Welcome to Pathways, a Macquarie Asset Management podcast where we provide fresh perspectives and insights for institutional investors and consultants about real assets, private markets, and macroeconomics.
Daniel:
Everyone talks about infrastructure as assets, roads, grids, renewables, data centers, but there's a whole second layer that most investors don't see. And that second layer is the companies that keep those assets running, efficient, maintained, compliant, and live. We call that second layer infrastructure adjacencies, and in today's conversation, we're going to unpack this really interesting sector. It's a space where private equity and infrastructure intersect.
Hi everybody, my name's Daniel McCormack, I'm MAM's Head of Research. To help me dive into this really interesting sector, I'm joined by Andrew Olinick, who's our head of Private Equity and Adjacencies. Andrew, you haven't been on the Pathways podcast before, so welcome.
Andrew:
Thank you for having me, Dan. Real pleasure.
Daniel:
Andrew, before we get into sectors and numbers, can you perhaps explain it in plain English: what do we actually mean by infrastructure-adjacent?
Andrew:
So, if you think about the infrastructure space, you obviously have the people that own those assets you just went through – ports, bridges, airports. But, as infrastructure has become a more mature category, there is a whole ecosystem of companies that help build, maintain, and manage those infrastructure assets; basically, extensions of that infrastructure world that help those companies to be more efficient, safe, and reliable.
Daniel:
Got it. So, you're buying companies that are servicing infrastructure, is that right? And does that mean it's infrastructure, or is it PE or, perhaps, is it a bit of both?
Andrew:
So, maybe it's helpful to think about how these businesses evolved and then we can talk about whether they're PE or infrastructure, and so. Infrastructure 20 years ago, by and large, a lot of these services would have existed within the infrastructure company themselves.
Think about a utility. They used to have all their own employees out working on the power grid. Today, they've got a universe of specialized providers that they work with that give them greater scale, reliability, and really help them meet the needs, which I'm sure we'll get into, that are happening today. Things like grid resilience. And so, think of it as a universe of companies on the services side that used to be part of an infrastructure company. They've sprung up to be a specialized supply chain. And then, therefore, they have heavy linkage to infrastructure. They're things that used to be part of infrastructure companies, but they tend to be platform businesses where you can also apply a PE framework to really help grow these businesses through a program of add-on acquisitions. I would say they have the defensiveness of infrastructure, but the growth of PE.
Daniel:
Fantastic. And big picture, Andrew, why have those capabilities of been carved out of infrastructure into independent service providers? Is it the growing complexity of the operation of infrastructure assets, or is it something else?
Andrew:
It's a number of things, right? If you think about what's happening in infrastructure, in general, it's getting older, it's getting more complex, it's getting more regulated, and there's increasing pressure to deliver better services for your customers and quickly to make those services digital and to be more cost-effective, right? That’s a lot for anyone to deal with. And then, if you think about the growth these businesses are having – take digital and energy – which are both seeing unprecedented growth, there's a real need for partners to help them manage that complexity, that aged infrastructure that would require specialized capabilities that maybe they never had in-house, and then to do it in a way where you can do a lot of work, do it reliably, and do it cheaply. That is not the previous DNA of an infrastructure company. That's the DNA of a specialized service provider. And so those have emerged, really, over 20 years to do things better, faster, cheaper than what an infrastructure company could have done in-house.
Daniel:
Well, with my economist hat on, specialization certainly makes sense, so I get the overall efficiency gains that can come from this kind of approach, rather than what we had before. Perhaps we can just pivot a little bit and talk about, why now? Why is this becoming an opportunity right now? You talked a bit about the complexity and perhaps some of the aging, but what has changed in the infrastructure space to make this the opportunity it is today?
