In this episode of the [i3] podcast, Conversations with Institutional Investors, we speak with Danny Latham, Partner and Head of Australia and New Zealand for Igneo Infrastructure Partners. We discuss the evolution of infrastructure assets, termed “Infrastructure 2.0,” which includes renewable energy, digitalisation, and waste management. Danny highlights the shift from traditional infrastructure to more dynamic, B2B-focused assets, emphasising the importance of cash flow predictability and regulatory risks. He also touches on the role of gas as a transition fuel, the potential of hydrogen, and the integration of water management in infrastructure projects. Finally, Danny explains his investment strategy, which involves active management, matching up hard assets with good people, and leveraging mid-market opportunities for value creation.
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Overview of podcast with Danny Latham, Igneo Infrastructure Partners
02:00 The Four C’s of Lending: capacity, capital, collateral and character
04:00 Funding versus financing; there is plenty of capital in the world, but are people prepared to pay for services and products?
05:30 My first venture into infrastructure was actually a prison in rural Victoria
09:00 Changes in the infrastructure over the last 30 years
13:30 There used to be a perception that these assets looked after themselves
17:00 Infrastructure 1.0 versus 2.0
18:30 Theoretically, infrastructure 1.0 should be a little less risky, but you are trading demand risk for regulatory risk
24:00 Are people taking more risk because of the odd YFYS benchmark? Yes, we are seeing that
26:00 Atmos Renewables, a key example of how Igneo invests
27:00 We’ve moved away from large caps, because we see more opportunities, better bolt-ons and better bilateral deals in the mid-market space
30:00 Today, our focus is on taking ownership stakes of 50 – 100 per cent, so we are driving the bus
35:00 Large, hyperscale data centres today are probably more frothy than other parts of the market
36:30 Australia’s power consumption will double between now and 2050. Where is that power going to come from? The potential conflict between energy transition, decarbonisation, and the reliability and affordability to support growth is a huge thematic across the globe.
38:00 Natural gas does have a long term role as a transition fuel
41:30 In the UK, the last coal-fired power plant has been shut down. In fact, one of the last assets we’ve acquired in the UK was a waste-to-energy asset that is located on an old coal-fired power plant site.
44:00 In a waste-to-energy model, you get paid for your fuel. So it is quite a different model.
46:30 In Australia, we are actually not that good at recycling water. One of our businesses takes wastewater and uses that to water the McLaren Vale wine region.
50:00 Adjacency benefits: Amazon has just bought the plot of land next to our waste-to-energy plant in the UK
54:00 AI and infrastructure; is it all about data centres?
Full Transcript of Episode 116
Wouter Klijn 00:00
Hello and welcome to the i3 podcast: ‘Conversations with Institutional Investors’. My name is Wouter Klijn, and I’m the Editorial Director for the investment Innovation Institute. For more information about our educational forums for institutional investors, please visit our website at www.i3-invest.com. That’s the letter i and the number three at invest.com. There, you can also subscribe to our complimentary newsletter. I3 insights in which we discuss investment strategy and asset allocation questions with asset owners from around the world. Now, as you all know, we love our disclaimers in this industry, so here’s ours. This recording is for educational purposes only. It does not constitute financial advice and is intended for institutional and wholesale investors only. Please enjoy the show
This episode of The i3 podcast was sponsored by Igneo Infrastructure Partners. As such, the sponsor may make suggestions for topics, but final control over the podcast remains with the investment Innovation Institute.
Welcome to Episode 116, of the [i3] Podcast, Conversations with Institutional investors. In this episode, I’m speaking with Danny Latham, who is a partner and head of Australia and New Zealand for Igneo Infrastructure Partners, a manager that’s owned by First Sentier Group. Danny and I are discussing the new wave of infrastructure assets, also referred to as Infrastructure 2.0. What is this and how does it fit in with an existing portfolio of assets? Are they riskier than traditional core assets, and what’s their return profile? We take a look at assets such as waste to energy in the UK, where Amazon has just bought a plot next to Igneo’s plant, we will discuss gas as a longer term transition asset and the national security aspects of it. Finally, we talked about capturing and repurposing wastewater and of course, AI, please enjoy the show.
Danny, welcome to the show.
Danny Latham 02:26
Thank you very much.
Wouter Klijn 02:27
So tell me a little bit about your background before we get into all the details of the deals and the pipes and everything. Why investing and why particular infrastructure?
Danny Latham 02:37
Sure. Yeah. So thank you. Thank you for the opportunity to be here. So in some respects, sort of my, my journey to infrastructure really started with, I guess my first exposure to the investment industry was more in mortgage securitization, okay, so back in the sort of the early 90s. So yeah, been around a little while, and so as part of that sort of evolution. So been involved in sort of a lot of the, I guess, a lot of the foundations around, sort of credit analysis and the like and, and I guess, sort of some of those learnings for being sort of good stead for, I guess, sort of the subsequent career in infrastructure. And I guess, sort of some of those principles around, if you like the four C’s of lending,
Wouter Klijn
The four C’s?
Danny Latham
The four C’s, yeah, so capacity, capital, collateral and character.
Wouter Klijn
Okay, so last one is a bit different than the first three?
Danny Latham
Absolutely. And I think this is sort of a, I think it’s probably an hour, an area that’s sort of less focused on. But when it comes to investment, investing, whether it be in the public markets or the private markets, a lot runs, we are still fundamentally a people business. And so as part of that people business, character becomes important, right? So who are you dealing with? Who are you backing? What are their values? What are their ideals, in terms of, sort of managing money as part of that fiduciary responsibility, in terms of whether it be in the infrastructure world, about or even in my previous life, in the mortgage securitization world, is, if you lend someone money, are they going to pay it back?
