Why I would NEVER invest in early stage infrastructure projects

I’ve been troubled by China and how to best invest for some time now. I relocated to the Asia-Pacific region 8 years ago in order to take advantage of what I saw as a tectonic shift of wealth that was underway.

There is an enormous amount of infrastructure build-out taking place across Asia, but especially in China. This project being the latest installment in a long running theme of a state-planned economy. In my mind there is no doubt that we’re experiencing an overbuilding boom inspired by easy monetary policies throughout the world. A lot of this infrastructure build out adds to GDP growth. GDP growth however is easy to achieve while real wealth growth is something altogether different. In parts of Asia we have office blocks going up in areas enjoying 25% vacancy rates. This is far from the worst either. It adds to GDP growth but certainly doesn’t add to new wealth.

This build out has the potential to be a real positive, although not for early stage investors. When you look at the construction of the railroads in the US in the 1800’s there was, at the time, massive over capacity but it laid the way for a much easier process of building wealth once the infrastructure was in place and the railroads had all gone bankrupt and been restructured.

To illustrate the point, about 95% of all railroads in 1895 were bankrupt and all canal companies went bankrupt. The building of the Chunnel is another example. The guys who invest in the first, second or third equity tranches in these projects all lose their shirts. Not to belabor the point, but the laying of all the fibre optic cable is another example. It is there for all of us to use and helps lower the costs of business massively, much the same way the railroads lowered the cost of business in the late 1800’s.

I think that we will have a similar setup in Asia, and the opportunity will lie in buying distressed debt of infrastructure projects for cents on the dollar. Naturally we may have to wait a long time for that… or maybe we won’t have to. I’m not smart enough to know. I do know that buying into them now is likely to be very painful and I therefore have zero interest in doing so. PATIENCE is required. Now is NOT the time to be buying these things!

The revenues generated directly from the infrastructure that has been put in place are rarely enough to provide for the return of capital let alone return on capital.

Ultimately the beneficiaries of infrastructure projects are many and diverse. Consider for example the Chunnel that links London and Paris. It is now possible for a flower seller in Paris to have fresh flowers on corporate breakfast tables in London’s offices each morning. This would not have been possible to the extent that it is today without the aforementioned Chunnel.

The Chunnel provides enormous benefit to industry throughout Europe and the United Kingdom; however the financiers of this are not so happy.  My focus is not on the Chunnel or Europe for that matter, these are merely illustrative points I make.

Among the factors that I generally look for before making any investments are, importantly, a lack of government intervention. Infrastructure is often politically sensitive, so I’m wary of government stepping in to save banks that have lent to the particular companies involved in the construction. If this happens then we don’t get the opportunity and instead will likely witness a Japanese remake.

If on the other hand the deck is cleared and the debts restructured two things will happen.  One is that the foundation for building real wealth will be laid. In this respect I think China is in a similar position to the US in the 19th century.

The second thing that is important is that for once buying infrastructure debt will be a road to riches.  As my friend Kuppy says. “The real big money is in buying the collapses”.

Here’s to waiting…

- Chris

“Get the important things right.” – N. P. Collingwood