The Infrastructure Opportunities Hiding in Plain Sight w/ NOVA Infrastructure’s Allison Kingsley and Chris Beall

0:04Chris Beall: Infrastructure has kind of been the non-player character of the asset class private markets for a long time and now it's actually in a starring role. And I think in some ways we saw that early.

0:16Allison Kingsley: That's Alison Kingsley, co-founder and partner at Nova Infrastructure. Nova focuses on smaller infrastructure businesses where competition for deals is scarce to non-existent, and the lack of institutional attention can leave some businesses remarkably underdeveloped. Her co-founder, Chris Beal, says that this sort of underdevelopment can create unusual opportunities to add value. One target company, for example, had no chief financial officer.

0:42Chris Beall: I think the primary source of financial expertise on the team was a tax accountant.

0:47Allison Kingsley: Chris argues that across large swaths of the infrastructure space, professionalization can drive substantial value creation.

0:54Chris Beall: What we talk about, one of the phrases we use is, do they know what good looks like in their sector?

0:59Allison Kingsley: Today on the show, I'll ask Chris and Allison what good looks like in infrastructure and what over 25 years of spotting opportunities that are under the radar of larger investors can teach us, especially now that interest in the sector is searched. I'm Humaq Arthur, Chairman of Bain's Global Private Equity Practice, and this is Dry Powder. Allison and Chris, I'm very excited to have you on Dry Powder today. Welcome to the show.

1:25Chris Beall: Thank you. Thank you for having us. It's great to be here.

1:27Allison Kingsley: When you say things like middle market value-added infrastructure, that's kind of a new phrase, at least for Dry Powder listeners, and a little bit for me as well. What did you believe the market was missing about middle market infrastructure on the value-add side that NOVA actually fits the bill to address?

1:43Chris Beall: Well, when we started, it was 2017 and there was a blog post of the year. The idea behind the blog post was that you have to have very large amounts of capital to play in the space. And while it's true, there are very large assets and infrastructure, we believe that there were also small and midsize assets that had all of the characteristics that investors were seeking in infrastructure. So downside protected contractual frameworks, hedges against inflation, the opportunity to grow and realize upside potential on the investments. And so we tested the thesis in 17 and 18, and we began raising our first fundraise in 19.

2:25Chris Beall: And we got great support from our investors and it's been a success so far.

2:30Allison Kingsley: I've also heard both of you in the past describe your approach as entrepreneurial. What does that mean when you think about an asset class like this? Allison, maybe we'll start with you.

2:39Chris Beall: Sure. We are founder-owner operators ourselves, and many of the groups, sellers, partners that we invest in are actually founder-owner operators themselves. And it is unusual. Infrastructure tends to deploy more capital on a per-strategy or per-deal basis by nature of it being real asset based. And so that tends to mean that you're getting somewhat more mature assets. And that's not actually the case for us. We're getting high growth. We're getting businesses where we are often the first institutional capital coming in. And we are talking across the table with the entrepreneurs who started those businesses.

3:18Chris Beall: They are proven. They are profitable. They have downside protection and real assets. Those are table stakes in that conversation for us. But really, we are talking about how are we going to grow your business to being able to reach that much broader, much wider institutional exit. And it is different when Chris and I, you know, we've known each other since high school. We've worked together for more than 25 years. We've been running Nova since 2017 and we did it as entrepreneurs. We are not just in jobs. We're not just in seats. And so that is a very different conversation with founders who are looking to sell and scale.

3:55Allison Kingsley: How does being a founder operator yourself shape the way you hunt for deals? Like where do you go looking for these relationships?

4:02Chris Beall: I mean, there's nothing I love more than hunting for deals. And it involves everything from showing up in areas that you think are alpha markets, markets that are high growth, segments that are high growth. And I mean, I've been known to ring doorbells, drop, you know, walk in with the FedEx guy to go talk to the CEO and start a conversation. and it's also interesting because your network builds over time. I think we've done, if you look at kind of portfolio companies of Chris or relationships of mine that I've done investments with and over 25 now going on 30 years, you realize that a lot of people that you started with are now running companies.

