June 2022 Issue
FW discusses data centre M&A with Robert M. Jackson at CyrusOne, Ismail H. Alsheik at Vantage, Josh Pang at The Carlyle Group, Sam Southall at Macquarie Group, and Kemal Hawa at Greenberg Traurig.
FW: What factors are driving the dramatic rise in demand for digital infrastructure? How has the coronavirus (COVID-19) pandemic affected demand?
Hawa: The proliferation of demand for digital infrastructure is directly related to the ever-increasing demand for and consumption of data. The advent of 5G, the internet of things (IoT) and big data analytics has further accelerated this demand. Coronavirus (COVID-19) shined a light on the digital infrastructure sector as central not just to the economy, but to society as a whole. Remote work and distance learning are only made possible through robust digital infrastructure that facilitates internet applications and video-based services. And in view of the dramatic increase in the use of social media and streaming video services during COVID-19, we can only expect the demand for digital infrastructure to continue to accelerate.
Jackson: Demand is fundamentally driven by the growth in data and data analytics as the digital economy becomes increasingly interconnected. Enterprises continue to outsource infrastructure needs and adopt hybrid solutions, with a portion of requirements being met through public cloud resources. Hyperscalers, including the well-known cloud service providers, are meeting public and private cloud demand, including internal product needs of enterprises being adopted around the world. The pandemic demonstrated the increased reliance on technology and in some ways accelerated it, underscoring the need for digital infrastructure to support various use cases. Companies are taking into consideration the longer-term implications for the ways their businesses changed during the pandemic, and many of these changes will likely be permanent.
Alsheik: A Pew Research poll published in September 2021 indicated that COVID-19 fundamentally changed the way we use and interact with technology: 90 percent of adults stated the internet was important or essential to them personally during the pandemic, 81 percent stated that they talked with others via video calls at some point during the pandemic, 40 percent stated that they used technology or the internet in ways that were new or different to them, and 29 percent of broadband users did something to improve the speed, reliability or quality of their high-speed internet connection at home since the beginning of the outbreak. When we could not get together in person, the internet is what allowed us to remain connected. But that connectivity was far from perfect: 30 percent of parents whose children had online instruction during the pandemic say it was very or somewhat difficult for them to help their children use technology or the internet for such purpose, and 34 percent of parents whose children’s schools closed at some point say their children had to do schoolwork on a smartphone, were unable to complete schoolwork because of a lack of computer access at home, or had to use public Wi-Fi to finish schoolwork because there was no reliable connection at home. Our digital infrastructure as it existed at the onset of the pandemic was not yet matured to the point where students could seamlessly continue their learning, and this was exacerbated in low-income households. In part, the dramatic rise of digital infrastructure is a response to the evolving and increasing relationship between humanity and computers, and the challenges we faced during the pandemic, particularly among low-income households – cell towers, fibre networks and data centres form the internet superhighway that will allow us to help close that unfortunate digital divide.
Pang: COVID-19 has accelerated long term secular tailwinds in multiple digital infrastructure segments. The underlying building blocks for demand were already strong, and the pandemic further accelerated the need for connectivity for both businesses and consumers, distributed computing infrastructure, and capacity to support data proliferation that we are experiencing in all business functions and our everyday lives. While the pandemic has been devastating to millions, it has also increased reliance on internet infrastructure for daily functions and kickstarted the transformation and adoption of technology-enabled activities. And the core pillars of fibre, data centres and mobile infrastructure are increasingly essential services in developed and emerging economies.
Southall: Demand is being driven by users as the world continues to be more connected. This was a trend prior to COVID-19 but the pandemic served to underline how much we depend on digital infrastructure in today’s world – to work, to communicate with our friends and families, to shop and to be at school. A lot of people in the pandemic would rather have gone without traditional utilities – such as hot water – than be deprived of their internet connectivity. This really underlines how critical this infrastructure is, and hence why it is now firmly in the domain of ‘infrastructure’. Demand from a financing perspective has been driven by the ascension of infrastructure funds recognising this criticality. Alongside traditional utility and infrastructure investments, digital assets are now seen as a core ‘must have’ allocation for all infrastructure managers.
