Mid-Market Infrastructure: Riding the downturn

Introduction

Mid-market companies are powerful engines of the real economy and a driver of innovation. In the U.S., mid-market companies with revenues between $10 million to $1 billion produce roughly one-third of the country’s GDP, investing 8% of revenue in research and development according to the World Economic Forum. In Germany, the Mittelstand¹ is responsible for 60% of the country’s jobs. 

Mid-market infrastructure – which we define as unlisted infrastructure companies with an enterprise value of $500 million to $2 billion, is no different. While investors tend to associate infrastructure with singular large infrastructure projects such as Heathrow or JFK airports, the mid-market segment accounts for approximately one-third of infrastructure deal value and three-quarters of the number of deals. By our estimates and using EDHECinfra’s unlisted infrastructure market size, the mid-market covers an investment universe equal to about $1.0 trillion in market enterprise value. In addition, there are more mid-market investment opportunities in sustainable and innovative infrastructure sectors—such as renewables and digital infrastructure—than exist in traditional large assets. 

Despite this compelling opportunity set, there is a perception that mid-market infrastructure investing carries a higher degree of volatility and market risk. The subdued outlook for global growth is weighing on investors’ risk appetite. Our research shows that investing in mid-market companies is a defensive play for investors that are looking for stable and yielding investments. The unlisted infrastructure mid-market has delivered enhanced returns alongside similar volatility and better downside protection compared with low-risk core infrastructure assets. 

That said, the investment returns for mid-market companies exhibit a wide range and are more sensitive than the average infrastructure asset to interest rate movements. Given these features, partner selection in mid-market infrastructure investing is arguably more critical for creating value to maximize the opportunity set across asset management and debt structuring. Moreover, inflation protection can be enhanced by sophisticated due diligence screening as illustrated by our case studies.

Mid-market outperforms the broader infrastructure market with lower volatility

Mid-market companies are vital contributors to most developed countries’ GDP. Mid-market infrastructure offers significant deal opportunities, with reduced competition, geographic and sector diversification, inflation downside protection, as well as opportunities for value creation while outperforming the wider infrastructure market. 

To carry out our analysis, we use datasets from EDHECinfra, the largest provider of unlisted indices and valuation metrics. EDHECinfra compute market prices for unlisted infrastructure companies using a marked-to-market methodology and statistical approaches to estimate the equity risk premiums. As of November 2023, their global dataset covers over 190 mid-market infrastructure companies and close to 300 and 600 core and global infrastructure companies across the major economies.

Figure 1: Unlisted mid-market infrastructure outperformed global and core infrastructure

The largest 100 unlisted mid-market infrastructure companies outperformed the general and core infrastructure market across five- and ten-year time periods, both on an absolute and risk-adjusted basis. The table below shows annualized returns for the top 100 mid-market companies over these three time periods were 12.4% and 15.6%, respectively, according to the Infra 100 Mid-market index. By comparison, the broader market returned 7.4% and 12.7%, as captured by the Infra 300 index. Elsewhere, the core infrastructure market—typically considered the lowest end of the infrastructure risk curve—generated 6.0% and 9.5%, respectively over the same time periods, and as measured by the Index 100 Core index.

Figure 2: Mid-market infrastructure stellar track record

Mid-market infrastructure represents a defensive play for investors that expect economies to be weaker than historical trends with the potential for a slowdown in the coming quarters. Contrary to popular belief, risk metrics, such as volatility and maximum drawdown (the decline from a historical peak), are comparable to the market average (Figure 2). Therefore, for investors pivoting towards greater risk-aversion, adding mid-market assets to a core unlisted infrastructure portfolio enhances the risk-return profile while retaining downside protection. As seen in the optimized portfolio below, adding 45% of mid-market assets to a core unlisted infrastructure portfolio increases the return per unit of risk measured by the Sharpe ratio while keeping the maximum drawdown constant.

Figure 3: Portfolio benefits of mid-market infrastructure exposure

So why are is now the time to invest in mid-market infrastructure companies?

Looking more generally at mid-market companies, they tend to demonstrate stable market growth in a weakening economy. For example, in the U.S., mid-market growth remained at historically high rates of 11.8% as at Q2 2023, compared to 4.8% for the S&P 500, according to Middle Market Center Indicator Report. In fact, U.S. mid-market companies sustained double-digit year-over-year revenue growth for four consecutive reporting periods, while 75% suggested their businesses were performing better than 12 months ago—11% higher than the historical average. In addition, two-thirds of companies expected strong growth to continue into 2024, according to the same data source.

