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leveraging up infrastructure assets

here from wallstraits tanjm explains how leveraging infra assets to get greater yields” This trend in leveraging up infrastructure assets is actually an old strategy updated into the 2000’s.

Recall in the 1980s and 1990s when leveraged buyouts (LBO) were common?

The typical LBO was as follows:
– find a business which is relatively stable, little debt and with stable cash flow.

– form a new entity with 20% equity and 80% debt.

– Buy the business – typically at a premium (e.g. 10% to 20% of fair value).

– Interest on debt is tax deductible.

– Use almost all available cash flow to pay off interest and principle payments

– after several years, debt is paid off. LBO has ended up with equity stake in original business.

Provided the underlying assumption about the stable cash flow was correct, the LBO made money because the after tax cost of debt was much lower than the return on the company’s assets – thus providing the opportunity to leverage on the difference.

Fast forward to 2005/6.

The phrase “manufacturing yield” probably was referring to the previous para. Despite the negative connotations of the phrase, there is nothing inherently wrong with it provided cash flows are stable and cost of debt is hedged – savvy investors just have to recognize and cater for it.

Another difference is that LBOs typically used 20-30% equity and 70-80% debt (at the cost of sharply increasing risk – any mistake in estimating cash flow could be fatal). In our case, it is more like 50-50.

The closest in description I can think of to a LBO among our yield plays would be Pacific Shipping Trust. PST is leveraged about 50%, but intends to use part of its cash flow to pay down debt principle over the next 10 years. As a result, you realize that at the end of 10 years or so, you end up with no debt on the original 8 vessels (and the structurers of this deal cleverly set it up so that the declining NAV caused by depreciation would be roughly matched by increasing NAV caused by debt repayment).”


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