IT geek: there's value in infrastructure, but you're too late for JLIF

John Laing Infrastructure's board says 142.5p a share is a premium of about 20.6 per cent to the trust's closing share price on 13 July, the last trading day before the discussions were publicly announced, and a premium of about 16.9 per cent to its latest net asset value (NAV) per share of 121.9p. The total offer price of 146.07p per share is a 23.6 per cent premium to John Laing Infrastructure's closing share price on 13 July and a 19.8 per cent premium to its latest NAV per share.

Since the discussions were officially announced on 16 July the trust's share price has shot up from 118.2p at close on 13 July to 139.6p at close on 24 July. This has taken it up from a discount to NAV of 2.6 per cent at close on 13 July to a premium of 14.9 per cent at close on 24 July.

If Dalmore and Equitix go ahead with an offer on these terms John Laing Infrastructure's board expects it will recommend that shareholders vote in favour of it. Dalmore and Equitix are conducting due diligence on the trust and have until 13 August to decide whether to go ahead.

The proposed deal is arguably good for existing shareholders, particularly if they bought in before the share prices and premiums to NAV of infrastructure trusts started to fall last autumn.

Infrastructure investment trusts had typically traded at high premiums to NAV because they pay attractive dividends, were considered to be stable and low risk, and some of their returns are inflation-linked. Their investments include private finance initiative (PFI) and public private partnership (PPP) projects. John Laing Infrastructure, for example, has 70 per cent of its assets in UK PFI and PPP schemes.

But at the Labour party conference in September 2017 shadow chancellor John McDonnell said that if they win the next election they will "bring existing PFI contracts back in-house". This caused the share prices and premiums to NAV of a number of listed infrastructure trusts to fall.

Their share prices and ratings were further depressed after services company Carillion (CLLN) went bust in January, as it provided facilities management for some of the projects these trusts, including John Laing Infrastructure, invest in.

The proposed takeover deal offers a higher price than where John Laing Infrastructure was trading even before the Labour party conference.

"This offer would be an excellent result for shareholders following a difficult 12-month period for the shares," comment analysts at broker Liberum. "The UK infrastructure sector has been battling several headwinds including the threat of nationalisation and windfall taxes from a Labour government and the collapse of Carillion."

However, the deal has not been confirmed, and if Dalmore and Equitix pull out or offer less after completing their due diligence it is likely that John Laing Infrastructure's share price and premium to NAV will fall.

So David Liddell, chief executive of online investment service IpsoFacto Investor, says: "If you are more cautious you could hedge your bets by selling half your holding in John Laing Infrastructure now, and holding on to the rest in the hope that the deal goes through. But otherwise I would hold on for the 142.5p plus 3.57p dividend, as you would make about 6p more per share than the current share price."

He also argues that even if the takeover does not go ahead John Laing Infrastructure would not necessarily fall back to its share price of 118.2p prior to the offer.

The broader sector

If you aren't an existing John Laing Infrastructure shareholder it is not worth buying in at around 139p in the hope that your shares might be bought for 142.5p – especially as there is a risk that this will not happen and the trust's share price might fall.

However, some of the other broad infrastructure investment trusts look as though they still offer value. The share prices of all the broad infrastructure trusts have increased by varying degrees between close on 13 July and close on 24 July, and their premiums have increased, or they have moved from discounts to premiums.

Source: Winterflood as at 16 and 25 July

But these are generally not as high as the share prices and premiums at which they have traded at times before last September.

Infrastructure investment trusts face a number of risks, including political risk (see the The Big Theme in the issue of 9 February for more on this). But Mr Liddell argues that concern about the political risks to infrastructure trusts is overdone. This is because nationalising existing PFI schemes could be difficult and take several years, and over the next few years governments might have other priorities. Also, there might not be an election and change of government until 2022, and it is not clear which party will get into power.

Even if existing PFI schemes are renationalised, investors are likely to receive compensation close to portfolio valuations. For example, a few months ago John Laing Infrastructure had said that if its 57 UK projects (71 per cent of its portfolio based on a value of £871.7m at the time) were voluntarily terminated it would expect to receive around 86 per cent of this value, implying a reduction in its NAV of around 10 per cent rather than a total loss, according to analysts at Numis Securities.

