The mid-market space offers superior optionality around transformation levers and exit routes. The wider dispersion of returns among mid-cap managers creates unique opportunities for investors to unlock alpha and achieve above-benchmark returns. And that’s probably why investors’ appetite for value-add infrastructure seems to be on the rise.

This shift comes in response to interest rate hikes and challenges faced by some assets, as well as the importance to deliver cash yield generation and inflation protection. These are just some of the market perspectives shared by Bruno Candès, a partner at mid-market infrastructure equity manager InfraVia Capital, when he spoke with Infrastructure Investor.

Two fundamental trends are driving exceptionally strong demand for infrastructure capital: the energy transition and digitalisation. The energy transition, in particular, is the poster child for mid-cap investemnt opportunities because it is possible to transform small infrastructure platforms into full-fledged independent power producers.

You can do so by acquiring mid-market assets, corporatising their processes, investing in the teams, investing in digital tools and growing capacity through M&A and capex.

For example, we invested in Reden Solar in 2017, a vertically integrated utility-scale photovoltaic PV platform anchored in Europe. By the time of our exit in 2022, we dramatically transformed it, increasing the installed capacity by seven times, expanding its geographical presence into five new markets and building a robust and actionable project pipeline.

Recently, we invested in Green Utility, an Italian solar PV platform, with the aim of replicating the successful journey of Reden Solar.

We also invested in pan-European platform Prosolia Energy, where our focus will be on supporting its international expansion and its transition into a full-spectrum energy solutions provider for industrial clients. It is also very true for battery storage, and we acquired GIGA Storage, with a small existing asset base, which we are now in the process of taking to the next level through capex investment.

And what is true in the energy sector is evidently also available for digital infrastructure, though maybe to a slightly lesser degree. As a matter of fact, some sectors have matured over recent years, making the entry points increase on the back of massive capex deployment in the previous cycle. Take fibre-to-the-home for example. The sector offers a consolidation opportunity; which is likely to happen at large-cap scale, whereas in the previous cycle this would have been in a mid-market investor’s sweet spot.

There is, however, still an opportunity to pursue a mid-cap buy-and-build approach in the data centre industry, where you can take operators that have started out in the colocation or enter-prise markets and help them transition into the hyperscale market.

We did that with NGD, which we acquired in 2016 and developed exponentially, addressing the demand of global hyperscale customers, large enterprises and HPC clients, resulting in the contracted IT load capacity being multiplied by more than 10 times over four years. We invested substantially in new infrastructure capacity and connectivity, and embarked on the development of a new data centre campus. We exited the investment in 2020, after having completed this first cycle of hyper-growth.

We are now planning to do the same with OpCore, which we secured in December last year.

Of course, you can apply the same investment model to the other sectors where we invest, such as healthcare and transportation, but there is no doubt that the energy transition and digital infrastructure are the most dynamic sectors today.

The mid-market is quite granular and commands deep knowledge and extensive networks. On top of that, one of the key features of the mid-market is the potential to expand assets, which requires a well-defined strategy focused on growth and business transformation. We believe that a key differentiating factor tu support mid-market companies and successfully execute the value creation strategy, is a dedicated asset management team with experts in areas such as business acceleration and transformation, talent management, digital and sustainability.

When you look at the statistics provided by consultants and funds of funds
that have access to broad market data, it does seem that large-cap deals are trading at a premium of around 20 percent to mid-cap deals. However, we believe it is difficult to take a definitive and hard view on this. And to be honest, I don’t think that is the most important point when considering the advantages the mid-market offers.

What is more important is that the transformation potential of mid-cap assets is far greater. When you buy a company with $100 million in revenues and $50 million in EBITDA, it is still a relatively young business, not fully institutionalised. There is a lot you can do to improve processes, strengthen management, invest in digital transformation and help the company with its carbon metrics, for example. That means you can create value beyond pure growth and capture exit premium within a reasonable timeframe.

By contrast, buying a business that is already generating billions in revenues is like manoeuvring a shipping liner. It is more difficult to shift the asset from its current trajectory and to really move the needle in a short period of time.

In fact, we believe that the deliverability of growth in the mid-market is possibly greater as well. From capex and M&A to in-market consolidation and cross-border expansion, there is probably a lot more optionality for growth.

Last but not least, the dispersion of returns is greater in the mid-market when compared to the rest of the market. So, if you are looking to generate alpha as an investor, the mid-market is the place to be. Selecting the right mid-market managers is key for active LPs to outperform benchmarks and deliver superior returns.

This is a subject of some debate and the answer you get will obviously depend on who you are talking to. Our perception is that following the increase in interest rates and a spike in inflation, and with some core assets notably running into trouble, there has been a slight cooling in appetite for core.

Core infrastructure has not consistently delivered on its key downside protection characteristics and inflation linkage, particularly over the past few years, leading, I believe, to weakening investor appetite. In any case, more importantly, capital has to be returned to investors for the fundraising market to normalise.

However, I also believe that LP interest in value-add strategies is increasing, as they have gained a better understanding of this strategy, which now has 20 years of history.

There is a lot of liquidity when it comes to infrastructure financing, in terms of capital markets, direct lenders and banks. The debt market is functioning very well.

We haven’t found the exit environment to be all that tough. We have exited three deals over the past two years. But in general, I would say that the variety of options to exit that you have as a mid-market investor are far greater than if you operate in the large-cap space.

We have the option of selling to strategic buyers and we have seen some of them returning to the market with hunting licences. You can also sell to another GP, of course. If you have completed the value creation story and shifted the risk profile, you can sell to core, and if there is still some growth to come in the business, you can sell to another core-plus or value-add investor.

You can also sell to direct investors that are looking to have greater control over their allocations. This is particularly evident where investors are looking to increase their exposure to local assets. Then there is the IPO market, which may occasionally make sense in the mid-market as well.

In short, the potential buyer universe is broad, and we have completed all of these different types of exits in the past