4:39Chris Beall: A lot of the executives that were maybe CFOs are now CEOs. And those are conversations that we've had over decades that are really bringing fruitful deal flow. Or interestingly, people that we've worked with and we've returned their phone calls, we've helped them find capital, even if we weren't the right capital partner. Those are deals that show up. I can think of three we're talking to right now that have showed up over five or six years just by being a partner, a lowercase p partner, because there comes a point when they are looking for transformative growth capital that we provide. And so that is some of the ways we're hunting for deal flow through those kind of relationship-driven, curiosity-driven sourcing.

5:22Allison Kingsley: Now, Chris mentioned some downside protections, contractual protections that are reflected in middle market deals, as well as some of the larger assets that we see trade in the infrastructure space. What other kinds of modes do you have in the value-added areas to uniquely add value and keep competitors out?

5:40Chris Beall: Infrastructure should be, and in our view, is things that are essential to economic activity. So things like electricity, things like water. Then we look for things that are hard to replicate. And so in some cases that stems from regulatory frameworks, in some cases, contractual frameworks, in some cases, integration with customers. And we look for all of those things and those are the essential characteristics of an investment, but that's not enough for us. So when we talk about value add, we look for five to six strategies, sometimes more that increase the value of the business. And so those may be geographic expansions, it may be vertical integration, it may be expansion into adjacent businesses.

6:27Chris Beall: In some cases, it's M &A activity that increases the scale of the business. And all those things, both the downside protections and the value-added strategies, have to be identified and cultivated asset by asset, contract by contract. You can't simply look at the macro environment. The core of what we do is bottom-up detailed assessments.

6:52Allison Kingsley: Those are unusual activities. And one thinks about the infrastructure space, things like M &A, things like adjacent markets. You don't often hear that when you hear about a lot of the larger deals. Can you walk me through a specific deal where you spotted an opportunity that you feel a larger player might have missed?

7:07Chris Beall: I think one investment that we had in Fund One, and we've subsequently exited successfully, was Bold Ocean, which is a U.S. flag shipping company that operated seven vessels in a very scarce market for the U.S. government, about 94 vessels in the world, and we operated seven. But this was a space that didn't have a lot of private equity into it. We sourced it through our relationships. We found the founders. We built trust with the founders, but we knew that this was a business that we were going to have to kind of transform across strategic financial and operational value add levers. And so through diligence and ultimately during our ownership cycle, we did work with everything from building a full management team to augment the founders, building a board with significant kind of expertise in the government, which was an important part of the business.

7:58Chris Beall: We built a financial, this is kind of, again, table stakes for many businesses, but not founder led first institutional capital. We built a capital stack. We built receivables line for the U.S. government. And then we went through the business and went contract by contract, asset by asset, which during due diligence and ultimately through our ownership, as Chris said, understanding what the underlying, not just value drivers, but risk management drivers are for that business, and then created a plan for the first hundred days, the first six months, nine months, and ultimately we owned the business for about three and a half or four years before we sold.

8:33Chris Beall: And doubled revenues, quadrupled EBITDA, 100 % renewal on all those U.S. government contracts, spread the risk so we didn't have vintage risk around the contracts, improved the operational safety on every single vessel. And then just the guts of the business changed all the business processes and systems to be integrated and more advanced and ultimately did sell that business as it was publicly announced to a JP Morgan transportation fund.

9:00Allison Kingsley: That's an awful lot of change. You know, when you find so many opportunities to tweak things or even transform things from management to systems, to capital stacks, to contracts, to operational issues, how do you decide where to intervene, how to prioritize things? How do you go about the process of creating this value with management?

