This article is sponsored by CIM Group, Digital Alpha, DTCP and Vauban Infrastructure Partners

Not that long ago, debate raged as to whether digital assets really constituted infrastructure. Today, the sector is commonly referred to as the fourth utility. The pandemic certainly reinforced the essential nature of connectivity, leading to a surge of capital entering the space, spiralling valuations and compressed IRRs. But has this really now become a core asset class, best suited to a low cost of capital, or is it still possible to climb the risk curve and add value in order to generate higher returns?

“When Digital Alpha was formed, digital infrastructure was a new category. People were trying to figure out whether it really had infrastructure characteristics,” says the firm’s founder and managing partner Rick Shrotri. “The pandemic marked a coming of age for the sector, however, as it became clear that digital infrastructure is mission critical. That’s when everyone piled in – infrastructure funds, private equity and corporates – and deals started to be done at eye-watering multiples.”

Vicente Vento, founder and chief executive of DTCP, points to recent acquisitions in the European tower space, which were done in the mid-20s EBITDA multiples. These deals are likely to be underwritten with a high single-digit or low double-digit return expectation, he says.

Vento adds, however, that it is still possible to deliver strong double-digit annual returns with fibre networks, data centres and tower assets, particularly if there is a greenfield component to the project. “It all depends on the stage you are investing at and on the maturity of the underlying assets. To achieve higher returns, one needs to assume certain risks, and work with talented managers that manage those risks and turn them into opportunities.”

Qilan Tang, portfolio oversight at CIM Group, agrees that while there are plenty of stabilised assets for those with a low cost of capital, there is also a very healthy ‘develop to core’ premium if you are willing to take some greenfield risk. “I think the industry has matured, but we are a long way from digital infrastructure only offering a limited band of low returns. These are complicated assets and there are many ways to add value and to command alpha.”

Elie NammarElie Nammar
Partner and senior director, Vauban Infrastructure Partners
Elie Nammar joined Vauban as a senior director in February 2021. He was previously an associate partner at Oliver Wyman and group principal strategy manager at Vodafone. During his tenure there, Nammar was a senior member of the TMT practice, helping companies define their growth strategies and optimise their spend.

“Despite the fact that the data tends to be the client’s responsibility, we still work to ensure there are no areas of weakness. That preventative play has value attached to it”

For Shrotri, the answer has been to step up to the active network layer: “There I think you can still get a lot of infrastructure characteristics, with anchor contracts and downside risk protection, as well as the chance to create value,” he says.

Elie Nammar, partner and senior director at Vauban Infrastructure Partners, believes that despite the volume of new entrants that have been lured into the sector, interesting opportunities still abound. “There are still quite a few areas of growth across fibre, data centres and towers. I also believe that, as we move forward, the definition of digital infrastructure will continue to widen, incorporating new types of infrastructure. There is still lots of work to be done,” he says.

Vento agrees. “Look at the level of fibre penetration in Europe; there is still a lot of room to build additional infrastructure,” he says. “Sure, there is a lot of money chasing these opportunities, but at the same time execution is key. You need management teams that know how to build on budget and on time, that have an understanding of the financing markets, and that can get customers onto those networks. A lot of business plans are underwritten based on the ability to build networks, but the ability to sell networks is just as important. It’s that know-how that bolsters risk-adjusted returns.”

Recalibrating pricing

The turbulent macroeconomic backdrop could signal a recalibration of pricing, of course. “There is always a lag when it comes to sellers accepting a new market reality. Everyone wants to hold onto last year’s numbers,” says Shrotri. “But it is important to all of us as fiduciaries that we are underwriting the business case of today.”

Nammar is also hopeful that the shifting dynamics will lead to the rationalisation of valuations, these having crept up due to the number of new entrants post pandemic.

Vento, meanwhile, believes that a certain degree of valuation rationalisation is already starting to take place. “Public valuations of European towercos have normalised from a peak at around 27x to about 20x,” he says. “So we are definitely seeing a reset.”

Qilan TangQilan Tang
Portfolio oversight, CIM Group
Qilan Tang is responsible for managing the composition and driving the performance of CIM’s infrastructure strategies. Tang started her career in the investment banking division of Credit Suisse Group, specialising in regulated industries. She has focused on portfolio management of alternative assets since 2008.

