International Public Partnerships — Consistently and responsibly delivering

This note initiates Edison’s coverage of INPP. We have also published an interview with Chris Morgan, senior investment director at Amber Infrastructure, in which he discusses the company’s strategy, performance and prospects.

INPP is a Guernsey registered investment company. It listed in November 2006 and its shares are traded on the Premium Segment of the London Stock Exchange. It is a member of the Association of Investment Companies (AIC) and a constituent of the AIC Infrastructure sector.

The company’s aim is to ‘provide investors with stable, long-term, inflation-linked returns, based on growing dividends and the potential for capital appreciation, by investing in a diversified portfolio of infrastructure assets which, through active management, meets societal and environmental needs both now and into the future’. This has been successfully achieved since listing with the company building a strong track record of generating consistent and predictable cash flows and financial returns, commensurate with its relatively low-risk investment strategy. We see strong reasons to expect this to continue.

In summary, the key elements of the investment case, discussed in detail in this note, include:

DPS growth since listing has been in line with the company’s long-term target growth rate of c 2.5% pa.4 However, for FY23 DPS was increased by 5% and the FY24 DPS is targeted to increase by 3% to 8.37p. Off this higher base of DPS, the company targets sustainable and predictable growth in line with the long-term target. Accordingly, the FY25 target DPS is 8.58p (+2.5%).

This accelerated near-term DPS growth reflects the high level of portfolio cash flow to inflation (0.7). It has enabled shareholders to benefit more immediately from the positive impact that the recent high level of inflation has had on the predicted cash flows from the portfolio.

The FY23 DPS was 1.1x covered by net operating cash flows before capital activity and dividends have been 1.2x covered on average over the past 10 years. Including disposal proceeds, FY23 DPS cover was 1.7x.

The net asset value of INPP reflects the fair value of its investments, which in turn is based on the future projected net cash flows, discounted at appropriate discount rates. While these same cash flows are reflected in the dividend policy, the level of dividends is set at a level that the company expects to be progressive and sustainable. The timing differences that result mean that it is important to consider NAV total return and not just dividends.

During FY23, NAV per share decreased to 152.6p from 159.1p share. The change is more than accounted for by a change in the discount rate assumption (comprising bond yield and risk premium), discussed later in this report. The underlying ‘NAV return’ of 9.6p (6.0% of the opening value) is driven primarily by the unwinding of the discount rate applied as well as higher than assumed inflation. It more than covered dividends paid to shareholders (7.9p, comprising the FY22 final DPS and FY23 interim DPS).

The NAV total return (the change in NAV adjusted for dividends repaid and reinvested) over five and 10 years and since inception is materially ahead of the broad UK equity market and inflation. Shareholder total return (the change in the share price adjusted for dividends repaid and reinvested) has also been strong over the longer term, but has been held back over the past two years by a broad de-rating of the sector. While it is unrealistic to expect INPP to fully decouple from listed peers, the company has taken clear actions to maximise the value of its shares, to which we would add active engagement with investors, and we believe that the fundamentals of the infrastructure sector remain very strong.

The end-FY23 discount rate of 8.4% represents the expected annualised growth of NAV, based on currently projected cash flows. On the same basis, an investment at the current 18% discount to NAV implies an annualised projected net return of 9.4%.

As inflation and interest rates began to rise through 2022, the listed infrastructure sector has significantly and broadly de-rated. INPP’s assets continue to perform well, it is a beneficiary of higher inflation and it has a strong level of protection against higher interest rates, yet its shares have moved from trading at a premium of more than 20% to an 18% discount. The INPP discount is in line with the AIC Infrastructure sector, shown in the peer group comparison section of this report, but this is a diverse group and, as we explain later in this report, we do not believe a direct comparison is appropriate given the characteristics of the company’s portfolio and its long track record of performance. Across the broader ‘alternatives’ investment company sector, including renewable energy infrastructure, private equity and real estate, discounts to NAV are in general much higher.