Institutional investors, meanwhile, do not seem so concerned, as Dalmore and Equitix have demonstrated. "While the listed social infrastructure companies have experienced a sharp de-rating and associated elevated volatility since John McDonnell's speech at the September 2017 Labour party conference, institutional appetite for infrastructure assets continues to grow," says Alan Brierley, director of the investment companies research team at Canaccord Genuity.

He says there is a two-tier market in which institutional investors ascribe a materially higher valuation than the current market level. For example, in April, HICL sold Highlands Schools PPP to Equitix at a 21 per cent premium to carrying value. And in May John Laing Group (JLG) sold a 15 per cent interest in the IEP Phase 1 project to AXA for £227.5m. John Laing Infrastructure also owns 15 per cent of IEP Phase 1 and this was valued at £174m as at 31 March 2018.

"Against this backdrop, investors should reflect on just how valuable these unique portfolios of scarce assets are in diversifying long-term returns, and delivering attractive and sustainable dividends, relative to the short-term and significant uplifts from these corporate actions," adds Mr Brierley. "It provides a clear indication that sector prices had become undervalued by the market. We also expect this offer to underpin valuation levels. For longer-term infrastructure investors, our longstanding overweight sector recommendation is a function of what we regard as strong fundamental attractions. The dividend yields are highly attractive, both on an absolute and relative basis, and are underpinned by long-term, stable and predictable cash flows. These companies give investors low-cost access to conservatively valued and highly diversified portfolios, and they have capital preservation characteristics that could have significant value in a more challenging environment."

Analysts at Winterflood add: "A potential bid is testament to the value these funds offer at present. While the methodology of marking investments to model has always been more of an art than a science, whenever the secondary market has been tested, carrying values of assets have tended to be proved to be conservative. The fact that the premium [to John Laing Infrastructure's closing price on 13 July] is equivalent to several years of returns while removing political risk to shareholders is not insignificant. This action illustrates the value on offer in the infrastructure sector, particularly given the limited availability of the underlying assets, and we expect the sector's rating to be materially stronger going forward."

A more immediate risk to infrastructure investment trusts is the possibility of rising interest rates, which could cause these and other securities offering a higher yield to de-rate. This is because their income would not be as high relative to cash rates. However infrastructure trusts offer very attractive levels of dividends and are on yields of between about 4 per cent and 6 per cent, so interest rates would have to rise quite a lot to match or approach what they offer.

Mr Liddell says investments that are trading at a high premium to NAV should be regarded with caution. "There are no free lunches and if you get a yield of around 5 per cent there must be some risk," he says. "But investors who want income and can tolerate a certain amount of risk [could consider infrastructure investment trusts]. They are not for the cautious, and if you add them you should already have a well-diversified portfolio and long-term investment horizon. But if infrastructure investment trusts account for a small percentage of such a portfolio and are mixed in with equity growth investments, they are a reasonable risk to take. They offer an element of diversification to pure equity market risk and could be held to give a high yield alongside lower-yielding equity-based investments. Infrastructure trusts provide some diversification and have some inflation linkage."

Mr Liddell says shareholders in John Laing Infrastructure who do not want to keep their entire holding could switch some of it into HICL Infrastructure Company (HICL) as it "looks reasonable, though not as good as prior to the announcement of the possible takeover of John Laing Infrastructure. It has a yield of around 5 per cent and is on a premium to NAV of about 4 per cent". See our update on this trust, which we count as one of our IC Top 100 Funds, on p39.

Numis analysts' preferred option is International Public Partnerships (INPP). "Given the share price move for John Laing Infrastructure, it is worth taking profits, and reinvesting elsewhere in the sector where share price moves have been less extreme," they say. "On a long-term view, we retain our preference for trusts that have actively positioned themselves to deliver attractive risk-adjusted returns through the economic cycle. The peer group has become increasingly differentiated by the longevity and quality of cash flows. In this regard, International Public Partnerships has an advantage over its peers, reflecting its primary origination capabilities. These have facilitated a number of attractive acquisitions, which should continue to underpin a robust portfolio performance."

For investors concerned with UK political risk Mr Brierley suggests BBGI SICAV (BBGI), which only has about 37 per cent of its assets in the UK. This trust provides exposure to 45 PFI and PPP projects in the UK, continental Europe, Australia, Canada and the US.

Roads and bridges account for 46 per cent of its assets, as its managers think these are simpler to operate than infrastructure in sectors such as health, which accounts for 21 per cent of its assets.

Trust performance