We tend to take cheap, reliable electricity very much for granted. I try not to. Spend a couple of weeks in sweltering Florida summer weather after a hurricane has knocked out your power and you wouldn’t either. Of course, since I live on a rural fringe at the edge of the Everglades, I tend to be one of the last power customers to see service restored. Fortunately, I have not been hit with a major storm this season in my locale, but season is not over yet (knock on wood). It is hard to see how people could have lived here year-round without electricity and air conditioning. You could say that air conditioning helped put Florida on the map.

But back to electricity. Unfortunately, the current power grid is a dinosaur tracing its roots back to early grid projects in the late 1800s. From that time on, the U.S. power grid grew in something of a haphazard, piecemeal fashion — but did it grow! By 1940, 10% of U.S. energy consumption was supplied by the power grid. Today, more than 40% of U.S. energy consumption is supplied this way. With advances in electric automobile technology displacing some petroleum usage as a transportation fuel, I imagine this figure will only continue to rise. The electrical grid, however, still retains systemic design flaws with roots in the early days.

In part because of its pedigree, the reliability of our electrical grid is showing signs of degradation in the face of increasing demand. The North American power grid is interconnected in such a way that a small technical or human error can cause deadly cascading failures. Over the last 20 years, power outages have gone up more than 125%. One of the most complex systems ever built, it has proven increasingly prone to failing from causes ranging from hotter-than-usual weather to trees falling across power lines.

Clearly, we need an upgrade to the power grid utilizing the latest technology.

Congress has recognized this, and in 2007 passed an energy bill that addressed the need to modernize it. Called the “smart grid,” it would bring real intelligence to power distribution. Consider the early telephone networks, with teams of operators plugging on switchboards to make connections. Today, these networks are almost completely automated. Human error is mitigated. If there is a fault in the network, voice and data are automatically rerouted through other links. This is the kind of improvement smart grid technology would bring to the electrical distribution network.

With the push toward alternative energy technology, new transmission lines will also be needed. Solar power, for example makes the most sense in the sunny desert U.S. Southwest. Wind power, on the other hand, is most readily available in the windy Midwest. If the U.S. ever starts building nuclear reactors again, these will also likely be sited in thinly populated areas. In each of these cases, it makes sense to build the new lines using the latest and greatest technologies, rather than obsolete ones.

Of course, these kinds of infrastructure upgrades and installations will carry a hefty price tag. There are literally hundreds of billions of dollars to be made in the smart grid business, both in the U.S., and abroad. Investors in the best smart grid and alternative energy companies will make fortunes. The leading company poised to reap the rewards from smart grid deployment and alternative energy is a small-cap Massachusetts-based technology firm that I think has serious growth potential right now.

While this play isn’t quite ready for me to release just yet, I’m going to make my research available to Penny Sleuth readers for the first time next week. You’ll get more details on Wednesday…

Ad lucrum per scientia (toward wealth through science),
Ray Blanco
Penny Sleuth

October 8, 2010

Profit from Congress’ Power Grid Upgrade was originally featured in the Penny Sleuth.

Bruce Flatt, CEO of Brookfield Asset Management (BAM: NYSE), calls it “the backbone of the global economy.” It includes things such as transmission lines, dams, roads, bridges, etc. Often neglected, rarely appreciated, except when they fail; these things are vital.

As investments, infrastructure assets offer long-term and sustainable cash flows, like trees that never fail to bear fruit. Infrastructure assets possess a number of very attractive attributes: They usually (but not always) require minimal ongoing capital expenditure. They possess high barriers to entry, limiting potential competition. They often appreciate in value over time and provide a nice hedge against inflation. Infrastructure assets also last a long time, up to 100 years on some assets. So return on investment tends to increase over time.

Yet for all of these virtues, the big institutional money has only just started getting into this area. Today, institutional investors on average commit only 1% of their capital to infrastructure investments, versus about 6% to traditional real estate. Flatt, a talented investor with vision (and a great track record), says the opportunity in infrastructure is similar to that of real estate a couple of decades ago. In fact, he asserts that infrastructure is the “next real estate.” In other words, values for the assets will boom, at the same time that investment interest also booms.

For example, Flatt notes that the market value of publicly traded real estate securities was only about $20 billion in 1990. Today, real estate stocks worldwide boast a market capitalization above $700 billion.

Flatt believes the market for infrastructure stocks will expand in similarly dramatic fashion. At a Grant’s investment conference last May, Flatt told attendees, “We think there’s $35 trillion of new infrastructure to be funded in the next 25 years.” Of that, some $11 trillion is for the developed world, mainly America and Europe. The rest is in rapidly growing emerging markets such as India and China.

Brookfield has already been an outstanding performer since I recommended the stock in the pages of my investment letter, Capital & Crisis, in February 2005. But I believe a lot of good news lies ahead still. Sometime in early 2008, BAM shareholders will receive new shares of a company called Brookfield Infrastructure Partners (BIP) — an entity dedicated to the operation of infrastructure assets. BAM shareholders will receive one unit in this new company for every 25 shares they own. Brookfield will retain a 40% interest in Brookfield Infrastructure Partners (BIP) and will manage the company under a long-term contract. BIP will possess two main assets:

1. Transmission lines — Over 5,000 miles of transmission lines in Chile, serving 98% of the country’s population. Also, another 1,300 miles of transmission lines in Brazil and 340 miles in Canada. The Canadian lines are an important part of that country’s grid, because they connect generators in northern Ontario to electricity demand in southern Ontario.
   
2. Timber — Approximately 634,000 acres of timberland located principally on Vancouver Island, mostly high-value Douglas fir, hemlock and cedar. BIP will also hold another 588,000 acres of similar timberland in Oregon and Washington. Though timber may not normally be thought of as an infrastructure asset, it has all the financial characteristics of an infrastructure asset.

For those keeping score at home, about 62% of BIP’s assets will be transmission lines, while 38% will be timberlands. It’s also a bit of a South America play, with about 48% of book value in South America and 52% in North America. The hydroelectric assets (i.e., the dams) stay with BAM. Going forward, BIP will be the vehicle Flatt will use for any new investment in infrastructure assets — such as highways, pipelines, ports, rail lines, airports, water utilities or other utilities.

Brookfield estimates that it would price BIP at 14 times its annual cash flow of $70 million — or about $25 per unit (there are 40 million units, all told). The partnership should provide about a 5% annual yield based on its expected payout of 65-75% of cash flow.

The idea behind this spinoff is to better showcase the company’s infrastructure assets and get a higher value for them in the stock market, rather than burying them in BAM’s vast empire. Overall, though, the spinoff should have little impact on BAM directly.

As for BAM, I peg its net asset value somewhere between $35-43 per share, compared to a current share price of $38.00. The effect of the BIP spinoff should knock around $1 off BAM’s share price.

More than one quarter of BAM’s net asset value (NAV) comes from its power assets. The company is the largest independent provider of hydropower in North America. One third of BAM’s NAV comes from its rapidly growing investment management business.

The company manages over $70 billion in assets. Bruce Flatt and his team have been growing the company’s NAV every year.

As for the new kid in town, BIP, I like it as a long-term income play. That 5% yield will be nice with plenty of opportunities to grow…as infrastructure becomes the next real estate.

Sincerely,
Chris Mayer
November 28, 2007

P.S.: Although BAM is above my buy-up-to range, there are still plenty of infrastructure opportunities out there. In fact, some of the most lucrative of these are in water infrastructure. In a report I wrote, not too long ago, I listed a number of these. Many are still in a great position for you to buy some shares yourself.

Investing in Infrastructure Stocks was originally featured in the Penny Sleuth.