In response to the prevailing discount, the board committed to taking a number of actions. In addition to revising the dividend targets, these included reducing of the company’s CDF, realising value from the existing portfolio and repurchasing shares at an accretive discount to NAV. More than £200m of assets have been sold at prices in line with or above the investment fair value, providing evidence of both the robustness of portfolio valuations and the strength of investment demand. Supplemented by existing cash flows, the proceeds have enabled full repayment of the CDF, the recycling of capital into previously committed, accretive new investment and the launch of a £30m share repurchase programme.

INPP’s flexible, £350m CDF enables it to smooth the cycle of acquisitions and disposals. However, with a cost of 1.7% plus SONIA it had become relatively more expensive. At end-FY23, £65m was drawn, down from £107m at end-H123, and has since been fully repaid. Debt liabilities in the form of letters of credit, amounting to £14m, remain, backing outstanding commitments to invest in two Australian availability-based public private partnerships (PPPs), but meanwhile the all-in cost is modest at around 1% pa.

Repayment of the outstanding debt paved the way for the commencement of share repurchases. The initial programme started in early 2024 and is expected to run for a period of up to 12 months. As further funds become available, the board says that it may consider increasing the £30m that has been allocated. As of 23 April 2024, 5.8m shares (0.3% of shares in issue) had been repurchased for £7.4m. We calculate an average price paid of c 127p per share, a discount of c £7m of shares have been bought back at an average price of 123.6p, an almost 17% discount to the end-FY23 NAV per share.

The two disposals, which generated combined proceeds of £212m, are:

To reflect more recent changes in the macroeconomic environment, particularly higher inflation, to which expected project revenues are strongly correlated, the board has introduced a new long-term return target for new investments, which was previously set at 7% per year.

Rather than setting the new target at a fixed level, it has opted for a more dynamic approach and has identified a range of qualitative factors to inform new investment decisions. These include:

By these measures, the returns available on share repurchases set a high bar but do not preclude all investment. As we highlight above, the net return that is currently available to the company on share repurchases is 9.4%.

In February 2024, INPP completed the commitment to acquire the Moray East OFTO for £77m, partially deploying the proceeds of the OFTO senior debt transaction. The company says that the projected returns on the investment were considered favourable relative to alternative capital allocation. Moray East OFTO is INPP’s eleventh OFTO investment and in addition to the projected investment returns, it has increased the company’s contribution to the UK’s transition to a net zero carbon economy.

During 2023, the company had completed on an existing £107m commitment to acquire five operational PPP assets in New Zealand, its first investment in the country. These were sourced by Amber, demonstrating its ability to originate suitable investments in new geographies. Total investment for the year of £108m also included a small follow-on investment in Ealing Building Schools for the Future scheme.

The investment adviser is Amber Infrastructure (Amber), a specialist investment originator, asset and fund manager with a local presence in 12 countries with a team of over 180 professionals. It has funds under management and advisory of c £5bn. INPP highlights Amber’s ability to actively and responsibly source and manage the company’s investments, and enhance their performance, as being one of its core strengths.

Amber has a team of over 45 asset managers, including a dedicated ESG team, with sector expertise and presence across the geographies in which INPP is invested. The team is responsible for the oversight and optimisation of INPP’s investments, with the key focus being to deliver long-term benefits for stakeholders by meeting or exceeding performance targets. Amber’s involvement in the management of each asset varies depending on the nature of the investment; it either manages the day-to-day activities or exercises its responsibilities through board representation and engagement with management teams.

Working with public sector clients, partners and service providers, Amber seeks to ensure the investments are being managed both responsibly and efficiently, creating value for shareholders while recognising the broader value of the investment to society and/or those that use them.

On behalf of INPP, Amber undertakes its own in-house research, as well as drawing on external expertise, to identify new investment opportunities and developments that may impact existing investments. This includes researching current ESG issues but also extends to the emerging technologies that are driven by, and support, environmental and social change.

