Venture Capital and Private Equity are already heavily invested in technology. So why aren’t they closing the funding gap needed to deploy InfraTech?
Whatever your opinion of Elon Musk, you can appreciate his interplanetary commercial ambitions and Howard Hughes-like marketing moxie. Musk runs three startups (Tesla, SpaceX and Boring Company) and thrives on the Silicon Valley principles of immediacy, agility and disruption. He operates through the unfiltered influence of social media and has been recently called out by regulators and investors for questionable decision making within and away from the companies he runs. That aside, there are some positive lessons to learn from the entrepreneur as infrastructure and technology investors begin to converge in the InfraTech age.
While both technology and infrastructure investing have surged in the past ten years, investor profiles have remained dramatically different. Technology investors are aggressive chasing long-term potential - the hallmarks of venture capital (VC) and private equity (PE). Infrastructure investors are much more conservative - more aligned with sovereign wealth funds, pension funds and insurance companies seeking stable yield and predictable cash flows linked to inflation.
One side favors the value created through disruption, while the other aims to avoid it. But for how much longer can these two sides exist on opposite ends of the investor spectrum? Every day technology is being deployed which may disrupt consumer behavior that underpins successful infrastructure investment models. For example, researchers from the University of California (PDF 1.99 MB)1, Davis found that people using ride-hailing services are less likely to use public transit such as bus or light rail services. Likewise, operators of the world’s largest public transport systems banking on rising ridership forecasts should be concerned about remote working trends and sharp domestic accountants eyeing their inflating monthly travel costs as an attractive way to cut spending. This could put incredible stress on budgets that are increasingly trying to balance themselves through less-than-certain user fees. Traditionally, such services are attractive for infrastructure investors, particularly if they operate on an availability-based agreement. However if people aren’t using public services as often as predicted, it could have a disastrous impact on the economics of long- erm contracts – especially those that transfer demand risk.
It is not just transport driven by smarter mobility where the threat of disruption lies. Low-carbon energy generation has also seen revolutionary technologies emerge - from well-publicized lithium battery and renewable energy schemes to lesser known decentralized models using micro nuclear reactors or power-to-gas energy storage. For these technologies to succeed, capital is needed - both for development and deployment. The aim of what KPMG firms are calling InfraTech is not to stifle or undermine investment in infrastructure, but to deploy technology that brings flexibility and innovation to traditionally rigid public service business models. This should make it more attractive for private investment.
There is no shortage of great ideas to deploy more technology-driven solutions in infrastructure. Virgin Hyperloop One is a good example - with both powerful capital and influential people on a quest “to create fast, effortless journeys that expand possibilities and eliminate the barriers of distance and time.”2 Such ambitious vision is unusual for infrastructure owners and operators. Most industry pundits would agree that the various sectors - from utilities management to building and construction - have not been as proactive at technical innovation as say the automotive and aerospace industries have been using advanced manufacturing. With generally low operating margins, monopolistic business conditions and less profit to chase, infrastructure providers have not been incentivized to change. The exception has been the natural resources segment - and the oil and gas industry in particular - where the remoteness and scarcity of resource as well as a heavy emphasis on operational safety have driven exploration firms to adopt the most advanced techniques (afforded of course by the strong commercial value of the underlying commodity).
Still, infrastructure companies want to innovate. They don't particularly like labels that suggest otherwise. Sometimes an outside influence - such as regulation or investor pressure to improve environmental, social and governance factors - is a catalyst. The challenge is creating the business case for change, putting `skin in the game' and influencing the design process early enough to implement new technologies that fundamentally revolutionize the way infrastructure systems and businesses operate. For example, it's hard to push a transport provider towards ticketless operations if the authority has already placed significant investment in barriers.
Putting `skin in the game' is where capital influence needs to push further. Construction companies invest direct equity into project consortiums to secure work. InfraTech investors need a similar strategy. This will drive implementation of their technology and provide concrete examples of the benefits realized.
VC and PE firms are flush with cash capable of shaping the future. Yet, mostly they invest in sales-driven technology companies that compete to deliver value through a supply chain. The more sophisticated VC portfolios investing in InfraTech are focused on mature start-ups that have significant revenue and a proven business model with sustained, repeatable, increasing Monthly Reoccurring Revenue. For more nascent start-ups without such characteristics, the available funding pool is typically limited to angel investors.
In some cases, these are small things - such as consumer way-finding apps or smart home interfaces - but in others, like micro nuclear reactors, they are massive leaps into new frontiers. As such, investing in infrastructure technology is not for the faint of heart. It's easy to boast about successful projects, but impossible to overlook potential that was never realized. Take for example Pelamis, a Scottish wave energy company founded in 1998. Pelamis had its first prototype operating in 2004, followed by a second generation machine a few years later. Despite years of development and positive feedback from Governments and investors, the financial crisis and several false starts attempting to deploy a commercial-scale project eventually got to the company and made it difficult to secure the necessary funding to continue. Pelamis went into administration in 20143.
The moral of the story is that a “Big Idea” isn't enough in this market without access to capital to execute. The mindset that allowed VC investors to thrive in the tech sector must be transferred to infrastructure investors seeking to make InfraTech a success. Institutional investors must also play a role by educating themselves on the potential for disruption in infrastructure and even mitigating such risk by co-investing with VC funds in the deployment of InfraTech.
Recent innovators are right to bring the Silicon Valley mindset to infrastructure development. Launching cars towards Mars or selling Boring-branded flame throwers raises eyebrows and get retweets, but that's just noise. Projecting confidence in innovation, engineering more operational flexibility into design and delivering infrastructure quickly and efficiently while making the most of new technologies - those are some of the hallmarks of success in the 21st Century of infrastructure development.