Wouter Klijn 04:20
Yeah, yeah. It’s kind of important. What about the other three C’s?
Danny Latham 04:29
Yeah. Well, I think that is actually a very direct correlation across to sort of investing in all its guises. So it’s understanding where the cash flows are coming from the variability of those cash flows, the capacity of the business to to pay. And this is sort of, I touch on, sort of in other aspects, but it’s also about this sort of financing versus funding sort of ability. So I think, as a general rule, there’s plenty of money out there to. Finance things. But in a cost of living pressured world, are people prepared to pay for the for the services and the products, and whether it be infrastructure, whether it be anything, so that’s sort of that, I think that that funding capacity is often sort of under, under appreciated and and so it doesn’t matter what you put into a model you need to under underpin that was sort of saying, what is the partly comes back to the character, what is the ability and propensity of people to pay?
Wouter Klijn 05:32
Yeah, yeah. So we’ll go a bit deeper into the investment process later on as well. But do you still remember your first infrastructure deal?
Danny Latham 05:42
I do actually, and and essentially. So if I sort of segue from my journey from sort of mortgage securitization, yeah, into infrastructure. Mortgage securitization was great, and was lending, it was getting people into houses and so forth. But fundamentally it was, it was sort of just financing, yeah, and so for me, I guess intuitively, it was about sort of what’s what’s more real, and infrastructure became something that is more real. And so I grew up on a farm. My dad was a builder, so a lot of my sort of upbringing was about real stuff. Yeah, yeah, tangible stuff. So that sort of segued into, sort of my, my jumping from sort of financing, which was a little bit less real, into something much more real and tangible. And my first opportunity, as I sort of looked at the as I jumped into that sort of infrastructure space, was actually a social infrastructure asset in in rural Victoria, basically the sale of a prison. So, so a very atypical journey into, sort of jumping into that sort of infrastructure space. But then sort of that was sort of a more of a lending type deal, the real big sort of infrastructure. First asset was the Melbourne City Link deal, where it was, it sort of quite interesting this sort of, we were the, we were the underbidder to what became Transurban, yeah, sort of way back there in the in the 90s. So, so that was sort of the, if you like, that, sort of that start of definitely something real in the context of of a new build toll road, in a fundamental piece of infrastructure in Victoria. Yeah.
Wouter Klijn 07:32
So how do you go from mortgages to a prison, which is a form of housing, to a toll road?
Danny Latham 07:39
Yeah, good question, because if you unpick it all, it all goes back to those sort of the four C’s I talked about. And this is really sort of as a if you like an infrastructure investor, and really an infrastructure investor on behalf of clients and that sort of fiduciary responsibility. It was really about sort of understanding the cash flows, delivering expected investment outcomes, to for the risk, to to those underlying clients. And so it’s back to those sort of four C’s. So, so as I mentioned, those sort of foundations in the securitization world did translate across to and they equally apply to all investing. So fundamentally, investing comes down to cash flows. Where are they coming from? What’s the variability, what’s the risk of those cash flows turning up? And how do those cash flows end up in the hands of investors?
Wouter Klijn 08:37
Yeah, with toll roads, it’s quite interesting, especially new toll roads, because much relies on, sort of the estimation of traffic flow and usage of the road itself, which, you know, can sometimes be a little bit of an esoteric art.
Danny Latham 08:50
Oh, absolutely. And I think you touched on a great point in terms of the evolution of this space over the last sort of 30 odd years. And if we look at sort of the, I guess, my experiences over those last 30 years, and it tends to be the ability to forecast and predict human behaviour has become the most challenging aspect of that sort of infrastructure journey. So particularly for as you, as you touch on, for if you like new build toll roads, where you actually then sort of say, what’s the likelihood that someone is prepared to pay a toll to save some time, versus sort of that they stay on the congested road? So that sort of predicting of human behaviour, I think, frankly, has been probably one of the biggest challenges and been one of the biggest one of the biggest issues of infrastructure over the last over the last 30 years. So as a general rule, particularly for by definition, humans tend to be lethargic and apathetic in terms of. Their behaviours, they tend to be creatures of habit. So they tend to, sort of for them to change is often misunderstood from, from an economist perspective, the economist will say your time saving is x, so therefore you should be your value of time is y, so therefore you should be prepared to pay a toll. Yeah, yeah. It doesn’t sort of get into the behavioural aspects around around people.
Wouter Klijn 10:26
Yeah, there’s a bit of behavioural finance in there, counting on people not to change their stripes. Absolutely, absolutely. I was going to leave the question question for last. But since you mentioned it, what are some of the biggest changes you’ve seen over the 30 years that you’ve been involved in this space, I can imagine that the type of assets have changed, but also the structures of the transaction themselves.
