Spotlight on digital infra

Digital infrastructure has become the nervous system of the global economy, and Covid-19 has accelerated our dependence on the physical assets that make fast digital connections possible. According to the regulator Ofcom, the average amount of time a UK adult spent online in the first months of the pandemic was 4 hours 2 minutes per day – up from 3 hours 29 minutes recorded in September 2019. It also found that the proportion of UK adults making online video calls doubled during lockdown, with more than seven in 10 doing so at least weekly. However, the pandemic only served to speed up our online dependency, and it’s a trend which is here to stay.

Digital infra is the infrastructure that facilitates the digital economy, and there are four main categories within that. Subsea cables connect the different continents with reliable and high-speed fibres. Thor Johnsen, Head of Digital Infrastructure at investment trust D9, says: “Subsea fibre is the backbone of the international fabric of the internet, with 98% of the world’s data flowing through that backbone.”

Then there are telecoms, typically mobile towers and masts that underpin mobile networks. Fibre cables are effectively the on-land network of cables delivered to homes and businesses. Finally, data centres, which Thor sees as the brain of the internet, are buildings containing many servers storing and processing enormous amounts of information.

Commercial attractiveness of infra

Bryan Fashola, Director of Institutional Banking at RBS International, says the sector is understandably experiencing an uplift: “We are seeing increased activity and investment in digital infrastructure projects post-pandemic. We are also seeing more deal-related activity, largely driven by the increasing attractiveness of providing stable contractual yield for funds.”

The digitisation of almost every aspect of our lives is driving a massive investment. In its Annual Internet Report 2018–2023, tech company Cisco forecasts that there will be 29.3bn networked devices by 2023 (up from 18.4bn in 2018) with half of them expected to be machine-to-machine. Meanwhile, Statista forecast there will be in excess of 75bn IoT devices by 2025. Therefore the infrastructure is needed to match this burgeoning demand for faster and more reliable connectivity as well as cloud-based tools and content.

Brad Mitchell, Relationship Director at RBS International, says the world was already evolving towards a digital future, but the pandemic accelerated change. “It forced everyone, even those that were perhaps less comfortable in a digital world, to adapt. Over a two-year period of a global pandemic and lockdowns people have adapted and are now coming out of it trying to find the right balance between the advantages of digital and in-person connectivity and how digital infrastructure supports that. As a result, the infrastructure asset class is now at the heart of our daily lives, and we need it to operate.”

New subsector for investment

At one level, it’s become so fundamental to people’s lives that it has similar characteristics to the traditional core infrastructure that we know in terms of hospitals, schools and roads. So long as the owners of those assets keep them available and working, they continue to get paid.

There’s now more of an opportunity for funds to invest in this new subsector. Typically, the service providers to the end consumer, such as the telecoms operators and the hyperscalers such as Amazon, Google and Microsoft, have found it expensive to do everything themselves – to facilitate and operate the infrastructure and to offer the end consumer service.

Johnsen adds: “The asset class is attractive not just because of the long-term cash flow and embedded inflation protection, but the opportunity for significant accretive investment growth.  We are at the starting phase of a longer sectoral shift towards digitization requiring more and more investment in global digital infrastructure  Our operating platforms present opportunities for further attractive investment to meet this growth. . Digitisation is a reality of life and business has realized digitization is the source of productivity and competitive advantage.”

Mitchell says: “By having a player who provides the infrastructure, improves it and operates it and ensures it’s available, it takes that significant capital investment away from consumer providers. They can focus on what they’re good at: delivering to consumers without the high cost of maintaining the infrastructure, and instead, paying to use the digital infrastructure they need.

“We’re also seeing unlisted funds with an infrastructure remit where their investment scope might be quite flexible and seek to invest in digital infra as part of their overall portfolio.”

But it’s not just about holding a single asset, Mitchell points out; it’s about building a network of different assets, combining them to provide an end solution to the customer. “This is slightly different to how your typical infra renewable funds might operate. They buy assets to help with a diversity perspective and spread risk; if one asset doesn’t perform well, hopefully another will. The same is true with digital infra, but there is also the element where the assets work together well. They complement each other.”

A complex asset class  

While interest is broadening, there are some challenges to look out for. One is pricing: as more people are interested, it has driven multiples higher. Johnsen cautions that there are layers of complexity involved in digital infra. “Generalist infra is a very different space,” he says. “You need layers of industry specialization and focus in digital infrastructure. You must have a deep understanding of the telecoms sector as it is such a unique space. You can’t fractionalise an electric cable coming into your house but you can a telecommunications cable. You can sell all sorts of things.”  

He likens it to a real estate asset where you can sell the shell, a floor, or just part of a floor. You can sell time in the unit itself: 20 years, 10 years, or a year lease. And then you can sublet that space. “Telecoms is similar to that. How you interact with each layer is important because it ultimately dictates what customers want. So, to truly identify the right opportunities, you have to be a focused investor.”

Another challenge, Johnsen says, is that it is an area that is moving quickly. “The timing of decision-making has accelerated. You have to be ready to move because the demands have accelerated, and you have to be able to quickly and efficiently deliver for your customers; you can’t sit on it.”

Rising interest rates will also be a challenge, but there are currently long supply chains as well. Johnsen says if you want to buy and develop fibre networks in the US, it could take you three years to get fibre cable to build and install.

Fashola notes that there are also potential ESG (environmental, social and governance) risks to consider. Data centres, for example, have enormous energy demands – they use about 1.5% of the world’s electricity supply and generate roughly the same amount of greenhouse gas emissions as the entire global aviation industry, given they require a lot of power to run and cool. Meanwhile, there are also planning issues: some local authorities may hold the view that data centres do not generate much in the way of local employment or benefits to the community, are likely to prioritise developments that provide more immediate community benefits.

Johnsen says: “We have and will continue to reject investments on ESG grounds. In terms of metrics for data centres, we’re not just looking at PUE, but also at carbon utilisation effectiveness (CUE) and water usage effectiveness (WUE), as well as Scope 1, 2 and 3 emissions.” Johnsen adds, “It is no secret that data centres are energy sinks, which is why we like to say it is more sustainable and less expensive to export data than renewable power. Traditionally, all datasets were processed in cities like London and Amsterdam - not energy efficient in hydrocarbon-dominant countries. We’re educating customers on splitting datasets and migrating energy-intensive, latency-insensitive data (e.g. natural language translation, protein sequencing, aerodynamic simulations) to renewables-surplus countries. This is driving rapid growth up in the Nordics.”