Andrew:
Let's just take one of the sectors, energy, for example, because I think it's the most clear-cut. We have had a period, Dan, which I'm sure you'll know and maybe you can comment on here as well, the last 20 years, with basically no demand growth in the US or Europe for energy, right? And then, in the last couple of years, we've seen meaningful demand growth, right? Obviously from data centers, which everyone talks about. But less talked about are things like electrification – that's cars, that's heat pumps. There's a variety of things that are driving that. And so, what's really happening now is that growth requires both new power generation capacity, but it also requires you to keep your existing assets up and running longer. Both of those require specialist providers to help meet the demand. These assets are beyond their useful life and they're heavily regulated. So, what's happening is a need to keep those assets up and running longer to meet those power demands. And that, that requires a whole other universe of engineering, testing, regulatory compliance. There's a whole range of service providers that never were needed that are now needed. These are even new categories for that space that have emerged just to meet this need. So, the ‘why now’ in energy and digital is the massive boom and we're dealing with increasingly aged infrastructure that simply needs to continue to operate for longer.
Daniel:
And that's probably a good segue into grids. I think grids are perhaps a good example to draw out here, and I know there're a lot of statistics on the age of our grids. I think in the US, it's something like 70% of transmission lines are approaching the end of their useful life. And in Europe, something like 30% of the grid is more than 40 years old. So, this grid infrastructure in the US and Europe is really getting very old now. Perhaps we can dive into this in a bit more detail, Andrew. Can you just talk about what the aging of the grid means for the opportunities set in the companies you look at?
Andrew:
There's a number of things that are happening here, right? There's age, and then there's also a need to make the grid do things that it didn't do in the past. Look, most of the stuff was built to last 40 to 70 years. We're at a point where we're beyond that in a lot of cases. And so a lot of things happen there. Regulators basically start to mandate that you do more work to keep it up and running reliably. That can involve testing. That can involve re-engineering. In some cases that involves re-permitting to enable these assets to stay up and running longer. And so, if you think about what sits underneath, that's testing providers, that's engineering companies, that's regulatory compliance consulting services. It's increasingly things like smart sensors that will sit on the grid that can detect when there's issues.
There's the macro, which I would say is aged infrastructure beyond its useful life. Then you've got the drivers of the investment, which principally are around regulation and what you need to do to satisfy them. And then you have all these different services that have sprung up to basically help manage that need. And then you also have other things that are concurrently happening that geometrically increase the complexity here. The main one I'll highlight is the changing weather patterns and the stress that's putting on something like the grid. In states like Texas and Florida, you have poorer weather, hurricanes, fires, floods. And that also can be a source of taking the power grid down. That was not something the power grid was designed to withstand. On top of that aged infrastructure, it also has to withstand conditions that were never meant to exist.
Corresponding to that, you have this wave of grid resilience investment which regulators now mandate and then fund. They allow the utilities to charge their customers for those investments. And so, these two kinds of waves are coming together: aged infrastructure and the changing conditions on the field that are necessitating this massive investment cycle.
Daniel:
Yeah, in the US certainly outages are on the rise. I think in 2024, which is the latest year for which we have data, the average household experienced 11 hours of outages, and that is double what it was over the prior decade. So, this aging of the grid is having real consequences, and if we can improve its function, then that's obviously a very good thing for customers.
Andrew:
Yeah, that is the driver, Dan. So, I think you hit the nail on the head when you look at that ‘hours per year’ of outage. That's gone up a lot. And in some cases, the real driver of why the investment has happened here is that in places like Texas, they've had weeks at a time where the power has been out. The regulators have simply said, this is not acceptable in a modern economy to have this happening. What do we need to do to make sure this doesn't happen anymore?
Florida was the leader in grid resilience. They actually approved a novel approach which allowed the utilities to split out a separate category of spend, which is grid resilience, and earn a return on that. That was wildly successful and a storm-prone state has reduced the downtime. That's spreading to other states now, and that's what this broader grid resilience theme is. It's going state by state in the US, being approved and funded by regulators. The last thing I'll say on this is that outage time is at risk of going way up, right?