Specifically for mid-market infrastructure investing, it presents lower execution risks, compared with large-scale projects. For example, 9 out of 10 large infrastructure projects go over-budget while 73% of 48 mega-projects suffer from poor execution, according to research by McKinsey Global Institute. Based on a study of 258 rail, bridge, tunnel and road projects worth $90 billion, the academic authors Flyvbjerg, Holm and Buhl found that “projects have become larger over time and that for bridges and tunnels, larger projects have a larger percentage of cost escalations.” Long delays in projects may combine escalating construction costs with increasing interest payments before the project is operational. The authors point to the two longest underwater rail tunnels in Europe—the Channel tunnel and the Danish Great Belt rail link, both of which had to be financially restructured.

Unlisted mid-market infrastructure performance during rising interest rate and inflationary environments

The sensitivity of mid-market infrastructure investment to changes in interest rates, inflation, and GDP growth are important risk metrics to evaluate the resilience of the sector within a broader infrastructure portfolio. First, let’s consider the performance of unlisted mid-market infrastructure companies during changes in interest rates. Rising interest rates act as a gravity force on valuations, increasing the importance of offsetting through income resilience. Over the last five years, the largest mid-market infrastructure companies generated higher income returns than the largest core assets, but with greater variability in overall total returns (see Figure 4 below). Higher, but more disperse, expected returns (IRRs) highlight the importance of asset selection.

Figure 4: Higher but more variable returns

Our research shows that overall, unlisted mid-market infrastructure companies are more sensitive to interest rate changes and have slightly lower inflation protection than global infrastructure. This indicates that investors can achieve better outcomes by selecting companies with strong cashflow links to inflation and through capitalizing on long-term private debt capital and more sophisticated financing solutions.

Figure 5. Unlisted mid-market infrastructure companies’ sensitivity to interest rates, inflation and GDP growth

As Figure 5 shows, there is a lower link between mid-market infrastructure companies’ investment performance and inflation. We analyzed the correlation through the end of 2021, and prior to the onset of exceptionally high levels of inflation across major markets. Infrastructure companies typically recover inflation in revenues and cashflows with a lag which means that the short-term correlations do not hold true. Just as there is variability in overall investment performance, the inflation protection profile of the mid-market sector is also broad. This underscores the importance of judicious asset selection and due diligence.

Case study: Norled and contracted, indexed revenues

Three years after our initial investment of 50% in the company, in October 2022, CBRE IM successfully acquired full ownership of Norled, a leading player in Norway's transportation sector. Norled stands out as the largest express boat operator and the third largest ferry operator in Norway by revenue, offering a unique investment opportunity in a rapidly growing and eco-conscious industry.

Serving over 17 million passengers and 9 million cars annually, Norled's growth strategy centers on securing new contracts, leveraging its extensive geographical reach, and expanding its market share. The company’s positioning in the mid-market segment underscores its financial resilience and growth potential.

Norled’s contracted revenues with regional public transport authorities are secured by long-term concessions spanning eight to fourteen years. To mitigate for volume risk, the company shifted to availability-based gross contracts, establishing a robust cashflow linkage to inflation. Moreover, yearly revenue adjustments based on the ferry index provides a stable foundation for returns.

Norled’s growth trajectory demonstrates strong promise—driven by ongoing operational improvements and recent wins on green tenders. The company benefits from a supportive industry marked by strong profitability, with approximately 25% EBITDA and 10% growth in recent years. This is largely attributable to the transition towards lower-OPEX electric ferries and industry professionalization, reinforcing Norled’s compelling proposition and combining revenue stability and significant upside potential with enhanced downside protection.

Less risk of stranded assets

Privately funded mid-market infrastructure deals dominate the infrastructure sector by deal count. There are at least five times more transactions in the mid-market infrastructure space than the large-cap sector, according to Infralogic. Mid-market deal volume since 2019 grew at nearly double (27%) the rate for large cap deal volume (16%) according to the same data source. Mid-market infrastructure transactions account for three-quarters of the total number of deals and one-third of the transaction value. Deal volume is particularly abundant within next-generation sustainability-oriented infrastructure sectors—from solar and wind, to social infrastructure and digital infrastructure. For example, the solar photovoltaics and onshore wind sectors have provided 25x and 9x more mid-market deals, and three to five times more volume, compared to large-cap deals.