Amber has significant expertise in the management of PPP projects, and directly manages the company’s investments, which have consistently fulfilled their key operational objectives outlined in contractual agreements. For FY23, 100% of forecast project distributions were received (FY22: 100%). Asset availability has been consistently strong and in FY23 was 99.8% (FY22: 99.8%), well above the minimum target of 98%. Asset performance deductions were 0.2% (FY22: 0.3%) versus a target of less than 3%. Through its active management of the portfolio, Amber also creates additional value for investors and enhanced value for project counterparties in areas such as refinancing and insurance, leveraging its scale across a large number of projects.

While INPP’s PPP concessions span the next 25 years, there is a growing emphasis on the process of transferring these assets and the associated services (hand-back) to the public sector in a way that avoids important financial and reputational issues. For INPP, the first hand-backs are in 2025 but will not be significant until the mid-2030s. The path of Amber’s capabilities and its sector experience will be important in facilitating an efficient and seamless hand-back. It closely monitors asset condition, maintenance and lifecycle works to ensure the assets meet the necessary criteria for hand-back. Where an asset’s condition does not meet the necessary criteria, the PPP company must undertake remedial works, the costs of which are generally contractually passed to subcontractors.

The investment adviser is a leading contributor to the Infrastructure and Projects Authority working groups, which aim to provide guidance and greater certainty to the public and private sector in the UK in relation to how hand-back should be delivered, to ensure a consistent approach is adopted across the sector.

Amber’s industry knowledge, local presence in all the jurisdictions where INPP invests, and its extensive network of industry contacts and relationships built over many years, represent a strong origination capability. It has sourced all of INPP’s investments since inception and has demonstrated an ability to identify opportunities at an early stage, assess whether these meet the company’s strict investment criteria, and price transactions effectively. The recent investments in New Zealand demonstrate Amber’s ability to originate investments in new geographies which meet the INPP’s investment objectives and consistent with its approach of having a presence in geographies in which it invests, Amber transitioned four members of staff, already actively engaged in the management of these investments to Auckland.

The portfolio comprises over 140 assets, of which the largest number by far are the PPP assets, in aggregate accounting for 42% of the portfolio. The majority of projects or companies that INPP is invested in benefit from availability based or regulated revenues and by fair value, PPP and regulated assets represented 90% of the total and operating businesses the balance. There are just three projects under construction, of which Tideway is by far the largest. Major construction works on the project have been completed, is approaching practical completion, and is expected to be fully operational in 2025.

A summary of the top 10 investments is included in an appendix to this report.

INPP seeks a high degree of influence over its investments and prefers majority stakes where this is possible. By fair value, it fully owns and controls 44% of the portfolio and holds a majority stake in a further 6%. Where it does not hold a controlling stake, it exercises influence through board representation. It also favours being an early-stage investor, leveraging the investment adviser’s extensive industry knowledge, contacts and local presence in key markets.

Investment is overwhelmingly in ‘risk capital’, comprising project level equity and subordinated debt where Amber’s sourcing and asset management expertise can best be used to optimise the risk return characteristics. Post the recent sale of OFTO, just 2% is invested ‘opportunistically’ in senior debt. The weighted average life of the investments is 38 years.5

Sector exposure is well diversified and by geography the investments have a broad spread across developed infrastructure markets. The majority of investment, and most PPP projects, are in the UK. We would also highlight that within the PPP projects, the exposure to third-party service providers is also widely spread with the largest being the Belgian railway services provider, Infrabel (17%).

Asset level debt is non-recourse to the company and the weighted average level of asset leverage is 67%, which INPP says is appropriate and conservative given the security of revenues and protection against interest rate fluctuations. As a proportion of portfolio fair value, 59% of asset debt, and effectively all PPP project debt, is hedged for the full term of the project. For another 31%, the risk of adverse movement in interest rates is limited through protections provided by the regulatory regime. The balance of 10% is primarily related to the investments in operational businesses.

