The world economic order is telling investors multiple different stories: on the one hand, central banks have (as of February) still been raising rates around the world with the caveat that there might be a pause after this round; on the other hand, inflation is abating somewhat, but recession looms and geopolitical tensions remain high a year after the Ukraine conflict began.

Mixed messaging motivates investors to seek resiliency, especially as portfolio rebalancing takes place. Some of that market resiliency comes in infrastructure debt investments, especially in the digital space.

According to the 2022 G20 Digital Infrastructure Finance: Issues, Practices and Innovations report, demand for broadband soared in G20 countries in the height of the covid pandemic due to lockdown measures and teleworking, with a net increase of up to 47 percent in total bandwidth produced by individual countries at internet exchange points in the first quarter of 2020. However, the crisis also exposed the limitations of existing digital infrastructure networks and revealed the vulnerability of the unconnected, who represented nearly 40 percent of the global population in 2021.

As the world emerges from the crisis, it is now generally accepted that digital infrastructure was critical to the resilience of the global economy in 2020-22 and will be a major driver of global growth and provider of social equity.

“We are pretty optimistic for a strong year in terms of total issuance,” says Steve Coscia, senior director, global infrastructure debt at Barings. “Even before the pandemic there was exponential growth in the demand for digital infrastructure and I think the pandemic accelerated that even further. I wouldn’t expect things to level off… and we will still see tremendous growth in these types of assets.”

Patrick Trears, global head of infrastructure debt at Ares Management Corporation, agrees. He says: “Infrastructure debt in particular has seen increasing interest from LPs over the last decade due to the asset class’s stable contracted cashflows and its inherent defensive characteristics against inflation.

“Currently, we are seeing our investment thesis play out with rising base rates and the consistent need for our assets globally. We believe these characteristics are not only attractive due to the growing private market space, but also because of the critical nature of the asset class.

Trears expects allocations to increase as volatility persists. This is because infrastructure debt can experience a “flight to quality” from investors seeking “more defensive investments”.

Increased comfort

When covid hit, there was an expectation of a pause and potential for downturn in investments, but that did not materialise. What started as a very brief halt in activity in the markets accelerated into a period of investment growth.

“We have seen there was quite a big competition between banks and institutional investors over the past years; and quite a drive for institutional investors to go into alternative assets like infrastructure debt, because the risk-return was better than in classical investments – especially because the fixed income market was non-existent given the low interest rate environment,” explains Jan Richter, vice-president at Berenberg Bank in Hamburg, Germany.

“This pertains to infrastructure in general but includes digital infrastructure,” Richter says. “There is a really high demand by the public, in general, and in the market, so we have seen very large transactions especially in the fibre space. We see that the fibre sector is coming of age, and the project and finance structures are, more or less, established so that a lot of investors feel increasingly comfortable lending to the digital infrastructure space.” 

One company that received significant investment was Germany-based Deutsche Glasfaser, to the tune of €5.75 billion. The company said that investment would make a significant contribution to the expansion of its fibre network to four million households in Germany by the end of 2025. Richter notes that the significance of this is how fast the digital infrastructure market has matured given that, for example, less than 10 years ago the fibre market was still in its infancy.

The capital structure includes a €3 billion loan, a capital expenditure facility for €2.5 billion and a revolving credit line of €250 million. In addition, Deutsche Glasfaser has the prospect of an additional credit line amounting to €1.5 billion. The financing, which was coordinated by the ING and Crédit Agricole CIB banks, replaces existing loans.

In the US, meanwhile, data centre operator CyrusOne was involved in a $15 billion take private acquisition by KKR and Global Infrastructure Partners. Another deal completed last year was the $11 billion acquisition of data centre firm Switch by DigitalBridge and IFM Investors.

Also of note last year was the debt refinancing of Everstream, which secured more than $1 billion and also raised additional capital to fund its network growth in 10 US states. That company is more focused on business-only fibre networks, while fellow fibre firm Metronet secured a $1.2 billion issuance.

“It shows you, you can get a broad spectrum of investment-grade and high-yield deals in the digital space,” says Coscia. “This year we will probably see a combination of high-yield and investment-grade investments,” he adds. 

“We will probably see businesses similar to Metronet with mature assets and a good history of contract renewals. We will also see some more greenfield development in fibre where you are taking a little more build-out risk, and risk in signing up customers. [Also], the US is a bit behind Europe in fibre build-out and you will start to see us catch up with a few more of those deals.”

Trears believes that private capital is going to play an integral role in the next stage of the infrastructure market. He says: “We are seeing continued shifts in the infrastructure asset class towards renewable energy, digital and new transportation assets, requiring significant capital to build. At the same time, we continue to see market dislocation and retrenching from traditional bank lenders, creating opportunities for private debt lenders.”

Looking ahead, while digital infrastructure markets are maturing, they are still relatively young and need careful consideration. A McKinsey & Company report, Infrastructure Investing Will Never Be the Same, says: “Exposure to new types of infrastructure assets demands that investors manage higher levels of risk. Many next-generation investments are self-evident, such as electric vehicle charging networks, battery storage, hydrogen distribution, and smart motorway and rail technology, 5G telecom networks, and data centres… However, to get exposure to these new asset classes, investors will have to accept a period of significant investment and negative cashflow, along with development, technology and commercial risks.”

As demand for digital infrastructure remains high, the growing debt market is expected to continue even as interest rates remain high.

Case study: EdgeConneX

Ares Management Corporation committed a delayed draw “sustainability-linked” debt facility of up to $1 billion to EdgeConneX, which provides data centre solutions. 

The money will be used to refinance existing indebtedness and to fund development and construction of its growing pipeline.

Ares has provided sustainability-linked loans through its global direct lending business, reflective of the company’s commitment to this asset class and to supporting a just energy transition.

“Sustainability-linked loans are an important part of our focus on integrating more robust ESG considerations into our investment process,” explains Patrick Trears, global head of infrastructure debt at Ares Management Corporation.

Digital infrastructure is attractive because of a myriad of core characteristics. “Within the digital infrastructure sector, we value high barriers to entry, long-term contracted cashflows, and stable operating platforms balanced with an underlying asset base – much like what we saw with EdgeConneX,” he notes.

The interest rate is subject to EdgeConneX meeting certain sustainability targets. The company’s existing strategy includes reaching net-zero carbon emissions, waste and water usage by 2030 and “developing and operating a data centre platform powered by 100 percent renewable energy”.

According to reports, Ares Management has provided other sustainability-linked debt facilities to engineering company RSK and waste management company Waste Services Group.