Data centre M&A in 2024
April 2024 | TALKINGPOINT | MERGERS & ACQUISITIONS
Financier Worldwide Magazine
April 2024 Issue
FW discusses data centre M&A in 2024 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: How would you describe M&A activity in the data centre industry over the last 12-18 months?
Hawa: I would characterise M&A activity over the last year as strategic. Although the overall volume of M&A activity was likely down due, in large part, to the rising cost of capital – the rising cost of debt specifically – the overall amount of capital invested in the data centre space continued at historic levels. The demand for data centre capacity is tied to societal demand and technological developments, which are independent of macroeconomic headwinds. The business plans and investment strategies of data centre operators and hyperscalers data are inextricably linked to this demand, and thus investment in data centres during the last 18 months continued unabated. With respect to M&A, several significant transactions closed in the last 18 months. While it is likely that some M&A processes were put on hold until the cost of capital stabilises, I would argue that a strategic buyer existed for every sell-side process that was commenced.
Southall: Relative to the market more broadly, M&A activity has remained robust. While the global landscape for M&A faced its most challenging period since the 2007-08 global financial crisis, the data centre market has remained buoyant. Infrastructure investors tend to think in generations not quarters and the long-term secular trends underpinning the investment case remain solid. However, as significant capital-intensive businesses, data centres are not insulated from macro headwinds, such as a slower fundraising environment and higher financing costs. Multiples have come down, but only modestly, and probably not sufficiently to establish a trend. Development economics as well as overall demand are supporting these valuations.
Alsheik: M&A activity has been robust. Deals included bankruptcy sales, joint ventures (JVs) and take-privates, highlighting the myriad ways investors are injecting capital into the sector and the long-term value they see for the data centre industry.
Jackson: Notwithstanding the challenges of the current capital markets, data centre M&A and asset recapitalisations remained active over the past 18 months, demonstrating the resiliency of real estate digital infrastructure as an asset class and investor interest in the sector. As investors look for data centre investments, M&A remains an important path to entry into the sector and new markets and as a way to accelerate scale for data centre platforms.
Pang: M&A activity in the data centre industry in 2023 was selective and targeted for most market participants. While the secular tailwinds of the industry are stronger than ever, the overall deal volume and value was lower, given difficult market conditions. Several smaller platform deals cleared recently but none as large as the $8-10bn deals that cleared in 2021 and 2022. In 2023, many players focused on optimisation, select organic builds and some tuck-in M&A.
“The size and scale of data centres has grown so substantially, and so rapidly, that a contractual refresh may be required.”
FW: What recent data centre transactions would you highlight? What do these tell us about underlying deal drivers?
Jackson: I was excited to see the market continue to embrace joint venture capital in the data centre space, both for development projects and to recapitalise stabilised properties. JVs are a great source of capital to support growth for development and to capture the value creation in stabilised projects, while at the same time preserving platform operational continuity, which is important for customers. Notable 2023 deals include Digital Realty’s JV with Blackstone, TPG and GI Partners.
Alsheik: I would highlight the recent $6.4bn equity investment by DigitalBridge, the leading global alternative asset manager dedicated to investing in digital infrastructure, and Silver Lake, the global leader in technology investing, in Vantage North America and EMEA. These investment are incremental to €1.5bn to be invested by AustralianSuper in our EMEA platform and includes expected investment from DigitalBridge and Silver Lake co-investors. As demand for cloud and artificial intelligence (AI) intensifies, these investments accelerate and extend our strategic capabilities across North America and EMEA to partner with global hyperscalers to meet such demand.
Hawa: Two transactions are particularly notable. The first is DigitalBridge’s acquisition of Switch, and the second is Brookfield’s acquisition of Compass. The acquisition of Switch closed at the end of 2022, and it is widely known that the timing of the transaction coincided with an overall downturn in the credit markets. Given the instability that the downturn in the credit markets created, it is a testament both to the strength of the company, and the financial market’s commitment to the sector, that the transaction was consummated without interruption. As for Compass, in view of the global macroeconomic headwinds, there are many in the industry who questioned whether valuation multiples in the data centre space could continue at similar levels, which were among the highest in any sector. The headline valuation is, again, a testament to the strength of the company, and to the financial community’s confidence in the sector.
Pang: The top transactional theme of the recent past has been AI-focused investments and projects, and I think one of the tangential elements of these investments is being overlooked. Specifically, interference workloads are driving increased ‘edge’ data centre demand, especially for latency sensitive end-user workloads. I would highlight the investment in tier 2 and tier 3 markets such as Involta Data Centers’ expansion into Wisconsin with a campus that can expand up to 20MW. We are seeing demand in these non-Ashburn, non-Santa Clara and other non-tier 1 markets move upmarket in size.