“Privacy and data security issues, and their national security implications, are central issues at the forefront of any digital infrastructure investment.”
FW: Could you provide an overview of M&A activity across the data centre industry in recent years? What types of acquirers does this segment typically attract?
Jackson: M&A has been broad and geographically diverse, with both single-asset transactions and trades involving large international platforms. As hyperscale customers expand their offerings around the world, data centre providers are expanding to meet these needs. This has led to significant strategic M&A, with a goal of being a preferred service provider for the largest hyperscale customers. In addition, both passive and active investment managers recognise the strong returns and long-term growth of the industry, which has also significantly contributed to M&A activity.
Alsheik: In the past year or so, we have witnessed unprecedented ‘blockbuster’ deal activity, including the acquisition of CyrusOne by KKR and Global Infrastructure Partners for $15bn, American Tower’s acquisition of Coresite for $10.1bn and Blackstone’s acquisition of QTS for $10bn. American Tower is a cell tower company that, prior to the Coresite deal, had a relatively small data centre footprint. This transaction allowed the company to dramatically expand its footprint, and demonstrated that strategic acquirers will always play a significant role in digital infrastructure M&A. In the other deals, we see a range of financial acquirers, from relatively seasoned players such as Blackstone, which acquired a 90 percent interest in two of COPT’s wholly owned data centre shell properties in 2020, among other data centre deals, to GIP, a relative newcomer to digital infrastructure. Across deal sizes, the range of potential acquirers is expanding as new entrants continue to be attracted to the promise of this space.
Pang: Investment activity remains robust across the sector, and the pace has accelerated since last year. Valuations remain high, as investors gain confidence in long term secular trends that are supporting growth in data centre demand. However, it is a good time to be cautious with valuations and use of leverage. Over the past few years, infrastructure private equity has increasingly played a larger role in acquiring, building and expanding data centre platforms. In 2020, the data centre sector deployed and absorbed a record 620MW of capacity, and as a result, other sources of capital in addition to infrastructure private equity will continue to play a significant role in the sector.
Southall: M&A has been very robust across all sub-sectors of digital infrastructure. The general, broader market backdrop has also been supportive during COVID-19, which has helped spur activity. I would characterise the last 12 to 24 months as a rotation. Traditional private equity investors have been pushed into riskier and more operational assets as core infrastructure players have come into more pure play operations. The data centre space is a bit different – infrastructure funds have been acquiring operating platforms, whereas traditional real estate capital is still chasing the sector – typically with an appetite for single assets.
Hawa: With respect to strategic transactions, the bulk of M&A activity has involved two data centre operators. Recently, however, we have seen broader consolidation in the digital infrastructure sector – most notably among tower companies and telecommunications carriers acquiring data centre operators. With respect to M&A involving financial sponsors, there are three broad categories of investors – private equity firms, real estate investors and infrastructure funds. Private equity firms approach data centre deals from a traditional cash flow analysis perspective, with cloud and managed services providers most often meeting their investment thesis. Real estate investors have been quite active, with a preference for build-to-suit and large single tenant sites and campuses. Infrastructure funds have been particularly active in the space due to their relatively longer-term investment horizons and return expectations, as well as their comfort level with the operational intensiveness of data centre enterprises.
“Data centres have gone from a ‘quirky, niche’ sub-sector of real estate to a core allocation for both real estate and infrastructure managers.”
FW: With large data centre operators increasingly requiring a global footprint to remain competitive, do you believe M&A is the most efficient way to meet that objective?
Pang: The buy-vs-build decision is often a complex analysis with no clear correct answers for a data centre platform. Once a data centre has captured market or regional density, the natural next step is to replicate its playbook in a logical new market where the success factors are favourable. Organic or brownfield expansion would allow for an existing platform to capture build economics, control the deployment and implementation of infrastructure and may be operationally more straightforward – similar to an ‘edge-out’ in the fibre industry. However, greenfield and brownfield investments often take years to mature, since data centres are long-duration assets, and there can often be merit in using M&A to improve speed-to-market, despite high valuation premiums and potential integration risk.
