Edmond de Rothschild on deploying debt in digital infrastructure

Senior and high-yielding lending opportunities are growing rapidly, says Jean-Francis Dusch, BRIDGE CIO and global head of infrastructure, real assets and structured finance, and UK CEO at Edmond de Rothschild

This article is sponsored by Edmond de Rothschild

How has digital infrastructure fared in the face of the demands placed on it by the pandemic?

Jean-Francis Dusch
Jean-Francis Dusch

Digital infrastructure has undoubtedly been a big winner throughout the pandemic. And it is easy to see why. Home schooling, home entertainment, working from home and even remote diagnosis in healthcare have all placed huge demands on the system and so exposures to the sector have held up strikingly well, both in terms of new investment made and for the credit position of existing investments.

In contrast, tensions have started to build in other sectors that have broadly been viewed as covid resilient, such as renewable energy, albeit with no default or loss of capital for investors.

Digital infrastructure, such as fibre optics, has gone from strength to strength. Even in greenfield situations which involve network deployment, underlying concession agreements provide sufficient protection to lenders to cope with delays in constructions and lesser revenue. The need for digital infrastructure was even more obvious during the pandemic and has had a very positive social impact.

What is the scale of the opportunity today, in terms of M&A, capex and refinancing?

The scale of the opportunity is very significant. When we first began to introduce digital infrastructure into our investment strategy six or seven years ago, we were a first mover and really had to make a case for investors to accept it as an infrastructure investment. We had to explain to institutions why it did fall within the parameters of infrastructure debt mandates, explain the technological risks, revenue drivers and how to best structure the underlying debt instruments.

Fast forward those years, and digital infrastructure now represents at least 20 percent of our portfolio. We could do way more actually, but we wish to keep a strong level of diversification. If I look back at the transactions we have closed since the beginning of this year, three or four will have been in the energy sector. Another three or four will have involved digital infrastructure assets.

Certainly, there’s always a great deal of refinancing activity embedded in telecoms. These are fast-growing projects/companies and the need to optimise the capital structures of those assets, as they evolve, is material.

Acquisition is another important component. Over the past two to three years, we have seen significant M&A activity in the towers sector, for example, but also more recently in the fibre optics sector. This is driven also by private equity players recycling their equity, for some, after three to four years to long-term investors, sometimes to institutions. We are also starting to see some consolidation, with larger players acquiring smaller operators. Then, of course, there is still demand for new network roll-outs in rural and urban areas.

And because digital infrastructure assets require optimum capital structures, there is also a strong demand, not just for the senior debt, which represents the majority of the debt funding requirement, but also for higher-yielding junior debt opportunities. It has, therefore, been a pretty quick process for us to build a large portfolio of telecoms assets within our sub-funds.

You’ve deployed across the fibre, towers and data centre industries. Where are the most interesting opportunities?

There’s a huge amount of deployment needed across all three sectors in terms of project financing, refinancing and acquisition financing of more mature brownfield assets.

Fibre is clearly going strong with opportunities across Europe. France, Germany, the UK, Netherlands, Spain and Portugal have been countries where we invested in the last three years. And the potential for growth remains significant as some countries are yet to implement their digital transition and plans. And there has been a number of tower acquisitions in European countries, including assets with very large footprints as well as smaller regional players.

Equally, there are a great number of opportunities in the data centre sector, but as an asset manager, we have had to think carefully about what the best approach to that space is going to be. We prefer to focus on situations where we have a very strong corporate offtaker with a long-term contract, as opposed to a multiplicity of short-term contracts with various counter parties.

We are selective in all sectors we cover and are usually very broad in our risk acceptance criteria, considering that each debt instrument structure is tailor made.

But for data centres, we felt our investors had specific requirements we tried to meet.

What impact will the roll-out of 5G and the proliferation of the internet have on the digital infrastructure opportunity set going forward?

Clearly, demand for bandwidth capacity is ever increasing, and the roll-out of 5G is occurring and requires financing. However, this seems to be more on a corporate basis for now.

What was important for asset managers was to reassure institutional investors that the 5G roll-outs would not be disruptive to the fibre to the home business plans in the medium and long term, and that actually they can be complementary, for example, for urban networks, with a view also to being environmently friendly. Therefore, we do not see technology risk as being any more pronounced in this sector than any other.

What is your approach to the evolving regulatory environment for digital infrastructure?

Our philosophy is to ensure we have a team that understands the latest technologies and how regulatory plans are likely to evolve. It is, therefore, important to have close relationships with the equipment suppliers and operators as well as with government and regulators. Being able to identify and mitigate risks appropriately, extensively and efficiently is part of the job.

And how are you approaching origination in the digital infrastructure sector? Is this an area where asset managers can differentiate themselves?

You differentiate yourself by being able to deliver on what you promised to your investors. Every leading asset manager will say they can source assets through their strong network of relationships with financial and industrial sponsors. The important thing is to make sure you actually do, and that your investment team have such a track record and have relationships with borrowers in order to source strong proprietary transactions that you can structure.

The senior level of our investment team brings over 20 to 30 years of deal structuring experience each, meaning they are trusted by sponsors. They can design debt structures which are tailor made to the underlying projects while meeting the requirements of our investors and providing a sustainable capital structure for the borrower.

We try, as much as possible, to enter a deal at an early stage and to source proprietary transactions, as an early mover and price setter. We are also keen to ensure, to the extent possible, that for those investors that have invested in several asset managers, we bring asset diversification and not
overlap.

What does the future hold for the digital infrastructure sector and the role of asset managers, such as yourselves, within it?

This sector is rapidly maturing right now. Demand is growing and is strong and steady; technology is evolving to meet ever-increasing capacity requirements. As a result, the pipeline for digital infrastructure is very strong. We are currently raising our BRIDGE fifth vintage, and I have absolutely no doubt that digital infrastructure will constitute a significant portion of our portfolio. Investments already closed in the beginning of this year are evidence of it

As a lender, how do you approach ESG in this sector? And how do you view digital infrastructure’s impact on the energy transition?

As a lender, and as a group, we have always been highly committed to ESG. In concrete terms, that means having an ESG policy and process in place, covering the way we source investments, the way we structure them and the way we monitor and report.

For example, our latest funds now measure the CO2 impact and contribution to the 2050 global warming reduction target for each investment using independent consultants to measure such impact. Equally, we have been closely monitoring the introduction of the EU’s Sustainable Financial Disclosure Regulation.

In terms of the sector itself, the ability to work from home and hold meetings by video conference is clearly a good way to reduce CO2 emissions by reducing travel. And we like to finance data centres which are powered by renewable energy. Finally, the digital infrastructure sector has created a great number of jobs, which is also a key indicator in our ESG reporting.