Infrastructure: The enormous US opportunity
After over a decade of underinvestment in infrastructure, many countries globally are facing a situation where the gap of investments is having a negative impact on GDP growth and resulting in hazardous situations. Furthermore, technological advancements, such as electric and driverless cars, smart grids and renewable energy are driving the need for new investments
Out of the major developed economies, US infrastructure has been maybe the most underinvested during the last 20 years. ASCE (American Society of Civil Engineers) has predicted that the lack of investments in infrastructure is costing every American family USD 9 each day1. It seems that the US has reached a tipping point. Investments have already picked up in areas where private capital has a strong investment case, for example communications and energy infrastructure. On the other hand in one of the most underinvested areas, transport infrastructure, investments are still lagging due to dependency on Federal decision making, funding and complicated permitting process. The expectation is that most of the new investments will continue to be done by means of private capital while political emphasis is on reducing and streamlining regulation. In this thematic insight we are taking a closer look at the state of US infrastructure and communications infrastructure, one of the segments where investments are already recovering.
The Net is the new underlying infrastructure for civilization itself
David “Doc” Searls2
(Americantechnology author and blogger)
How big is the gap?
Failing infrastructure has a negative spill over effect on the economy. Congested roads and airports increase travel times and transport times leading to higher costs. Similarly failure to deliver electricity or clean water will lead to lower productivity. Higher costs and lower productivity will ultimately lead to lower GDP, employment and personal income. ASCE has estimated that each US household will lose USD 3,400 of disposable income each year as a result of underinvestments in infrastructure. The impact on business is estimated to be as dramatic. If the gap is not closed by 2025 ASCE estimates the economy to loose almost USD 4 trillion of GDP and 2.5 million jobs3.
Surface transportation is clearly the most underinvested segment of infrastructure in the US with an investment gap of over USD 1.1 trillion. Federal gas tax, which is the main source of funding for building and repairing roads and bridges, has not been increased since 1993. Tax revenues vs miles driven has been steadily declining and public investments have reached multi decade lows. According to ASCE, 56 000 bridges and 20% of roads in the US are currently structurally deficient or in a poor condition4.
The negative impact of declining gas tax collection is even more significant as traditionally greenfield investments were funded from the Federal budget. Since the financial crisis Federal infrastructure expenditure has been negative net of depreciation. However, state and local governments, which used to be responsible for maintenance and operations, have grown infrastructure investments since 2013. As states increase their role in greenfield investments public-private-partnerships (P3) are also likely to become a more common way of financing and operating new projects. The US is currently lagging significantly behind other countries in using P3 to fund infrastructure. Goldman Sachs estimated that in 2016 P3 investments accounted for 0.05% of US GDP versus a median of 0.6% in the 16 other countries they studied. The US increasing P3 investments to the median level of 0.6% over the next decade would result into USD 411 billion of incremental investments. Canada and Australia, for example, fund 15-20% of their infrastructure investments through P3 and Colombia had USD 6 billion of P3 investments in 2016 compared to the US having USD 9 billion, although Colombian GDP is 2% of that of the US. These numbers give an idea of the potential of P3 deals as infrastructure expenditure increasingly moves from Federal to state level.5
Permitting process is another bottle neck for investments. Getting environmental permits for a greenfield road project currently takes on average over 10 years, while in the 1980s the time spent was on average two years. Long permitting processes mean higher project costs and lower returns. Furthermore, the costs often increase to millions of dollars rising the project’s risk profile significantly. A long review is often followed by an environmental lawsuit leading to a decade of litigation. President Trump’s infrastructure program is expected to contain a “regulatory relief proposal”. The target would be to shorten permitting time to 2 - 5 years and to increase the transparency of the regulatory process.
Pockets of growth
Despite the challenges in funding and permitting there are already pockets of growth within the US infrastructure sector. Growth is usually driven by either strong demand driving the economics of new investments or by hazardous situations resulting from underinvestments. We will look into the example of communications infrastructure where investments are driven by strong growth in data volumes. While energy, transport and water infrastructure have been around for years, communications infrastructure is a new, heavily technology driven and therefore fast evolving segment. It is estimated that globally USD 8.3 trillion will be needed in communications infrastructure investments between 2016-306.