Danny Latham 10:49
So if you think from it, from an industry perspective, if we go back to sort of the mid 90s, particularly here in Australia, obviously the real estate and the property space have been around for forever. It’s really around that sort of mid 90s that the private equity and private infrastructure funds management really started to sort of take off. And there was a whole congruence of factors that sort of sort of all came together at that point in time, one of which was obviously mandated superannuation, so that the pool of capital was increasing. There was a whole lot of micro economic reform in Australia at the time, really striving for productivity improvements. And as part of that, there was also, in some states, like Victoria, there was sort of financial stress. So there was whole lot of factors sort of manifested at the point in time in terms of supply of opportunities, and then also demand for those opportunities. And that sort of really started in that sort of space. So that’s the origin of it. And then over the last 30 years, what we’ve seen is the as the growth and the development of the infrastructure space globally, and not dissimilar to the evolution of the infra of the property sector, it has grown and developed. So if I look at it, I’m trying to think where, what the analogy now is, is I think where I think the infrastructure sector is probably beyond the the pimply adolescent, yeah, we’re probably now into the to the young, young adult phase, and at the point of, sort of getting married, having children, and the sector has grown. It’s segmented by by sector, by geography, by by by risk, and so so back in the sort of the mid 90s, it was a bit more of a homogenous sort of product. It’s now grown and developed. And so from an investor perspective, there’s there’s much greater choice in terms of the number of players, the number of managers, the number of strategies. And so therefore there’s a greater opportunity for the end investor to then say, well, okay, what? What works for me in terms of my own objectives, in terms of risk and return? So I think that’s probably the main it’s that evolution in terms of diversity of options. Now, as part of that, the definition has certainly evolved. So if we go back to the start of my infra journey, it was reasonably traditional. It was very much sort of the infra 1.0 it’s now evolved, and it’s now to the 2.0 which we can dig further into. But it’s even then beyond that, sort of, almost, sort of a very, very diverse extension of the of the definition and and, like beauty, it’s very much in the eye of the beholder as to what people’s definition of infrastructure.
Wouter Klijn 13:56
Did you see sort of an increasing specialisation as well? Because I think there’s sort of, you mentioned the private equity industry that’s involved in many infrastructure projects, and you’ve seen sort of an evolution there, where initially they had similar models, like, you know, reduce costs or change management, but now they’ve evolved to target very specific parts of different business models. Some of them use AI. It’s much more specialised. Is that similar in the infrastructure space?
Danny Latham 14:24
Yeah. I mean, I think the the thematics that play out on a from a PE perspective, are no different. So I think there’s, there was a perception incorrectly, that these assets looked after themselves. Fundamentally, these are large, complex businesses, and in some cases, much more oversight visibility from a community perspective, so many more stakeholders in terms of of those sort. Of having a view around these businesses. So in terms of the they certainly don’t look after themselves. So I think that’s one of the I think one of the main aspects in terms of that sort of evolution is these need to be, if like actively managed, no different to PE the the end game might be different. So depending upon the nature of the asset, depending upon the structure in which it’s held, it may be that they they’re held in an open ended fund, and they’re sort of very much sort of built out over a long period of time. So it’s less focused on an exit in five to 10 years time. It’s but nonetheless, you are actively managing these businesses you are, you’re appointing the boards, you’re appointing the management teams, and then you’re down in the trenches.
Wouter Klijn 15:46
So you mentioned there that we’ve moved on to infrastructure 2.0, how is it different from the first iteration? Do they still include include core assets? I mean, can you tell us a little bit about is there a different risk profile, are they more like greenfield projects?
Danny Latham 16:04
Sure, I mean, that’s sort of that evolution of the sector, and it’s not, it’s not just an infrastructure thematic. So what we’ve seen is a fundamental shift in terms of, and I guess you can put it in the context of, sort of the third industrial revolution, or the fourth industrial revolution, and then sort of what flows off the back of that from a from a broader community perspective, but also from an infrastructure perspective. And so if you think about, sort of the the traditional infrastructure, arguably, is probably more of a second industrial revolution type, types of scenario around those sort of traditional assets, of of utilities, water, gas, electric, telco, and then more on the sort of GDP correlated assets, more around sort of your ports, airports, road, rail. So if you think about they are very much a early 1900s sort of thematic as we move forward into, I guess, that sort of third and fourth industrial revolutions. It’s more about electrification, Internet of Things, AI and and that’s sort of how that sort of set up. I put sort of the the traditional infrastructure in that 1.0 and now we’re moving to the 2.0 and the 2.0 is really driven by a lot of those sort of macro thematics that we see that are not just infrastructure related. So energy, energy transition, or decarbonization, digitalization, de globalisation, as we’ve moved from a sort of a global world to a much more sort of look after ourselves in a post pandemic world, and then a lot feeding off the back of that also is a lot more about circular economy. So how do we, how do we do more locally with what we do? How do we, how do we recycle our waste. How do we be very focused on our water use, etc, etc. So that’s, I think that’s the part of that evolution, and they can co exist. But as a general rule, I think what we see is that the the infrastructure, 1.0 tends to be a bit more traditional, a bit more of a of an interface with government. So these sort of regulated monopoly assets that are sort of focused around sort of economic regulation, because they’re monopolies, and the influence of regulators in that, if you go to the 2.0 it’s a bit of a sort of move from a B to C world to a B to B world. So if you think about a lot of the 2.0 assets, whether it be solar farms, wind farms, data centres, there’s there’s less of a government involvement in that part of the world, they also tend to be a bit more sort of smaller to mid cap assets, rather than large cap assets.
Wouter Klijn 19:01
Does that mean that the return streams are also less stable? I mean, do they, if they’re less monopolistic, less government involvement? Is there less predictability in sort of the cash flows?
Danny Latham 19:14
Theoretically, right? Yes. However, if you then look at actual experience, particularly over the last sort of three to five years, particularly as the as the interest rate cycle and the inflation cycle has turned we’ve seen that sort of translate into cost of living, pressures, rising interest rates, etc. That should be in a traditional infrastructure world, under traditional infrastructure regulatory models would translate through to inflation protection, prices being passed on to consumers, et cetera, et cetera. However, in a cost of living, pressured world that increasing pressure to. Increased prices has then come with regulatory risk. And so this is where it sort of comes down to, they intuitively should be less risky. But our experience has been, certainly, over the last five years, is you’ve almost traded off that sort of demand risk with regulatory risk. And so we’ve seen it in so UK, water is a great example. It’s a sad example, in terms of from an investment outcome, of of how that sort of regulatory risk has manifested,
Wouter Klijn 20:32
Walk me through that situation, what happened there?