The company’s PPP assets mostly comprise individual concession-based investments, which span various sectors such as education, healthcare, justice and other social infrastructure sectors across multiple jurisdictions. Revenues are nearly always based on the availability of the asset, rather than the extent that it is used, are long-term and are contracted with government or government-backed entities.

While there are many variations, these typically involve the creation of a private company (usually in the form of a special purpose vehicle, or SPV) that contracts to design, build, operate and maintain a social infrastructure asset, to agreed service standards, for a specified period of time, after which the asset reverts to the public sector. Further de-risking the cash flows that INPP expects from its PPP assets, construction costs are fixed in advance, the operation of the assets is outsourced on long-term contracts, and the cost of debt funding is hedged or fixed for the term of the contract. Most PPP revenues are availability based and the only notable demand-based revenue exposure within the PPP assets is in Diablo Rail, in the form of passenger usage, but even here there are mitigations built into the contract.6 Diabolo is a rail infrastructure investment that connects Brussels Airport with Belgium’s national rail network. The majority of its revenues are linked to passenger use of either the rail link itself or the wider Belgian rail network. Diabolo was negatively affected by the restrictions on international travel and national lockdowns implemented during the pandemic, but passenger numbers have broadly returned to pre-pandemic levels and the project has now resumed paying distributions.

During the pandemic, INPP committed a further €24m to Diabolo to protect its liquidity position and ensure compliance with debt covenants, although only €17m of this was utilised.

The use of economic regulation within the infrastructure sector is most often applied to businesses or assets that are monopolistic in nature and is aimed at protecting the interests of consumers while ensuring investors are provided with a fair return on their investment via a predictable and transparent regulatory framework. INPP’s investments in Cadent, electricity OFTOs and Tideway are each regulated by a statutory independent economic regulator, providing it with a relatively high degree of predictability regarding future returns on capital.

INPP’s investments in operating businesses include Angel Trains, BeNEX and digital infrastructure companies. On behalf of the company, Amber holds a board position on each business, through which it engages in their governance with the aim of ensuring effective risk management and driving the overall financial, operational and ESG performance of its investments.

On behalf of INPP, Amber has a strong track record of delivering construction projects safely, on time, to budget and to a high-quality, by understanding the project environment and the potential risks that may occur. It works closely with the contractors, technical advisers and management companies, where applicable, throughout the construction period in order to mitigate risk and ensure the assets can perform as expected and create value for both investors and communities.

Tideway is a significant project, but with major construction works now completed (the defects completion date is in 2028) it is now substantially de-risked.

Two smaller projects are for an extension to the Gold Coast Light Rail Network and for new facilities at the Flinders University Health and Medical Research Building. Both projects are scheduled to complete in 2026 and 2024, respectively. Neither has any current material value within the portfolio.

ESG is core to INPP’s investment process, and the company is committed to integrating ESG considerations across the investment lifecycle. In doing so, it aims to reduce risk, enhance and sustain value creation and drive environmental and social progress for the benefit of all stakeholders.

INPP supports the 2030 Agenda for Sustainable Development that was adopted by the UN member states in 2015 and alignment with the UN SDGs is a key part of the company’s approach to fully integrating ESG into all aspects of its business. All of INPP’s investments support at least one SDG, a demonstration of the positive environmental and social characteristics of its portfolio.

Each year, portfolio investments, current and under construction, provide facilities to support the education of over 180,000 pupils, provide medical treatment to over 610,000 patients, deliver more than 200m low carbon passenger rail journeys and, including the early FY24 investment in Moray East, power c 3.7m homes with renewable energy. When it becomes operational, Tideway will eliminate c 37m cubic metres per year of untreated sewage from discharge into the River Thames

INPP is committed to providing all stakeholders with clear and accurate sustainability disclosures and during 2023 the company developed a set of new portfolio-level key performance indicators (KPIs) to enhance and advance its sustainability agenda. These KPIs are informed by industry best practice and encompass material topics such as achieving net zero emissions, fostering diversity and inclusion, and adhering to the sustainability criteria outlined in the EU Taxonomy, a classification system to assist companies and investors to identify ‘environmentally sustainable’ economic activities to make sustainable investment decisions.