9:21Chris Beall: Well, the foundation of the VIAD strategies are diligence. And so identifying where there's gaps. So in the bold ocean example, there was no CFO. I think the primary source of financial expertise on the team was a tax accountant. And for a company, there were two things where basic financial analysis added value. One was the company had taken on some new government contracts. And so they were working on receivables that were 120 plus days, but their payables were two weeks because they were mostly labor. And so you had this mismatch. And so we recognize that the business was going to need more working capital than they had prepared for and that that would be a problem if they didn't deal with it by creating a working capital facility for them.

10:05Chris Beall: The other insight was that when they bid these contracts, because they had no revolver, no independent source of capital, they were bidding the cash flow to match their large maintenance expense. So ships go through dry docks every three years. And so they had the sawtooth component to each contract because they were trying to match the cash flow to spike in years where they had maintenance. But then they were managing to an average to win the contracts. And so by putting a working capital facility in, we were able to smooth those sawtooth profiles and define your contracts were then stable, predictable cash flows.

10:47Chris Beall: And so those are not sophisticated financial technologies or revolve around an ABL line, but they were revolutionary for the business because they allowed the business to plan for the future and really stabilize that cash flow. And so all those things, those simple examples came out of due diligence. And it really is being specific in due diligence and identifying those individual things that we can take action on and control. And then ultimately putting the people in place to execute. So we are not managing these businesses at the Nova level. We are identifying people with skill and experience to manage the businesses.

11:32Chris Beall: And so one of the phrases we use is, do they know what good looks like in their sector? And so if you're talking a business with five to 15 million of EBITDA, frequently we're looking for executives who've managed businesses with 50 to 60 million of EBITDA. They know what good looks like and they know how to move the business from that smaller kind of less resource level to a more process-oriented level that you would expect from a mid-size or even a large-scale company.

12:06Allison Kingsley: So it sounds like, Chris, in addition to some of the strategic value-add things that you do like M &A or entering new businesses, there's a whole element here, a whole menu of professionalizing these smaller to mid-size businesses over time with lots and lots of opportunities all across an individual business. And so when I look through the Nova portfolio and I look at the company's past and present that you've invested in, there is a very wide variety of value-added infrastructure assets in there. One question that popped into my head was, how do you develop a repeatable playbook in diligence and then in post-diligence value creation across such a wide variety of assets?

12:45Chris Beall: I think there's two things. One, the assets that we invest in, for the most part, are the assets we've been investing in, the asset classes we've been investing in for 25 years. And no one or two people can know everything about any individual industry, any collection of assets. And so we have to build relationships with people who do know the industries. We have a network of senior advisors that work with who many have 30 or 40 years of experience in these industries. and even they sometimes have to update their information because things change. The industries today don't look like they did 10 or 15 years ago.

13:26Chris Beall: And so it's interesting because we do see people who are our generation experts or digital info experts. And we have people on our team in those areas that I would put side by side with any expert in those fields. They just happen to sit on a team that has a broader mandate. And being in the middle market helps us, I think, do that as well.

13:48Allison Kingsley: That was my next question, because I know in private equity, you know, this push towards specializing has been intensifying over the course of the last decade. And it seems like, to your point, Chris, there's a little bit of that happening now in infrastructure on the digital side or on some other sides. But does this tight focus on the middle market, Allison, and the check sizes that you write, does that enable you to remain more of a, I won't say generalist, but say multi-sector specialist in the space?

14:15Chris Beall: Well, we are mid-market specialists and we do bring that playbook and all of that pattern recognition over decades into every single one of these deals. We also bring the personal recognition of having started and grown our own company fund, as the case may be. But I do think that the diversification that we bring to Nova is a benefit, certainly to our LPs. I think our LPs value the diversification value that we don't have vintage risk when it comes to certain sectoral trends. And you can see that when you look at kind of any of the macro data, there tend to be sectoral trends that unfold digital energy, I think, transportation.

14:55Chris Beall: And so when you have a diversified fund, all else being equal, there is a benefit in terms of kind of the downside protection and the risk adjusted returns. I think for us as well, it helps us, again, on the sourcing angle. Longstanding relationship with a port CEO, which is a transportation-related relationship, but then he gets a water deal, a desalination opportunity, and calls us and says, what do you know about water? And we can say, we do know about water. And some of our deal flow comes through those interstitial spaces between the sectors. We have a renewable natural gas, compressed natural gas business.