Danny Latham 20:37
I don’t think we’ve got long enough to go through. So at a high level, and this sort of comes back to, sort of, I touched on a little bit earlier, in terms of that, that that financing versus funding issue, yeah. So if we look at back, way back and under the under the Thatcher government, there was a there was a huge requirement to invest in those networks to, for example, to reduce the 30% leakage in the in the water networks in the UK, particularly around Thames. So at that point in sight time, that was the government said, well, we don’t have that capacity to fund that capex. So we’ll pass it on to the new owners, in the case of the privatised businesses. And so at that point of the cycle, it was about the regulator saying, well, we need investor capex to fix these businesses. I think what’s then happened over the last sort of five to 10 years is that that pendulum has swung away from the investor towards the consumer, and so this is where it comes to that sort of regulatory political risk, in terms of, you can’t increase the price of water. So, so the businesses then get sort of squeezed, because their their cost pressures are increasing their requirements to deliver service standards are increasing their ability to deliver those has been constrained because they haven’t been able to increase prices. And so that’s that’s where that sort of crunch became. So was that there was that pendulum shift. And so from an igneo perspective, we’ve been sort of very deliberate. And if I go back to those four C’s, it sort of comes back to sort of a capacity and a willingness to pay for the service provided. And so we very deliberately have moved more to that sort of B to C. Environment, sorry, B to B, I apologise. B to B, environment away from that B to C, and that sort of dealing with customers who are willing to pay value the service. And generally, it tends to be more on that 2.0 space rather than the 1.0 space.
Wouter Klijn 22:57
Yeah, you mentioned there that part of the 2.0 infrastructure, there’s decarbonization and digitalization. Those tend to be projects that probably still need to be built, Greenfield projects. Does that raise the risk level? And if you look at those type of assets, and you look at it from a portfolio construction perspective. And so you have an existing portfolio of traditional core infrastructure assets. How do you blend that with these new type of assets?
Danny Latham 23:30
It’s probably partly symptomatic of the, I guess, the evolution of the sector. And so even if you sort of look here in an Australian context, particularly with for the super funds, as it moves to that your future, your super benchmarks, and the MSCI benchmark, that has tended to sort of focus more, probably more towards the 2.0 than the 1.0 assets, because it’s it’s pushing the market to pursue higher returns?
Wouter Klijn 24:01
I think the the benchmark used in your future year super is quite aggressive, isn’t it?
Danny Latham 24:06
And it is a, it’s a, it’s an odd benchmark, right in so far, it’s most, most indexes you would think you can replicate. In the case of the that benchmark, it actually is taking the median from all the various funds that contribute to the performance over a quarter. The benchmark actually takes the median performance of the fund on a quarter by quarter basis. Okay, so it’s difficult to replicate unless you buy the whole market. Yeah. And so from that perspective, it’s a bit of an oddity. So I sort of moved away initially. It was sort of more sort of NAV weighted, and then sort of saying, well, that that got a little bit distorted depending on the size of the contributors to the benchmark. So I think this, it’s not perfect. Yeah, but that has, that has certainly changed behaviour.
Wouter Klijn 25:04
So are people taking more risk because of the benchmark?
Danny Latham 25:07
Yes, we we’re seeing that Yes. So it may turn out to be sort of unintended consequences from a, from a from an end game perspective, because, I think from a super fund perspective, they’re solving for a liability profile that needs to be paid out in 10-20 years’ time. So have that sort of volatility in the short term. I don’t think is great, but far better for me to sort of talk about, sort of what government policy is in terms of sort of the Australian super system, but I can sort of comment it in terms of what I’ve observed from a behaviour perspective. And that behaviour is to is for investors to seek higher returns. Yeah, so that tends to sort of suggest more towards the 2.0 than the 1.0 assets. Now that also translates into, probably a segment of the market where, one, there’s the most opportunity, and two, on the back of that, the most capital that’s needed. And so that 2.0 I think, as I talked about, is energy transition, is digitalization, is that sort of transport and logistics in that circular economy? If we look at that sort of just sheer demand for capital, that’s enormous.
Wouter Klijn 26:36
If we look at a transaction in that energy transition space, you’ve mentioned Atmos renewables as a good example of your investment strategy. So that’s a renewable platform of nine operational wind farms, so in three different states. So it clearly plays into the whole energy transition space. But what makes it a prime example of how you invest?
