Increase in number of cell sites in the US over the past decade (Source: Ericsson)
Will be deployed in digital infrastructure in 2020 (Digital Colony)
New data centre capacity to be installed in Europe in 2020 (CBRE)
Among the many managers, investors and advisors Infrastructure Investor has spoken to since the pandemic broke out, there has been a prevailing line when they have been asked to describe the events taking place in the market.
Ever the understated, infrastructure investors have generally not talked of dramatic changes or paradigm shifts. Instead, the oft-spoken comment is that covid has “accelerated existing trends”. That is certainly true when it comes to digital infrastructure and is reflected in the five industry experts joining us for our inaugural roundtable. All are established players investing through generalist vehicles or dedicated infrastructure funds.
It also suggests that the excitement surrounding the sector – touted in a recent Campbell Lutyens report as one of LPs’ most-favoured strategies across private markets – is not just a flash in the pan. Our experts were investing before the crisis and now have valuable expertise, and indeed assets.
But how are they coping with the increased competition now that all the excitement around the sector has kicked in? “Anything where there is a significant degree of judgement or operational complexity, particularly around the sales structure, I think is still pretty difficult for some of the larger, more passive players who don’t have such expertise,” says Matt Evans, global head of digital infrastructure at AMP Capital, which expects to have half its latest fund invested in the sector once it is fully deployed. “There’s no question we’ve seen probably a 3-5x EBITDA multiple increase in fibre sales – less so in data centres.”
“One of the interesting trends that we see is the establishment of stronger minimum standards for broadband in order to qualify for government subsidies”
Evans’s point regarding operational complexities brings a nod of agreement from Mark Prybutok, managing director at GI Partners, which in September reached a $1.8 billion close on its GI Data Infrastructure Fund. The latter was its first in the sector, though the firm had previously invested in digital infrastructure through private equity and real estate funds.
“Part of the impetus for setting up a dedicated data infrastructure fund was that we saw the sector as a whole has de-risked and re-rated, which is entirely appropriate based on a long-term multi-decade track record of performance,” Prybutok explains.
Rick Shrotri, managing partner at Nevada-based investment firm Digital Alpha, agrees and is convinced the sector is benefiting from long-term shifts that are being reflected in returns and the pricing of assets.
“The fact is, the internet has become mission-critical, not just nice to have,” he says. “Our vantage point is that, while there is this increased demand right now for connectivity and assets that are going to provide service with reliability, there’s even greater demand today for variability [in data consumption]. There’s a lot of evolution taking place in the market right now, such that there is the ability to add value and to capture value.”
Another sector specialist, Omar Jaffrey, founder of New York-based Melody Investment Advisors, says the growth of the sector this year has earned it the moniker of “super-duper core infrastructure”, and that we are currently witnessing its most fascinating paradigm.
“If you look at the public stocks of data centres and tower companies, they were all up 50 percent last year and up 20 percent this year,” Jaffrey explains. “It’s a super-solid sector, but there’s also good top-line and free cashflow growth. Adjusted for growth, the macro tower sector is a pretty fantastic place to invest today. The supply/demand gap and the growth are the key trends and if you recognise that, then you take current valuations into that context.”
“We’ve seen probably a 3-5x EBITDA multiple increase in fibre sales – less so in data centres”
Aveen Ghurbhurn, partner at Paris-based Vauban Infrastructure Partners, is also keen to place digital assets in the core infrastructure bucket.
“We have seen a very strong increase in the demand for fibre connection in France, which is very good for our business plan and this, of course, naturally drives valuations higher,” he says. “Telecoms is now seen as an essential infrastructure asset and can be compared to water, gas or other urban distribution networks.”
Plugging the fibre gaps
Ghurbhurn’s reference to these networks is a reminder that there remain significant barriers in this sector. Although urban customers enjoy a relative ease of access to fibre networks in many countries, people in rural areas are much harder to reach, with governments and investors alike still searching for solutions to this issue. “You’ve got governments that have made considerable commitments and have set up the structure of the market whereby ubiquitous fibre-to-the-home is essentially inevitable,” Evans maintains. “But in markets where it’s more market-led, I think there are still real question marks about what might happen with wireless over the next three to four years.”
Perhaps the answer to such issues lies in public-private partnerships, be that in the traditional sense or otherwise. “From a US market perspective, it’s interesting that opportunities zones were created by the US tax code to encourage investment in some of the more impoverished areas,” says Shrotri. “One of our portfolio companies, Quantela, has done a deployment where you had matching grants coming in from different levels of government. That really was a catalyst to be able to bring that connectivity to bear. It was about how do you distribute the access and still create a viable economic model for all the parties involved? Having support from the government in this context was frankly unexpected and a positive development.”
