A great capacity to build

DIF partner Willem Jansonius discusses starting small, building scale and enhancing value in the global under-developed telecoms infrastructure sector.

This article is sponsored by DIF.

Q: What is driving demand for digital infrastructure?

WJ: The key driver behind escalating demand for digital infrastructure – be that fibre, towers or data centres – is changing consumer behaviour.

We are all doing much more on our smartphones and data volumes are exploding – growth rates average typically 60 percent per annum – which is driving the growth of storage in data centres. Traditional copper networks are struggling to keep up and will require replacement. The rollout of 5G will only intensify those trends.

Q: What areas of the market are most attractive?

WJ: The digital space is one of the most active and interesting parts of the infrastructure landscape. At DIF, we focus on the smaller and mid-cap end of the market and are investing through our DIF Core Infrastructure Fund. We are not looking at very large or trophy assets.

We target regional data centres and fibre networks where we can buy up smaller projects, build them out via expansions and build a large-scale portfolio through add-on acquisitions. The digital infrastructure market offers great contracted infrastructure projects that offer stable cashflows but also significant upside potential.

Q: Does the investment proposition differ from region to region?

WJ: It is very much a local market. A fibre network in Germany will be completely different to a fibre network in France, the UK or US. You really need to look at local circumstances, local demographics, local levels of business activity and local levels of infrastructure – if there is any. Our broad network of local teams is a major differentiator in this approach.

Q: Which regions offer the best opportunities?

WJ: Fibre markets offer great opportunities, although some European markets are already quite well built out. The Benelux and Nordic regions, for example, are competitive and fibre penetration is high. Other countries, such as the UK, France, Germany and Italy, are still a fair way behind. Parts of southern and eastern Europe also offer attractive investment opportunities, as does the US.

Europe is behind the US when it comes to data centres. There is still a lot of capacity to be built, both in the hyper-scale segment and the more regional segment.

“If platform companies are well built out, refinanced and de-risked from a contractual perspective, there is a high degree of appetite, especially from the large global investors’’

Q: How are competitive dynamics and are they changing?

WJ: Digital is probably the most dynamic and fast-changing infrastructure sector. The strategic players are very active at the larger end of the market. We see a lot of the big American data centre players being very active, as well as the big tower companies in both Europe and the US.

An increasing number of infrastructure funds are also looking at this sector but, particularly in the greenfield segment, there are still many interesting projects to be done. Valuations on the greenfield side are pretty healthy, while at the plain vanilla brownfield end of the spectrum pricing is getting rich.

At DIF we always look at opportunities in terms of what we can do with an investment, once we have done a deal. Get that strategy right and the returns can be very attractive, while downside cases are protected through contractual structures.

Q: Do you primarily back greenfield opportunities?

WJ: We invest both in greenfield and brownfield. Especially in fibre we look at many pure greenfield opportunities. In other areas we will look to find a good nucleus and then build those out. Across all sectors, our strategy is to start small and build scale through acquisitions and greenfield rollout. That way, once we bring a portfolio or company to a certain size, we can sell it to larger investors at attractive valuations and realise a premium for creating an enhanced portfolio. In this way, with limited risk we can deliver value-add returns.

Q: What is that exit environment like right now?

WJ: If platform companies are well built out, refinanced and de-risked from a contractual perspective, there is a high degree of appetite, especially from the large global investors. The market is very active and good quality investments are in high demand.

Q: How do deal structures differ in the digital space to other areas of infrastructure?

WJ: Digital infrastructure tends to have far less project finance than other areas such as PPPs or renewables, with the possible exception of French telecoms.

With the smaller scale investments in data centres and fibre that we look at, you see more acquisition finance or real estate-style financing structures, particularly in early-stage projects. You want that flexible financing at that point in a company’s development.

When the portfolios have been built out you can refinance with a more traditional structure to obtain more attractive financing terms and increase the returns.

Increased risk should result in an increased return, but we come across transactions where we struggle to understand how other parties are separating the services from the infrastructure and how they are valuing those components.

Q: How much of a challenge is technology risk? How do you mitigate it?

WJ: In digital infrastructure, it can be complicated to differentiate the services and technology component from the pure infrastructure component of a deal. A lot of other funds are moving increasingly into telecoms services and, in our view, that means taking on more technology risk and more business risk.

Beauty is in the eye of the beholder, but at DIF we are pretty conservative. We like to focus on the asset-heavy, lower tech risk deals, and on pure infrastructure with good contracts and decent counterparties. With the deals we have done, the technology risk is with the contracted counterparty and not with the project.

France, once lagging in respect of fibre penetration, will be one of the leading fibre countries in the world in five years. Regulatory intervention, particularly in rural areas, is critical and France has set up a very healthy model which some other countries could do well to follow.

Q: What about policy risk? Isn’t digital infrastructure highly reliant on governments and regulators?

WJ: Regulators have always played an important role in digital infrastructure. The way the French regulators have created the rural broadband concessions and tendered those out has led to a massive round of investment in French rural broadband that is unlikely to have happened without regulatory involvement.

We also see in other countries commercial developments happening without any government support, but it always requires efficient permitting procedures in order to make it all happen. This is, happily, largely clear on most local governments’ agendas.

Q: How would you describe underlying LP appetite for this sector?

WJ: LPs generally like digital infrastructure. The returns are usually good and there are positive benefits for society in terms of keeping up economic growth, job creation, and also energy efficiency gains, which are all viewed very positively. At the same time LPs are also cautious, while it is a new sector that not everybody fully understands yet, and every infrastructure fund has its own approach.

Where we approach the sector more through contracted projects, others may take more development and technology risk. In order to further mitigate market risks we mix digital infrastructure in a broader fund strategy that also targets the energy and transportation sectors. I think investors appreciate this diversification.

Q: What does the future hold for digital infrastructure and the role of infrastructure funds?

WJ: Digital infrastructure will continue to be a very high growth area in Europe and North America. There is still a lot of catching up investment to be done compared with, for example, Japan or South Korea. But it is important to remember that the pace of change in the telecoms industry is far higher than in other infrastructure segments. It is vital to have specialist knowledge inside the deal teams and to be working with the right operators.

You need to understand these assets well or deals could go wrong. Through its network of local offices and specialist knowledge, DIF is well placed to source the right opportunities in underserved telecom infrastructure markets and enhance these during its ownership.