Danny Latham 27:00
I think it goes back to the sort of thematic I touched on earlier about sort of the, I guess, the growth and evolution and maturity of the sector. So we’ve certainly invested in sort of many large cap opportunities over the last 2030, years. But fundamentally, Igneo as a business is very much a sort of a global mid-market specialist. And what we looked at in that space is sort of we looked at to deliver, we’re an active manager, so we looked at to deliver alpha to our investors. And that alpha can come from two aspects, one increasing earnings or and or reducing risk. And a key, key plank of that, that strategy or that philosophy, is really that buy to build, and that’s really, really where Atmos comes in. So as a value investor, we see that building these businesses is where we see the best value. And so we very deliberately have moved away from the large cap part of the market, and very much into the mid market, where we see more opportunities, a greater ability to do bolt ons and bilateral deals. I mean, everywhere, every manager will talk about their utopian outcome of the number of bilateral deals and proprietary deals. And to be fair, I mean, Atmos is a great example of that, of that philosophy, really, that we put into action so we built what a business over the last five years. And part of that is really a combination. This sort of comes back to the character point at an asset level as well. We’ve actually combined hard assets with soft assets and and that sort of physical assets with people. And we built that over, over those, over that time. So if we look at that journey over the last five years, we’ve initially acquired a brownfield operating wind farm. That original was a project. It was an asset. The O and M for that asset was outsourced to another party. Now, from our perspective, my comment about we need to put the two together. And so over that journey, over the last number of years, we then built out a management team, in the first instance, the corporate infrastructure around that, that business, then an O and M capability. We then in, sourced and reconnected the people and the assets and brought that under the under the one house. And then we then look to do, do further bolt ons, and some of those bolt ons that came with some of the people we built, we bought with those assets came with a development capability. So fast forward to today. So Atmos is now top five renewables player in the Australian. Market. So with some 17 renewable plants, about 1.6 gigawatts of capacity, and a pipeline of another six gigawatts over time. So in terms of some of the metrics, the EBITDA has increased from 40 million to 160 million over the journey, over $1 billion of follow on equity has been invested in seven bolt on transactions and on that value creation thematic. This is sort of, as I said, as a value investor, that’s what we’re seeking to deliver to our investors at least 100 basis points of value creation on that on that strategy.
Wouter Klijn 30:41
Yeah, so why was it important to bring the operations and management back inside the business? Is that partly to do those bolt-on acquisitions, or is it governance? What makes it important?
Danny Latham 30:51
Both, it is about it’s about control. So if I look at the evolution of Igneo as a business over our our full journey, there’s almost two stages of our evolution from from 94 to 2007 was much more of a passive approach around our involvement with these assets from 2007 and this is really driven on the back of our real estate business at the time, which was very much active hands on management of shopping centres and office buildings and so forth. So that that philosophy translated from the real estate business across to the infrastructure business. So from 07 to today, increasingly we’ve we’ve we’ve always been an active manager from oh seven onwards. The the stakes we take in the assets has really increased. It to from today, our focus on is on 50 to 100% of a business. So we are very much driving the bus in terms of that now. So that’s at an Igneo level, at an asset level. It’s the same philosophy. So you want to have, there’s a, there’s a huge value of incumbency in the in this sector. So an Atmos is a great example of that, where, if there’s a, if there’s a new brownfield opportunity that comes into into the market, and put it in context, these will be smaller deals, mid market, small cap deals, most of the big guys won’t get out of bed for so that gives the opportunity to do it on a bilateral basis, because the track record of Atmos and Igneo is so has been so effective in doing Those sort of bolt on strategies, we then become the go to contact, because people know we can contract, can transact.
Wouter Klijn 32:48
Yeah. So do you have certain targets for, like, margin, increase, of earnings, of revenues? Is there sort of a minimum that you’re trying to achieve in every transaction?
Danny Latham 32:58
There is, I mean, there’s, always a base case return. When we look at our original underwriting case, when we look at an asset we will there’s a minimum return. So if you look at across the broader portfolio, at the moment, that sort of return profile at an asset level is above 11% return per annum. What we’re finding, as I touched on, is that, and Atmos is a great example. The bolt ons that we’re doing tend to be at least 100 to 200 basis points better than that. And that’s really and I think this is where sort of that mid market versus large cap thesis comes out. We’re seeing better value in the in the mid market space. And that value manifests itself in three ways. And it’s it’s not rocket science. It is buying well more levers in terms of how you manage these assets and then potentially how you exit them over time. And I think we’re just saying that there’s a there’s a there’s a better value proposition in buying in the mid market space that translates to the bilateral deals, the proprietary deals, negotiated outcomes, rather than sort of auctions, where it’s a bit of a cost of capital shootout. And so it’s more in that buying, well, these smaller assets then you’ve and because we control the assets where we’re driving the bus, we can have many more levers to pull in terms of that value creation.
Wouter Klijn 34:27
Yeah. Now the energy transition is not just about solar and wind. What do you look at as some of the potential blind spots that other might have missed in this transaction? I think you own a gas network, for instance, Clarus, but you also have been looking at hydrogen, as I understand it. Are there any sort of, you know, hidden gems in this transition?
Danny Latham 34:51
I think the main sort of comment is to say that this has historically been a bit of a tendency to look at sort of each of these sort of segments. Assets on a silo basis. The reality is there’s increasingly more adjacency benefits associated with with these assets. So for example, a data centre is clearly focused on power and water, and increasingly about renewable power and recycled water. And so again, as a value investor, we say, well, okay, as part of that thematic, where is the best value play in the context of that? So we are looking at, sort of, how do we supply so we generally are not playing at that large cap, hyper scale end of the market that tends to be, if we look sort of at various points of the cycle, different assets or different sectors in different geographies offer different value or are more frothy than at other points of the of the cycle. And so if we look back a few years ago, renewables was frothy. Large hyperscale data centres today is probably more frothy.