The recently published sustainability report, the company’s third, provides full details of its sustainability agenda and progress.

In this section we focus on the alternative reporting measures provided by INPP, which give a clearer picture of the underlying financial performance compared with the statutory IFRS reporting. An important difference relates to the treatment of capital return from investments that are treated as revaluation movements in IFRS, but form part of operating cash flows from investments, along with the dividends and interest received from them.

Including proceeds from realisations, net operating cash flow from investments after corporate and financing costs was £263.5m in FY23 (FY22: £172.8m). Net operating cash flow covered dividends paid/declared of £151.6m or 8.13p per share by 1.7x or 1.1x excluding the proceeds from realisations.

Only a part of the proceeds of the £200m OFTO transaction were received by year-end. On the subsequent receipt of the balance, the remaining £65m of drawings from the corporate debt facility were repaid.

The end-FY23, fair value of the investment portfolio decreased to £2.8bn, compared with £2.9bn at end-FY22. The net movement includes the cash distribution from investments (£307.1m) and new investments made (£108.1m). The portfolio return of £226.8m primarily represents the unwinding of the discount rate applied to the expected cash flows of the investments (the ‘expected return’), but also includes the impact of achieved performance versus that assumed. In FY23, higher inflation had a positive impact and the benefits of the active management are also captured in the portfolio return. The end-FY23 weighted average discount rate for the portfolio was 8.37%, an increase of 86 basis points versus end-FY22 (7.51%), driven by higher government bond yields. The increase in the discount rate had a negative impact on the fair value of £172.2m, which was partly offset by a £37.4m impact from changes in macroeconomic assumptions that feed into the expected future cash flows of the investments.

Fair values for each investment primarily reflect future projected net cash flows, based on detailed financial modelling, discounted at appropriate discount rates, but are also reviewed against any recent available evidence provided by market transactions for similar assets in comparable markets. Although future cash flows are typically fixed under contracts, there are certain variables that require assumptions to be made, primarily for inflation and interest rates as well for foreign exchange rates and taxation.

The discount rates that INPP uses to value each investment comprise the appropriate long-term government bond yield plus an investment-specific risk premium. Some, but not all, of the rise in bond yields in the past two years has been offset by a tightening of the average risk premia applied, offsetting the expansion seen during the period of historically low, and arguably unsustainable, bond yields. The discount rate of 8.37% is nonetheless the highest that it has been in the past 10 years, despite the maturing of INPP’s portfolio, the quality and reliability of portfolio cash flows, and continuing strong investor demand for infrastructure assets.

Within the INPP portfolio, the range of discount rates applied across the various investments is 7.2% to 10.8%. In a similar way, discount rates vary widely between companies across the sector, depending on the investment risk, the quality of cash flows and the ability to manage these, and it is inappropriate to compare companies on this basis. The best test of whether any particular discount rate is appropriate is whether or not investment return expectations are met. On this measure INPP has a strong track record. Over the 10 years to end-FY23, the annual investment return on the portfolio (£226.8m in FY23) has averaged 7.8% compared with an average discount rate of 7.4%.7

Long-term macroeconomic assumptions have been relatively stable and consistently applied over time, with short-term flexing to capture higher current inflation.

End-FY23 NAV was £2.9bn or 152.6p per share versus £3.0bn or 159.1p per share at end-FY22.

The ‘NAV return’ of £183.6m was driven by similar factors to the portfolio return (above), but also includes the company level costs and working capital variances. In aggregate, changes to the assumptions themselves for the discount rate, inflation rates and tax rates had a negative impact of £134.8m. The cash distributed to shareholders in INPP was £151.6m.

