SAVCA speaks to professionals from two infrastructure members, Vuyo Ntoi (VN), Investment Director – Head of Southern and Central Africa at African Infrastructure Investment Managers (AIIM), and Emile Du Toit (ED), Head: PAIDF 2 at Harith General Partners.
 
What role do credit ratings play for private equity investors into infrastructure projects?

VN: Credit ratings are key part of the considerations that private investors in infrastructure projects take into consideration. Unlike standard commercial companies, infrastructure projects tend to have one key counterparty, either in the form of a regulator or a single customer. To elucidate this further, such a counterparty could be an entity like SANRAL, in the case of private toll roads, which plays the role of concession grantor and regulator. In the independent power space in South Africa, Eskom is the single client purchaser of power.

The credit ratings of these key counterparties, or the organisations standing behind them (as credit enhancers), such as National Treasury, are key, as they are an indicator of the ability of the key counterparties to stand behind their obligations under the project agreements. These could include the obligation to repay all the debt under certain circumstances, such as project termination, or the simple obligation to pay for power supplied under a power purchase agreement (PPA).

The ratings are important in that they allow the private investor to assess the merits of the investment and price their capital to be invested, based on the perceived risk. In certain circumstances the perceived credit risk might be so great that the investment opportunity is not pursued by the private party.

In the current environment of ratings uncertainty, it might be important to highlight that the credit rating that is really important is the local currency rating rather than the US Dollar rating, which plenty of market operators are focusing on.  A significant proportion of the obligations of Treasury and SA parastatals are local currency in nature.

ED: The only impact of credit ratings (in the case of government credit ratings) in private equity investments are the potential impact on the cost of debt that these private equity investors can raise from the commercial banking market. 

As the credit rating of a specific country deteriorates, the cost of debt (especially if raised from foreign investors) that can be raised for large infrastructure projects in that country also increases, ultimately leading to a much higher unit cost for the end-user of the infrastructure services (such as power, water or transport). 

The reason for this is because the ultimate off-taker in private sector infrastructure projects are either the public sector utility or a government backed centralised buyer, and if the credit quality of such an off-taker is perceived to be lower (which is the case when credit ratings deteriorate), the risk of providing debt to such a project increases and the cost of that debt then also increases.

How do Environmental, Social and Governance (ESG) practices feature in mobilising private equity in sub-Saharan Africa?

ED: The majority of Investors in Private Equity funds are large institutional investors that subscribe to the highest standards of ESG.  One such example is the UN PRI code, to which for example GEPF and other major pension funds subscribes.  As a result, it is critically important for Private Equity Fund Managers to ensure that the investments they conclude always complies with the highest ESG standards.

VN: The major infrastructure funders operating on the continent adhere to the Equator Principles and the IFC Performance Standards, which govern the environmental, social and governance aspects of projects. As a result, the Projects that these entities pursue have to be compliant with these standards.

Private equity investment in African infrastructure has been an emerging theme over the past decade and more. What are your views on the current opportunities for infrastructure investors on the continent? What is the interplay of risk, opportunity and investor appetite?
 
VN: Private equity infrastructure investment in Africa is a burgeoning industry that is attracting a large number of new players. This phenomenon could be a boon for the sector or prove to be a challenge.

Our experience has been that in large, well-organised markets, there has been plenty of demand for investment opportunities. An example of this has been in the South African renewables market, where a large number of international infrastructure players have entered the fray and increased competition for project equity. The result of this has been positive for the SA power consumer, who will receive very competitively priced renewable energy in their mix, but has given some equity investors pause, as returns have come under pressure.

In other markets the same phenomenon has taken hold to a limited extent, resulting in project economics that are not necessarily reflective of the risk being taken on. The caveat to that has been that projects outside South Africa have largely been hard currency (usually US Dollar or Euro) denominated, and return margins have largely remained the same, as US and Euro interest rates have remained close to zero. We believe that seasoned infrastructure equity investors should look through the economic cycle when determining their required returns.

We believe that the growth in the number of parties interested in investing in African infrastructure will also crowd in local pension funds and other longer-term capital, which will create a natural exit market for funds investing in infrastructure across the continent.