Wouter Klijn
There’s a lot of interest there than other
Danny Latham
than other parts of the market. And obviously it’s an enormous thematic in terms of that the AI boom and the data centres to support that we are, we are sort of very again, come back to sort of those four C’s, which are very, we’re very cash flow focused. And how deliverable are those cash flows? How near term are those cash flows? And so we have a very much a propensity to focus on nearer term cash flows and not paying away the future, yeah, and so. So we are seeing aspects of the market don’t give too much away. We are starting to see sort of aspects of the market where we can see silver that adjacency benefit. If we look at sort of globally, yeah, there’s a lot of focus around around renewables. There’s a lot of focus about just sort of fundamentals of of power consumption and power demand. And so if you look at sort of here in Australia, the energy consumption, electricity consumption, I should say not energy electricity consumption is looking to double over the course of the of the sort of AEMO (Australian Energy Market Operator), the the market operator has come out and said, doubling of capacity over the course of the next, sort of now, to 2050 so where is that power going to come from? And that’s becoming sort of a, a key issue. And this, this is an issue globally, about, almost the in some jurisdictions, the potential sort of conflict between energy transition, decarbonisation and reliability of supply and reliability and affordability of energy to support growth. And that’s really one of the big, huge thematics that’s playing out globally. We’ve seen more recently, the US go a different path, potentially to the to the rest of the world, but the here in Australia, Europe is very much on that sort of energy transition story, but we also need to be cognisant that power needs to be reliable, it needs to be affordable.
Wouter Klijn 38:27
So in that discussion, where do you see the role of gas? Because some people say it’s a fossil fuel, but people say it’s a transition asset. I think, from what I understand, you take a more pragmatic approach. You’re looking at improvements rather than sort of exclusions. But what’s your philosophy around that?
Danny Latham 38:48
Absolutely So our view on natural gas, it does have a long term role as part of the as a transition fuel in the net zero journey. It’ll remain a critical part, particularly here in Australia, of the of the energy mix and And increasingly, there’s a focus on things like energy security. So again, if you look at sort of the aemos, sort of 25 year roadmap, I think, I think what’s not terribly well understood that they’ve actually forecasted, that the power coming from gas generation is actually increasing from forecasts to increase from 11 and a half gigawatts today, it’s actually increasing to 15 gigawatts in 2050 Now on the flip side, so in that environment where electricity consumption is doubling, we’re actually seeing a sixfold increase in grid scale renewables, so wind and solar and an enormous increase in battery and storage capacity. So it’s part of the problem, but it is fundamentally part of the. Solution as well, to to provide that certainty of the light staying on, so fundamentally, to bring the community along in terms of this transition store a journey the power needs to stay on.
Wouter Klijn 40:14
Yeah, and I think guess is particularly good example of where it ties back in with national security, because we’ve seen in Europe where large parts were not fully dependent, but to a degree dependent, on gas coming from Russia. And there was a bit of a scramble when that came into jeopardy. Has that changed the nature of the projects that are coming up?
Danny Latham 40:39
It has and what we’ve and you raise a good point in the context of the perception around decarbonization, particularly in Europe. And so if you look at sort of that sort of evolution, even pre Ukraine, sort of more so say, in places like Germany, post Fukushima, sort of that sort of move away from sort of nuclear in Germany, whereas the likes of France is very much kept on the path of nuclear being a key part of the of the energy, the energy mix. And so therefore timing wasn’t great in the terms of shutting down some of the sort of the nukes at the point that then sort of gas become more constrained in the particularly in the German market and across Europe. So therefore it sort of came back to that sort of reliability, certainty of supply, certainly keeping the lights on, become a more pragmatic view around the energy transition and and so we are seeing different opportunities. We’ve seen investor sentiment evolve around the broader story and and I think one of the things that’s become a little bit more holistic is sort of, what’s the what’s the broader game around abatement in the first instance. But if you can’t abate all of the emissions, where do you then go in terms of carbon capture and so forth? And we’re starting to see that in there. And obviously Ken Henry came out recently, and sort of it was a very interesting sort of pivot in terms of how we sort of moved away from productivity, but moving to things like environment, environment and regulation and environmental approvals and so forth. That’s not, that’s not dissimilar, if you, if you look at the UK, I mean, the last coal fired power station has been shut down, yeah, in fact, one of the assets we’ve acquired in the UK is actually a waste to energy plant, which is actually located on an old coal fired power station, right? So purpose, and that’s, that’s actually the feedstock that supplies that waste to energy plant. Is actually municipal waste that’s been diverted away. And this is sort of this adjacency. It’s, we don’t sort of live in silos. It’s all sort of interrelated. The feedstock that’s coming to or supplying that plant is being diverted away from landfill, and obviously in somewhere like the UK, where there’s less land, landfill is becoming a big issue. From an environmental perspective, it’s actually you’re then moving away from potential release of methane that’s coming out of those, that’s leached out of those, or leaked out, I should say, out of those, those landfill sites, it’s applied to. So from methane CO two is produced when you burn that municipal waste. But the next part of that, that story, and this is where, probably the UK is more advanced than anywhere, is around, then the capture of that, of those co twos and SOX and NOx in terms of the flue gases and to liquefy that. And this is already pilot projects that have been proven up at a small scale. So at the point in time that the it moves to a sort of a carbon pricing, or more developed carbon pricing regime, you then can move to that sort of abatement of capturing carbon, rather than just the avoid the abatement of it.
Wouter Klijn 44:06
Does that capturing of the gases make the income stream less attractive? I mean, I can imagine it is quite an expensive technology?
Danny Latham 44:16
Well at the moment. So if you think about the economics of those sort of waste to energy plants. There’s a feedstock that’s coming in. So if you think about the municipal councils and so forth that are so they’ve got, they can dispose of that waste either into landfill, which costs you money, because you need to pay to a landfill Levy, or you then pay our plants to take that waste, you burn that waste, you produce electricity which you can then sell. So in some respects, the if we can get, then get a revenue stream on the back of the of the carbon, and we need to, it needs to be economic in terms of the 100. Of millions, hundreds of millions, pounds of investment required to to put onto these various plants. But we’ll only do that, obviously, if it’s economic, but it will then be an additional revenue stream, rather than a cost to these businesses.
