Data centre M&A in 2023

June 2023  |  TALKINGPOINT | MERGERS & ACQUISITIONS

Financier Worldwide Magazine

June 2023 Issue

FW discusses data centre M&A in 2023 with Robert M. Jackson at CyrusOne, Ismail H. Alsheik at Vantage Data Centers, Joshua Pang at The Carlyle Group, Sam Southall at Macquarie Group and Kemal Hawa at Greenberg Traurig.

FW: With data centre-oriented M&A seeing a record-breaking number of deals closed in 2021 and 2022, how would you gauge the appetite for such transactions throughout 2023?

Hawa: There is a fascinating tension that currently exists in the data centre M&A environment. This is a challenging global economy – to say the least – in view of war, pandemic, inflation, rising interest rates and the threat of recession. These conditions adversely affect all industries; the digital infrastructure industry is no exception. At the same time, data centres remain central to, and are perhaps growing even more critical to the global economy. Remote work, remote learning and streaming video and social media demand have dramatically accelerated. Devices continue to proliferate, and the global need for data continues to intensify. All of this points to a continued high level of investment activity and M&A in the data centre space.

Jackson: Data centre real estate is an extremely resilient sector and should continue to perform well through an economic downturn. While growing at a slower pace than in recent years, the world’s largest cloud businesses remain robust with double-digit growth rates. The pipeline for deals and valuations remains strong. The tightening of the capital markets and increase in interest rates may cause some companies with weaker balance sheets to recapitalise.

Alsheik: In the first quarter of 2023, global M&A activity hit its lowest point in a decade due to various factors such as rising interest rates, high inflation, economic uncertainty, market volatility and bank failures. Nevertheless, the demand for data centre capacity is increasing as the cloud market grows. Building and operating data centres to meet this demand requires significant amounts of capital. Investors will continue to show interest in the data centre sector through M&A and capital markets transactions this year, seeking exposure to this growth opportunity.

Pang: M&A activity has been robust, and 2023 likely will follow this trend. The higher costs of capital may force sponsors to cautiously pursue M&A deals. Given the demand for data centre capacity, stakeholders will continue to invest in this digital infrastructure but may focus on value-creating organic investment.

Southall: 2023 has been an interesting year thus far. Due to volatility of the markets late last year, transaction activity has not been particularly buoyant. This seems primarily due to a bid and ask spread between buyers and sellers as opposed to a lack of appetite for the sector. The ‘up and to the right’ trajectory witnessed over the last 24 months may not be the trajectory for 2023 and beyond. However, data centre M&A deals remain robust, and pent-up demand will eventuate as the broader financial markets and macroeconomic backdrop calm. Moreover, the need for development platforms appears to be increasing. This is due to unabated end-user demand coupled with increasing challenges to create supply. Established platforms with development sites and access to power are more highly sought after than ever.

FW: What makes data centres a particularly attractive target for investors? What key factors are driving deals in this sector?

Jackson: Data centres are the backbone of business today, whether through traditional colocation or cloud-based services. Because the world is data driven, increasing amounts of computing power and storage are required to keep up with accelerating demand. Achieving scale is critical to success in the industry. A strong and flexible balance sheet is needed to finance the significant amounts of capital required to capture growth opportunities. M&A is a potential pathway for companies to transform their market profile by creating the necessary scale.

Pang: The data centre sector is attractive because of the underlying growth and sustainability of long-term demand. Even through the recent market volatility, pandemic-driven macro-disruptions, geopolitical instability and other headwinds, demand trends such as data proliferation, connectivity demand and distributed computing instil confidence in investors. Over the next decade, the growth of artificial intelligence (AI) applications may expand and redefine current data centre ecosystems.

Southall: Data centres tick a lot of boxes. For infrastructure investors, the mission-critical nature of the asset class and the inherent customer stickiness, as well as more ‘typical’ characteristics that infrastructure investors look for – such as long-term contracts typically with creditworthy tenants – make this sector highly attractive. The sector also benefits from secular, non-cyclical growth. Increasingly, data centres are becoming ‘green’ and representing appealing opportunities for environmental, social and governance (ESG)-focused investors. Macroeconomic factors mean that buyers are more thoughtful about what they pursue and when. Debt markets are slowing down big-ticket M&A, but minority stakes and non-control transactions are increasingly on the agenda. Historically, infrastructure investors have been attracted to capital-intensive industries. But the sheer scale of the capital need is causing the larger operators to become more creative with sourcing this capital in a time when capital is slightly less abundant.

Hawa: There are two main factors driving deals. First, given the insatiable demand for content, the data centre industry is now foundational to the global economy. Despite macroeconomic challenges, there is no indication the demand curve for data centre capacity will change in the long term. The centrality of digital infrastructure to the global economy has resulted in the sector being discussed in utility-like terms. Second, data centres are safe harbours for real estate investment. While other areas of the real estate industry have been hit hard, the demand for data centres continues to grow. Major financial sponsors have indicated they plan to redirect resources from areas like commercial office space, retail and hospitality toward data centres.