“While the global landscape for M&A faced its most challenging period since the 2007-08 global financial crisis, the data centre market has remained buoyant.”
FW: In what ways is the proliferation of artificial intelligence (AI) affecting data centre size and scale? To what extent are upgrades required to handle the processing requirements of AI?
Southall: AI is one of the main drivers of demand that we have observed over the last year. While deal sizes overall are larger, AI itself has not really led to changes in scale of individual deployment sizes. We still observe a lot of demand in the 5-20MW range, but we are seeing customers wanting expansion capabilities for larger overall campuses into 200MW-plus. The big change that AI is driving on training models is the increased rack density required at facilities. Over the last five years, we have seen customer demands move from approximately 5kW per rack to 70-80kW per rack for AI training models. At these densities, liquid cooling is going to be required, which means that new facilities need to be designed with this in mind, which creates lots of interesting questions about legacy assets that lack liquid cooling capabilities.
Hawa: The proliferation of AI has resulted in the need for data centres of unprecedented size and scale. The size and scale of data centres has grown so substantially, and so rapidly, that a contractual refresh may be required. Just five years ago, a 5MW data centre deal was considered a significant transaction. The risk allocation provisions of data centre contracts, including limitations of liability, indemnification and service level agreements, were geared to transactions at that level. We now see 500MW data centre campuses – literally 100 times the size of what was considered a significant transaction just a few years ago. All parties involved, both data centre operators and tenants, should, in my view, evaluate whether the risk allocation provisions in their precedent transactions remain viable in view of the size and scale of modern data centre projects.
Alsheik: AI applications encompass two disparate AI workloads: training and inference. Training, where AI applications learn and process data, requires data centres with dense racks, using significant power and expelling an immense amount of heat. Liquid cooling is crucial for 80-20kW. Training workloads leverage numerous GPUs in a confined space. As such, the data centre footprint can be much smaller than a typical data centre. Inference workloads generate information and responses based on the AI application’s training and are typically in traditional data centres since the data processing is less intensive than training. These data centres are less dense, at 10-20kW-plus per rack, and generally use air or water for cooling. They are also larger to accommodate thousands of racks and servers. Upgrading traditional data centres for AI training workloads requires consideration of space allocation to reduce waste square footage, power densities, cooling requirements, and the ability to support heavier rack and server weights.
Pang: I expect data centre platforms targeting the AI workload market to adapt and invest in infrastructure better suited to handle the demand across four main areas: cooling, power supply, backup and redundancy, and connectivity. On cooling, traditional density ranges from 4-8kW per rack, and AI-dedicated racks can reach up to around 40kW. Retrofitting infrastructure, and the incremental nature of AI demand, would likely lead to purpose-built data centres exclusively handling AI and AI-like workloads. Power supply and backup require proximity, access and control of power substations. Similarly, backup power is critical because an outage in the middle of a training or GX run can be extremely costly, so data centres must have two or more PDUs to eliminate single points of failure. Lastly, low latency will become critical for the efficiency of training and running models and interconnectivity upgrades.
Jackson: Customers looking to support AI deployments generally require large data centre campuses with significant expansion opportunities. Also, AI deployments can be at much higher densities from a power perspective, meaning more servers in a smaller amount of physical space. For legacy facilities, higher densities could stress the design of the data centres, creating operational risks that require additional investments to mitigate. For newly developed facilities, higher densities could require a smaller footprint for the data centre, which may reduce the overall cost.
“It is more likely than not that the data centre M&A landscape will continue to be active over the next five to six years.”
FW: For data centre operators, what are the financing challenges associated with large-scale deployments arising from increased demand?
Alsheik: The accelerating demand for larger deployments, including cloud and AI deployments, requires significant amounts of equity and debt capital. Data centre operators should establish relationships with banks and investors that recognise the unique opportunity in data centres and wish to be partners with a trusted owner and operator in the sector.
Southall: The primary challenge today is securing ample capital to deliver the step change in demand, projected at 15GW of demand, or the equivalent of $16bn of annual rent payments driven by AI by 2030. Particularly for large-scale deployments with yields only marginally greater than all-in capital costs, small changes in financing can quickly render developments uneconomic. Data centre operators concentrate on capital formation in debt and equity markets. New financing for intellectual property is emerging, with JVs increasing in popularity to raise significant capital for ‘mission critical’ assets without resorting to dilutive equity at the operating company level. Some listed real estate investment trusts and private operators embrace these strategies. Bifurcated risk profiles between ‘DevCo’ and ‘YieldCo’ structures attract diverse capital. On the debt side, sophisticated parties are developing borrowing base instruments and warehouse facilities, supporting debt financing during the development phase, before refinancing into the asset-backed securities (ABS) or other more permanent markets.