Wouter Klijn 45:15
And there’s there seems to be an interesting dynamic there that you get paid for the fuel that you’re getting?
Danny Latham 45:20
Correct. That is, that is quite odd. Yes, in a normal world, you would normally be paying for the gas, or you’d be paying for the coal. So it is a, it is a different model, but, but it’s all part of that, I guess, that circular economy aspect of and even here, in an Australian context, increasingly so, one of our, one of our sort of smaller platform businesses, is integrated Waste Services here in Australia, and that’s actually increasingly taking on the back of the changed dynamic around waste. And who’s going to No one’s buying our waste anymore, and we need to look after it locally. Then it’s a also you need to focus on recycling. So for example, there’s a lot of construction and demolition waste, and so like, if you, if you renovate your house, it’s more expensive to get rid of the rubbish than it is to buy new sort of dirt. So it’s that thematic where you you’re looking to recycle that waste you don’t want to put into landfill, because it costs you money to put it in landfill. So the more you can sort of repurpose that construction and demolition waste. So for example, crush it, use it for road base. And so become much more, much smarter in terms of how we, we think of materials and resources and be and don’t you sort of dump it, and is there, is there an alternative purpose for it? And so it’s a different mindset. And that’s that, I think also increasingly, then translates across to to to say something like water, yeah. So Australia, as the the driest continent on Earth, leave me out Antarctica. We’re not that good in terms of, sort of, how do we, how do we recycle our water? And so a lot. So even here in Sydney, we a lot of the water that comes through our networks ends up in the ocean, yeah, one of our businesses down in in Adelaide. So rather than pumping that water out into the ocean, which is sort of waste, why? Why not repurpose it? So actually, we use it to actually irrigate the McLaren Vale one wine region, yeah, so use it for much more noble purpose.
Wouter Klijn 47:45
Yes indeed, for wine production. Just just to come back to that example of burning waste for energy, yeah, I could imagine that when you run a coal plant, you sort of know what the yield is you’re getting from burning coal. But waste, I could imagine can be more variable in terms of how much energy you produce from it. How do you predict that?
Danny Latham 48:05
No, absolutely. So, yeah. I mean, depending on the sort of the, I guess, the calorific value of the plant, of the feedstock that comes in, but generally, where there are prescribed specs, specifications for for that feedstock that comes in, into the plant, and so that’s sort of monitored, and that’s sort of, then you can have a within sort of thresholds, a reasonable level of predictability around the calorific value and how that translates into energy production, right?
Wouter Klijn 48:34
So it’s not on a Monday you get 50% less than on the Tuesday.
Danny Latham 48:38
Yeah. I mean, there might be sort of events that sort of changed, sort of the mix of, so is there, is there a an FA Cup final at Wembley, but generally it’s, it’s reasonably constant,
Wouter Klijn 48:50
Yeah, okay, now, because, I mean, it’s one of the characteristics of infrastructure that you have a sort of predictable, stable income stream. So I could imagine that you want to have clear measurements around that what you produce every quarter Correct?
Danny Latham 49:05
No, absolutely. So this is so infrastructure, as you say, has been and as it should be. It’s been sold, and it has, frankly, it’s also delivered over the last 20 or 30 years as that stable, predictable asset class that has been and ridden through very a lot has happened in the last 20 or 30 years, whether it be sort of the covid or the financial crisis, or here in Australia, sort of the Asian crisis and so forth, with things like, sort of our ownership of Brisbane Airport. And I think what the infrastructure, in my view, the infrastructure sector has proven itself to delivering in that I mean, I think some of the lessons learned, probably more as a lead into the financial crisis, were around things like capital structure and so don’t, don’t, sort of over. Lever these assets and try and dress them up and to be something that they’re not, keep the fundamental characteristics of the asset and don’t distort it through the capital structure, so predictable, inflation protected, high yield and generally this sector has has delivered that over the last 20 years.
Wouter Klijn 50:19
You mentioned earlier, data centres been very popular, as you said. It might be getting into frothy territory, and it plays both into the energy transition and sort of the digitization trend there. But from what I understand, it’s also has an interesting sort of infrastructure around it and network around it. So it’s not just the data centres itself, there is the energy supply, but there’s also a water element, I think you mentioned, and I believe you sit on the board of coNEXA, which is a sustainable water infrastructure business, what are sort of the opportunities? There?
