Valuation trends – market vs theoretical approach to discount rates

By Ben Morris

Tuesday 1st March 2022


  • Ben Morris, Partner, Valuations (Infrastructure and Energy), London
  • Karishma Merchant, Director, Valuations (Infrastructure and Energy), London
  • Dixon Grant, Manager, Valuations (Infrastructure and Energy), London

Transcript – Valuation trends – market vs theoretical approach to discount rates

The transcript below is provided to help the viewers go back to find specific sections of the webinar, and we have included the time stamps to facilitate this. Parts of the transcript has been generated automatically, so we recommend watching the video to get the full context.


Everyone, just say we’re going to hold on a few more minutes to allow to allow people to join, So, please bear with us.


Hi, everyone. I can see a lot of attendees joining in, but the numbers are constantly increasing. So, we’re still going to just wait for a couple of minutes to give everyone else a chance to join in.


For those, for those just joining, Just say We’re going to wait another couple of minutes to allow more people to join, and then we’ll start, OK, two minutes, time.


It just joined us, but we’ll wait another minute, or so, and then we’ll kick off.


OK, I think we got a good number of people. So let’s, let’s kick off. And thank you, everyone, for joining today.


Um, Christian, I don’t know whether you want to go to the agenda.


So just before we introduce yourselves I want to say what we’re planning to do in this session.


So if you go back to the agenda, We are going to start off by talking about some trends we see in terms of debt valuations and debt pricing, most of this is linked to the public markets.


But we might add 1 or 2 insights from private transactions we’ve seen as well.


Then we’ll move on to equity valuation trends, focusing, specifically on the infrastructure and renewable energy sectors.


And as part of that, we’ll be using the Mazars  index in both cases to really show what the trends are in terms of share prices.


Public valuations versus underlying asset valuations, so that’s equity valuation trends.


Dixon will be leading on those and introduce himself in a minute, but then after that, some Krishma will turn to a slightly more theoretical discussion.


We’re going to look at the CAPM approach to determining this discount rate in particular.


And how that compares with transactional discount rates, to the extent there’s a difference, but why that might be. So, that’s, that’s the agenda, that’s what we are planning to cover..


There’ll be time for Q and A afterwards, and I think there’s a dashboard for people who want to send questions over, so please do, send your questions, and we’ll do our best to answer them at the end.


Just to just introduce myself now, I’m Ben Morris.


I’m a partner in Mazars Energy & Infrastructure team, and I focus on, a mix of valuations and also transaction advice.


I’m Karishma Merchant, and I am a director in the energy and infrastructure team at Mazars. I’m based in London and I focused on the valuations of infrastructure and energy assets.


I’m Dixon Grant, I am in the Toronto office as a manager in the Energy and Infrastructure team, and I also focused on valuations.


Just before we kick off with the main agenda, a very brief introduction on Mazars  just for anyone who isn’t familiar with us, Mazars is a global accounting, tax and advisory firm.


We are in 90 countries rounded and over one thousand partners worldwide.


The only other slide I was going to mention about Mazars is that we do have a sector focus or a focus on particular sectors


All three presenters today are exclusively focused on energy, infrastructure and environment.


You’ll see there are other sectors that the firm specializes in.


Ok, over to Dixon to talk about some debt trends.


Perfect. Thanks very much, Ben. So this slide is about debt valuation trends.


On this slide, we have government tenure debt, as well as corporate sub investment, grade, and investment grade debt across four main regions across the world, The data’s for 2019 through 2021. The ultimate key takeaway from this slide is that there are sort of competing and conflicting trends driving debt in Q 4 of 2021.


In particular, that is, uh, gross concerns related to omicron variant in that quarter


, that’s offset to a certain degree by rising inflation, and then corresponding rising in interest rates in certain jurisdictions.


The ultimate outcome of this is that we saw essentially flat growth in, in debt, between Q3and Q4, between in 2020 and 2021.