Alsheik: As the cloud market continues to expand, there is a growing need for data centre capacity. Building and running data centres to meet this demand requires substantial investment. Investors will likely continue to channel massive amounts of capital into the data centre sector this year through M&A and capital markets transactions to capitalise on this growth opportunity.

FW: How do you foresee the increasing use of data-rich digital services impacting the demand for data centre capacity and, in turn, the investment value of these facilities?

Pang: Over three gigawatts of data centre capacity were absorbed in 2022. Data-rich digital services experienced monumental growth and were essential to businesses achieving competitive advantages, providing value to their customers and modernising business operations. All these digital services live inside computing workloads, and most computing workloads reside in a data centre, thus driving demand. Not all data centres are created equally; investors and operators must understand what types of workloads function best within a given data centre deployment to properly make operational, customer and investment decisions.

Southall: AI is probably the hottest buzzword in the space and the world right now. A recent Citi presentation stated that there were over 200 mentions of AI during Big Tech Q1 2023 earnings calls, which highlights how this topic is number one on the agenda. All of these technologies will require significant new capacity. AI will also accelerate the convergence of compute ecosystems, which may be a positive for ‘neutral’ data centre providers.

Jackson: The next era of data centre demand and growth will be driven by AI. AI technologies require massive amounts of computing, power and storage. We are in the earliest days of the commercial adoption and leveraging of AI. As businesses create custom AI deployments, these platforms will require more and more data centre space and power.

Hawa: Every credible forecast projects substantial growth in the global demand for content in the long term. Concomitantly, the long-term investment value in data centres is strong. In the short term, however, there is a tension that may impact valuation multiples. Valuation multiples for data centres have been among the highest of any sector in recent years, and there are strong indicators that valuations will remain high; investors are flocking to the space because the sector’s foundation is solid. However, the increasing cost of capital – the cost of debt specifically – has placed downward pressure on multiples.

FW: To what extent has private equity (PE) interest contributed to the rise in data centre M&A in recent years, and the overall value of closed deals? Are data centre acquisitions viewed as long-term safe havens for investments, even during turbulent times?

Southall: There has been real growth recently in infrastructure private equity (PE). Infrastructure PE firms have bigger funds, lower return hurdles and long-term, sometimes perpetual, hold periods. Our view is that these long-term investors look at the mission-critical and long-term nature of data centres and see valuations and appetite. However, nothing is immune to macroeconomic factors. And various Big Tech players have started to talk about ‘efficiency’, with most large players announcing layoffs and pull-backs in capital expenditure. This may have some impact around the edges and make industry participants more cautious. But, on the whole, we expect data centres to remain a robust, protected pocket of value for the foreseeable future.

Alsheik: PE has had a significant impact on the data centre industry. The Wall Street Journal reported that, in 2021, there was $48bn worth of data centre M&A globally, with approximately 66 percent of those deals attributed to PE. The trend continued into 2022 with PE firms accounting for more than 90 percent of the estimated $48bn in data centre M&A. PE firms are actively seeking deals in this space and deploying capital at an accelerated rate.

Hawa: Financial sponsors – including PE funds, infrastructure investors and real estate funds – have played a pivotal role in the industry’s rise. Major financial sponsors rushed into the space, providing much-needed capital and strategic advice. Regarding whether data centres are long-term safe havens, I would make two points. First, the sector is so foundationally strong that it is discussed in utility-like terms. And second, financial sponsors are aware that the industry is an operationally-intense industry. A successful project requires sophisticated capital and management, strong tenant relationships, quality construction teams and financial discipline, among other things. Strong execution is required, notwithstanding the industry’s overall strength.

Pang: PE has supported the data centre industry’s development over the past couple of decades, and that financial sponsorship has accelerated over the past few years. While no two data centre platforms are the same, most data centre investments are viewed as safe long-term investments, which has heightened sponsor demand at the right prices. Most data centre transactions since 2021 have involved PE or PE-backed operators.

Jackson: PE firms are attracted to the opportunity to earn outsized development returns. They appreciate that data centres are the critical infrastructure of the 21st century digital economy.

FW: What, in your opinion, were the notable data centre acquisitions made in 2022? Were there any specific features of these deals worth highlighting?

Hawa: In 2022, data centre M&A activity was robust. KKR’s acquisition of CyrusOne and Carlyle’s acquisition of Involta were particularly notable because KKR and Carlyle are among the world’s largest financial sponsors. And their commitment to the space – along with Blackstone’s acquisition of QTS a year before – demonstrates that the data centre space, which was a niche portion of the economy as recently as a decade ago, is now central to the global economy.

Alsheik: Two trends are particularly noteworthy in data centre acquisitions. First, take-private transactions have taken some of the largest data centre players out of the public market. Second, these deals are increasingly being completed by a consortium of investors rather than a single fund. The consortium approach enables the acquisition of larger targets by like-minded investors that share conviction in the acquired asset.

FW: Along with the explosion in demand for data centre acquisitions, are there any other potential investment opportunities in the sector’s value chain that are gaining attention?