Danny Latham 50:57
No, absolutely. So you touched on, sort of the energy so I’ll just quickly touch on that. So I’ve talked about that, that waste to energy plant in the UK on the old coal fired power station, Amazon has just bought the site next door, right? Because if you think about from a data centre perspective, they’re wanting sort of base load, predictable, secure electricity supply, yeah. So that’s a little bit more complex than just throwing the cable over the fence and plugging in, but that’s an example of that adjacency benefit that increasingly, as you touched on around water, I think increasingly, is now a focus on not just power, it’s also about water, and That becomes almost just as the supply of power becomes a almost that increasing focus from a social licence perspective, so will water. So if we look at various parts of particularly parts of the US, but also here in Australia, the ability to site data centres is very much dependent upon can you get access to power? Can you get access to water? So even here in Sydney, we’ve seen more recently, the ability to put more data centres into the Macquarie Park precinct has been constrained. So that is becoming an increasingly a part of, part of the part of the discussion. And if you look at it from a from a broader perspective in terms of that sort of the water supply, so, yeah, very deliberately, from it from a connector perspective, and we’ll touch on that from a hydrogen perspective as well. So if you think about, sort of, when you what you look at, sort of water, what’s the, what’s the specification of that water, and what’s the, what can you use it for? So again, rather than pumping water out into the ocean, how can we recycle it? It doesn’t need to be drinking water spec. And so how can we use that sort of repurpose that water? So we’ve got a water water treatment plant, recycled water treatment plant in Fairfield, sort of almost in the geographic centre of Sydney, and it can take that sort of treated effluent. And in some, some cases, it sort of almost helps Sydney Water. Well, it does help Sydney Water because it basically takes load off their sewage system, which is, which is overloaded, so, so, so conexor is almost helping Sydney Water in relieving them of that burden. Because if you think about a number of the large sewage outflows, whether it be North Head or Malabar, they’re sort of 100 year old pipes. They’re at capacity, the ability to upgrade them is difficult, and so the more around that sort of load management is is a win, win. And then you get rid of through the customer, and the customer is saying, Well, okay, I don’t need drinking water to run my data centre. I don’t need my I don’t need drinking water to irrigate my my vines. And so it becomes a very, very sensible sort of holistic strategy around what’s the best use of that water and the most efficient use of that water.
Wouter Klijn 54:13
So as you own different assets within the energy space, within the water treatment place. Can you see certain synergies starting to develop there, or are they still separate?
Danny Latham 54:27
No, no, there’s definitely synergies. So I touched on whether we’re so we may not, for example, want to play in the in the in the hyper scale data centre space, partly because it’s in that large cap part of the market, and that’s not where we’re playing, but as a supplier to to those businesses, absolutely. And that’s sort of that very much, that that transition from the B to C to the to the B to B. So, so if you think about from a from a data centre, the hyper scale is impact. Particular good credits. Come back to my four C’s. They’re good credits, good capacity to pay and and that’s a, that’s a good investment decision to supply them with water over, over a long, long period. It’s a, it’s a thematic that’s not going away.
Wouter Klijn 55:17
So data centres, I mean, it has touch points with the energy transition with digitization, but for many people, it’s also a play on AI, which is part of the reason why it’s became become so popular. Is there another way to play the AI theme through infrastructure?
Danny Latham 55:36
I think data centres is the most direct route to that. I think probably more the the AI boom is probably more as a as a user and a beneficiary of that technology, in terms of how we apply that, in terms of the operations of our assets. So that’s sort of, it’s more of, how do we, how do we become more efficient in terms of managing our assets and running them, whether it be predictive technologies around maintenance, whether it be sort of, how do we manage our sort of fleet of garbage collection trucks in New Zealand? So I think so in terms of specific it’s more using AI in our businesses to become more more efficient. So the direct investment on the back of that sort of accessing that thematic is more around the data centres, but I think it’s, it’s similar, I guess, to you touched on hydrogen, yes, before. So where, from a risk perspective, we’re not in the business of the bleeding edge of of technical and innovative change, but we’re happy to provide products and services to those businesses that are taking that risk. So so for example, so taking going back to connect, sir. So up in, up in Newcastle, it provides, currently, it provides water to Orica recycle water for their ammonium nitrate plant. So they, they are increasingly a beneficiary, and they’re, they’re looking at hydrogen as part of that broader strategy that step from ammonia to hydrogen as part of that story, the port of Newcastle is looking at terms of that sort of, there’s sort of a world beyond coal, or diversifying away from coal. Notwithstanding this a lot of metallurgical coal coming out of the out of the Hunter is sort of saying, Well, okay, let’s look what is, where does, sort of the port of Newcastle go. So we’re looking at, sort of working with the port of Newcastle to to supply them with water. And again, if you think about from a from whether it be from an ammonium nitrate perspective production, or whether it be hydrogen, you’d actually don’t want drinking water because that’s that’s got fluorides and chlorine, so you want to demineralize that water back to pure water, and so the recycling is of treated effluent is maybe a more efficient path to get there.
Wouter Klijn 58:17
Yeah, fair enough maybe to finish up. You’ve been in this industry for 30 years. You know what keeps you interested in this space? And do you have any sort of daily habits that keep you sharp?
Danny Latham 58:25
Yeah? I mean, I think the, I think one of the one of the aspects of infrastructure, is because it’s, we’re all immersed in it, yeah, on a day to day basis, you’re a user, you’re a customer. So, so in that respect, you’ve got a sort of a front row seat, in the context of what that means from from a user experience. I think my fair share of airports around the world over the last 30 years, I do pay for my carbon footprint in terms of, sort of what we pay in terms of abatements and credits. So that’s and I can’t sort of come back to that sort of that original, sort of intuitive feel about infrastructure as real as tangible. And back to my sort of upbringing, and I look at that in how it then translates to, I think about my four children and sort of next generation, and what that means for them. Can I make a difference in terms of the world that that I leave behind, and so that all of those aspects sort of keep me pretty focused on, not only that, not only the today for our investors, but it’s almost a dual benefit of delivering for our investors, but also leaving a better world for my children and others.
Wouter Klijn 59:56
Fair enough, that’s a noble course. Well, Danny, thank you very much for coming to our office and thank you for your time. Thank you very much.
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[i3] Insights is the official educational bulletin of the Investment Innovation Institute [i3]. It covers major trends and innovations in institutional investing, providing independent and thought-provoking content about pension funds, insurance companies and sovereign wealth funds across the globe. The [i3] podcast is available on Apple Podcast, Spotify, Amazon Music, YouTube Music, or your favourite podcast platform.