How has COVID-19 impacted the opportunities you’re seeing in the communications infrastructure space?
When COVID-19 first hit, we immediately saw equity markets trade down and a lot of sellers pulled processes amid the general uncertainty. Meanwhile, managers focused on reviewing the impacts on existing investments, ensuring they were adequately capitalized and implementing any necessary continuity plans. However, it didn’t take us long to come back from that point. Equity markets rallied in May and June, processes restarted, and investors became increasingly comfortable operating in a remote environment.
Clearly, travel has been a challenge. We typically avoid auctions and travel restrictions have impacted our ability to have meaningful conversations with sellers, develop relationships with management teams and complete onsite due diligence in person. That said, we do have a physical presence in all the jurisdictions where we invest, either through our international offices or network of operating partners. Having boots on the ground has meant that we continue to have access to existing and potential assets and so the effects of COVID-19 have been somewhat mitigated. Indeed, you could argue that COVID-19 has brought certain efficiencies to processes – a lot less time is spent in airports.
Finally, for infrastructure managers that may have been on the fence about whether communications assets belong in an infrastructure portfolio, the pandemic has reinforced how critical these assets are in order for society to effectively function. You only need to look at government exemptions from working from home measures. Unsurprisingly, the communications industry was explicitly recognized as being essential to the economy.
What are the key drivers behind the communications industry, beyond the spike in demand caused by COVID-19?
The biggest driver is simply the continued growth in data creation, data transfer and data consumption. People want to be increasingly connected and mobile. Organizations are using more data to make better-informed decisions. Enterprise data and computation processes are being moved out of the office and onto the cloud. The fidelity and richness of media continues to improve, and devices, assets and equipment are increasingly being controlled remotely rather than manually, giving rise to the internet of things. All of these behavioural changes are necessitating a huge amount of additional investment in communications infrastructure.
Which sub-sectors are offering the most interesting opportunities?
We’ve seen a lot of opportunities in rural broadband both pre- and post-COVID. There are thousands of communities across North America and Europe that don’t have access to decent internet connections and we’re finally seeing political will to bring those communities up to speed. We’re also seeing a willingness from internet service providers to backstop revenues in order to get access to newly built infrastructure.
Whereas in the past, there typically wasn’t a separation of the infrastructure owner and service provider, now we’re increasingly seeing investment structures where we’re able to access the infrastructure assets more directly, limiting the direct revenue risk associated with ramping up the network. It’s more of a project finance model and one we are very familiar with.
There are significant opportunities in the data centre space as well. During the dotcom boom, a lot of large enterprises built sizable, sometimes military-grade, facilities with the expectation that they would grow into them over time. With the emergence of the cloud and the heightened focus on environmental considerations, we expect to see more companies increase usage at their facilities. In order for them to do that, they’re looking to infrastructure managers like us to take ownership of the facilities to bring in additional tenants and drive efficiencies.
Finally, we’re also seeing interesting opportunities in the smart city sub-sector. Local governments are beginning to recognize the benefits to constituents of improving city-wide connectivity. It’s not just about getting fast speeds for everyone – there is a public safety component when existing networks can’t handle the needs of first responders. There are environmental benefits as well. Smart city assets are able to conserve power when not in use. And then there are economic benefits. Connectivity is proven to attract business and boost economic activity.
You mentioned environmental concerns around data usage. How do ESG concerns impact this part of the market?
A lot of data centre tenants are environmentally conscious and so are driving facilities to be as energy-efficient as possible. The denser a facility is from a power perspective, the less energy used to cool the facility in proportion to the total energy consumed. It’s not just about being environmentally friendly, efficient buildings are more cost-effective as well.
Do you see any meaningful differences in the way communications infrastructure is developing regionally?
Different markets are at different stages of maturity. For example, the US and UK are both significantly behind much of Europe when it comes to fibre penetration rates. In North America, that’s largely because the region has been slower to adopt a shared infrastructure model. That has to change. If you look at the amount of capital that’s going to be needed for 5G and ubiquitous networks, it’s going to take a lot longer for the business case to make sense if operators aren’t sharing infrastructure and are instead overbuilding one another.
Government incentive models are also a key differentiator. In the UK right now, for example, with subsidies available for rural broadband, you have a significant amount of investment flowing into the space. It is effectively a landgrab until the subsidies run out or the entire country has new infrastructure, whichever comes first. In Mexico, the government has spent the better part of the last decade working with the OECD to design regulations to stimulate competition. They have essentially issued a request for proposal for a national wholesale provider to provide open-access cellular services in a way that will hopefully drive significant investment in that region too.
Communications is clearly a COVID-19 winner, but just how competitive is the space and how rich has pricing become?
At a macro level, the communications industry behaves as an intersection between traditional private equity and traditional infrastructure. The number of specialist data communications managers is growing, and I think we’ll increasingly see more real estate investors moving into the space. Real estate managers are likely to see digital real estate as a hedge to commercial real estate in light of remote working conditions.
With all those pools of capital chasing deals, it’s no surprise that valuation multiples are at near historic highs. The industry has also been extremely resilient in the face of the global pandemic, which is only making these assets look more attractive to managers that don’t already have exposure to the sector. But, when you look at the future of data and at future applications, and the sheer amount of new infrastructure investment that’s going to be required, communications suddenly starts to look a bit less crowded.
From our perspective, we tend to focus on the mid-market and to leverage our investment expertise and relationships to identify opportunities that are not necessarily being broadly marketed.
What is your approach to value creation in the context of such a high valuation environment?
Buying well comes first. We’re looking for businesses that have both attractive top-line growth and are able to generate attractive ROICs through expansion opportunities. In the current multiple landscape, particularly if you’re paying full price for something, you’re going to want to average that down by deploying capital at build multiples well below your entry point.
Perhaps unlike some other core infrastructure assets, in communications, there is a wide range of asset quality and risk. For example, we see data centre businesses trade at anywhere from 8x to 30x, which highlights why having a deep understanding of the space is so important. It is easy to overpay if you don’t know what you are doing.
What other risks, or challenges, are associated with investment in this sector?
For us, it’s important to ensure we are not exposed to any kind of technology risk. We often see businesses pitched as infrastructure, where a significant portion of the revenues are coming from services that can easily be displaced by a new entrant. We’re focused on trying to get as close to the underlying infrastructure as possible, which enables us to be less concerned about market disruptions.
How have LP attitudes to risk been affected by COVID and what impact has that had on appetite for communications infrastructure?
Investors definitely recognize that having data infrastructure is important to building a well-diversified infrastructure portfolio. It provides a nice hedge to other areas of the asset class, such as transportation. While there may have been lower transportation volumes during the pandemic, there has been a definite uptick in data. And, of course, not every investor has the allocation to commit to a standalone communications fund, so it’s attractive to include that as part of a broader infrastructure offering.
What are your thoughts on what the future holds for communications infrastructure?
The exciting thing about communications infrastructure is that while the acceleration of data creation, transfer and consumption is a certainty, it is anyone’s guess as to what the future use cases will be. We hear about machine vision, telesurgery, Cellular V2X – a multitude of new technologies that are only possible as networks are upgraded. While it’s fun to make predictions as to what new technologies and use cases will emerge, our predictions don’t need to be accurate for our investments to perform well. Regardless of the end-use, the future for communications infrastructure looks bright.