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Private Equity Targets a Risky Stagflation Bet

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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 in April 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 Plc 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 market’s 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 monopolize 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.

There’s still enough competition between private equity buyers to keep prices in the M&A market high. Auctions will be won by those funds willing to accept the lowest returns as they throw ever larger wads of equity into transactions. Whereas a conventional buyout would target a 20s-percent return, infrastructure fund may settle for less than half that.

Accepting low returns leaves no margin for error. Yet infrastructure is not a one-way bet. In towers, for example, the risk is that satellites or alternative ground-based networks come to be a serious competitive threat. Consolidation among mobile operators could limit the universe of customers. And telecoms operators that have shifted from mast landlord to mast tenant have a reason to minimize rental costs that wasn’t there before.

Of course, private equity and infrastructure funds are drawn to situations where stock-market investors are fretting and potentially missing the long-term upside. Macquarie’s tilt on gas sits ill with the energy transition until you consider the possibility of adapting the network for hydrogen power. And it’s not as if private equity has no pain barrier: A £15 billion ($18 billion) deal for UK Power Networks recently collapsed because vendor CK Infrastructure Holdings Ltd. wanted a higher price, prompting buyers KKR and Macquarie to withdraw, the Financial Times reported.

But without shareholders asking them to immediately justify every move, infrastructure funds’ discipline on pricing will have to come from within.

More From Bloomberg Opinion:

• The ECB Needs a Formidable Tool Against Fragmentation: Marcus Ashworth

• Europe’s Natural-Gas Crisis Is Worse Than It Looks: Javier Blas

• Boris Johnson’s Fall Is Populism’s Latest Act of Self-Destruction: Adrian Wooldridge

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Chris Hughes is a Bloomberg Opinion columnist covering deals. Previously, he worked for Reuters Breakingviews, the Financial Times and the Independent newspaper.

More stories like this are available on bloomberg.com/opinion

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