That is present for the government debt trends, as well as the investment grade debt.


We did see some tightening of spreads for the Southern investment debt in that quarter as well.


One of the key things that we wanted to talk about as well, is that this data is through to the end of 2021. And obviously, there’s a lot going on in the world, in the past couple of months, and especially past couple of weeks. And so, without trying to really tie it to anything, in particular, we have been seeing debt trends in the past couple weeks, past couple months, and Q1 2022 to increase a bit higher. So, we’re seeing trends for increasing debt rates across the board.


Overall, as this relates to evaluations, this debt influences the risk-free rate and the cost of debt that’s used in the valuation calculations and valuations of assets.


With that maybe Karishma we can move on to the equity valuation trends.


Thank you.


So just as a brief introduction to this, Mazars develops its own indices.


We currently have two indices, one that is a global infrastructure index.


That’s sort of focused on the asset level of tracking global infrastructure assets, share prices quarter over quarter, and that’s what we’re talking about on this slide. The other one, is a global renewable index that focuses on renewable infrastructure funds.


So, Mazars’ Global Infrastructure Index includes, I believe it’s 9 funds across 15 countries.


You can see it here. It’s the maroon line, in the top chart. There are other, obviously, other publicly available indices that track infrastructure here. You can see that S&P Global Infra Index.


We believe that we’ve constructed our indices to be a little bit more asset specific. We believe some of the more publicly available ones are a bit more broad and include sectors like construction, companies, transportation operators, utilities, and so on. We’ve identified the specific companies in our funds in our index is to try and track valuations at the asset level as closely as possible.


So the ultimate key takeaway from this slide is, for the global infrastructure funds, we saw a positive sentiment towards equity, investments in, in infrastructure in Q 4, 2021. The S&P Global Broad Sector Index did show sort of flat trend for Q 4, 2021.


While our Mazars’ Index had sort of marginal growth in the quarter.


And in fact, has essentially, if you can see in the top chart on the left, which shows average share, price has essentially reached pretty close to pre COVID levels of share price. Below you can see that the share price, premium to net asset value has reached about 15.9% in Q4, 2021, which is a pretty large increase over the 10% that was seen in Q3.


This is sort of driven, and this sort of positive sentiment towards equity investment in infrastructure is also supported by the sheer amount of IPOs that have been happening in the sector in the past year.


And in particular, in Q4, just a few stats for UK and Europe alone, there was over four billion in capital raise for new list funds. There is at least five new listed funds focused exclusively on infrastructure assets, and in Q four alone, there was $2 billion worth of debt. I’m sorry, £2 billion worth of debt, and capital raised and Q four along.


Um, you know, initially we did it was there was trends towards quite a lot of IPOs in the sector. Again, if we’re talking about Q 1, 2022, and sort of the early trends that we’re starting to see, we’re starting to see a bit of a slow back in, in the trends that we’re seeing. less of growth. In terms of the average share price and less IPOs that perhaps than what we were originally expecting. Again, that the situation is fluid. Global macro economic and sociopolitical geopolitical environment does impact infrastructure quite a bit. And so, you know, we’re very interested to see how this plays out over the next the rest of the quarter.


Next slide, please.


Right, so, as I mentioned earlier, this, this slide relates to Mazars’, renewable energy index. And you can see here, again, there’s the S&P global index in blue dashed line. On the top chart on the left, that shows average share price for that one, and then our magenta, or maroon line is the Mazars, or yieldco index.


And you can see that both of them are showing, um, slight declines from Q3 to Q4. That same trend is also being shown in the share price premium to NAV.


This is all in spite of the sort of increases in power prices, in the short term. So, that is a trend that we have been seeing. Over the course of of 2021 in general, power prices are increasing. Long term power price forecasts are also increasing and, you know, if we expect that to continue, we would expect that to eventually impact asset valuations for Yieldcos in the future.