Alsheik: There are boundless opportunities for investment in industries intertwined with data centres. We can expect to see greater investment in the industrial equipment, including mechanical, electrical and plumbing inputs, that sit within the data centres. There are the servers and computing equipment, networking equipment and storage equipment, and other IT hardware used in data centre operation. Additionally, there is data centre infrastructure management software and other software used in operating data centres. Entities that manage and provide security to data centres present another investment opportunity. Finally, power providers play a critical role in enabling data centre operators to meet their ESG goals, with sustainable energy being a key part of capacity generation.

Southall: Tenants and developers are increasingly looking toward technologies that lower the cost of power from both an ESG and a ‘total cost of ownership’ perspective. We have seen several developers look to colocation sites with renewables, specifically sites near solar and wind farms. Additionally, next generation cooling technology is gaining traction as investors and tenants become more comfortable with liquified cooling as an alternative to traditional air cooling. This has largely been driven by the increased density of data centre equipment creating a challenging environment for air-based cooling methods. We expect this market to grow significantly alongside data centre capacity growth.

Hawa: Data centres – although a standalone business model – are part of the global communications ecosystem. Data centres house the content, but the transmission and routing of data is only as robust as the communications networks that support them. Although networks held up relatively well during the pandemic for many, particularly for second and third-tier markets and unserved and underserved areas, a network upgrade is required for their schools, libraries, hospitals and medical facilities to experience the same quality of service as those in dense urban areas. Financial sponsors recognise this, as evidenced by a dramatic uptick in investment activity in the network space, particularly in the fibre-to-the-home market.

Pang: Both investments ‘up the stack’ and ‘down the stack’ have increasingly become potential investment areas over the past two to three years. Looking ‘up the stack’, demand is increasing for the layers of managed data infrastructure, software, and converged services and technologies that are often bundled with data centre colocation. ‘Down the stack’, we see investment opportunities in land banking, construction, operation and maintenance, and supply chain-related technologies that have traditionally only been considered data centre adjacent.

Jackson: Investments in the vertical data centre ecosystem, particularly on the supply chain side, are notable. For example, creative power solutions are increasingly valuable as utilities around the world struggle to meet the growing demand.

FW: Looking to 2023 and beyond, what key trends and developments do you expect to shape M&A in this sector?

Hawa: Power availability is a global concern with virtually every major market facing severe power constraints, including the Frankfurt, London, Amsterdam, Paris and Dublin (FLAP-D) markets in Europe, and Silicon Valley and Northern Virginia in the US. New development projects are facing significant delays in power availability in many of these markets. This means that M&A strategies will become more critical. Data centre operators will increasingly need to acquire existing facilities with available power whether they be other data centre sites or brownfield sites. The lack of power availability will drive M&A activity in secondary markets globally, many of which are not facing the same power constraints.

Jackson: The data centre industry remains a remarkable growth story with accelerating demand driven by fundamental changes in technology. We are in the early days of AI adoption, and those who invest now will be rewarded over the long term.

Alsheik: PE funds, as well as pension funds, sovereign wealth funds, family offices and other investors who back them, will continue to play a significant role in funding the considerable capital requirements of data centre developers as the market continues to grow to meet the demands of the technologically-enabled world.

Southall: There are three main trends expected. First, growing capital needs will drive more creative structures and sourcing. We are seeing continuation and syndication vehicles gaining more traction as well as appetite for minority transactions. We are also seeing more structured transactions, such as transactions for preferred equity, to help solve some of the capital needs of operators, particularly for earlier-stage platforms. Second, as the broader economy stabilises, pent-up demand will lead to an acceleration in deal activity. Those who can brave moments of uncertainty will be rewarded in the long run. Third, strong markets will continue to benefit from pricing power as constraints in some markets, such as power limits in Ashburn and Santa Clara, continue to command a premium. Operators with ESG initiatives will also continue to grow.

Pang: Beyond the cyclical waves of M&A, capacity expansion and consolidation, there are also key developments in ESG. Across the sector, ESG efforts will likely strengthen the arenas of efficient energy consumption, standards of sustainability, environmental reporting standards and data sovereignty protections.

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 chief legal officer 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 17 years of experience as a corporate lawyer, the last seven 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 managing director 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 represents many of the world’s largest investors and lenders in the digital infrastructure sector domestically and internationally, including in M&A, investments, financings, joint ventures and development projects. He also counsels the world’s premier data centres, telecommunications carriers, tower companies, cloud providers, fibre providers, submarine cable operators, internet providers, equipment manufacturers, electric utilities and others in the negotiation of leases and colocation agreements, master service agreements, licensing deals and other commercial transactions. He can be contacted on +1 (202) 331 3119 or by email: hawak@gtlaw.com.

© Financier Worldwide

THE PANELLISTS

Robert M. Jackson

CyrusOne

Ismail H. Alsheik

Vantage Data Center

Joshua Pang

The Carlyle Group

Sam Southall

Macquarie Group

Kemal Hawa

Greenberg Traurig