Jackson: The good news is that notwithstanding the historic tightening of the capital markets over the past two years, debt investors’ enthusiasm for data centres continues to be robust, albeit at higher coupon rates. There is a relatively deep financing market for stabilised scaled data centres with credit tenants. Financing for development projects that are dependent upon utility power delivery is more challenging. For the new startup AI-centric companies, credit quality could be an issue for project financing. Last, industry market participants – both data centre operators and their customers, as well as lenders – need to carefully evaluate how contracts and loans are structured in order to minimise the cost of capital. More efficient capital will help support capturing the growth opportunity in the data centre space by minimising costs.
Hawa: I would highlight two of the larger financing challenges. The first simply pertains to the amount of capital necessary to complete modern day data centre projects, which can run in the hundreds of millions of dollars given the size and scale of some projects. The second is the cost of capital – the cost of debt specifically. As for the former, we have seen a variety of creative financing solutions implemented to fund current projects, including strategic partnerships, JVs, project finance arrangements and preferred equity investments, among others. As for debt, the private credit markets have stepped up and played a valuable role. We have seen a variety of creative debt financing arrangements as well, with ABS financings and other structured products among the most notable. These products allow for the pooling of assets, which protect investors from risk and increase liquidity.
FW: Against a backdrop of global power supply shortages, what steps can data centre operators take to manage their deliverables?
Pang: Data centre developers turned their focus to managing power limitations and related supply chain limitations as customer demand arising from generative AI began to outpace absorbable supply by a meaningful amount in Q4 2023. This underscores ongoing concerns around securing power supply, efficient cooling alternatives for higher-density workloads, and also the capital goods. For example, scaled data centre operators have begun to secure long-term partnerships with vendors such as Schneider Electric and others, with multibillion-dollar agreements that guarantee a supply of manufactured data centre components.
Alsheik: The global power supply shortage is one of the industry’s biggest challenges. Companies must develop innovative solutions to meet this challenge, including embracing renewable energy from solar, wind and hydro. Today, nine of our campuses across North America and EMEA are powered in part by renewable energy.
Jackson: Working with customers to match increasingly limited utility capacity with the highest and best application use – for example, based on latency requirements – is essential. Data centre operators may need to invest in utility infrastructure or utilise ‘bridging’ power solutions, such as on-site natural gas generation, to meet customer timelines while permanent utility capacity is built out. It will become increasingly important to work with customers to forecast load utilisation. Finally, aligning interests among data centre operators, customers and utilities will support a viable long-term ecosystem.
Southall: Managing power delivery and utility performance risks is a key differentiator we see in data centre operators. Operators are pursuing three strategies to deal with the increasing risk of power supply shortages and utility performance. First is early engagement with utilities and exploring self-perform options to have greater control over the contractor performing the utility upgrades. Second is increasingly exploring on-site generation options, although this creates new permitting risk. And third is working with customers to ensure protections are in leases to mitigate the risk of a third party that neither the tenant nor lessor can control. We are sceptical of small modular nuclear reactors (SMRs) being used for on-site generation and are more bullish about on-site generation using hydrogen as a fuel. The hydrogen market is forecast by Morgan Stanley to quadruple from now to 2050, and we foresee it having much lower regulatory risk than technologies like SMRs.
Hawa: Data centre leases and services agreements typically contain a variety of service levels and performance metrics, and various remedies and service level credits apply when the operator fails to meet those standards. The remedies for late delivery can include termination rights and late delivery credits. While the last few years were challenging with war, pandemic, inflation and the threat of recession causing significant strain on the global economy, the data centre sector faced supply chain challenges because of such strains, including with respect to equipment. The greatest supply chain challenge facing the industry is global power shortages, however such challenges are outside an operator’s control. Power availability is dependent on third-party electric utilities. Given such challenges, parties should consider whether force majeure clauses can address the challenges posed by global power shortages, or whether such challenges should be addressed during contractual negotiations.
“Creative ways to bring capital into the sector will create win-win opportunities for sources of capital and operators.”
FW: What essential advice would you offer to strategic or financial acquirers pursuing a data centre deal in today’s market?