You know, there’s a lot of strong demand for renewable assets, particularly solar and storage. and should potentially put higher, you know, upwards pressure on pricing.


There’s also a lot of regulatory, technical and financial factors that are, you know, showing positive drivers for renewables in, you know, the coming years. one would expect.


Now, again, if we’re going back to what’s been happening in Q 1, 2022, we are, again, seeing slight reductions in average share price and premium to NAV in just the past few months, Probably due to uncertainty related to geopolitical situation right now.

CAPM – Capital Asset Pricing Model in Infrastructure and Energy


I’ll pass it on to Karishma for their CAPM session.


Thanks Dixon,  so, some of you who may have attended this webinar before know that every quarter we release a blog, which talks about what the trends are in the, in the broader sector, And we pick up one topic of interest that, you know, we’ve seen, certain observation that we’d like to share with all of you also. This quarter, we decided to talk about traditional valuation approaches to calculating discount rates versus what we see in transactional in the transactional discount rates. The two questions that often arise when we’re looking at valuations are how closely does CAPM as a methodology, as a commonly accepted valuation methodology align with what we see in transactional discount rates?


And when it comes to infrastructure and energy assets, what is the best the most optimum way to derive discount rate?


So, those are the two things I really wanted to kind of, you know, touch on today, and discuss.


Now, as you may be aware, the capital asset pricing model, it is a common methodology used in valuations to determine discount rate.  The essence of CAPM is to take your relevant risk free rate, and add to this the equity market risk premium, which is adjusted for the relative volatility of comparable companies.


Um, any CAPM result would, of course, needs to be adjusted for the specific asset that is being valued. Nonetheless, the chart here shows the first shot at the bottom of the slide shows what the implied CAPM discount rates are.


And we’ve tried to avoid a long period where we’ve, you know,  seen what the impact was of COVID was as well all the way through to the end of 2021.


You can see that you know, the various components of CAPM have reacted differently. So, for example, the risk free rates when COVID struck fell significantly, but beta’s role was the general trend that is being observed, is that, in the last few years, that has been an increasing trend. If he were to just look at the implied discount rates, if we used CAPM to calculate discount rates.


What is used for this, of course, is the listed infrastructure funds, which are focused more mainly on renewable energy.


Now, as against that, if you look at what the same listed funds are publishing in terms of their weighted average discount rates, you can see that there is a declining trend and especially in the same period, from what we saw during COVID there was a sharp rise. There’s actually a decline in this period, in the discount rates. Of course, I should clarify that, what we’ve captured here are the weighted average discount rates.


And it is different to the specific discount rate that is obliged to each project, for example, your weighted average discount would take into account the mix of your projects, how many are under construction, how many are operational, different geographies involved? So it takes into account the mix of the portfolio, but at least this gives you a general direction of travel.


So the main question that arises is why is this discrepancy happening? where we see an increasing trend in CAPM versus reducing trend in what discount rates that are actually being used in the sector.


Now, some of the reasons could be that, you know, when funds set, their targets are done. If based on the fundraising environment, and says, to a significant extent, they can ignore the short-term fluctuations in the theoretical cost of capital.


And to the extent that competitive pressures force transactional rates to go down, funds have to adapt, and then, you know, either choose to compete or not compete in that market. But if they’re choosing to compete in that market, that competitive trend will drive the discount rates down.


Another reason for higher CAPM rates could also be the increase in the risk free rate.


But quite often by has used, normalized, just relate to avoid this sort of fluctuation in CAPM. But you would also then compare that to the actual cost of debt. Which we have seen be relatively flat during the period that we’ve looked at. And that is probably because the financial institutions of the lenders end up reducing their spreads. When interest rates are reducing, or increasing, they would probably adjust our spreads to try and maintain a similar level of cost of debt.


So this begs the question that, if you’re valuing an infrastructure asset, what is the most optimum approach to you should be looking at CAPM, or should you be looking at transaction discount rates?