Because you now have data centers, which are consuming an immense amount of load. In some places, it's stressing the grid. And so that's probably the next wave, which is how do you actually ensure that with data center capacity coming online, needing to be up all the time, that doesn't squeeze out some of the consumers that also rely on that electrical grid. So that outage time, as you mentioned, is sort of the critical metric.
Daniel:
Certainly, you mentioned data centers and all the new technologies that are coming and the demand for data is really creating a whole new dynamic here to power demand and therefore pressure on grids. Perhaps something a little bit more mundane though, Andrew, I've heard you talk about: vegetation management. Most of the US electricity infrastructure is above ground, right, it encounters vegetation all the time, and that creates problems. It may not be super sexy, but as I understand, this is a real issue and it's really important. Could you just talk through for the audience, why that matters and how it feeds into the opportunities in this space.
Andrew:
It's a really good one. It's a very tangible one. It's one sometimes people joke about because you talk about vegetation management and they say, is that a fancy word for tree trimming? And to some extent it is. But the reality is, and we'll go into some of the stats here, think about where you have power lines as a consumer. You drive around, you see them. They're often right close to trees, and those trees, as they get overgrown, impede the power lines. And then what ends up happening when you have a storm or lightning is the tree knocks into the power lines and all of a sudden, you have a massive outage.
That can happen both in what we would call distribution, which is the power lines that bring the power to your house, and that can also happen on transmission, which are the wide expanses of power lines you'll see along highways, that carry it from where it's produced to where it's consumed. This is just massive expanses where you have a lot of vegetation and trees. It's a really simple problem, but it's a really challenging problem for the utilities.
So, what they do is they hire these companies called vegetation management companies, which historically had people that would be out in trucks trimming trees, right? And that was the Version 1.0 of this. Mission-critical utilities will spec this into their spend. It's something they have to do and on a regular basis but it's also increasing in sophistication. And so now, utilities will, through their partners, do things like employ drones to basically survey the area and figure out where they need to work on first. They're using software to model this and so the really simple thing of having trees overgrown is also becoming a place where utilities are becoming very strategic and tactical on how they monitor and triage what to do along that vast infrastructure.
To bring this to real life, what the consequences of this are, vegetation overgrowth was a key reason that PG&E in California had a major wildfire event that basically caused their bankruptcy. They had over $30 billion of liabilities from overgrown vegetation that caused a massive event on their ecosystem in 2017 and 2018. That's also been the impetus that's driven a lot of this grid resilience investment in places like Florida, so it all connects back. What I would say on the vegetation management is it’s mission critical. If the trees get on the power lines and cause them to come down, it can have really significant consequences. This is really the ‘low-cost/high cost’ of failure where it doesn't cost a lot to do the vegetation management, but not doing it well can lead to catastrophic results.
Daniel:
Really interesting, Andrew, I think that's a fantastic real-world example. Let's now turn to renewables, as I know that's an area that you focus on. Renewables certainly feel like they're newer, but I know there are some wind farms in some of the first-mover markets in this space, which are approaching the end of their design lifetime. I'm talking about places like Spain, and Germany, and California, and Texas. What are you focused on in the renewable space?
Andrew:
So, let's take a macro view and then we can drill down into the aged infra and what that means in terms of the investment that's needed there. One of the things I would say at the highest level is: obviously there's been a little bit more pressure on renewables to slow down that investment, particularly in the US in recent times.
And as we talked about earlier, there's also this massive power consumption need. And so, you basically need every ounce of energy you can get, right? What's ended up happening is in an era where it's harder to build new renewables, there's an increasing focus on keeping the existing renewables up and running longer, right? And it's become a lot more economically attractive to do things like significant repair and overhaul of things like wind that require quite a lot of maintenance as they age. Exactly as you said, we're now hitting a point where these assets are 10 to 20 years old and they need significant repair and overhaul.
