Edited and written by: Anton Werner, Writer (specialized in coverage of IT, commercial real estate and global Private Equity industry)
The International Finance Corporation (IFC) is a sister organization of the World Bank and member of the World Bank Group. The corporation’s global emerging market footprint amounts to $94 Billion in assets and offices in over 100 countries.
It has built over the years on several investments carried out in the data centre space across emerging markets, including in GDS in China and India. I was impressed with last month’s CFA Society New York event Speaker Andrew Cross, Deputy Treasurer, Asia & Pacific, IFC, World Bank Group who addressed latest challenges of Central Banks and Reserved Funds especially in Asia.
In Asia, the IFC is separately focused also on investing in data centre companies with country and regional expansion strategies and opportunities for scale while selectively also considering greenfield projects.
How would you characterize the Asian data centre business?:
Asia is the hottest market: it’s larger, has more growth potential, has the largest pool of investors, and also has some of the most developed independent, carrier-neutral data centre markets (a prime example would be India). Emerging markets in Asia also have the greatest range of industry development–from countries without real independent data centres to those with a well-established, competitive industry.
We refer to most markets in Asia as either “maturing”— two examples are India and China, which have competitive digital ecosystems, an outsourcing culture, and hyperscales coming on-shore in independent connected data centre networks—or “rising”—such as Indonesia and Vietnam, which have stand-alone independents developing on the first wave of industry outsourcing.
Rapidly growing markets, however, also come with associated constraints. India and Indonesia have limited land for sites (particularly in the urban centres), challenges due to sometimes unreliable and insufficient grid power and problems with the cost and/or scope of fiber connectivity. On the regulatory front, emerging Asia also has more data sovereignty (Indonesia) and foreign ownership (China) laws pertaining to data centres.
Asia is somewhat unique in emerging markets in that it has been able to attract foreign direct investment and multinational cloud providers from both China and the United States, many of whom already have a strong presence in multiple countries.
The presence of the large cloud providers also creates the demand for hyperscale builds. In India, for example, we should see more new builds of 30 MW and above, and the emergence of the mega data centre or data campus.
What are some of the challenges the region faces today?:
When it comes to equity financing, data centre CAPEX needs are significant, but the market is liquid and there is a strong appetite for quality projects. Asia has been fertile ground for the larger private equity funds (e.g. Bain, Blackstone) as well as the larger data centre global strategists (Equinix, Digital Realty, GDS); many of these firms have already established a presence, especially in the largest cities.
While the Asian market is familiar with the business model risk, adding the emerging market risk is still new for many equity and debt investors. In emerging Asia, the cost of debt and, to some extent, equity return hurdles, are generally lower than in other emerging markets.
However, debt is mostly inexpensive for larger firms, given the focus of commercial banks on domestic “blue-chip” clients. Start-ups and younger firms thus have limited options; for example, they typically have lower leverage structures tied to asset based financing.
In many of these situations, we work with local operators and tailor financing solutions with mezzanine and local currency. We generally avoid leverage for startup or growth financing, in the absence of committed offtake and/or sound existing cash flow.
Emerging Asia also has a deeper (but still limited) pool of human capital compared to other emerging markets, and we see home-grown hybrid cloud providers offering national and industry-customized offerings that try to cater to smaller to mediumsized enterprises.
In part this shows some promise given the disadvantage hyperscale providers can have in deploying skilled staff locally and in customising their offer to specific industry or enterprise verticals.
Which new markets and locations are becoming increasingly attractive based on lower real estate and power costs?:
The most attractive markets are those where large-scale data growth can be found. This growth, ideally coupled with a culture of outsourcing and open digital infrastructure ecosystems – meaning those which have dynamic and competitive telecommunications and power sectors – creates the most attractive markets.
No market has solved for all this perfectly, but in the emerging market space in Asia, India shows a promising mix of these characteristics. This is stimulating strong investor interest. We are also looking at projects in China, Indonesia, Vietnam and Bangladesh – markets of a very different profile, but where we believe we can add some value.
What are the biggest challenges in APJ today for data centre operators when it comes to funding?:
Data centre investors take on a fair amount of speculative build risk in emerging markets in Asia, particularly new foreign entrants. Without the ability to pre-lease the space it is harder to find debt or equity financing, especially cheaply or at attractive rates.
Customers are reluctant to sign lease contracts until a site, building shell, and necessary utilities are in place, given the challenges of accomplishing this. This reality, and the market demand risk to fill the space – especially in new data centre markets that are unfamiliar with outsourcing business models—results in tepid investor appetite.
In fact, both foreign firms and local start-ups face scepticism that the constructed space will be absorbed. The problem is exacerbated by the fact that contracts are often difficult to sign without clarity on funding sources.
As this is a common hurdle for all data centre projects, entering developing markets only adds an additional obstacle. Data centre players look for investors who can add value and share the risk, especially if they are planning to enter emerging markets.
What are the opportunities for investors that tap into the region’s booming data centre market now?:
In many emerging markets the major opportunity is to secure an early mover advantage, in terms of securing both quality clients and locations. Early movers in emerging markets, such as our former client Teraco in South Africa can develop strong and resilient market share positions within several years.
However, investor patience and liquidity is needed as the time required to build a brand and customer base can be longer than expected, and how a firm builds this base is very important. Our experience has shown that such bets can have large payoffs.
A big opportunity, for example in a market like Indonesia, is to convince hyperscale providers that the time has come to place capacity onshore. Although the development of Indonesia’s data centre industry has been hampered by the close proximity of quality, well-connected capacity in Singapore, the sheer size of demand in Indonesia will require more on-shore capacity.
Data sovereignty laws and latency requirements of hybrid cloud and various software platforms also increase demand for local space. So far, the distraction of growth in developed markets and the relative conservatism of global strategic players and their investor base presents an opportunity for new entrants in emerging markets.
It is probable, therefore, that many global players will only enter some emerging markets through acquisition, giving investors in quality local players good exit options. IFC is also working to identify viable data centre divestiture opportunities from state-owned operators, including leading telecommunication firms and financial institutions, to help address emerging market growth.
What investment trends do you envision for the region concerning data centre businesses?
Large private equity firms and data centre strategic players will seek to acquire quality, local operators that have achieved cash break-even and secured well-located sites near urban centres with reliable power and connectivity. We will also see the eventual vertical integration of data centres by hyperscale providers in the largest markets.
As we have observed with other sectors (e.g. telecommunications towers), once a matured business model is introduced to emerging markets, its path to maturity is often much shorter than it was in developed markets. We also note that mature markets like the U.S. have shown that industry consolidation, when it occurs, has resulted in good returns to sellers.
What are the issues of risk management and exposure to those investors?
Key issues include difficulty in securing quality sites, the lack of low cost connectivity, scale and reliable grid power, but also data sovereignty policies and restrictions on foreign investments. Connectivity is especially an issue in markets with a dominant state-owned incumbent and/or complex municipal rights of way and permitting procedures.
A dominant state-owned incumbent may not be as agile in developing new generation capacity, for example. It would be extremely difficult to enter such markets without ensuring there are other co-investors with significant resources (financial or otherwise) and familiarity with the sector and country.
From May 14 to May 17, 2018 IFC is hosting the 20th GLOBAL PRIVATE EQUITY Conference at the Ritz-Carlton Hotel, Washington, D.C. The Global Private Equity Conference is the leading emerging markets private equity event in the world, convening over 850 investment professionals from more than 60 countries annually.