So one of the main things that you know we wanted to talk about was our view on how we approach valuations.


One thing that we’ve seen is capital that is available just for investment team that’s been driving discount rates down and asset valuations up. The attractiveness of the sector from an ESG perspective continues to drive further investment in infrastructure assets and therefore we do see relatively low number of assets attracting a level of capital investment.


That’s going to continue being an important force in driving market pricing.


So rising interest rate and inflationary environment will also ultimately impact on the transactional discount rates.


But, having said that, it will have a more immediate impact on CAPM, versus what we see in the transactional discount rates.


One thing that we should, as valuers always say is that price is not the same as fair value. But in the infrastructure and energy sectors relying on CAPM can often be flawed if you use that as the only guide to determining the fair value.


So, in our view, ultimately, you have to use a variety of cross-checks, transaction benchmarks are the most appropriate way to go, because they actually show you what is happening in the market, you know, compared to CAPM.


But transaction multiples can often give you a good cross-check, as to what is happening and it reflects the current market indication.


Perhaps breaking up a tiny bit that I could hear, I think if others couldn’t hear all of it we will be will be issuing, of course, a blog in the next couple of days, a bit more detail, and then, of course, you can also just drop us a line as well, if there’s anything in particular


I think we’re probably over to Q&A at this point, and just very happy to address any questions people might have, but I think that message around CAPM, and it’s certainly something we’ve been thinking about quite long time as valuers


Of course, there has to be benchmarks, to be able to use benchmarks so yeah, that’s a transactional.


So it could be that, that there are some sectors and some assets where, you have to resort to CAPM,  or other methods to get an answer.


But I think our view is that, especially work when you’re talking about assets, and you have transactional benchmarks relating to, they’re very similar assets, or perhaps even the same, in a way, the same risk profile.


Using discount rates that you observed as a guide to valuation is a very powerful thing today.


And ultimately, more likely to get you to the right answer than the more theoretical approach.


The other caveats I put on that. There is often an inordinate amount of attention given to the headline discount rate and because just the next thing on the headline can seriously mislead as well, I think that, as ever, it has to be held at discount rates used as well. How it links to underlying valuation assumptions, some of the input assumptions in the model.


It could be, could have really material effects on the final outcome.


Um, take it off, conservative input assumptions.


What looks like a really low discount rate, might get you to a lower valuation overall than a higher discount rate, but really bullish assumptions and say, You can look at these things in isolation they have to be taken together.


I’ll leave you with that message, and I think we do have 1 or 2 questions.

Expected return for private investors in the energy sector in Africa


Um, actually, one question I’ll share, which is: do we have an indication of private investors expect the rates of return in energy sector in Africa? Yes, we have done quite a few valuations in Africa.


You’re right to say that in some markets and maybe fewer transactional benchmarks, and  others say, so you then have to result of our theoretical approach. And that often involve is taking the benchmarks you can observe You’ve got in front of you, and apply relative country risk premium to that.


So that can be one way of doing it.


Yes, we do see various projects across Africa.


Any more questions?


I think we’ll, we will give people a couple minutes to ask, we have about 20 minutes or so presentation that we want to allow some time for questions.


Also, interested in people’s views on CAPM Theoretical approaches If they agree with it, with the argument we’ve put forward or have other perspectives.


Um, there’s, there’s another question that, within the CAPM framework, which parameter has the potential for significant error and the various parameters. Basically your equity premium, you’ll beta and your risk free rate. I wouldn’t say that any of them have any potential for significant error because under CAPM and you look at all of them together and not only in isolation.


So for example, one of the slides that we were talking about, and I’ll go to that slide to just demonstrate what happens in the market, um.


So, for example, if you see this slide.


You’re breaking off a bit Karishma I’m not sure we can hear, I think I’m having a bit of an internet issue. I’m just trying to go to the slide, which has the CAPM graph.