“The holy grail is a PUE of 1.0 and there are many ways to get there, including renewable sourcing but also managing energy efficiency. It is about the insulation you use and the use of closed-circuit hot air systems”

The current environment might generate good opportunities, Vento adds. “We are starting to see debt and equity providers becoming more selective. As investors we like the characteristics of digital infrastructure: real assets with long-dated contracts, a strong underlying trend of data growth, and high profitability and cash conversion once the building phase is completed. Performing assets will continue to do well, but companies that are not tracking their plans might get consolidated.”

Nammar also believes that the current environment might create investment opportunities, including around 5G. “It could be that instead of 5G evolving in a similar fashion to fibre, first in cities and then with incentives put in place for rural areas, that a wholesale approach for rural areas is adopted early, leveraging on 5G’s slicing capabilities, given that operators may be unwilling to invest in rural districts due to limited economic rationale,” he says.

Digital infrastructure is also well positioned to weather the macro storm due to the resilience of its demand profile and ongoing innovation in the space. “There is a tremendous need to build out complementary access technologies in the US, for example,” says Shrotri, citing wireless fibre and fixed wireless access. “There will be a lot of scope to build and acquire those assets on attractive terms. The same is true of IoT. These are entirely new areas of the internet which, until recently, have been relatively small. Now, of course, every building in the world needs to get smarter, and that is creating significant investment opportunities.”


Indeed, innovation is a consistent theme in digital infrastructure. “The beauty of this space is that you can push into new frontiers, so long as you have those anchor contracts and principal protection in place,” Shrotri says. “If you have that as well as deep domain expertise, you can really de-risk execution and take advantage of the innovation that is intrinsic to the sector. What differentiates digital infrastructure from other categories, is that ability to add value, innovate and deliver strong returns, all whilst maintaining the principles of downside protection.”

Nammar believes that 5G will be critical to the next wave of digital infrastructure, touching on fibre, because towers will need to be connected, and touching on towers, because of the need for densification, as well as on active equipment and the Internet of Things, which will require 5G enablement. “5G will also impact data centres as more data is consumed and as edge computing steps into a new era,” he says. “Nonetheless, for 5G to reach its true potential we will need to see more consumer user cases driving adoption, rather than just more of the same.”

Rick ShrotiRick Shrotri
Founder and managing partner, Digital Alpha
Rick Shrotri has been a technology and telecommunications investor for over two decades. Prior to founding Digital Alpha, he was managing director of Cisco’s business acceleration team. He also worked for Samsung and Goldman Sachs.

“The pandemic marked a coming of age for the sector. That’s when everyone piled in… and deals started to be done at eye-watering multiples”

Shrotri points to the demand for low latency highlighted by ideas such as the metaverse and the advent of automation, including self-driving cars, as a catalyst for innovation. “It is creating a need for different network architecture,” he says. “There will need to be a more distributed way to access the internet, requiring different levels of computer and processing power at the edge.”

Innovation not only involves technological advances but also creativity in deal structuring, Shrotri adds. “The need to make buildings smart is creating the opportunity to deliver innovative financing structures, where we as investors share the revenue upside of putting this infrastructure in place,” he says. “For example, putting the right sensors in place could lower the cost of fire safety insurance, whilst water monitoring infrastructure can proactively identify leakages.”

Tang agrees that there is a lot of scope for deployment when it comes to connecting the digital infrastructure sector with other forms of more traditional infrastructure, such as renewable energy production and waste management. “This is an area where there is a real need and opportunity for innovation,” she says.

However, Tang adds that innovation needs to be considered in the context of client needs and capabilities. “Obviously, we want to build data centres with 2035 client demand in mind. But, at the same time, we can’t take huge innovative leaps in design because clients won’t be able to keep up. So innovation tends to involve constant small tweaks in design and development.”


But while digital infrastructure is relatively immune to macroeconomic turmoil, due to its strong demand profile, capacity for innovation and, of course, the explicit inflation protection mechanisms in place, it is not without its challenges, which include the risk of cyberattacks.

Tang points out that unless you are providing outsourced management of the network, it is really the client’s responsibility to manage cyber risk at a network level, while the infrastructure investor protects the physical infrastructure with data backups, cameras and drones, for example.

“We acquire assets that provide passive infrastructure, and while cybersecurity is a very high priority, our portfolio companies are mostly responsible for the physical security of the infrastructure – making sure no bad actors enter a data centre or tap into fibre lines. Our customers are typically very savvy and responsible for the security of the active elements of the network themselves,” Vento adds.

