12 Jul 2022
The evolution of digital infrastructure assets
With high demand and high valuations, there will be winners and losers in the digital infra space.
Digital infrastructure assets have been in the spotlight in the wake of Covid-19 and the digital acceleration precipitated by the pandemic. Interest has gathered pace and valuations have soared. While some observers suggest caution over the risk of an asset bubble, future demand is broadly expected to grow.
In November 2021, for instance, the International Data Corporation (IDC) Worldwide Digital Transformation Spending Guide predicted that digital transformation spending will have a compound annual growth rate (CAGR) of 16.4% between 2021 and 2025 – exceeding $10 trillion in total.
The EU has a plan to spend $200bn over the next 10 years through its Digital Europe programme. Meanwhile, China aims to spend the most of any nation on digital infrastructure, with $1.4 trillion allocated to its Made in China 2035 and China Standards 2035 initiatives.
Thinking long term
The rise of digital infrastructure is far more than a consequence of the pandemic and people’s desire to work from home, however. Trends such as digital healthcare and monitoring, the metaverse, as well as the expansion of existing and established services, will put more demand on digital infra.
Bryan Fashola, Director of Institutional banking at RBS International, says: “If you think about healthcare and access to digital GPs, or how we consume media, or the decline of bricks-and-mortar shops and banks, we’re seeing that shift all the time. Digital infra has such an impact on the population’s quality of life.”
And looking to the long term, there is no sign of these trends slowing down. “We’ll see new things, such as emerging tech like blockchain and the metaverse, with retail giants like Nike investing in metaverse property and stores,” adds Fashola. “And those who have foresight and the ability to build and invest in that infrastructure will be in the driving seat.”
Ripe for investment?
Brad Mitchell, Relationship Director at RBS International, says: “Obviously there is a massive demand for digital infrastructure, and new entrants come in and want to deploy capital and acquire assets. There is always a challenge when that happens: there’s a large amount for demand but little supply, which forces prices up.”
But the question is, are those prices inflated? Is it a bubble? Mitchell says that depends on the fund manager’s intention for the assets. For an unlisted fund, there will be a strict timeline for the fund life, which might be 25, 20, or only 15 years, while listed funds have a longer or infinite lifetime. As a result, unlisted funds are time-constrained in this space: they have to acquire the asset, optimise it, make their improvements, and then sell it for the realisation.
“That time constraint will put more pressure on that valuation,” adds Mitchell. “It’s fair to say the more time you have, the more you may be willing to pay for an asset because you can hold it over the long term and make those developments, which may take some years, and then get more value out of it in the future.”
“There is a realisation that one of the best ways to resolve economic disparity is to fix the digital divide both in-country and internationally”
Bryan Fashola, Director of Institutional banking at RBS International
No space for dilettantes
For Thor Johnsen, Head of Digital Infrastructure at Digital 9, an investment trust, digital infra is here to stay. “Overall, it’s not a fad, but there are elements that are a bit of a fad with everybody trying to get into it. I spoke to some real estate investors looking to build data centres and thought: ‘You don’t know what you’re getting into.’ It isn’t a real estate asset, it’s a telecom asset and a network asset.
“If you ask them: ‘What’s the fibre connectivity to the asset for customers they’re trying to attract?’ they often won't know. Ultimately, that will dictate the commercial opportunity for that asset.”
Johnson concedes that high valuations may cause issues. “There is a sense that the next three to five years will dictate who wins and loses. Who will be the aggregator, and who will be aggregated? I don’t like that concept because that means they over-acquire or over-merge. But who will still be in the room?”
He adds there is no doubt that the big content players will still be there.
Shadows of the dot-com bust
For all its potential, the dot-com bubble of the late 1990s and its crash in the early 2000s haunt the digital infrastructure space. Mitchell says: “I think it’s too early to say if it's a bubble. But this is very different from the dot-com era.
“A brand-new technology – the internet – was the driver of that bubble that people were only beginning to adopt. It was a case of: ‘If we build it, they will come.’ We’re now in a space in 2022 where digital is all-pervasive: the demand is already there, and the hardware that drives digital needs to be fast, reliable and secure.”
Fashola adds: “The dot-com era was more about internet companies than infrastructure. But almost every time you build a cable today, you presell 80% of it.”
Furthermore, investors are looking beyond western countries. “If you look at the developing markets, I think digital infra is very exciting,” adds Fashola. “It’s different from other developing market cases. These assets are difficult to seize or change due to regulatory regimes, and the tenants tend to be international. Building the infrastructure in these countries will be a big challenge over the next five to seven years, but it will happen because the world is more connected. And there is a realisation that the best way to resolve economic disparity is to fix the digital divide both in-country and internationally.”
Ultimately, supply will struggle to keep up with demand for some time. Johnsen says: “Customers like Meta and Google are already filling out their capacity. There’s no doubt we will be in a shortfall of capacity in a number of years, particularly when you layer on the supply chain issues to add more capacity.”
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Welcome to Depositary Insights Summer 2022 edition which offers the latest thinking on regulatory and industry developments from NatWest TDS.