Debt financing for digital infrastructure assets such as mobile and fibre-optic networks, telecom towers and data centres has been a growth area for many years, in step with increasing global digitalisation and connectivity. Much of the financing has backed private equity-owned assets.
Covid-19 was a shot in the arm for digital infrastructure investment. The pandemic highlighted the critical role digital infrastructure plays in the continuity of business, society and government. It’s often said that a decade’s worth of digitalisation and tech adoption in the way we work and live took place within two years. At the same time, the 2020 crude oil price collapse, covid restrictions and increased remote working upended long-held assumptions that traditional infrastructure assets, such as airports, power plants and public transport hubs carried perpetually low risk.
“Borrowing from an infrastructure fund can cost as much as several percentage points less than from a leveraged finance lender”
Another key driver of digital infrastructure expansion is that governments across the world are focusing on “narrowing the digital divide”. Increasingly, it is a key ESG ambition to provide mission-critical infrastructure to underserved communities and enhance existing capabilities to help level the playing field, enabling a consistent, first-rate digital experience for consumers and business.
Following these trends, during the pandemic many infrastructure lenders started to diversify away from transportation, energy, utilities, and other traditional asset classes into digital infrastructure. Other alternative lenders raised specialised funds to invest in the space. As a result, there is now a broader array of lenders deploying capital in digital infrastructure, and a substantial increase in dry powder available.
In line with the expansion of willing lenders, the definition of infrastructure has blurred and become more subjective. This applies to banks, too, which a few years ago accounted for the bulk of infrastructure lending. Whereas previously the construction of a physical data centre could qualify as digital infrastructure, lenders today may consider the computers inside the facility – and the services offered through those data centres – to also be infrastructure. What’s important to investors is that assets are defined by attributes including client stickiness and high barriers to entry, thus providing protected and sustainable revenue visibility.
Broadening the definition of infrastructure means that the attractive lending terms for borrowers associated with traditional infrastructure assets can now apply to digital infrastructure – borrowing from an infrastructure fund can cost as much as several percentage points less than from a leveraged finance lender.
Infrastructure Investor’s own data highlights that 2021 was a record-breaking year for digital infrastructure. Over half of all infrastructure funds raised had a digital focus, with more than $64 billion generated. In specialist fundraising, nearly a third of funds were digital, up from 22 percent in 2020.
Digital infrastructure is even more attractive to investors in today’s highly uncertain macroeconomic and geopolitical environment. This is because, compared with other sectors, data consumption and internet growth have been relatively uncorrelated to the economic cycle and the impact of inflation.
Asset valuations reflect investor interest. They were very strong throughout the pandemic and have remained robust throughout 2022, in stark contrast with other TMT sectors. For perspective, in comparison with software multiples, which have experienced median declines of more than 20 percent, including much larger drops for higher-growth and software-as-a-service segments, digital infrastructure valuations are largely flat. Leverage for digital infrastructure deals has also increased somewhat, which further supports dealmaking activity and investment in the sector.
With the growing number of lenders available and the huge volume of capital to deploy, digital infrastructure investing is becoming increasingly competitive.
To tempt borrowers and sponsors, lenders are becoming more creative in the financing structures offered. They now offer more structured solutions such as holdco/opco financing packages, and ground rent lease financings, which can help maximise debt capacity and optimise the weighted average cost of capital for borrowers. Lincoln International recently advised DigitalBridge on the refinancing of Finland-based tower operator Digita Oy, whereby the company reduced its average cost of capital and secured funding through a holdco/opco structure.
Other lenders have competitive advantage through their highly specialised expertise. One of the most dynamic areas in digital infrastructure is data centre land banking finance. This is a very niche area that requires a combination of capabilities: expertise across real estate, pre-development finance and digital. Lincoln was able to provide that expertise when it advised Vantage Data Centers, one of the leading providers of wholesale data centre infrastructure to large enterprises and hyperscale cloud providers, on raising pre-development finance to build European facilities to serve their clients.
As the lines between infrastructure and private equity investing continue to blur, the biggest challenge for private equity sponsors looking to access lower cost infrastructure financing is credit positioning. Although the standards for what constitutes infrastructure credit have come down, lenders still need to be convinced about the revenue stability and barriers to entry of the potential borrower. A specialised adviser can not only help with positioning but also with identifying the most relevant contacts within each lending institution.
The digital infrastructure lender base and the volume of funds available have been transformed in recent years. It is one of the hottest investor spaces, and the long-term outlook is positive despite the global macro environment. The digitalisation of the world continues at pace and will require high levels of ongoing capital investment in its infrastructure.
According to McKinsey & Company, digital infrastructure investments will increase 6 percent to 11 percent annually to 2030. However, the intensifying competition means many investors will need to work smarter to optimise the opportunities ahead, particularly those who are new to the space.
Xenia Sarri is a managing director in Lincoln International’s London Capital Advisory/Debt Advisory practice