Scales of the city

The inhabitants of the growing urban centres of the emerging world are ambitious people. Many of them have moved to the city for a better life; many of them are able to achieve this – in material terms, at least – because they tend, on average, to have more money than those living in rural settings.

Private equity firms are eager to act as financiers of those services, such as hospitals and education, that enable city dwellers to have a healthier, more edifying or generally pleasanter existence – services often known as “social infrastructure”. Private equity investors are, however, for the most part more ambivalent about the huge brick, concrete and tarmac infrastructure projects which most people think of when they hear the term.

“We think there is a tremendous amount of opportunity in infrastructure”, says Mark Yusko, chief investment officer at Morgan Creek Capital Management, a $4 billion multi-asset manager based in Chapel Hill, North Carolina, whose investments include private equity. “But I’m not that big a fan of traditional infrastructure – roads, ports, airports and so on.” This is, he says, because traditional infrastructure is attractive to large investors with deep pockets, such as sovereign wealth funds and pension funds, which are looking for very long-term investments with stable if unspectacular returns.

In practice the process works, he says, through a form of reverse auction. “The first guy says, for me to do this, I need a 15 percent return” – an acceptable level for private equity investments. “But by the time that you get to a German pension fund that says, I only need 4 percent to be interested, it’s not a very high return.” Private equity, is Yusko’s inference, needs to find other things to do.

That isn’t difficult. Many emerging cities are growing at rates last seen in the developed world during the 19th century. Istanbul’s population was below 4 million in 1980, but is now quadruple that. Lagos, Nigeria’s and Africa’s biggest city, has shown an even more spectacular rise: its population has mushroomed from about 2 million back then to 21 million now. It is the scale of these huge markets, as well as the rising income of their inhabitants, which makes them attractive.

The commercial opportunities for private equity are greater, say investors, when consumers are gathered together in large numbers, rather than spaced out. As a result, a city of 10 million people is a lot more promising than a rural district of 10 million people when it comes to healthcare and other forms of social infrastructure. “In a diagnostic centre in a city you can probably service a hundred people in a day with a particular disease, but in a rural area” – where the population is thinner – “it might be a single person”, says Alex-Handrah Aimé, head of the Johannesburg office of Emerging Capital Partners, a private equity firm specialising in Africa.

The high income of the urban middle class is also enticing. They can, say private equity experts, afford treatments which might seem like luxuries to rural people. Because of their greater wealth, “many people are not looking just for basic healthcare”, says Aimé. “They want preventative healthcare, and lifestyle healthcare, such as plastic surgery.”

Responding to these opportunities, “we have been spending a lot of time investigating opportunities in the healthcare sector”, says Aimé. The firm has also recently made a deal in higher education, which presents strong possibilities in emerging cities for the same reasons of wealth and scale, though it is not yet able to disclose details.

The Abraaj Group, which is active in growth markets around the world, has invested in both health and education in emerging cities. In 2007 it bought a 50 percent stake in Acibadem, a hospital group which operates in urban areas in Turkey. It sold its stake to Malaysia’s Integrated Healthcare Holdings and a related Malaysian company in 2012. In the same year it purchased a 25 percent share of Gems Education, a private school chain with 20 schools in Dubai. After expanding the chain to more than a hundred schools across six different cities, it restructured the stake into a loan in 2012. In both cases it achieved returns above 100 percent, says Mustafa Abdel-Wadood, partner at the Abraaj Group in Dubai. “The opportunities are where you have scale”, he says.


Seasoned investors caution, however, that for all the attractions of social infrastructure, it has a political dimension which investment in fast-moving consumer goods does not. MRI scans are far more politically charged than Mars bars.

Abdel-Wadood of Abraaj suggests that this political dimension can work in investors’ favour. “In all emerging markets private capital is welcome, because governments realise that their single biggest challenge with growing populations is providing employment opportunities”, he declares. Key to this is the growth of cities, so that they can continue to suck in workers from the countryside. “The constant upgrade of the infrastructure, including the social infrastructure – healthcare and education as well as roads – is what’s driving the growth of the cities. If services don’t keep pace with the growth of cities, the quality of life goes down, so fewer people migrate.”

Abdel-Wadood acknowledges that in some parts of the world, “there has been a sense of demonising business when delivering messages for public consumption”. He adds, however: “But the private message is always around encouraging investment.”

Moreover, when emerging market governments decide that they want to back a particular kind of infrastructure, they can put a tailwind behind it which is rarely as strong in developed markets, where infrastructure plans are, for sometimes positive and sometimes negative reasons, bogged down by the democratic process.

Thomas McDonald, managing partner at Jaguar Growth Partners, a private equity firm based in New York, cites the case of car parks in China – a country whose cities are, he notes, short of 50 million parking spaces. “The lack of parking is a problem which the government wants to fix, so it will be helpful in facilitating development and solving problems.” This is a far cry from the case of the city of Savannah in the US state of Georgia, for example, where opposition to concrete car parks has galvanised residents into a general battle against the modern development of the city’s old quarter over the past half-century.

Jaguar is in a minority among private equity groups in enthusing about some bricks and mortar infrastructure. Returns from investment in car parking are protected, to an extent, by the relatively small scale of this market, when compared with the mammoth projects that sovereign funds and many pension funds require.

What Yusko of Morgan Creek draws attention to is political risk. In 2012 Morgan Creek made a private equity investment, through China-based Greenwoods Asset Management, in a Chinese hospital management company called Phoenix Healthcare Group. Morgan Creek exited the investment through the company’s successful 2013 initial public offering. The Chinese government is clearly keen on using private capital to build the country’s healthcare system, Yusko notes. However, “I’m not saying that it will always be that way”. When it comes to infrastructure in emerging urban dwellings, “the fear of government intervention is clearly there”.

Asked how to deal with the risk that government policy changes before an exit from an investment, be it on a municipal, state or federal level, he says the answer is diversification – “creating a diverse portfolio of investments across a lot of different countries”. In the end, therefore, political risk is best managed using the same techniques as with market risk, and with other forms of hazard and uncertainty.