Pandemic Could Drive Data Center M&A, Reshaping Industry Landscape

Economic disruptions are times of both peril and opportunity. This will certainly be true of the COVID-19 pandemic, which is altering demand for digital infrastructure, as well as the availability of capital and the competitive landscape.

The pandemic of 2020 has accelerated some activity. Leading players have raced to close deals and raise capital amid the economic chaos from lockdowns. One provider slashed debt with a quick trip through bankruptcy.

What we know from the industry’s previous economic dislocations – the dot-com bust and the 2008 financial crisis – is that the strongest data center players adapt and develop new strategies.

• The nuclear winter of 2001-2003 reformatted the competitive landscape, wiping out many incumbents and seeding future giants.
• The 2008-2009 downturn saw an acceleration of new business models, as the wholesale data suite became the building block for the enterprise market, as corporations sought to conserve capital by migrating IT infrastructure to colo and cloud platforms.

What will be the themes that emerge during the COVID-19 pandemic? Financial strength and patient capital provide a distinct advantage in this environment.

“Obviously, liquidity is the central thesis of the day,” said Marc Ganzi, the CEO of Digital Colony. “The deal environment right now is those who do have liquidity are working hard. We’ve never been busier.”

The data center sector will likely be a beneficiary of the shift to a socially distant, contactless economy. Infrastructure funds with deep pockets have been active investors in digital infrastructure. Merger activity is likely to continue, with deals driven by both strategy and opportunity.

“From an M&A perspective, what we started seeing in the last year is different types of investors getting introduced to our sector,” said Aaron Sawchuk, the CEO of ColoSpace. “That certainly includes the infrastructure funds, but also the sovereign wealth, pension funds and family offices. They’re aggressive with both their valuations and the way in which they’re looking to deploy capital into the digital infrastructure space.”

“There continues to be strong investment activity, and foreign capital has indicated their continued interest in investing,” said Jim Kerrigan of North American Data Centers. “With so much dry powder on the sidelines, I believe that the data center space will be an overwhelming recipient of this capital.”

“With so much dry powder on the sidelines, I believe that the data center space will be an overwhelming recipient of this capital.”
Jim Kerrigan, North American Data Centers

“The fundraising environment right now for our digital business remains incredibly robust,” said Marc Ganzi, the CEO of Digital Colony. “Investor appetite is quite strong and our capital formation team right now is in active dialogue with literally a couple of hundred investors.”

Opportunity Amid Chaos

Economic crises are times when empires can crumble, and new ones rise in their place.

At the height of the dot-com boom in 2000, Exodus Communications ruled the colocation world, with 42 data centers and a market value of $30 billion. A year later it filed for Chapter 11, hobbled by the dot-com bust and the chilling effect of the 9-11 terror attacks.

As Exodus was entering bankruptcy, a newly-formed investment firm called Global Innovation Partners began aggressively acquiring distressed or undervalued data centers. Those properties would later form the nucleus of Digital Realty, which is now a global colossus with 267 data centers across the world.

A year later, a struggling California provider averted bankruptcy with a complex series of deals that included a 1-for-32 reverse stock split and mergers with two Asian providers. The resulting cash infusion laid the groundwork for a “new Equinix” that would go onto become the dominant player in colocation, with 200 data centers and more than 9,800 customers.

The data center industry of today is more mature, with a tenant base dominated by huge tech companies rather than startups. But the competitive playing field is dynamic, and the barrier to entry and growth is lower than ever before.

The Strong Will Survive, and Thrive

Capital is dear and markets are spooked, particularly in commercial real estate. Digital infrastructure is capital-intensive, so the ability to line up funding will be a key differentiator. That financing could be traditional debt or equity, but will also include transactions that monetize existing assets, such as securitized debt offerings and joint ventures.

Leading data center players have moved quickly to lock down deals to fund strategic initiatives or reduce debt. These include:

• Equinix sold $1.2 billion common stock to fund acquisitions, along with a $1 billion joint venture partnership with Singapore sovereign wealth fund GIC to build hyperscale data centers in Japan.
• Sabey Data Centers arranged $800 million in funding, using securitized notes to arrange low-cost capital for continued expansion of its data center campuses.
• Regional data center provider TierPoint lined up a $320 million equity investment from three global infrastructure funds and its existing investor group.
• CoreSite issued $150 million in senior notes in a private placement, which allow the company to fund future development projects.
• Aligned expanded its existing credit line by $80 million to a total of $575 million, saying the additional finds will allow it to accelerate growth.

Several other providers acquired property and facilities to expand their geographic reach. Vantage Data Centers entered  the UK market with the acquisition of Next Generation Data, Compass Datacenters purchased a development campus near Toronto, and Landmark Dividend bought a PayPal data center in Phoenix through a sale/leaseback transaction.