Hawa: Although there are many considerations, I would advise strategic and financial acquirers to be mindful of provisions in underlying contracts that ultimately affect the financeability of the asset. I would highlight three such considerations: restrictions on assignment and change of control, cross default, and service levels and credits. Risk allocation and enforcement rights are fundamental to a lender’s investment thesis. Greater risk and more limited enforcement rights make it more challenging to finance an asset on favourable terms. It is important to note, however, that the data centre market is a sub-market of its own, and terms that are quite common in the data centre sector may not be as common in other industries. Thus, risk allocation and enforcement rights cannot be viewed through the traditional lens.
Alsheik: When you invest in a data centre asset, you are in most cases investing in a team. Understanding how they work together, what values they espouse, what they prioritise and their strategic vision for the future is paramount.
Southall: The space is getting unprecedented attention in mainstream media, so it is important to stay disciplined and recognise that not everyone will be a winner. Execution is key. Supply chain complexity is increasing, power procurement strategies need more attention, and customer demands are constantly evolving. It is easy to see the sector as providing commoditised real estate but that would be a mistake.
Pang: Three key differentiating factors are consistently winners. First, ownership of critical infrastructure, since asset ownership and control is key. Second, workloads tied to the best secular tailwinds enable higher-growth internet bandwidth flows and cloud, with direct exposure to data traffic and cloud services. Lastly, prudent customer selection. This means differentiating between high-quality customers and low-quality customers, especially given the total cost of ownership, and dynamics around unit economics.
Jackson: Acquirers need to evaluate the quality of the team, the platform and the customer relationships. Scale matters significantly to the customers that are driving growth in data centre demand and also to the capital markets underwriting projects and platforms. Also important is understanding the markets you are investing in and the customers utilising the capacity. There are challenges in some markets related to permitting, zoning, water scarcity and environmental conditions that could impact data centre operators, new projects and growth prospects. Key is to understand the end-user customer dynamics, the software applications, the IT hardware, and the technology drivers of the data centre capacity demand, both in the near and long term.
“Aligning interests among data centre operators, customers and utilities will support a viable long-term ecosystem.”
FW: With data centre demand forecast to grow exponentially through to 2030, what are your expectations for data centre M&A over the coming years?
Jackson: I expect M&A to pick back up in the near term, assuming capital market conditions loosen a bit. The scale that was required to be successful five years ago is no longer sufficient due to the size of the commitments required to capture the opportunities in the market today. Financial strength and predictable, efficient access to multiple sources of capital – both debt and equity – will be essential to support the anticipated growth.
Hawa: M&A activity surrounding the data centre sector will be prolific in the coming years. Strategic M&A transactions will continue, as providers expand their international footprint. Financial sponsors will continue to engage in M&A and investment due to the sector’s centrality to the global economy and society. Data centres are integral to the interconnected ecosystem that comprises the global communications network. This network is only as robust as its weakest link. As data centres proliferate, there will be a proportionate need for other aspects of the network to become more robust, including terrestrial fibre, towers, submarine cables, along with the equipment, chips and infrastructure enabling content transmission and routing. New M&A activity in real estate will likely occur, as data centre operators seek to procure land with access to power and water, which may include greenfield sites or the acquisition of brownfield sites with historical access to power.
Southall: Most of the large infrastructure general partners have now made their bets, so we would expect to see less in the way of ‘mega’ M&A in the private markets and anticipate that more activity will be focused on recapitalisations, JVs and strategic financing that can support operators delivering against the substantial requirements the industry is facing. We are also interested to see whether the demand explosion that is being observed at the hyperscale level will trickle through to the ‘edge’ providers, driven by AI models moving from predominantly ‘learning’ to ‘inference’, which will be more latency-sensitive and distributed.
Pang: While crystal-ball gazing is fun, the industry has proven to be highly dynamic, with continuous changes in customer demand characteristics, infrastructure development business models, and financial sponsor behaviour. It is more likely than not that the data centre M&A landscape will continue to be active over the next five to six years. Given the need for both organic, new-build investment and M&A consolidation and expansion, both vertically and horizontally in the value chain, I believe the data centre sector will be one of the most active in the telecoms industry.
Alsheik: I expect investment in this sector to increase substantially. We are likely to see more and varied entrants into the field, including private credit sources and long-hold investors. Creative ways to bring capital into the sector will create win-win opportunities for sources of capital and operators.
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. Prior to joining Vantage, he was a partner in the mergers and acquisitions (M&A) group of Jones Day, where he focused on data centre transactions.
Joshua Pang is a managing director and head of digital infrastructure for Carlyle Global Infrastructure. Prior to joining Carlyle, he served as a 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 and 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.
Based in New York, Sam Southall is managing director at Macquarie Capital. 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, public-private partnership (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.
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