Vincente VentoVicente Vento
Founder and CEO, DTCP
Prior to founding DTCP, Vicente Vento was the global head of M&A and a senior vice-president at Deutsche Telekom. Before that, he held advisory and asset management positions at Morgan Stanley, Blackstone and Royal Capital Management.

“A lot of business plans are underwritten based on the ability to build networks, but the ability to sell networks is just as important. It’s that know-how that bolsters risk-adjusted returns”

Shrotri, however, believes that a proactive approach to cybersecurity can nonetheless have financial value. “At the end of the day, the customer doesn’t care where the breach takes place. They want to make sure their data is secure, and guarantees around that security are something that can be monetised. Cyber-threat is a risk but it is also an opportunity.”
Nammar agrees. “Despite the fact that the data tends to be the client’s responsibility, we still work to ensure there are no areas of weakness,” he says. “That preventative play has value attached to it.”

The importance being placed on cybersecurity, meanwhile, is only increasing in the face of geopolitical unrest. “Customers are also a lot more sensitive to back-up power, and we have seen companies storing additional diesel so data centres can run for longer even if there are outages,” says Vento.

Indeed, energy security issues and high energy costs have compounded pre-existing concerns around sustainability, increasing pressure on digital infrastructure assets to go green.

“Our customers are ultimately paying the electricity bills, so the need to deliver highly efficient infrastructure is critical. In Europe, it’s also very important that energy be sustainably sourced,” says Vento. “Renewable energy is a must-have for most large corporations and government. Previously, this was seen as an ESG issue, but now energy scarcity is also a concern.”

Greening digital infrastructure

Nammar says that Vauban’s data centres are already 100 percent powered by renewables. “We are also exploring alternatives to diesel as a backup power source, including batteries, of course, as well as hydrogen and liquid methanol, although it is still early days.”

DTCP’s portfolio companies source most of their energy from renewable energy sources and are also active in the carbon credit market. “We too are looking at alternatives to diesel backup power generation, although diesel still tends to be standard for the industry. We are seeing a number of innovative backup power generation systems, including those running on natural gas, batteries and hydrogen. This is still in its infancy but could develop quickly given demand from clients.”

Cooling systems are also a client priority, with air-cooled data centres preferred to liquid-cooled ones, particularly when liquid mechanisms use gases that can be damaging to the environment. “We are also seeing projects that feed the heat, which is a waste product for data centres, into district heating systems for residential areas,” says Vento.

“It is possible for a data centre to become neutral or even a positive contributor to environmental goals, despite its high energy use. That is the ultimate end game.”

Tang adds: “The holy grail is a PUE [power usage effectiveness] of 1.0 and there are many ways to get there, including renewable sourcing but also managing energy efficiency. It is about the insulation you use and the use of closed-circuit hot air systems to reduce the heat released into the atmosphere, for example. Future-proofing data centres is critical for the long-term returns of data centre developers and operators.”

Shrotri, meanwhile, says that it is not just clients that are increasingly focused on ESG, but investors as well. “LPs want to know that we are not supporting less efficient use cases such as crypto-mining, for example,” he explains.

But Shrotri adds that the direction of travel for data centres is inherently more environmentally friendly in any case. “As networks evolve, the reality is that not all data centres will be hyperscale.

“There will be a lot more edge facilities required, which are more efficient because you are reducing the transit of that data, as well as enabling new use cases that themselves have environmental benefits.”

Managing supply-chain disruption

While digital infrastructure benefits from many structural advantages that protect it from the worst excesses of macroeconomic cycles, the sector has not been immune to supply-chain disruption.

“It appears the price of raw materials is stabilising but lead times are still high – double or triple what they were a year ago in some cases,” says Qilan Tang of CIM. “Uniquely to digital infrastructure, production shutdown has been compounded by increased demand from both developers and clients. The big hyperscalers have massive orders for critical infrastructure to the scale of multiple gigawatts. That isn’t something that you see with renewables. You don’t see public utility off-takers competing with developers for solar panels.”

Tang says the solution lies with domain expertise. “We recently faced a situation where the lead time on a critical component was too high for our timeline. We reached an agreement whereby the vendor sent us the parts so we could do the build on site under the supervision of their mechanical engineer. In this environment, if you don’t have a team in place that can innovate, it is going to be challenging.”

Vauban’s Elie Nammar, meanwhile, says the key to managing supply-chain issues is preparation. “You need to have the foresight to put the right solutions in place and you have to be flexible enough to pivot to new ways of doing things if you are going to deliver on time.”