“The reality is security, privacy and managing the integrity of the data. Those are some of the areas that, frankly, we haven’t solved completely”
Although Digital Alpha benefited from partnerships less akin to PPPs, Vauban’s progress in France has been in no small part due to the French government’s creation of localised and monopolised networks through a formal PPP programme.
“We started 10 years ago in deploying fibre-to-the-home networks in France,” Ghurbhurn begins. “What was a game-changer here for rural areas was the state intervention. The regulatory framework allowed us to create a business model that was balanced and that helped us deploy FTTH in rural areas. We are doing good business out of this regulatory framework. This protection forbids any competition from alternative networks. It was a fabulous instrument that made fibre in rural areas now very well deployed, compared to other regions in France.”
Bridging this particular infrastructure gap can be difficult because the variables in connectivity are not always a simple split between urban and rural areas. “There’s actually ‘haves and have-nots’ when it comes to internet/broadband/wireless connectivity in markets that we had thought were pretty robustly built out,” says Jaffrey. “That’s what covid has highlighted. Historically, we would think of where it makes most sense to deploy our dollars profitably. But there is now also a social layer and an economic layer that you have to address in metro, suburban and rural areas.
“Many students are not able to attend online classes today, and many professionals are not able to work remotely due to poor infrastructure. Government has a very important role to play to help catalyse those build plans. You’re also dealing with telecom players that have stretched balance sheets, and therefore financial players like us can actually help catalyse the investment gap by using interesting structures. You’d be stunned about what you have to do with fibre, even in metropolitan environments that you thought were built out.”
“We are big believers in bringing broadband to the edge of the network, wherever the end user sits, across many different transport mediums,” adds Prybutok. “One of the interesting trends that we see is the establishment of stronger minimum standards for broadband in order to qualify for government subsidies. There is now widespread recognition that broadband access is critical to bridging the gap between haves and have-nots in our society.”
Cross-asset class conundrum
One of the challenges that makes digital infrastructure stand out compared with other infrastructure sectors is its presence across other asset classes, such as private equity and real estate, with Prybutok’s GI Partners a prime example.
With that in mind, how are our participants differentiating assets and what are they looking for from their investments?
“We are looking for businesses that have strong recurring and contracted cashflows, meaningful barriers to competition and resiliency to technological change,” says Prybutok. “What types of businesses within data infrastructure would definitively not be a fit? Those where the purpose that they’re serving is so specifically targeted that a change in underlying demand for that use-case could result in assets being significantly devalued. A data centre which was solely geared toward mining cryptocurrency is one example.”
“The macro tower sector is a pretty fantastic place to invest today”
Melody Investment Advisors
Jaffrey holds a similar outlook, and is keen to not be caught up in technological risk.
“You’ve got to look at counterparty risk, the duration and residual value of the asset and the customer strengths/needs and contract lengths,” he says. “Whether it’s data centres, fibre or towers, you’ve got to look at all of these key elements of risk – the better these are, the more like infrastructure the investment opportunity is.
“Location strength, zoning and permitting can lead to local monopoly-like characteristics. And that, coupled with demand/supply dynamics at the local level, help make an investment more solid. If the investment opportunity’s success is driven by research and development, marketing and technology superiority/advantage, large selling, general and administrative expense costs and lower free cashflow conversion, then to us it looks more like private equity or growth equity. Regulatory risks can end up creating binary outcomes which we would put in the growth-equity bucket,” Jaffrey adds.
Although Evans agrees with both Prybutok and Jaffrey on essential characteristics, he echoes Ghurbhurn’s point that holding monopolistic positions within the sector is crucial to assets being classed as infrastructure.
“It’s not so much contracts as understanding the underlying supply and demand dynamics,” Evans says. “The original investors in the tower sector were investing on the basis that these towers were irreplaceable and essential to the mobile network operators. That characteristic carries across a lot of the newer telecoms sectors that infrastructure investors have started to put capital into. Is there a sufficiently deep demand that you could have confidence in for the sustainability of cashflows on a very long-term basis? That’s what we focus on.”
For Shrotri, the differentiation of infrastructure from other asset classes also depends on articulating to counterparties what characteristics managers are expecting from assets. “There’s also an obligation on us to communicate what is a viable economic model and a fair model,” he says. “How do you take a combination of fixed and variable payments? How do you think about economic models over time with these new services? That’s the partnership with government and is for us to educate [people about this] based on the experiences we’ve had around the world.”