Communications infrastructure – driven by data
The outlook for capital expenditure in communications infrastructure, driven by the extraordinary growth in wireless data, looks very promising during the next decade. Internet of things (IoT), cloud computing and centralized data all contribute to traffic. As an example driverless cars will have a long list of sensors, cameras, ultrasounds and radars all generating and consuming data. Cisco expects wireless data CAGR to be 47% between 2016 and 2021, but it could be even higher.
Wireless capacity can be created in three ways: more spectrum, better technology and more cells. As there are limited spectrum resources and steady technological evolution, demand for cell sites is solid underpinning tower companies growth outlook. In addition demand in the US in the coming years is driven by FirstNet first responder wireless network, 600MHz broadcast spectrum auction and carriers starting 5G deployment. FirstNet is planned to cover 50 states and AT&T is estimating the size of the investment at USD 40 billion. 5G investments are likely to last for the next decade, estimated capex being up to USD 250 billion. 5G will enable mobile data to move from smart phones and tablets to IoT including self-driving cars, telemedicine, smart cities and use of sensor networks in, for example, agriculture.
US telecom tower companies are well positioned to capture this growth. Due to planning and permitting issues there are high barriers of entry. It is very hard to get the permit for a new tower site close to residential areas. Furthermore, the market is concentrated with three leading tower companies having 55% share of the US market. Average tenant ratio for the tower companies is currently just over 2, leaving upside to the maximum of 3. American Tower estimates that return on Investment (ROI) increases from 3% to 18% as number of tenants increases from one to three.7 Furthermore, tower companies have automatic annual escalators of 3% in their long term contracts, giving them a protection against inflation. Small cells and fiber will offer additional growth opportunities for tower companies in densely populated areas.
Increasing speed and capacity from 5G will rely on higher frequencies and network densification. This requires significant deep fiber investments in order to support the estimated fourfold of data in the next five years. A current government-funded project “Connect America Fund Phase II” is a USD 9 billion program connecting 3.7 millon homes and businesses to broadband. Private companies are also investing heavily in fiber. AT&T for example, is upgrading 12 million homes to “fiber to the home”. Deloitte estimates that in order to meet future broadband needs, the US needs an estimated USD 130-150 billion in fiber infrastructure investments in order to support broadband competition, rural coverage and wireless densification.8 The investments will be a combination of P3, financial investors and communications infrastructure and service providers.
Data centers, housing networking, storage and server equipment are also well positioned to benefit from the explosion in data volumes driven by IT outsourcing, IP traffic growth and cloud adoption. Similarly to telecom towers, data centers have high barriers of entry. Not only are they protected by planning restrictions, but high up-front investment and long lead-time to secure necessary equipment act as additional barriers of entry. Furthermore, increasing computer processing density and utilization rates mean that data centers have constantly growing power and cooling requirements. Most companies still manage their IT systems in-house, meaning that they own their own data center with expensive IT professionals. We expect the migration from internal IT infrastructure to third-party data center facilities to continue. Data centers have multi-year lease contracts and low client churn. Most generate a majority of their new sales from selling to existing customers. Co-location strategies which offer interconnection between clients within a data center further add to client stickiness. As operating costs are largely fixed, data centers have high operating leverage from adding new customers.
The US is currently facing a significant investment gap in infrastructure which is already resulting in lower GDP growth through inefficiencies. While the current administration is willing to tackle one of the big bottlenecks, permitting, investments will mainly rely on private capital. We are seeing pockets of growth emerging either in areas where the economic incentive is high, such as communications infrastructure, or when lack of investments is resulting into hazardous situation, such as electricity blackouts. Communications infrastructure, where growth is driven by the explosion of data volumes, is in our view one of the most interesting areas for private investors and listed infrastructure companies. We expect tower companies, data centers and infrastructure contractors to be able to enjoy high growth rates with improving returns as a result of economies of scale.