Meanwhile, colocation provider INAP addressed its debt challenges with a quick trip through Chapter 11 bankruptcy, completing a prepackaged restructuring in just seven weeks to strengthen its bottom line.

M&A Trends: What Deals Make Sense?

Matching capital and demand will be trickier than ever in this market. Demand will soar in some verticals, and drop drastically in others (pro sports, retail, travel). Real estate lending and construction environments could alter the landscape.

“There is a strong focus on tenant credit and a genuine flight to quality,” said CBRE in an overview of how the pandemic has impacted the sector.

“We anticipate that over the next couple of quarters, organizations who may be feeling financial stress may look to monetize,” said Sawchuk.

That creates options for the strongest providers, and those who are experienced making acquisitions. It’s no surprise that Equinix, which just purchased Packet, is now “in advanced discussions” to buy a portfolio of data center sites.  Another potential acquirer is Digital Realty, which just closed its $8 billion deal for Interxion, and is notable for always keeping its balance sheet ready for action.

Another intriguing player is NTT Global Data Centers, which recently consolidated its data center acquisitions and has pledged $7 billion to add capacity across the globe. The combined company operates more than 160 data centers spanning more than 20 countries, making it the third-largest global data center company after Equinix and Digital Realty.

Infrastructure Funds and Platform Plays

Acquirers have several approaches, including buying portfolios of assets, or acquiring an operating service provider.

“The real capital flows are in buying other companies – for example Digital Realty buying Interxion,” said Jack Funchion, who heads the financial services vertical at Digital Realty. “I don’t think you’re going to see as many data center assets trading hands. Folks like us don’t often look to buy older data centers and renovate them. We’d prefer to buy dirt and build out of the ground.

“But the real activity is in private equity and sovereign wealth funds investing in developing companies, or expanding into new markets by acquiring companies,” Funchion added, noting Macquarie’s recent deal for Australian provider AirTrunk as an example.

“Many investors are taking a wait and see approach while they try to work out if pricing has moved, while others see this as a great time to buy.”
CBRE

In recent years, a series of large global investors have entered the industry, using acquisitions to try and create business platforms for the data center industry. The strategy is usually to create a national footprint supported by a back-office support operation, and service offerings to address common customer needs. Examples include:

• Cyxtera and its security-focused colocation network, backed by BC Partners and Longview Asset Management.
• Macquarie Infrastructure Partners and its growing portfolio of data center companies, including Aligned, Netrality and AirTrunk.
• STACK Infrastructure, created by IPI Data Center Partners.
• Evoque Data Center Solutions, a platform play from Brookfield Infrastructure Partners.
• EdgeCore Internet Real Estate, a wholesale data center platform backed by Singapore sovereign wealth fund GIC.

“Many investors are taking a wait and see approach while they try to work out if pricing has moved, while others see this as a great time to buy – perhaps taking advantage of an institutional owner who needs to service redemptions,” said CBRE. “New investors to the data center space are busy educating themselves on the sector.”

“I think everyone’s looking at risk today and we’re all repricing risk,” said Ganzi. “There is a definite flight to quality in terms of the assets that we’re looking at. You don’t want to be taking advantage of people in this environment, but at the same time you don’t want to be overpaying now.”

Digital Transformation as a Deal Driver

One of the most ambitious acquirers is Colony Capital, which operates Vantage Data Centers and DataBank, along with a network of fiber, tower and antenna assets. Ganzi says Colony’s entities have up to $3 billion in capital to grow through acquisitions of digital infrastructure, even as it seeks to exit positions in healthcare and hospitality real estate. Ganzi notes that the company recently lined up four credit lines in 60 days to complete deals – including Vantage’s acquisition of  Next Generation Data.

“We think there’s a lot of opportunity out there to help customers as they pivot out of legacy assets and move towards more next-generation digital assets.”
Marc Ganzi, Colony Capital

As we noted in our recent overview of COVID-19’s impact on data center demand, the digital transformation that was thought to be a multi-year evolution has been dramatically compressed. Ganzi believes this provides a sense of urgency for many companies.

“The real dislocation right now is perhaps happening in companies that have older legacy assets,” Ganzi said in Colony’s recent earnings call. “As we think about turning the corner towards 5G and cloud computing, and next generation applications like AI and autonomous vehicles, there are some legacy telco assets that were built in the 1970s and 1980s and early 1990s.

“We think there’s a lot of opportunity out there to help customers as they pivot out of legacy assets and move towards more next generation digital assets,” he said. “As the pandemic has unfolded, we’re all seeing how vital a role mobility and reliable digital infrastructure plays in the world today. If you can get deals financed and you can put adequate to conservative leverage on those deals, you can get deals done in this environment.”