Disrupting the disruptors
There is no doubt that, with our five experts, we are in the company of some of those at the forefront of digital infrastructure investment. However, the fact this roundtable is being held over Zoom – rather than some of the video-conferencing platforms that pre-date it – is proof that early-movers can lose their advantage.
So, what should our managers be mindful of, both in terms of new opportunities and challenges? “The first wave of cloud computing was all about centralising data storage and computing power into the hyperscale data centres that we all think about,” says Prybutok. “The next stage, which we’re just on the cusp of and which will enable many coming 5G applications, is taking some of those workloads and distributing them out towards the edge of the network to drive speed and network efficiency. That’s going to be a fascinating space to watch.”
“Telecoms is now seen as an essential infrastructure asset and can be compared to water, gas or other urban distribution networks”
Vauban Infrastructure Partners
Jaffrey warns about a potential change of models, pointing to the way the satellite model was disrupted through streaming.
“Different business models could be exposed to different layers of risk from future developments in use-cases and technologies,” he warns. “As an example, what’s happening with your end customers? Is your customer outsourcing or insourcing or potentially competing with you? Could they change their stance in the market with respect to their needs? 5G/Edge Compute and OpenRAN are all intriguing opportunities, but create technical challenges while also offering opportunities for collaboration. One needs to adjust the business plan as these evolve. I see shifters, not disruptors.”
Shrotri again points to how these are “mission-critical” assets being managed and how they can be subject to significant threats. “The reality is security, privacy and managing the integrity of the data,” he says. “Those are some of the areas that, frankly, we haven’t solved completely and where there’s going to continue to be the need for vigilance and investment.”
“We’re probably less focused on the wireless elements, but more focused on what’s going to need to sit behind it in terms of fibre being driven very deeply into these networks,” adds Evans.
Ghurbhurn, however, is unconcerned, seeing little threat to Vauban’s fibre deployment.
“We have a 25-year investment horizon so we need to convince investors about the robustness of the business plan,” he says. “The dominant technology in France is fixed-line copper, which lasts for 60 years. Fibre lasts for at least 30 years, and we don’t see a technology emerging so rapidly over time to displace this. So, over the period we are looking at as an investment horizon, we don’t see fibre being disrupted.”
It is that kind of bullishness which sums up the mood at our roundtable, as we bask in the delight of 2020’s winners.
Aveen Ghurbhurn, partner and investment director, Vauban Infrastructure Partners
Ghurbhurn has more than 15 years’ experience in infrastructure PE with major partnerships in the telecom sector. In 2020, he has been instrumental in the design, launch and fundraising of Vauban Infra Fibre, a digital platform with a significant market position in France’s fibre sector, with around 25 projects representing 11 million FTTH plugs in the country.
Mark Prybutok, managing director, GI Partners
Prybutok is co-head of the GI Data Infrastructure Fund Platform, which manages $1.8 billion in investor commitments. He has been an infrastructure private equity investor for 13 years, leading investments totalling more than $2.7 billion of equity. He was previously a partner at Alinda Capital Partners, where he led the firm’s telecom infrastructure strategy.
Matt Evans, co-head of Europe, AMP Capital
Evans joined AMP Capital in 2013, where is also co-head of the global origination team and responsible for digital infrastructure, a sector in which he has extensive experience. He was responsible for the acquisitions of Expedient, Everstream, VX Fibre, eNet, Axion, Angel Trains (2015 transaction), among others, and led the exit of the AMP Capital-managed 5.5 percent stake in Thames Water. Before joining AMP, Evans worked for Macquarie Capital Advisors for 14 years.
Omar Jaffrey, founder and managing partner, Melody Investment Advisors
Jaffrey is the founder of Melody Investment Advisors, an investment manager focused specifically on communications infrastructure. Over his 30-year career, he has been involved in M&A, and public and private debt and equity raises, principally in TMT. Jaffrey was vice-chairman of TAP Advisors, a managing director of UBS Investment Bank and a managing director at Merrill Lynch, with prior positions in investment banking at Bear Stearns and Goldman Sachs.
Rick Shrotri, founder and managing partner, Digital Alpha
Shrotri has spent his career managing industry-shaping technology and telecommunications investments. Before founding Digital Alpha, he was managing director of Cisco’s global infrastructure funds team, where he worked on growth strategy and investments with the firm’s senior leadership. Prior to Cisco, Shrotri worked in the Seoul headquarters of Samsung, where he focused on external innovation including M&A and JV structures for the semiconductor and mobility divisions.