As more investment flows into digital infrastructure, data center developers and service providers are seeking the right capital strategy to support their business model. Approaches vary, but there are now a growing number of ways for companies to fund their growth.
A good example is the recent $2.1 billion funding by Flexential, which used asset-backed securitization (ABS) and green bonds, illustrating two recent trends in data center finance:
- Success-based funding that leverages the equity and cash flow in existing data centers.
- Sustainable loans that reward borrowers who meet “green” criteria for energy efficiency or the use of renewable energy.
Chief Executive Officer Chris Downie says the financing package lays the groundwork for the next phase of Flexential’s evolution as a company.
“We are in a capital-intensive business,” said Downie, adding that the deal “was the culmination of a lot of hard work. We had to prepare the company and assess our growth story to accomplish a financing of that nature. It was an evolutionary step to be able to enter the ABS marketplace.”
Flexential is among the data center providers that have built used their development and leasing to secure the funding to expand their infrastructure and services. Here’s a look at Flexential’s journey, how the transaction evolved, and the tools the company used to match its growth strategy with the investor interest in the data center sector.
Flexential’s Journey and Growth
As it has grown beyond its roots as a regional provider, Flexential has built a national footprint and global connectivity. The company now has nearly 40 data centers and more than 3 million square feet of capacity across 20 markets. With its theme of “beyond four walls,” the company is targeting customers that need to connect across markets, and operates a private 100 GB network for its data centers.
When we checked in with Downie at the start of 2021, Flexential had a growing portfolio of services and markets, and was focused on helping enterprise customers sort out a complex IT landscape, and leading with hybrid IT options.
Downie noted the surge of investment in the data center industry in 2020 by large financial players like infrastructure funds, sovereign wealth funds and marquee Wall Street firms. These investors bring affordable capital, and Downie’s goal was to position Flexential for growth.
“We’re certainly thinking about getting access to that capital,” said Downie. “It’s accelerating capacity for a number of our similar scale brothers in the industry, so our financial strategy should incorporate that.”
Flexential was formed through the 2017 merger of Peak 10 and ViaWest to create a national network, and is backed by private equity firm GI Partners, an experienced investor in the data center industry. Peak 10 targeted second-tier markets in the Southeast, while ViaWest built a similar network in the Western U.S. The combined companies rebranded in 2018, with a focus on “the power of people in a technical world.”
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In recent years Flexential has begun to invest in larger data centers to support a strategic expansion into the market for wholesale data center space, in which a tenant leases a finished suite of “turn-key” raised-floor space. Those tend to be larger deals than seen in retail colocation, Flexential’s historic focus, in which tenants buy smaller amounts of space by the cabinet or cage.
Analysts say the differences between data center business models are blurring, and customers are focused on outcomes rather than distinctions between wholesale or retail space. But the different models matter to investors, as they may bear on the risk of making a loan or investment.
Using Existing Data Centers to Raise Growth Capital
Most data center developers are constantly building new facilities, with some sites under construction, and some gradually filling with clients. There are still others that are fully leased by a single tenant, or multi-tenant buildings where most of the space is leased. These buildings are business assets that can be sold or used as collateral.
There are several ways that data center operators are using existing sites to raise growth capital:
- Joint ventures, in which a developer sells an equity interest in one or more data centers to an investor. Terms may vary, but the investor will typically buy a stake of 50 percent or more, while the developer retains an equity position, and earns fees for managing the property. The developer can use money from the sale to fund construction of more data centers.
- Asset-backed securitization (ABS), in which a developer uses the equity and cash flow from a pool of properties to secure a loan. Because builders have data centers in various stages of development, some of these assets can qualify for a lower interest rate than the entire portfolio. The ABS process bundles assets into pools, with groupings being assigned different credit ratings based on their occupancy and cash flow. This allows the borrower to closely align these secured loans with the risk profile of investors.
The first use of ABS secured notes in the data center industry in 2018 featured Vantage Data Centers, a wholesale provider whose clients included the world’s largest and most credit-worthy companies. STACK Infrastructure, Sabey Data Centers and Aligned also used this approach to raise funds. But as of early 2021, the only data center ABS deals involved wholesale providers.
That changed last March, when DataBank raised $658 million using secured notes, a sign that investors were comfortable with asset pools including multi-tenant colocation facilities.
Downie and the Flexential team went to work preparing a large ABS deal that would include 23 of the company’s 38 data centers. The $2.1 billion transaction, finalized in early December, includes $1.6 billion in the form of a green bond that includes stringent standards for efficiency in the use of energy and water in new data centers.
Flexential said the funding “dramatically improves the company’s investment grade credit profile, lowers the cost of capital, and allows Flexential to deploy greater data center capacity to meet accelerating demands in new and existing markets.”
“The securitization allows us to fund our growth well into the future,” said Downie. “We’ve been focused on expanding the platform, both in scale and capabilities. The securitization helps accelerate that.”
Flexential issued the green notes under its new Green Finance Framework, which emphasizes low climate impact in new data centers, and investment in legacy data centers to improve their efficiency. Any new data center construction funded through the offering must have a Power Usage Effectiveness (PUE) of 1.4 or below, as well as zero water usage in cooling to be included under the framework. Flexential will be reporting on the performance of its green assets on an ongoing basis.
“For us. the green finance framework was an opportunity,” said Downie. “We’ve actually been in the sustainability business. We already manage our facilities to a PUE level that’s better than traditional data centers. (Sustainability) is becoming increasingly important to our customers.”
The Road Ahead for Flexential
One of the key trends in DCF’s Annual Forecast is an acceleration in investment in regional markets. “In 2022, the capital infusion will extend to regional markets and service providers specializing in ‘second-tier’ cities and edge computing,” we wrote.
Downie certainly sees this shift in Flexential’s business.
“Ten years ago, the interest was primarily in the big Tier One markets,” he said. “In the last three years, we’ve seen a lot of consumption move to a broader geographic profile. Our markets are increasingly relevant, as data center capacity is no longer limited to these larger markets. The higher relevance is driven by consumption, and then the investors follow.
“I think we’re still in the early innings (of growth) and you see more activity quarter by quarter,” said Downie. “We will look to fill gaps in capacity where our customers request it. There are more Tier Two markets that could be strategic for us, particularly on the East Coast.”
“Our markets are increasingly relevant, as data center capacity is no longer limited to these tier one markets. This higher relevance is driven by consumption, and then the investors follow the edge computing.”
– Chris Downie, Flexential
Downie sees a continued recovery for enterprise IT customers, who continue to refine their pandemic spending strategies.
“We saw enterprises accelerate spending in the beginning of 2021,” said Downie. “In 2021, we were very focused on developing hybrid offerings. We still feel we have a tailwind in 2022. We’re bullish on the forward growth opportunity.”
Beyond the immediate growth in hybrid enterprise deployments, Downie sees opportunities in edge capacity. He highlighted Flexential’s partnership with American Tower, the huge telecom real estate landlord that has begun deploying a network of small modular data centers at its telecom tower properties. The companies are working on a local edge solution that tethers American Tower sites with Flexential data centers and the FlexAnywhere connectivity fabric. Early deployments have been announced in Atlanta, Denver and Boulder, Colorado.
As Flexential continues its growth strategy, it has the financial strength to consider new options, especially as it builds and fills more data centers.
“The securitization positions us well for our next chapter.” said Downie. “It’s a more sophisticated financial vehicle that gives us some competitive advantages.”