Southall: M&A can be attractive to strategically reduce time-to-market which might be important for operators to quickly scale, for example if they have global customers that want to grow internationally too. We are seeing this with some of the hyperscalers. But M&A will typically command a premium – particularly in markets like we have experienced recently – so it should be considered in light of strategic objectives and appraised relative to a build strategy. The quick way is not always the best way, and no one-size approach will work, but typically hybrid approaches make sense, such as acquiring a small operation to establish presence and then using that to build-out.
Hawa: M&A is certainly an effective way to enter into or expand an existing market. But it is important to remember why a global footprint is important. The internet and the cloud are inherently global in scope, and hyperscalers and other major players in the industry operate on a global basis. Accordingly, many data centre operators are expanding globally to meet the needs of their key customers. Customer needs extend not only to new markets, but to additional capacity in existing markets. Thus, greenfield and brownfield builds and development projects will also be key components to meet hyperscale capacity needs in a given market.
Jackson: M&A is one of the quickest ways to build a global footprint, but efficiency or effectiveness can be judged by capacity to meet customer needs. A stabilised asset transaction can help build scale but not solve the requirements for future growth. Acquiring a team capable of delivering future supply can be achieved faster through M&A, but execution still requires additional capital resources and organic development.
Alsheik: M&A can certainly play a part in helping large data centres remain competitive, including in Canada, Europe and Asia Pacific, but organic growth fuelled by responding to an evolving market also plays a critical role.
“Valuations remain high, as investors gain confidence in long term secular trends that are supporting growth in data centre demand.”
FW: How are digital infrastructure investments being classified in the current market? To what extent are data centres now viewed as an asset class by financial buyers?
Hawa: Twenty years ago, no aspect of digital infrastructure was financed or classified as ‘infrastructure’ as an asset class. It was only about a decade ago when data centres and towers were first classified as ‘infrastructure’, and now virtually every segment of the industry, including fibre, falls into the infrastructure asset class. Indeed, data centres and towers are often financed as core or core-plus infrastructure currently. It is notable that these categories have typically been reserved for utility and utility-like enterprises, which are marked by long-term contracts and concessions and rate regulation and stability. Digital infrastructure has some, but not all, of these indicia of ‘infrastructure’, but nevertheless digital infrastructure is increasingly being referred to as the fourth utility.
Pang: Over time, digital infrastructure investments have migrated to the infrastructure asset class. Since the early 2010s, and especially over the past five years, the digital infrastructure sector has gained wide acceptance for three primary reasons. First, the value proposition of the infrastructure is to deliver essential services. Second, there is a strong ratio of utility-to-cost due to the mission-critical nature of essential services. Third, underlying physical assets is the key driver of value, and asset-based delivery of the service is a common theme across the digital asset classes. Specifically for the data centre asset class, there are at least a half-dozen different data centre business models, and depending on the degree of asset ownership and asset control, it can be viewed as infrastructure or ‘maybe’ infrastructure.
Southall: Data centres have gone from a ‘quirky, niche’ sub-sector of real estate to a core allocation for both real estate and infrastructure managers. Attractive secular tailwinds and fundamentals of the tenant attract capital. Investors are attracted to the sticky nature of tenants – they become entrenched. which is positive for long term terminal values. Creating connectivity ecosystems helps increase tenant stickiness, and this is much more attractive than a long-term contract.
Jackson: Data centres are being viewed as both real estate and infrastructure investments. The acquisition of CyrusOne by KKR and Global Infrastructure Partners is a great example. The combined groups have vast real estate and infrastructure resources and expertise to facilitate CyrusOne’s growth. Over the last several years, investor perception of data centre companies has shifted from being that of a niche ‘alternative’ investment to a more established and desirable asset class.
FW: Could you provide an insight into why valuation multiples remain high across the digital infrastructure sector, consistently outperforming other sectors?
