in our infrastructure deal funnel. Among the main subsectors of infrastructure that we track — energy, renewables, telecom, environmental and transport — environmental is the fastest-growing category by number of deals. While historically the environmental subsector included assets similar to renewables, they didn't always fit perfectly into that category. For example, it's difficult to argue that burning garbage at an energy-from-waste facility is a "renewable" source of energy. However, it's easy to quantify the environmental benefits of preventing that garbage from emitting greenhouse gases while rotting away in a landfill. And if you can generate electricity from it at the same time, that's quite literally turning trash into treasure.
When analyzing the underwriting of environmental deals, it becomes clear that environmental infrastructure assets exhibit three key characteristics that make them attractive in today's uncertain economic environment:
1. Inflation Indexation: Infrastructure has long been touted as a hedge against inflation thanks to long-dated contract structures that generally enable asset owners to raise their prices by a flat 2-3% per year. That structure works well for asset owners when inflation is ≤ 3%, as it has been since the outset of the private infrastructure asset class roughly 20 years ago. However, what if inflation is materially higher than 3% for an extended period of time? And what if your asset is locked into a 20-year contract? This is where environmental infrastructure assets tend to have a leg up on the other subsectors. Inflation-linked pass-throughs tend to be more common on waste, water, recycling and other environmental asset contracts, enabling owners to pass increased operational expenses through to their customers in real-time.
Average Performance During Periods of Elevated Inflation
(≥3%); 1999-TTM Q3 2022
Expected Inflation Over the Next 10Y vs. Past 10Y Inflation
2. Relative Value: The energy, renewables and telecom sectors have made up 61% of all deals closed by private infrastructure investors over the last five years. Transaction multiples in these sectors were driven up by a steep increase in demand, an overall increase in competition in the private infrastructure space and an abundance of cheap financing. In contrast, environmental assets tend to exhibit lower transaction multiples on average due to their stability, smaller size and highly fragmented nature. Today, we're finding that environmental infrastructure assets provide an outsized opportunity to assemble, rather than buy, high-quality, scaled platforms at attractive relative valuations.
Private Infrastructure Transactions - Last 5 Years
Avg. EBITDA Purchase Multiple - Trailing Five Years
3. Necessary Service: The majority of environmental infrastructure assets provide an essential service to facilitate the functioning of a developed society. While running a fiber connection directly into our homes that loads Netflix in stunning 4K resolution 20 nanoseconds faster would be nice, our lives would not be materially different if that never happened. However, how long would developed societies last without the garbage man showing up? Dare we say a month? Maybe two? How long would those societies last without access to clean drinking water or sewage treatment facilities? Unfortunately, Lucretius doesn't have any wisdom to offer us on this matter, as he was born in the first century, when Netflix still delivered DVDs in the mail. Nevertheless, I have a feeling that he might agree with us on this point.
U.S. Waste-to-Energy Volumes
Assets that fall into the environmental infrastructure category have proven to be remarkably resilient during prior downturns and periods of market uncertainty due to their necessity, high barriers to entry and relatively small share of customer wallets. Given the current uncertain economic environment, we anticipate infrastructure General Partners will continue to increase their focus on assets that exhibit real inflation indexation, relative value and recession resiliency.
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
