Digital disruption is transforming infrastructure deals
As the co-leads of the U.S. Infrastructure activity at Ardian, a world leading private investment house with $82 billion in assets under management and headquartered in Paris, our work gives us a unique vantage point into the shifting global infrastructure landscape. Our firm has infrastructure investments across the globe, and we have seen that the days when infrastructure investors could afford to think only about concrete, glass and steel are over. Digitalization is spreading in all directions, transforming the role that these physical assets play in our lives.
As a global leader in infrastructure investment, we have been analyzing digital disruption in our industry for several years and recently published Augmented Infrastructure, a comprehensive study we undertook with French digital consultancy Fabernovel. Our research shows how blending digital services with real assets can create new revenue streams, generating huge flows of real-time data that can benefit owners and users alike. But as the infrastructure markets evolve, stakeholders need to understand what it takes to succeed in that digitalized future.
One of our major goals with Augmented Infrastructure was to set out a new framework for assessing the impact of digitalization on infrastructure assets. This is critical because the competitive landscape is changing quickly: infrastructure owners and digital service providers are both trying to own the relationship with the end-user, and this is disrupting up the infrastructure value chain.
We’ve seen clear examples of this convergence between infrastructure owners and digital service providers in Netflix’s evolving relationship with Verizon and Comcast. In 2014, Netflix’s user growth put heavy pressure on the U.S. networks’ capacity, and initially publicly criticized Verizon, accusing of reducing the bandwidth allowed to its users. Eventually the two agreed on a partnership to secure faster speeds from its major carriers.
Other digital services, however, are becoming infrastructure owners themselves, investing heavily in cloud computing and renewable energy capacity. Google now owns 8.5% of the world’s submarine cables, signaling the emergence of a vertically integrated business that claims to be able to support a quarter of global internet traffic. Questions over whether services like this should be unbundled, as the European Union has done with its energy market, have huge potential importance for the future value of these infrastructure assets.
Similarly, our report highlights developing competition issues with the emergence of potential digital infrastructure monopolies, such as Google Maps. In July 2018, Google Maps reviewed the platform’s tariff policy to increase its cost per request by 1400% - i.e the cost paid by a service using the API each time a new user executes a request based on it. This opened a new revenue opportunity for Google thanks to its dominance in online mapping.
Faced with this new environment, how should we rethink our valuation methodology?
We have identified five critical attributes, which form the foundation of a new approach to value creation. Augmented Infrastructure assets should be:
Intelligent: capable of monitoring their operational performance and capacity in real time and maximizing their efficiency of the best level of service they can deliver. Our portfolio company Ascendi, a motorway operator, created SustIMS, a system developed with two Portuguese universities, to monitor the condition of its assets, schedule inspections, assess risks and model deterioration and maintenance costs.
Open: forming part of an ecosystem that is open to other players and can support additional services. Amsterdam’s Schiphol Airport has opened its API platform to give external developers access to its business data, enabling them to create services that will benefit their customers as well as airport users generally.
Prolific: able to support a growing range of services and provide opportunities to monetize them. 5G mobile services have the potential to become “the platform of platforms”, providing the basic infrastructure that will enable connectivity for everything, everywhere. It will have 10 times the capacity of 4G, one tenth of the latency and consume 100 times less power per unit of data transferred.
Resilient: able to absorb shocks and adapt to a changing environment. In 2017, our portfolio company Indigo converted 1600sqm of car parking in the Paris district of La Défense into co-working, events and exhibition space. This met local demand for new facilities, adjusted to reduced demand for parking space and protected the asset’s long-term cash flows.
Impactful: aiming to have a positive impact on society, and as a minimum working to reduce negative externalities. Our renewable energy platform in Italy, 3New, has multiplied its generation capacity ten-fold since 2007, creating sustainable jobs and providing clean energy to thousands of customers. Its growth reinforces the ESG principles that are central to Ardian’s investment strategy.
Ardian Infrastructure now uses the Augmented Infrastructure scoring system for digital due diligence in all our investment memos. We intend to review our existing portfolio annually using this model. The goal is to score every asset or prospective transaction under each of the five headings to assess what the company is doing and benchmark it against its peers to identify opportunities and best practices. The scores give us a map of the market opportunity under each criterion, indicating where the major value creation opportunities and obstacles lie.
These attributes apply to differing degrees depending on the asset involved: an airport is likely to be far more prolific than a windfarm, for instance. But using the Augmented Infrastructure framework should allow all stakeholders – from infrastructure owners and operators, to digital service providers, public authorities and private investors – to gain a better understanding of how their assets are likely to perform in the future.
We firmly believe that using our framework to assess and value infrastructure assets will open up new value creation opportunities. Equally, we think it will have defensive benefits, by helping infrastructure owners to anticipate disruption that could reduce the visibility of the asset’s long-term earnings potential.
Inevitably, in an economically critical sector such as infrastructure, regulation remains a central concern. This is partly because the digital service providers that are now becoming infrastructure players come from a much more loosely regulated world – technology – than the asset owners and operators whose markets they are moving into.
To meet this challenge, infrastructure owners and operators must innovate and update their assets, and they need to be able earn a return on these investments. But here again, regulation gets in the way. Current concession agreements most often put greater rewards on physical capex that will expand the capacity of an asset, rather than on digital innovations that could improve its flexibility – even though these could lead to end-users receiving a better service.
The industry is therefore going to require innovative thinking from public authorities and governments to frame new contracts that incentivize a wider range of investment. However, we believe infrastructure investors cannot afford to wait for that shift to happen. The cost of standing still and failing to invest in digital innovation is rising.
We are convinced that investors that are not actively working on the sustainable transformation of their infrastructure assets could be destroying value without realizing it because the risk of obsolescence is increasing. The GPs that emerge as leaders in Augmented Infrastructure will create more value than their peers and enjoy a true competitive advantage.