Investors Dig Deep for Underground Infrastructure Opportunity

Even though M&A was down across sectors last year, opportunities in underground trenchless infrastructure continue to attract investor interest and should be more fruitful as dealmaking recovers.

That can largely be attributed to legislation, such as the Inflation Reduction Act and the Chips and Science Act, both of which incentivize domestic industry and clean technology investment, particularly in underground infrastructure. And that’s not stopping anytime soon.

“There’s a ton of built-up backlog of work that needs to get done, whether it’s replacing old piping, or managing cross boring that’s occurred, or the kind of multi decade build out of fiber that’s ongoing right now and we expect to continue growing at a double digit growth rate,” Huron Capital Partners principal Cale Kaczmarek says. “Where we see the largest opportunity is investing in businesses that are doing the repair and maintenance, replacement, locating and services like CCTV [closed-circuit television]-type underground work for piping, including for wastewater and drinking water.”

Where we see the largest opportunity is investing in businesses that are doing the repair and maintenance, replacement, locating and services like CCTV-type underground work for piping, including for wastewater and drinking water.

Cale Kaczmarek

Huron Capital Partners

Scott Kolbrenner, a managing director at Houlihan Lokey, says that his firm has seen demand from both public and private owners grow meaningfully as assets, including infrastructure that has sat underground for decades as well as new infrastructure that needs to be built, require design, re-design, installation and maintenance by expert hands.

Wrestling with Valuations

Kolbrenner added that, while buyer demand is high, valuation multiples have ranged from mid-single to low-double digit multiples, depending on two critical factors: margins and, especially, organic growth. But some say getting there has required a degree of negotiation with sellers, particularly given the incentives outlined by legislation aimed at repairing the nation’s existing infrastructure.

“Some (telecom) sellers were like, ‘What are you talking about? The Inflation Reduction Act has all of these investment incentives,’” Karl D’Cunha, managing director at advisory firm Ankura, says. “So here we’re pushing back for the 9x, 10x, or 11x multiple, which is really hard to get, and that was in a low interest rate environment.”

Even with interest rates poised to fall, Kaczmarek says that, in Huron Capital’s view, the valuation of a particular company has less to do with government incentives than how service oriented it is.

“The more that the business is focusing on service, maintenance, repair, locating and reoccurring services such as cure-in-place piping activity, the higher its valuation will be, compared to one that’s only building out a new community or a new sewer, for example. That’s going to have a little less attractiveness, just from our perspective.”

A Fragmented Market

Already, underground infrastructure has proven an attractive investment target. In April, global alternative investment firm H.I.G. Capital acquired Tower Engineering Professionals, a full-service provider of engineering and maintenance services for tower, mobile network and other telecom infrastructure customers. Later that year, middle-market private equity firm Quad-C Management closed on an investment in trenchless infrastructure rehabilitation products and services provider Vortex Companies. And in November, Fort Point Capital, a Boston-based private equity firm, announced its investment in Visu-Sewer, which provides critical wastewater infrastructure rehabilitation and maintenance services for the Midwest and Mid-Atlantic regions of the United States.

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With an estimated $44 billion in funding from the Infrastructure and Jobs Act alone set to come to market in 2026, investors have raised billions to further pursue infrastructure acquisitions in what’s developed into a robust growth market.

But investors are finding that they have to be particularly discerning about the companies they put their money behind due, in part, to the nature of the market.

The underground trenchless infrastructure space is “highly fragmented,” Kaczmarek says. “It’s a very localized business…So if you think, ‘I want to be in geography X, Y and Z,’ there’s often a highly fragmented base of companies to potentially work with. And obviously. there are a lot of things that have to line up well for a transaction to occur, (including) whether it’s the right time for the business to want to partner with a firm like ours.”

Fragmentation notwithstanding, Kolbrenner says growth in the underground trenchless infrastructure space is expected to be at least in the mid-single digits, and exit opportunities will range from selling to private equity firms or strategics, depending on the needs and goals of the exiting sellers. However, he adds that whether firms have a sufficient number of employees with the experience to execute the jobs remains an impediment to growth.D’Cunha notes that, due to the expense of having full-time employees exclusively, companies in the underground infrastructure space have a good mix of contract and full-time workers in order to be attractive to investors. He added that while larger and more established companies have found that balance, others in the lower and middle market continue to struggle.

A Fine Time for M&A

D’Cunha characterized the investment universe for trenchless underground infrastructure as a “bunch of big players, and a ton of smaller ones, with many of the larger deals being peer-to-peer.” However, that doesn’t suggest that the pace of M&A is going to slow down anytime soon.

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Houlihan Lokey’s Kolbrenner says that the firm anticipates significantly more mergers and acquisitions as the needs of aging owners and assets long-held by private equity seek to transact.

But D’Cunha also says that, at least in the short term, exits will be problematic due in part to increased volatility, the upcoming presidential election and uncertainty throughout the industry.  “Long term, there will be a lot of successful exits because of the Inflation Reduction Act and the massive amount of dry powder there is with infrastructure funds, but that’s going to take time,” says D’Cunha. “I think 2024 is going to be a really tough year across the board for exits in private equity companies.”

Whatever macroeconomic factors impact the trenchless underground infrastructure space in the coming months, some say the relationship between providers and asset owners will continue to grow ironclad as they work across disparate services.

“The infrastructure services industry has long been a leading proponent of cooperation for the greater good: one morning these firms might compete for new work and that afternoon they could be JV partners on a completely different project,” Kolbrenner said. “In this world, it pays to be a ‘good’ corporate competitor — fair, trustworthy and reliable.”

Middle Market Growth is produced by the Association for Corporate Growth. To learn more about the organization and how to become a member, visit www.acg.org.