OK, so the question was, within the … framework, which parameters are you able to hear me now?


Is this any better?


OK, great.


Uh, OK. Just stop me if you can’t hear me. But, what I wanted to just show is that when all of these, you know, individually parameters interact, they all interact in tandem.


So, you’ll see that, when covid happened, the risk free rate fell, but the Betas went up. So if the interest rates, had remained at the same level and the beta still had gone up. The raise in the, the implied, increasing the discount rate would have been significantly higher. But you can see that all of them, you know, as they react together, you know, did they all try to balance each other out? So, you know, an increase in risk would mean that the yields either fall in the yields or the government yields may fall. And, you know, be done, which is a measure of the risk, but then increased. So, it wouldn’t necessarily mean that the significant error.


But, as a valuer, or you have to apply judgement in all of these parameters, and what is the alpha that, you know, one would apply whether it’s positive or negative to arrive at your discount rate.


Which is why we say, you know, that transaction benchmarks are the best guide to, to give you an indication of what the discount rate should be.


Yeah, Yeah.


I think Just to add to that, I think, I mean, I think you answered the question really well, but I think, um, I’m not sure what we’re saying is that there’s a significant error.


In any of these parameters, say, the risk free rate is what it is, it is typically linked to the offline rates or something equivalent.


The beta is January measure volatility and the active premium is a January measure of yeah.


You know what before will pay all things being equal for a , you know, if you’re like average share, or average XE above the risk free rate.


The problem is, as Karishma said, that the problem is applying it to an asset, are in a specific asset valuation context, because even if you have a perfect view of people, Value Fund that only holds assets like the ones you’re evaluating.


As Karishma said, there’s still an alpha.


So, transactional contacts, you then have to adjust that.


Um, you know, we haven’t talked about things like control premium, but not exist versus quantity, concentration risk, and some of the other things that might be what you’re comparing a sort of general result to a specific asset result.


It’s, I guess what really struck us, though, is that the direction of travel is different. If you’re just not getting.


Say the same trends. Even if you’re consistently the same thing, You know, to get to your alpha, so.


So, yeah, it’s not, there’s error, but it’s just it doesn’t really capture what’s going on in the market, For all the reasons Karishma listed before.


Um, you’ve asked, it points out the CAPM and at least takes into account country risk premiums and the advantage.


I think that’s really good point.


But, of course, it is possible to take transactional benchmarks from one country, other relative country risk premium, to get to results in another country too/. So it’s not all about them, you don’t necessarily have to have contrast in that country. And I mean, the other thing to say, though, is that it’s not just about country, then.


It will say, it’s understanding how the risk factors when you’re comparing one asset to another.


And, you know, for instance, if you’ve got two renewable energy assets in two countries, you know, how do the revenue regimes compare, you know, do you have similar amounts of price risk, and regulatory risk, and so on?


That might be a bit separate from country risk.


Yeah, And we have a question then.

CAPM has been a flawed approach for infrastructure renewables

So from Marco, CAPM has been a flawed approach for infrastructure renewables as a beta, is: the result of short-term stock price fluctuations. Whereas, in, for in assets and  long term, stable assets.


Could you expand on this?


Yeah. I mean, maybe, Indeed, that does drive some of this although.


It can be taken over a long term, as well, and there are different approaches to calculating them.


That maybe that’s part of it, but then, again, what we thought was the betas calculated in relation to funds are themselves only holding long-term introduction


Renewable energy assets, so, you know, we’re not saying that’s the same as valuing an asset, but it is interesting that CAPM is not generating the same result when we look at that.


Um, Charles asked: could we have the drivers of the declining trend of weighted CAPM?


Well I don’t think it is declining actually, I think if anything, it’s increasing is what we’re seeing, um, so Charles maybe if you ask a follow on question just to clarify that, I think what the chart on the bottom left of this slide shows is if anything are increasing picture.