And the way it works in the wind space, for example, is they would have had a partnership with an OEM, someone like a GE Renova, that would have sold them the wind turbine for the first part of their life, and beyond that, they have the opportunity to either continue to work with them or find an independent service provider that can do that and more than what someone would have done for them in the past. There're some really interesting businesses that basically exist to help with that beyond-warranty period, to do things like repair and overhaul. There's lots of things you need to do with these assets, repair the parts. You need to repower them over time, they start to lose their power and need things like the gearboxes to be redone.
We're hitting a part where that cycle is happening and there's a really interesting set of independent service providers that work on a full life-cycle basis with the asset owners to figure out what maintenance they need to do, help them go on to the actual structures and do the testing and inspection to figure out what's needed. They tend to have facilities where they can do repair and overhaul, and then they can actually go back onto the structures and keep them up and running.
And that work is really cost effective if you're an asset owner because it helps you extend the useful life. We talked about the offtake for this type of power. There's basically insatiable demand and so you will basically continue to sell your energy into the market if you're able to keep it up and running. And that has become an area of increasing investment, not just in recent times, but sort of boosted by what's happening in the broader renewables, new-build market.
Daniel
So, is it fair to say that it's about the installed base of renewables power here, as in, even if the renewable build-out slows, the fact that that installed base is aging all the time is still driving demand for the services that your companies are providing?
Andrew
That's fair, and I think right now I'd say a lot of the investment is going into preserving the installed base and making it last longer. Obviously, we'll see how the policies in places like the US evolve. I think over time, I would still expect that to become more favorable for a new build. But for now, it's a little bit subdued, particularly in offshore wind. I'm curious what you're seeing. You sit in Europe. I think Europe has a different environment for new building of renewables. I'm curious if maybe we can compare and contrast a little bit what is going on in the US versus Europe.
Daniel
Yeah, I think there's a real difference, and I think it stems from the political environment. In the US, clearly, wind is on the nose, but in Europe, that's definitely not the case. And I think, in fact, recent events in the Middle East have only served to reinforce the importance of energy security. From a European perspective, solar and wind are domestic sources of power. They're cost competitive in many cases, and you're not reliant on a foreign power for that power, for that energy. So, I think Europe is probably accelerating in the direction of renewables rather than decelerating. There're big regional differences here depending upon where you sit.
Andrew
My thesis is very much that even in Europe, as these assets approach end-of-life, given the demand for power, you're still going to see repowering, you're still going to see people spending the money to keep these up and running. So, it's acute – more acute perhaps in the US – but I think it will also be very prevalent in Europe as well.
The other thing we touched on – and I wanted to make the point before we leave this topic – and that runs across the gamut of the infrastructure services space, is the additional presence of technology and really using technology to predict, to do predictive maintenance and to use drones.
That's a theme, particularly in this category. Think about wind structures. They're hard to get to. They're very man-intensive to take people up. They have safety risks. Another thing we're seeing is particularly this. But when we talked about the utility services businesses before, like vegetation management, there's an increasingly tech-enabled services universe of things like drones that help and take pictures and then feed into predictive maintenance that's really making the maintenance of these things more efficient, whether you can actually determine when you need to take something down, in a much more precise way. So, I just thought I would point that out.
Daniel:
Yeah. Previously, wasn't it the case that to service a wind turbine, you had to have a guy go up on a rope to even to do inspection? Whereas now you can just have a drone fly over it and check out a lot of what needs to be done. Is that right? Could you perhaps talk about that a little bit?
Andrew:
There's a whole category of inspection, which was basically what you just said: a guy on a rope doing a lot of visual inspections. They were trained with their eye to see things in a way that we wouldn't necessarily see. In some cases, they used photography, but there's a whole universe of things that were done just based on a trained engineering individual. And we're really seeing a pretty big shift – which hasn't necessarily made its way into the regulation in terms of what you can do in all cases, but I think will – where you can use a drone. You don't have to send that person up. You can use much more precise imaging. You can then take that imaging and run it through, certainly computer systems, but now even AI, and you're going to get a much more precise answer around the risk of that asset going down. Do you need to take it down for maintenance now? And I think you'll find that, compared to things done by a trained eye and that time scale, you'll start to get a lot more precise.