The key sensitivities of NAV to the valuation assumptions are in respect to the discount rate and long-term inflation assumption, as shown below.

In calculating that the expected cash flows from the existing portfolio can sustain progressive dividends for at least the next 20 years, a substantial prospective return for investors, INPP has allowed for the eventual run-off of those investment in projects that have time-limited concession-based contracts, most of which have little or no material residual value at expiry (for example, when a school is handed back to the education authority) and whereas their cash flow distributions initially contribute ‘income’, in the form of dividends and interest, over time the distributions will increasingly constitute a return of the capital invested. Without reinvestment, INPP’s NAV would also be expected to decline, which is why it is also important look at NAV total return. Fortunately, although the recent increase in the cost of capital represents a strong headwind to accretive investment, it seems unlikely that this will persist. Interest rates are widely expected to decline and meanwhile the expected future requirement for privately funded infrastructure remains vast. For projects to be viable, the returns will need to meet investor hurdle rates.

The AIC Infrastructure sector, of which INPP is a constituent, is a diverse group in terms of the types of assets companies focus on and the risk-return balance that they target. On this basis, any direct comparison between the companies is inappropriate. INPP’s discount to NAV of c 18% is in line with the peer group market cap weighted.

HICL Infrastructure and BBGI Global Infrastructure are perhaps the closest peers to INPP, investing in core infrastructure assets, in developed markets. However, compared with INPP, the HICL portfolio contains has a greater exposure to pure demand risk while BBGI is focused only on PPP.

Compared with INPP, 3i Infrastructure has a more concentrated portfolio, with a much greater exposure to demand-based revenues, albeit in structurally supported growth sectors, which it actively manages for growth.

Pantheon Infrastructure provides a diverse portfolio of operational infrastructure assets, primarily sponsor-led co-investments and an arm’s length ability to influence the management of the underlying assets.

As their names suggest, Cordiant Digital Infrastructure and Digital 9 Infrastructure, which has recently announced its intention to wind up, are focused on a range of operational digital infrastructure assets, with a greater focus on growth and an increased risk appetite versus INPP.

GCP Infrastructure invests in UK assets with a focus on debt, including a significant weighting to senior debt.

Sequoia Economic Infrastructure is an international investor in infrastructure debt.

INPP’s board comprises seven members, six of whom are deemed independent, who collectively bring to the company a breadth of relevant experience.

The board is chaired by Mike Gerard, who has over 30 years of financial and management experience in global infrastructure investment and has been involved in some of the largest infrastructure projects in the UK. The other board members are Julia Bond, Stephanie Coxon, Sally-Ann David, Meriel Lenfestey, John Le Poidevin and Giles Frost. Giles Frost is a founder of INPP’s investment adviser, Amber Infrastructure, and is chair of its ultimate holding company, Amber Infrastructure Group Holdings Limited, and is therefore deemed non-independent. Details of the board members are available on the company website.

As part of the board’s succession planning, John Le Poidevin will retire from the board at the AGM in 2025 and Giles Adu will become a director with effect from 1 September 2024. Giles Adu has over 30 years’ experience spanning investments, funds and advisory across debt capital markets, real estate and alternatives.

The ongoing charge ratio (OCR)8 was 1.2% in FY23 (FY22: 1.1%) and in line with peers. INPP says the increase in OCR in the year was principally due to the timing effect of the reduction in NAV. With no employees, most of INPP’s costs are investment advisory fees, £32.2m in the year (2022: £27.9m).

The investment advisory fees payable to Amber are calculated as follows:

The investment advisory agreement can be terminated by either party at five years’ notice. It may also be terminated where less than 95% of the group’s assets are available for use for certain periods and where the investment adviser has failed to implement a remediation plan agreed with the group.

As at 31 December 2023, the Amber Group held 8,002,379 (December 2022: 8,002,379) shares in INPP or c 4% of the total shares outstanding, further aligning the interests between the two parties.