Figure 6: Mid-market transactions versus large infrastructure transactions by size and number of deals

Mid-market infrastructure proliferates in sectors which benefit from structural megatrends and are the epicenter of innovation. With strong industry tailwinds, mid-market companies are suited for platform investments. The asset class is poised for an investment super cycle across innovative industries, including electric vehicles (EVs) and renewable energy. According to the International Energy Agency Stated Policies Scenario, the global EV fleet (excluding two/ three-wheelers) will surge from almost 30 million in 2022 to about 240 million in 2030, achieving an average annual growth rate of about 30%. In renewable energy, annual grid investment must double by 2030 to achieve global climate targets. The scale of the opportunity set in mid-market infrastructure lends itself to platform investing. This involves maximizing the potential of infrastructure companies, underpinned by megatrends such as the global energy transition, by targeted bolt-on acquisitions that complement original company investments.

For example, a utility-scale solar company might consider a strategic advantage in bolt-on acquisitions of other renewable generators with different technologies (onshore and offshore wind, battery storage) and location. In this way, it can achieve geographic and resource diversification and scale benefits in operations and maintenance and insurance procurement.

Case study: Forum Mobility and EV infrastructure 

Forum Mobility, a California-based company, specializes in community charging depots for short-haul ground freight transportation vehicles known as drayage. The company's core focus is on developing zero-emission drayage charging infrastructure, catering to the rapidly expanding North American drayage market.

In December 2022, CBRE IM entered a strategic partnership with Forum Mobility to establish an AssetCo to fund the development of zero-emission drayage charging infrastructure. This partnership was strategically timed, capitalizing on the prevailing regulatory environment and government incentives promoting the shift to electric vehicles.

Operating in the mid-market segment offers several key advantages to Forum including attractive deal flow, resilient cash flows, and supportive regulatory tailwinds.

• Attractive Deal Flow: The logistics industry is undergoing significant changes driven by e-commerce and a shift to "just-in-case" inventory management. Strong secular trends are expected to buoy market conditions and maintain strong demand for efficient, sustainable transportation solutions, ensuring Forum Mobility's continued growth and relevance in the industry.
• Contracted Revenues: The company's community charging depots underpin their revenue stream with fixed subscription payments from long-term dwell contracts with logistics management companies and beneficial cargo owners operating zero-emission vehicles. This ensures stable and predictable income, contributing to the company's financial stability.
• Regulatory Environment: Government incentives, together with strong regulations, make the total cost of owning electric trucks competitive, driving demand for Forum Mobility's charging infrastructure.

Forum Mobility's strategic growth in the mid-market segment, coupled with its partnership with CBRE IM, positions the company as a key player in advancing EV infrastructure development for short-haul ground freight transportation. The company's focus on emerging sectors and its ability to offer integrated solutions make it a promising investment choice in the evolving world of logistics and electrification.

Conclusion

Investors are expected to continue to pivot towards risk-averse investment strategies as the market heads into period of economic slowdown. The mid-market infrastructure sector is rich with long-term opportunities across next generation sustainable industries with the potential for enhanced returns. The largest 100 unlisted mid-market infrastructure companies outperformed the general and core infrastructure markets across short to long-term time horizons on an absolute and risk-adjusted basis. Contrary to popular belief, mid-market investing has similar downside protection and volatility over longer periods compared to broader global infrastructure.

Adding mid-market infrastructure to a core infrastructure portfolio enhances the risk return profile while retaining downside protection. Thus, unlisted mid-market infrastructure investing represents a defensive play for investors that expect economies to be weaker in the coming quarters. While mid-market infrastructure companies are more sensitive to interest rate changes and have slightly lower inflation protection, these characteristics can be offset through careful asset selection and debt structuring.

¹ Commonly defined as a statistical category of small and medium-sized enterprises.

Sources:

1. World Economic Forum, Fuelling the US Economy’s middle market growth engine, April 12, 2018.
2. The Journal of Portfolio Management, vol. 48, number 9, EDHECinfra Market Size and Structure
3. Middle Market Report Q2.
4. Bent Flyvbjerg, Mette K. Skamris Holm and Søren L. Buhl, "What Causes Cost Overrun in Transport Infrastructure Projects?" Transport Reviews, vol. 24, no. 1, January 2004.
5. How Big Things Get Done by Bent Flyvbjerg and Dan Gardner, 2023, Penguin Random House Inc.
6. McKinsey, ‘’Megaprojects, the good, the bad, and the better,” McKinsey Global Institute, January 2013.
7. IEA World Energy Outlook 2023, October 2023.
8. IEA, Electricity Grids and Secure Energy Transition, October 2023.