Investment Dollars Flow Into Data Center Sector

Investment Dollars Flow Into Data Center Sector

Investment dollars are flowing into the data center industry, making it easier for providers to fund expansions that will bring more supply online and increase competition in key markets, according to experts in data center finance.

NEW YORK: Investment dollars are flowing into the data center industry, making it easier for providers to fund expansions that will bring more supply online and increase competition in key markets, according to experts in data center finance.

“We’ve never seen a better time in this space for financing,” said Paul Vasilopoulos, a Managing Director in Communications Infrastructure and Services at The Bank Street Group. Vasilopoulos was one of the participants in a panel on data center investment at last week’s DataCenterDynamics conference in New York.

“A few years ago, there was a lot of skepticism about the sector among investors," he said. "I think that has changed. People have seen that the data center business grew dramatically in 2008 and 2009, and the sector continues to grow at a double-digit pace. As a result, we’ve seen financial sponsor activity throughout the space.”

That funding typically comes from private equity firms who invest in regional providers with a strong management team and successful business model, but limited capital for expansion. A number of private equity firms have put together teams of executives with a track record in the data center sector. That focus on experience is important, according to the panelists.

Few New Entrants

“Despite that (investor interest), you don’t see a lot of purely new entrants in the market,” said Josh Rabina, co-founder of Sentinel Data Centers. “The markets are getting smarter. They’re not inclined to fund new players, and less inclined to fund models that don’t scale. The providers have become much smarter, and these (data center) builds are all incremental. The market has gotten more intelligent, and the fundings are success-based.”

The data center market is also benefiting from the venture capital sector’s enthusiasm for cloud computing and social media, as money raised by companies in these sectors is often spent on infrastructure to scale web applications.

“There's a lot of money flowing into the data center space, but sometimes it’s disguised,” said Brian Thomas, Vice President of Global Corporate Planning at Equinix. “All this money flowing to Salesforce or IBM or Equinix may look like a different solution. In reality, it's a data center investment.”

The same holds true for the IPOs for Zynga, Groupon and LinkedIn, all of which are investing in infrastructure.

Debt Financing Accelerates

Investor interest in the data center industry even extends to debt financing, which was a difficult and expensive proposition following the financial meltdown of 2008. In recent weeks, data center providers have raised more than $620 million in debt to finance expansions of their facilities.

Why are investors so keen on data centers? Demand for data center space is driven by broad societal trends, as the Internet becomes a more crucial tool for communications and the delivery of products and services. The growing reliance upon computers by consumers and businesses has resulted in an explosion in the volume of digital data.
In addition, the interest in cloud computing is prompting more companies to consider shifting their IT operations to third-party data center providers.

“The outsourcing trend isn't just going to continue, it's going to accelerate,” said Vasilopoulos. “It's a much more efficient use of capital.”

Challenges Accompany Increased Funding

The flow of investment dollars into the data center industry creates challenges as well as opportunities. As more providers expand their data center footprints, it increases the risk of overbuilding. Providers are closely tracking the balance between supply-and-demand in active data center markets.

“We are looking markets right now,” said Sentinel’s Rabina. “It's very difficult for anyone to say with a straight face what supply and demand in a particular market will look like in two years. Look at Santa Clara. Two years ago I would've run for the hills. Everyone was building, but much of that space has been absorbed.

“We're seeing the same dynamic now in New Jersey,” he added, “We had a quiet period that lasted about six months, and now we're seeing enormous demand. On the wholesale side, these facilities can get taken down in 5 megawatt chunks.
“It all comes down to the patience of the capital,” said Rabina. “That's why I like being private.”

More Attention For Second-Tier Markets

Vasilopolous noted that the geography of the data center industry continues to expand, providing investors with the opportunity to deploy capital in smaller markets with less competition.

“I think we’ll be seeing a little bit of a sea change in the next 12 to 18 months,” he said. “You're seeing more Tier II cities getting attention. Investors would prefer (a provider) who has geographically diverse revenue streams.”

As regional players expand, it can create more competition in major markets. This is being seen in northern Virginia, where three West Coast providers – Sabey Data Centers, RagingWire Enterprise and GoGrid – are opening new data centers. As investment supports the entrance of new players into a market, it can be disruptive to pricing, which affects incumbent providers.

“Our most prosperous time was when the capital markets were shut down,” said Thomas. “There are a lot of assets coming online. How do you avoid price compression? If you’re going to Santa Clara, you're probably going to get a good deal.

“If you look at the sheer volume of money coming into the space, as a tenant, the question is where you want to deploy your assets,” Thomas added. “We've really shifted from a geographic focus to looking at it from a vertical perspective. We have started to get smarter about who we will bring into the data center to build an ecosystem. We're trying to spend in the right places and right ecosystems to protect against that commoditization.”

Construction Advances Mute Supply Concerns

If scarcity of capital provides discipline, will the availability of funding lead to overbuilding? Data center construction has changed dramatically since the dot-com bust, when developers employed the “barn” approach to construction, building out huge expanses of data center space up-front, at enormous expense. Today’s designs focusing on incremental builds of “pods” of space, with some providers adopting modular approaches that further compartmentalize construction and capital investment.

Even so, there are occasions when multiple investment groups may be chasing the same opportunity.

“Some investors understand the market, and some don’t,” said Rabina. “There’s a subset of the market that’s sprinting for the exit, and I think that’s resulted in some overbuilding. It will be interesting to see how that plays out.”

For the moment, Rabina is not concerned. “I think pricing is at a very healthy spot,”he said. “This entire industry is competing with build-it-yourself projects. Our collective value proposition has got massively stronger than it was five years ago.”

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