Like a physician with her stethoscope at the outset of a check-up, astute shareholders and directors should use the level and trend of a utility’s market-to-book ratio (MtB) as one of the first...
Banking on Predictability
A renewed capital investment structure is required for long-term investment in power infrastructure.
The bank markets and the long-term fixed income markets, or institutional investors, have long memories, and their pain is still fresh. Over the last few years, they have had to watch their investments in power infrastructure become distressed, bankrupted, or reorganized.
Even as we argue that the infrastructure financing markets may have stabilized for the time being, both from a financial and a fundamental standpoint, the undeniable fact is that investors still remember what's happened in the United States, and they remember privatizations in foreign countries where they experienced similar losses. In short, investors are wary.
Without mention, the ability to attract investment is central to developing new infrastructure that will help resolve many of the power issues we face today.
Yet, given the recent power markets, and investor sentiment, many utilities could not be blamed for believing that sources of funding have dried up.
Because of our extensive activity in the market, Lehman Brothers has a different perspective. There is money and there are opportunities that lie in the infrastructure financing market today-but only with the right capital investment structure.
Finding Asset-based Solutions
In the last few years, many investors have experimented with a number of capital investment structures, whether unregulated, regulated, or diversified hybrid models, with mixed results. Today, the question from investors is, how do you then come and participate in the next asset-based solution?
That is quite a difficult question to navigate, but we believe, with respect to infrastructure policies, the employment of a financing mechanism similar to that used with Public Utility Regulatory Policies Act (PURPA) contracts would be extremely well received by infrastructure investors.
If you look at the construction of bilateral PURPA contracts, they generally separated fixed and variable components, not unlike gas pipelines. The fixed component was meant to cover certain items, and the variable component was meant to cover-off certain items. The financing markets generally viewed that as a rate base and financed it as such, but it favored an arbitrage of debt over equity.
The total composition of debt in the capital structure showed numbers that were higher than those for the utilities that were the obligors on the power purchase agreements. That worked, and it still works. Those contracts are still valid. In fact, investors are buying assets to get to those contracts and leveraging them again. Furthermore, these contracts would mitigate the unknown risks.
These PURPA contracts are old and cold at this point, but the fact remains they are long-term contracts. Many of those contracts are still operative in nature. In fact, many of the projects that were financed using these contracts have been gobbled up in the merger and acquisition market over the past two years, as financially distressed parties have looked to raise capital in the most efficient way. In some cases, the value of these assets backed up by these contracts were more valuable to them in a sale context than selling their own corporate securities, either debt or equity, to the extent