That will also be enhanced with things like sensors, which are getting increasingly cheap, where you can also put them in and understand the condition of an asset. I think you're going to have a much more complete picture in real time of your infrastructure and automate a lot more of that with less human intervention.
With things like power infrastructure, transport infrastructure, our view is that it's going to be a long-running trend that honestly creates some pretty interesting investment opportunities in those types of businesses as well.
Daniel:
Improve safety as well. Going up a wind turbine with a rope attached, obviously there are safety protocols put in place, but it's not a no-risk thing to do. So having a drone do it is fantastic from that perspective.
Just to round this out, Andrew, I heard a stat that something like 90,000 wind turbines will hit 20 years of operation between now and 2030. Ninety thousand – that's just a huge number. That only serves to highlight the demand and the growth in demand that is in this space.
Great. Let's turn to data centers now, which are everywhere in the news. Could we perhaps talk through how this is relevant for infrastructure adjacencies? I know you're not talking about a landlord-type investment here; you're talking about servicing these data centers. Could you just explain that for the audience?
Andrew:
When you think about the data center space, we're focused much more on services or products or technologies that could be sold into a data center. And there's a really broad menu here. There's so much growth in data centers that there's a lot of those companies.
I'll give a couple of examples. You can have a company that helps engineer a data center. They all require specialized engineering. You could have a cooling system which is sold into a data center. There's been a lot of M&A activity in that space recently. They help cool the facility, which is obviously critical to its operation. You could have a business that does certification of data centers. So, there's a whole universe where you need to make sure that the data center has the uptime you expect it to have. There's even certification of people that work in data centers to make sure they have their credentials.
And then there's an increasing world of physical security where you have to make sure …These are really mission-critical strategic sites now and so there's a security of data center universe of companies that has emerged. It's become pretty broad. These companies benefit from the growth in data centers, but in different ways, right?
Some of them will track the growth of the data center itself, so they sell recurring maintenance services that are spec’ed into the operation of a data center. Some of them will be much more tied to the new build of a data center, right? And so, as the build comes down, so will their revenue, and some of them have varying degrees of technology risk. There's obviously things in the space where technology is changing very quickly – cooling systems or things like that, there is a lot of innovation happening there. So, this is a space where I think there's quite a lot to consider. There's good growth, but there's very different models and very different risk profiles that an investor can choose to access here.
Daniel:
And complexity is a big thing here, as I understand, right? Just to give one example, I know liquid cooling is much more effective than air cooling, but it results, as I understand, in a sort of step-change in complexity for the data center. So, complexity, how big of a driver is that for you?
Andrew:
I mean, complexity here is massive, right? If you think about this, it's not just the square footage growth of the data centers. There's a lot more built into that square footage and you can measure that in chips, you can measure that in systems like cooling systems, like you just highlighted, Dan.
And so, if you think about the box, the box has a lot more highly specialized equipment in it. And with that highly specialized equipment comes cost, right? So, there's just a lot more dollars per square foot. But then there's also a cascading set of risks you need to manage where this facility needs to both never go down, never break. You're talking multiple billions of dollars per facility now.
There's a whole lot to manage in terms of getting it to work right, making sure it operates in the right way, making sure it's safe and protected, that investment that has multiple billions of dollars of equity and debt capital in it. So yeah, exactly right, massive complexity. And again, think about the example we had on the utilities before. That's where these service providers really come in. That's where they shine in helping the owners of these businesses manage all that complexity.
