Data center owners have much more revenue to capture

The incursion of Microsoft or Alphabet does not threaten some companies that are of great interest to funds

Data centers go up, and up, and up. A buying spree led by infrastructure funds has pushed up prices for companies that lease large banks of servers. Post-pandemic demand for data, coupled with cheap financing, should support deal valuations.

In recent years, infrastructure investors have snapped up data center firms like CyrusOne and Switch. Funds such as EQT and KKR are pursuing Global Switch, Bloomberg reported in August, potentially valuing the London-based group at $10 billion, or 34 times 2021 EBITDA.

Short seller Jim Chanos points out that Microsoft, Amazon and Alphabet are building their own data processing facilities. Each company was operating 60 or more data centers at the end of 2021, according to Synergy Research. That is a threat to operators that have the tech giants as clients. CyrusOne – acquired by Global Switch suitor KKR for $15 billion in November 2021 – gets 19% of its revenue from Microsoft.

But this gloomy thesis has not yet materialized. The pandemic has skyrocketed demand for facilities that host data online, while supply chain shortages have made it difficult to install new capacity. In Chicago, the cost of renting space in a data center for large deployments increased 14% from the end of 2021 to the beginning of 2022, according to JLL. Vacancy rates at Illinois town centers fell from more than 9% in 2021 to 5.6% in 2022. In Northern Virginia, the nation’s largest data center market by capacity, vacancies have fallen to 1.2%, according to datacenterHawk. Rents in Europe, where Global Switch has most of its facilities, are more moderate. Even there, however, temporary moratoriums on new buildings and other planning controls are restricting expansion.

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New forms of financing add to the waste. When Blackstone bought QTS Realty Trust for $10 billion last year, it issued bonds secured by the target’s data centers. These mortgage-backed loans are based on a percentage of the value of the company’s assets, rather than a multiple of its cash flow, effectively increasing the available leverage. Blackstone raised $3.2bn in an offering, which is more than 10x QTS’s 2020 EBITDA. It’s well above the 6x limit for leveraged loans advised by regulatory guidelines. If the company’s revenue growth and margins hold up and Blackstone folds in five years, the additional debt could help raise the acquiring company’s IRR by three percentage points, we estimate.

When supply catches up with demand, tech giants will pose a threat to independent data center operators. But for buying companies, the combination of immediate growth and large doses of leverage can keep the party going.