Silicon Valley-based manager Digital Alpha believes it can plug a capital gap in the digital infrastructure market, according to founder and managing partner Rick Shrotri.
Speaking to Infrastructure Investor following last month’s close of its second fund on over $1 billion, Digital Alpha Fund II, Shrotri said the vehicle was focused on providing what it sees as “outcome-based” financing models, in addition to more conventional equity investments, to plug a gap in the digital infrastructure market.
“This is taking risk on the outcome. If we’re going to deploy a solution, we have conviction that it will accrue to the benefit of the counterparties using that solution,” he said.
“We will share the upside and the downside of that infrastructure. That’s a different type of financing. It’s not traditional equity, it’s more of a synthetic equity structure. We believed from the outset that there is a capital gap in the market. We needed not only to have the right instruments available, but also the relevant domain expertise. In order to succeed, we believe that you need a deep understanding of certain trends in the market such as how Internet of Things will evolve and how 5G will evolve. That’s where our alpha comes from.”
As with the firm’s first fund, the deployment of its follow up, so far totalling about $300 million, will come alongside a joint venture with technology group Cisco, which Shrotri says is core to Digital Alpha’s differentiation. Shrotri was a managing director at Cisco for nearly 10 years before establishing Digital Alpha in February 2017, closing its first fund later that year.
‘Like an online toll road’
Shrotri said the challenge of raising a digital infrastructure fund at the time was entirely different to what it is today, and he found himself speaking to LPs in more traditional infrastructure terms.
“With our first fund in 2017, we had to define digital infrastructure and explain to investors what it is. We used analogies of toll roads that people were familiar with,” he recalled. “If you take a toll road and build an internet equivalent, everything passes through a certain place and you effectively collect a toll on that basis and the traffic pattern can be forecast, with guarantees. For Fund II, there was a lot more awareness among LPs that digital infrastructure was a vital and growing part of the infrastructure investment required for the future. Then it became about execution and adding value.”
Dan Meade, Digital Alpha’s head of investor relations, added that the group had certainly seen more of an “equalisation” for the second fund between those investors viewing it as a private equity fund, and those who believed it to be an infrastructure play.
“Given our strategy, we’ve always felt we sit in between legacy infrastructure and private equity,” he reasoned. “From our investor base, broadly speaking you’ve seen the traditional real asset investors that have viewed us as a higher-returning growth alternative with differentiated dealflow. The private equity side of the house has viewed us traditionally as a path to their target returns, but with a lot of the downside protection and ‘sleep at night’ elements of traditional infrastructure. Given our partnerships and history, we feel we’re able to combine that best of both worlds.”