The cost of failure has gone up considerably in recent years, hasn't it? And that, that just has to be a driver here, doesn't it, because if the data center goes down, the cost is high, so if you can do predictive maintenance, or whatever the case may be, to prevent that from happening, that's real value-add here, isn't it?
Just an anecdote here. I was listening to someone in the insurance industry talk about the data center space and hadn't even appreciated this, but there's a whole bunch of constraints that the insurers now put on these businesses in terms of what they need to do. As a service provider, you're now mandated by insurance companies that the owners have to do X, Y, and Z thing before they can even commission the data center, before they operate it. I mean, think about that, right? These sites have multiple billions of dollars of invested capital. They're now being insured, and now the insurers are saying, I want to protect my insurance investment and putting a whole bunch of constraints on it. And so that sort of cost, that complexity that now-regulated and insured framework is also putting a whole bunch of mandates around what you need to do as the data center owner.
Daniel:
Fantastic. It's certainly a fascinating area and the way you unpack it there with the involvement of insurers just really reinforces it. So, we've talked about grids, we've talked about renewables, we've talked about data centers. Let's bring it all together. If I'm an investor listening to this, what should be the two, three, four key takeaways?
Andrew:
Ultimately, for me, this is not a niche or an add-on infrastructure ecosystems service. This has become its own industry, and it's sizable. There's a lot of companies, and as we talked about, they're becoming central to the operation of these assets. They're needed now. The infrastructure owners can no longer do these things or could never do these things in-house.
So, I'd say it's not a niche, that's point one – it’s a super critical part of an infrastructure owner's program. Number 2. this isn't just about growing capex. There's a lot more complexity in this. And so, you end up both with growth in capex but, also, the complexity per dollar of capex has gone up immensely. That's where these service providers, as I mentioned a minute ago, really shine – helping manage all that complexity.
The third point I would make, we think these businesses have what I call defensive growth, right? I would say they're defensive because they're part of an infrastructure spend, which is very recurrent, and then you get spec’ed into their workflow, so you have a very predictable revenue stream. But then you can grow them. They've got the organic growth, but you can do, as we talked about earlier, PE-style value creation.
So, we think there's this really interesting, ultimately risk-adjusted growth in the space. I would say it's definitely one where you need some specialist experience to underwrite these because you have to understand not just the business itself, but you have to really understand the ecosystem that these businesses operate in. As we talk about utilities, you need to understand what are the utilities doing, why are they doing it, where is their stability here? Where could that change?
You’ve got to almost be an infrastructure expert that can also underwrite these business models, which tend to be services or critical manufactured products. There's a lot of things that are coming together, right? So, we talked about power, we talked about digital. There's a convergence that's happening here as well. And so, you have to see the whole picture, not just individual sectors. You have to understand where these things are converging and what some of the implications of that are. And so, to summarize, I really feel like it's an interesting category, it's a specialist category. It has this defensive growth, but you really need to know the underlying end-markets as an investor to be successful.
Daniel:
You're certainly right. Previously, power infrastructure, data centers and renewables were viewed as separate sectors. And they are separate sectors, but they're all coming together now in one linkage, which is, data centers are driving an increase in power demand, which means we need to reinforce and strengthen the grids. Renewables are helping to provide that demand for power. We basically can't build power supply fast enough, so renewables are helping there. But renewables, because of their intermittency, mean we need to harden and reinforce grids as well, so these three things are all intersecting, and I think it's a really fascinating area.
Andrew, we're at time now, so we should wrap this up. I think this was just a fascinating discussion, and what's become clear to me over the last 20 to 30 minutes or so is that this is really its own ecosystem. I didn't realize how big it is, and how much opportunity there is, and how many service companies there are operating in all of this. Fantastic. Thanks very much for coming on the podcast.
Andrew:
Really fun. Thanks, Dan. Thanks. Appreciate you having me.
Daniel:
To our listeners, I hope you found that as interesting as I did. Thanks very much for joining, and until next time.
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