Edmond de Rothschild on the digital debt opportunity

This article is sponsored by Edmond de Rothschild

To what extent did covid accelerate digital consumption and the subsequent demand for digital infrastructure?

Covid certainly supported the growth of data consumption, as people around the world were forced to do most things remotely, from work and education to healthcare activities. But while covid may have accelerated changes in behaviour, growth of data usage is a natural evolution of society and already underway. Therefore, one could consider that the majority of the digital infrastructure investment that we have seen would have taken place irrespective of the pandemic. Underlying business plans may have become more readily achievable, however, as the truly essential rationale for digital infrastructure became more apparent.

How is this evolution in human behaviour translating into infrastructure debt opportunities in terms of capex, M&A and refinancings?

Increased data consumption has led to a significant number of greenfield digital infrastructure projects, such as fibre optic networks and data centres. That has triggered significant capex financing requirements for the past 10 years now.

We are also seeing widespread opportunities to finance M&A activity as smaller operators in the fibre space, for example, merge or are acquired by larger operators and deep-pocketed financial sponsors. Further M&A opportunities are being fuelled by equity stakes being passed from one sponsor to another for larger assets.

Lastly, some projects and companies have naturally matured and so there has been a lot of refinancing activity in order to optimise the capital structure of digital assets finance. Indeed, we have seen some very large transactions, such as sizeable fibre businesses in Germany and Spain.

In short, there are a vast array of opportunities for asset managers like us that are equipped to understand these industries. When we launched our debt platform BRIDGE in 2014, digital infrastructure was an essential pillar of our deployment strategy, making us one of the first debt funds to embrace the sector.

But it is fair to say that it took some time for our investors to get comfortable with the drivers and risks underpinning digital assets. We really had to make a case for their inclusion. We had to explain why they did, in fact, fall within the parameters of infrastructure, and how those investments could be structured to make the sector available to institutions.

We therefore only completed a handful of digital deals in the first few years, but since 2016 there has been a very significant pick-up. Digital infrastructure today represents approximately 20 percent of our portfolio; over the past 12 months, digital infrastructure has represented around 40 percent of our deployment activity at present, although this will be rebalanced by year end. And because digital infrastructure covers the whole spectrum of financing opportunities, there is strong demand, not just for senior debt but also for interesting higher-yielding opportunities including junior debt.

Given there are so many potential opportunities, what is it that you look for in an asset when deciding whether to provide financing?

We take each asset on a case-by-case basis, considering the technology, geography, regulatory framework, underlying revenue streams, counterparties and contracts, among others. We look at most transactions available in the market, and then analyse each based on their merits.

Although our most recent fundraising saw us amass in excess of €2 billion to date, we are still able to be highly selective. There might be three assets that look very similar on paper, but when analysed in depth, it may emerge that the regulatory environment is slightly more favourable in one region, or the counterparty is a little stronger. The debt structure that we put in place will then reflect the specifics of the project.

What impact will the advent of 5G have on existing technologies?

I think the impact of 5G will be limited. We have been active in this sector since the days of 2G and, based on that experience, we forged our view on this issue five or six years ago. We see the technologies as complementary; we don’t believe they will cannibalize one another. 5G will require a lot of towers because of the necessary capacity, so it may therefore be easier to use existing cable to link the last mile.

Equally, we believe satellites could be the answer in less populated areas where there is still a need for access to communication. 5G will find its place at some stage, of course. Ultimately, technology arbitrage is more or less one of a range of challenges and opportunities that we always keep under review.

Do you believe that digital infrastructure is a net positive when it comes to ESG? As a lender, how can you influence the ESG credentials of the sector?

The positive social impact of digital infrastructure is huge in terms of connecting people, education, health and the ability to work from home, for example. There is a job creation component too, of course. So, the S in ESG is well covered. There have always been question marks around the asset class’s environmental credentials, such as, for example, data centres’ high levels of power consumption. We favour data centres powered by renewable energy, of course.

In terms of how we, as lenders, can help influence ESG, firstly we make it clear that we follow the UN Sustainable Development Goals. We have also been preparing ourselves for the Sustainable Finance Disclosure Regulation and the EU Taxonomy since our inception. ESG criteria are embedded in our asset selection and due diligence decision making. We also believe there is natural alignment on the ESG front between financial sponsors and debt funds; both are backed by institutional investors that will have stringent ESG requirements.

How concerned are you by the level of cyber risk that may exist in the assets that you back?

Cyber-threat is something that has existed since the origins of data – so going back more than two decades. It is, of course, something that must be carefully monitored, but I question whether the risk is to the infrastructure itself or actually to its users. Ultimately, it is the corporates and individuals using the infrastructure that are exposed to hacking. The infrastructure is neither at stake nor responsible for those attacks.

In my view, it’s like expecting someone who is building a motorway to take the risk of car accidents as a result of poor driving into account. If the revenue underpinning an asset could be impacted by cyber risk then, of course, that is one of the risk parameters that we would consider.

How do you differentiate yourself as a lender in the digital infrastructure space?

I would say that we are a first mover. Our team’s head of digital infrastructure has 25 years of experience in the field, so we really have seen the sector evolve through the decades. We structured the debt for the first mobile network, even before the advent of 2G. We saw the emergence of alternative carriers in the 2000s. We have financed cable projects, including undersea cable, and we have financed satellite projects.

We are knowledgeable, but we are also humble in terms of the development of new technologies and the way in which they will find their place. We also bring operational experience, as some of our team members have been seconded to operators over the years.

Equally, the fact that we have advised governments on how they should implement digital infrastructure regulation gives us a good understanding of how regulators will act. We have a good sense of what their goals are, and that influences how we analyse risk and the way we choose which assets to support.

Finally, we have a longstanding track record as an alternative arranger of debt within this sector. The fact that 20 percent of our portfolio involves digital infrastructure gives us credibility when it comes to structuring debt, in a way that allows us to monitor those investments and intervene if things are not going as they should. These are not crystal-ball bets on the future, but rather informed investment decisions based on a great deal of experience. That gives our investors a lot of comfort.

How well insulated is digital infrastructure from the inflation that is starting to take hold?

It is the users of digital infrastructure that carry the most inflation risk. In that sense, inflation will trigger an increase in revenue, as well as an increase in operating costs, of course.

It remains to be seen, however, whether the inflation we are starting to experience is just a reaction to other macroeconomic and political events, which will normalise in due course, or whether it represents a medium- or long-term trend. It is naturally something that we are monitoring across all sectors, but I don’t believe that digital infrastructure will be adversely impacted in any significant way.