Um, Diane asked:

Valuation of assets under operations versus pre-construction vs pre-development


What about assets under operations versus pre-construction vs pre-development, similar solar, so we’re not going to get into this share valuation metrics on this call I don’t think that will be appropriate, but there is there is a consistent, um, transactional Benchmark that we’ve seen and in difference we’ve seen. so I think actually if you look at some of the listed yeildcos I think quite a few of them will comment on that, to see you certainly take that out. It’s not that there isn’t always going to be one answer.


I’ll say it depends on and specific construction risk of a specific asset and.


Looking at how the other contracts, that structure.


That’s how the risk of transfer, though, all those things actually are important and on something reasonable construction risk premium looks like.


Charles is actually asking about the waste average discount rates and what the drivers are for the decline.


So, I think Karishma did talk rather earlier when you’re talking about some of the factors you think this comrades everytime did you want to say a bit more.


Um, yeah, I think part of it is driven by the competitive environment that is there. Infrastructure of assets offer, guaranteed long term cash flows, which are very attractive to spread, especially certain kinds of investors. So, in a, in a volatile, and they also offer a lot of inflation hedge, which means that they’re, you know, very attractive.


Especially to the likes of pension funds, which means, you know, with the limited number of assets available in the secondary market or greenfields face.


There’s a lot of capital chasing them so a large driver all stirred reducing trend is the is the competitive environment space that we have. But you can get a lot of information from the listed yieldcos, you know, where they report on this trend and they also talk about what are some of the drivers?


Ben, do you want to add anything?


The other thing is we have a question then the source of years for premiums and other common variables, Subsectors Premium, Beta is liquid through, etcetera.


I think say well, say some of the solstice …. So, if we’re talking about the risk free rate, for instance, then that’s not based in UK based on guilt yield??


The length, the duration of that guilt??? will typically depend on the asset we’re looking at.


Similarly, the equity market, risk premium, I think, is, it’s a fairly standard number, and maybe Karishma can comment on what the sources of that


What we have tried to do in this analysis, though, is, when we talk about them, the basis and actually applying this, we have just used I think for this graph, we’ve just used yieldcos


So, it’s, it’s onshore wind and solar focused funds,  all they do is own wind and solar assets, pretty much.


So, say that the beta should actually be quite specific to this industry.


If there are other ways of doing it, there’ll be and, of course


What funds or what companies are appropriate to take for for beta will depend very much on what you’re valuating, the country, the industry, et cetera. so you’ve have a very different answer.


If you’re looking at digital infrastructure, for instance, or transportation, et cetera. This is an illustration.


So it’s a combination of general, general data, an then, really applying market knowledge to get to some specific things that you can apply to that


Karishma, anything you want to add to that? comments on the Market history.


No, not particularly, but, I mean, in terms of sources, that are plenty of platforms out there, You know, like, you got capital IQs and Bloomberg’s of the world. There are a lot of platforms available that provide this information.


To date commonly available. Based on subscription. There’s no, there are a few infrastructure specific platforms as well, but those are not necessarily for Betas its more to track transactions and, you know, specific information related to transactions, and that’s what we typically use to understand transactions. I should add that, you know, because your question says, Do you get sources specific for infrastructure?


one of the main sources we do use is, because Mazars is a global leader in model audit, we do have access to a lot of, you know, industry knowledge, as being part of the infrastructure to an energy team. So, that industry of all market intelligence is what also helps us understand what the valuations, you know, what are the drivers evaluations?


All right.


I think we’ve covered, we’ve covered all the questions.


Then there were others with a hand up.




Maybe misinterpreting that. The hands I can see it side.


I think, any more questions?


I know I can’t see any more.


All right, So, I want to thank everyone for joining the webinar with us today. Hopefully you found this a useful session.


If you have any follow up questions, please feel free to just drop us a line by the LinkedIn or email


But, in the meantime, have a great day.


Thanks, everyone.

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