Southall: On the one hand, the lower cost of capital infrastructure means that investors are rotating into the space. These investors need a lower return so, all else equal, will pay a higher price and thus a higher multiple. On the other hand, it is a sector with significant growth. Look at the multiples paid by sophisticated investors such as KKR for assets like Metronet, on account of the significant growth potential. It is very rare to see both a sector re-rate from a risk and cost of capital perspective, as well as where there is growth. Typically, a sector will become mature and have lower growth, but be offset by lower cost of capital players. Here, both dynamics are occurring, which is what is driving multiples. I expect that it will continue generally, but not forever. There is an element of euphoria and I think as public markets slow down and rates increase, investors might take stock, which will slow down deal excitement and compress multiples a bit – but expect them to remain healthy.
Pang: Underlying secular building blocks for demand growth are the key drivers for high valuations, but there are also other factors too. Across digital asset classes, private market valuations remain high as investors gain confidence in long term secular trends such as data proliferation, connectivity demand from both businesses and consumers, and distributed computing. However, it is a good time to be cautious with valuations and use of leverage, given low interest rates are a partial contributor to the record-high valuation levels that we have observed over the past two to three years.
Hawa: Valuations are high in the sector for two main reasons. The first is due to the substantial long term projected growth in the space, and the second is due to the enormous amount of capital that is available for the sector. In view of the proliferation of internet and cloud-based services, and the advent of 5G and other bandwidth-intensive applications, dramatic growth is projected in the industry for the foreseeable future. That level of growth and stability have certainly resulted in higher valuations. With respect to the amount of capital dedicated to the space, virtually every financial sponsor in the world has earmarked funds for digital infrastructure, which has made M&A and investment processes highly competitive. And of course, the more competitive the process, the higher the valuations.
Jackson: Demand for products and services reliant on digital infrastructure, including data centres, continues to grow rapidly. Data collection and analysis is proliferating across all industries, and new emerging sectors such as self-driving cars, virtual worlds and artificial intelligence remain in their infancy. Valuations are a reflection of this continued demand, as well as the increasingly complex and challenging developments required to deliver digital infrastructure.
“The dramatic rise of digital infrastructure is a response to the evolving and increasing relationship between humanity and computers.”
FW: How important is it for data centre investors to understand the legal and regulatory landscape and monitor what is on the horizon in terms of change? What impact are issues such as national security, data privacy and the increased focus on personal data having on this space?
Alsheik: Operating data centres involves a lot of the same legal issues one would encounter in any other business, and particularly businesses involving real estate assets, including labour and employment, real estate and intellectual property. Prior to undertaking M&A opportunities, potential expansion opportunities, potential customer opportunities and fundraising from a global investor base, data centre lawyers should apply a rigorous analysis to national security, data privacy, antitrust and other regulatory regimes to avoid bear traps or delays down the road.
Jackson: Understanding the legal and regulatory landscape is critical throughout the lifecycle of data centres. Requirements to secure permitting and power are increasing and changing. Customer environmental, social and governance (ESG) requirements are evolving, and regulations to operate data centres, such as data privacy and emission standards, are evolving. Solving the needs of customers is foremost, and those needs change with the legal and regulatory landscape.
Hawa: Privacy and data security issues, and their national security implications, are central issues at the forefront of any digital infrastructure investment, and any investor in the space must understand the legal and regulatory landscape associated with these issues. Most countries have enacted privacy and data security laws to protect their citizens’ personal data and national security interests. These laws must be navigated in connection with any transaction. In the US, the Committee on Foreign Investment in the United States (CFIUS) undertakes a robust review of foreign investments in the digital infrastructure sector, which can considerably add to deal timing and complexity. In Europe, compliance with the General Data Protection Regulation (GDPR) fundamentally affects the manner in which digital infrastructure operate, which has a direct impact on deal structure. And in China, a variety of other companies with foreign ownership restrictions, privacy and data security laws fundamentally affect whether, to what extent, and in what manner companies and investors can enter the market.
“Demand is fundamentally driven by the growth in data and data analytics as the digital economy becomes increasingly interconnected.”
FW: What are your predictions for data centre M&A over the coming months and years? What deal drivers and regional hotspots do you expect to shape this space?