15:35Chris Beall: Is that an energy transition business or an environmental services business when you're doing landfill waste to energy? We currently have in fund two kind of a powered land business. Is that an energy business or is that a digital infrastructure business? And we are able to bring mid-market specialty and expertise to that. But also this broad sector coverage allows us to see deals, which right now cross sectors, from both perspectives. It's a funny thing. So right now, one of the very popular sectors is digital infrastructure. And so you have digital infrastructure experts. So one of my favorite examples is I have a colleague that I've grown up with in the industry for years who's now a digital infraspecialist who for the last 15 years was a midstream energy investor.

16:22Chris Beall: And so as sectors get popular and capital flows into the sectors, many of the people at these specialized firms didn't grow up there and don't necessarily have the expertise. So I think you have to be cautious when you look at the specialist and make sure that you're, in fact, getting the expertise that you desire and that you're not getting just whatever the brightest star in the system is at that particular moment. Right.

16:49Allison Kingsley: And it has been a lot of change in the industry, as you said. And with that change in mind, let's roll the clock forward a little bit and look into your crystal ball. And I'd love to have you both just describe for me what types of investment opportunities you're most excited to pursue over, say, the next five or 10 years.

17:06Chris Beall: It's a funny thing now because obviously AI in the digital infrastructure and data center sectors is very popular right now. But the traditional infrastructure sectors, the renewal that we need in our infrastructure hasn't gone away. It's not like all of the other infrastructure sectors have magically come up to a state of good repair. And so you look at the American Society of Civil Engineers grades for infrastructure and the D's in transportation, the C's and D's in water have not suddenly become A's because digital infrastructure is popular. And so there's still a tremendous need for renewal of the basic infrastructure in the country and waters, very popular groundwaters, increasingly scarce.

17:50Chris Beall: airs. The droughts are prominent examples of that. We still have aging roads. If you drive around the New York metro area, I mean, there's potholes that are as large as your car in some cases. And rail is still bottlenecked. And just yesterday, you had all three New York metro airports out. So I think all of the sectors that we have invested in are still attractive areas for investment. But now you have the overlay of this tremendous need for data centers and the need for digital infrastructure that goes along with it. And so that's very exciting from my perspective, because you get to mix a little bit of the old with the new as far as interesting opportunities.

18:34Allison Kingsley: You know, what I'm hearing is, despite the fact that we have these huge municipal bond markets, it sounds like you're seeing opportunities in toll roads and in water utilities and in other types of infrastructure where you think there are still lots of checks to be written that may be being overlooked?

18:51Chris Beall: Yes. I think one of the most significant CapEx movements in our lifetimes is happening around AI data centers. That is moving capital into those areas, many of which have investable opportunities for middle market infrastructure fund like ours, but it doesn't diminish and in fact may pull capital away from other sectors in which we have always invested and will continue to invest in. Some of those may be transportation, logistics, waste, water, things like that, not just the headline grabbing digital. I do also think that when you play it forward, Chris also always talks about you cannot predict the future.

19:34Chris Beall: It's hard to predict it three years from now, five years from now, and 10 to 30 is almost impossible. For us, though, we are asking questions about what's coming and about some of the business model changes. So and what may be what I call strategic infrastructure. So government, space, defense, those business models are changing. And that is creating opportunities for infrastructure investors like us. And so we are, as always, curious and looking around corners for that piece of infrastructure for coming investable activities.

20:12Allison Kingsley: Well, Chris and Allison, it's been an absolute pleasure to have you on the show. I learned a lot. I'm sure our audience learned a lot about value-added middle market infrastructure investing. It's been a terrific conversation. Thank you again.

20:24Chris Beall: Thank you. Thank you.

20:30Allison Kingsley: I'm Hugh MacArthur. Thank you for listening.