‘Pipelines for data’

For a growing number of the globe’s citizens, access to wireless data rivals access to electricity in past generations.

As Trent Vichie, a co-founder of Stonepeak Infrastructure Partners, puts it, being able to open a website or check emails on one’s phone “has become essential to function in society”. But the modern citizen’s increasing reliance on smartphones is just one of the factors driving investments in communications infrastructure in the US as well as in its neighbours, Mexico and Canada.

Infrastructure funds reckon several trends are combining to create opportunities throughout the sector which bear characteristics similar to investments in transport and energy. Telecommunication towers, once owned largely by carriers, are now part of many portfolios. Growth in global data consumption of around 45 percent per year has been driving opportunities in these assets, as well as in broadband and fibre optics, with data centres and carrier hotels also bringing in investors.

DATA SURGE
Since smartphones started buzzing about around the turn of the decade, growth in data consumption has been exponential, both in the US and globally. This has required denser communications infrastructure, with infrastructure funds playing a part in financing the expansion.

“There is no other infrastructure sector, I don’t think, that has the kind of fundamental tailwinds that the communications sub-sector has,” Todd Bright, managing director of private infrastructure in the Americas for Partners Group, tells Infrastructure Investor.

Several factors could drive stronger growth in the coming years. In the short term, the buildout of ‘FirstNet’, a government network for first responders, and a recent 600MHz spectrum auction will be catalysts, according to Patrick Wilson, an assistant portfolio manager for investment management firm CenterSquare. Wilson says he must look back to the 4G rollout in the early part of this decade “to really get to a time where the story was sounding this optimistic going forward from a carrier-spending perspective”.

While these factors contribute to optimism for the rest of this decade, spending could get a further boost in the 2020s, when 5G is expected to start rolling out. These prospects have drawn more infrastructure investors into the sub-sector.

“We are just looking for investments that have infrastructure characteristics,” Vichie explains, pointing to high barriers to entry and long-term contracts. “There are certain segments of this space where you can find that.”

One of those segments, in which Stonepeak and others are invested in, is the tower sector.

THE EVOLUTION OF UNBUNDLING
A decade ago, the list of the largest US telecom tower owners prominently included the ‘Big Four’ carriers – Sprint, T-Mobile, Verizon and AT&T – which held the infrastructure used to provide service to customers in their portfolio. But since 2009, these companies have sold off the towers to focus on their core business, preferring to lease or buy capacity instead.

Tower ownership is now dominated by three publicly held companies: American Tower Corporation, Crown Castle and – in distant third – SBA Communications. But privately owned tower operators have also drawn in investors. Stonepeak and Goldman Sachs have each invested in Vertical Bridge, the largest private US tower operator, while Macquarie holds a stake in InSite and Mexico Tower Partners.

Wilson sees the major tower companies as “too big to ignore” for investors and views towers as attractive investments. With the majority of revenues coming from the top four carriers, Wilson says, cashflows are “very predictable and very stable”. And maintenance costs are minimal, because “there’s really not much need to continually invest in [what is] essentially a steel pole in the sky”.

Not all are equally enthused. Bright says his firm has not found enough value in tower investments, struggling with the sector’s high entry prices. He notes that investors are paying up for the extra returns derived from adding tenants to the towers and wonders if “too much value is [not] being attributed to this operating leverage”.
At the company level, trends which began in the tower space are being seen elsewhere in the sector.

“The unbundling of towers from the carriers themselves started a while back,” explains Bright. “Now, that is bleeding over into other parts of the communications value chain including subsea cables as well as terrestrial fibre and data centres.”

In 2015, Partners Group announced the financing of the 12,000km, $500 million Seabras-1 project, a subsea fibre optic cable running from New York to São Paulo. Subsea cables are nothing new – they were used in the 19th century for telegraph lines, while the first such fibre optic line was laid in 1988.

But traditionally, cables were owned by a consortium of carriers. The Seabras-1 project follows a similar model to the one that has emerged in towers, as carriers will purchase capacity rather than owning the infrastructure itself. “This is a novel business model being brought to a very mature technology,” says Bright.

Recent years have seen a wave of infrastructure funds investing in fibre and broadband, sectors boosted by rising data usage. In February, EQT Infrastructure acquired Lumos Networks, a US fibre services provider, for $950 million; the same month KKR purchased 40 percent of Telxius, a firm whose assets include cables to and across the US and Mexico, for €1.27 billion. And last year, Partners Group bought Calgary-based Axia NetMedia for C$272 million ($202 million; €188 million).

NEW ASSETS
One of the fastest growing areas within communications infrastructure is data centres, sizeable facilities that house and cool computer systems and components. Large companies, which in the past stored servers in-house, are now outsourcing this storage function.

“The secular tailwinds in the sector are compelling,” Brian McMullen, a managing director at Stonepeak, tells Infrastructure Investor. “We believe that growth in data traffic, processing and storage will remain robust. We’re also still in the early stages of enterprise migration to the cloud and content moving closer to the edge.”

In February, Stonepeak acquired a majority stake in Cologix, which operates 24 data centres in the US and Canada. Other managers have yet to make decisive steps into the sector: Guido Mitrani, an executive in KKR’s infrastructure team, said the firm is still monitoring the asset class.

“It is really down to the contractual characteristics of the assets, whether it fits our definition of infrastructure,” Mitrani tells Infrastructure Investor. “It needs to be quite specific in terms of the contractual arrangement.”

Across telecoms at large, fund managers say they expect returns in the mid to high teens, on the higher side of those seen in other infrastructure sub-sectors. Enthused by the growth potential of communications assets, investors looking for infrastructure characteristics are turning to this subset.

“They look at it as a standard sub-sector within infrastructure,” says Bright. “These things are pipelines for data just like pipelines for oil and gas.”

In Mexico, increasing data usage along with government reforms passed in 2013 have not just boosted the sector but also opened the door to private dollars. The telecom sector grew by 11 percent annually between 2011 and 2016, although it remains too soon for a final verdict on the reforms.

With expanding need for reliable internet connectivity creating diverse opportunities across the sector, telecom infrastructure may be getting too big for investors to ignore.

“It is not only the capacity but the quality and reliability that is going to be relevant,” Cristina Gonzalez, a principal at KKR, tells Infrastructure Investor. “It really comes down to how the supply side is going to be able to cope with the level of demand, and in a suitable way.” ?