Pang: While I do not enjoy crystal-ball gazing, I do believe history can often repeat itself. I believe M&A and investment into new capacity comes in waves, and it is possible that after the recent wave of consolidation, there will be a few years of integration and strategic organic investment in the data centre sub-sectors that have recently seen a wave of deal activity. However, other sub-sectors of the data infrastructure landscape and certain regions with above-average fragmentation can soon become ripe for both horizontal and vertical consolidation. Nevertheless, given the continued demand growth for internet infrastructure and data centre capacity, it is also possible that most players will choose to focus on value-creating organic investment as opposed to M&A in the near-term future.
Hawa: The demand for data is projected to grow dramatically over the next decade, with thousands of new data centres required globally to meet that demand. Existing data centre operators are expanding their footprint into new and existing markets at a rapid pace, and new operators are arising with regularity. At the same time, large enterprise customers are increasingly migrating to the cloud and selling off their data centre assets. As a result, I fully expect to see continual waves of consolidation, and for M&A activity to continue at high levels for the foreseeable future.
Alsheik: It is my belief that financial acquirers with significant resources and track records of success outside of digital infrastructure will continue to find ways to expand into this space, particularly through acquisitions of established enterprises and venture-style or joint venture investments in upstart players. This will continue to have a favourable outcome on multiples and will bring fresh perspective to the industry.
Jackson: M&A will continue within the sector as providers look to build local expertise and global reach. As hyperscalers expand around the world, data centre companies will position themselves as preferred providers to meet their digital infrastructure requirements, partnering with capital providers to support this growth.
Southall: I expect to see more activity at the edge and convergence of ecosystems. Generally, we should see healthy activity, but as public markets slow down and rates increase, investors might take stock, which will slow down deal excitement and compress multiples.
Robert M. Jackson joined CyrusOne in 2015 and is responsible for its legal, human resources, environmental, health, safety and sustainability and risk teams. A versatile leader and executive, he brings a relentless passion for digital infrastructure, real estate investment, development and value creation. He is a graduate of the Indiana University Kelley School of Business, the University of Missouri-Kansas City School of Law, and the University of Florida Levin School of Law. He can be contacted on +1 (469) 289 2153 or by email: rjackson@cyrusone.com.
As senior vice president and general counsel at Vantage Data Centers, Ismail Alsheik is responsible for leading and setting the strategic direction for the legal and corporate compliance function for Vantage Data Centers globally. He is a respected leader with more than 16 years of experience as a corporate lawyer, the last five of which have been focused on the data centre industry. Prior to joining Vantage, he was a partner in the mergers and acquisitions group of Jones Day.
Joshua Pang is a managing director and head of digital infrastructure for Carlyle Global Infrastructure. Based in New York, prior to joining Carlyle Mr Pang served as managing director at Blackstone. Throughout his career, he has been investing in and partnering with leading businesses and management teams across digital infrastructure asset classes, including data centres, bandwidth/broadband and mobile infrastructure, and adjacencies such as communications IT, services and software. He can be contacted on +1 (212) 813 4807 or by email: pang@carlyle.com.
Sam Southall is a senior vice president at Macquarie Capital, based in New York. He is engaged primarily in leading digital infrastructure principal investing transactions on behalf of Macquarie’s balance sheet, focusing on the Americas. His experience includes investing into a variety of data centre platforms and terrestrial telecommunication assets. Prior to moving to New York in 2017, he was in London with Macquarie and worked more generally across the infrastructure and energy sector, including transportation, social, PPP and renewable energy transactions. He can be contacted on +1 (212) 231 1159 or by email: sam.southall@macquarie.com.
Kemal Hawa focuses his practice on corporate and securities law and transactions, with an emphasis on the telecommunications, media and technology industries, domestically and internationally. He assists clients with the negotiation of transactions in the cloud computing space, including the negotiation of data centre and colocation leases, globally. He also has extensive experience in the negotiation of network infrastructure transactions, including submarine cable system consortium and private subsea cable deals, terrestrial fibre optic network transactions, and transactions involving antenna towers. He can be contacted on +1 (202) 331 3119 or by email: hawak@gtlaw.com.
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