US Data Center Operators Have Financing Advantages Over EU Counterparts

European data center firms are at a disadvantage to the US firms that have been purchasing them, because EU- and UK-based financiers have been shy of using innovative financing to raise the large sums of money needed for construction, according to financial experts in the sector.

This contrast was seen in April when Vantage Data Centers, a US firm that has exploited financial schemes made infamous during the 2008 financial crash, purchased Next Generation Data, the UK-based data center operator that claims to run Europe's largest data center.

Although they were peers when they opened their doors ten years ago, the latter relied on traditional bank financing and expensive venture loans to raise only a fraction of the $2 billion that Vantage has raised for acquiring rivals and building hyperscale data centers in Europe.

Financial experts say European firms have been missing a trick.
 
Sukand Ramachandran, managing director of Boston Consulting Group's finance and technology practices, told Data Center Knowledge that European data center operators are disadvantaged because they have less opportunity to raise capital to fund growth using the method Vantage employs -- a financing scheme called securitization.

"They have less access to capital, therefore their growth curve will get dampened as a consequence," he said. "Unless you have the ability to increase financing through vehicles like this, just simply from the financing side, it puts European companies at a disadvantage against somebody in the US."

He said that whether a Vantage would even be possible in Europe is a question of how well European capital markets understand the industry, and their appetite to invest in nontraditional methods such as securitization. Europe has no precedence for it, he said, and its fragmented financing makes it hard for companies and banks to go through with it.

Jon Mauck, managing director of Digital Bridge, the investment house that directed Vantage's innovative financing after acquiring the data center operator in 2017, told Data Center Knowledge that he agreed that US firms have an advantage because they can raise capital more efficiently.
 
"I believe securitization is a competitive advantage for hyperscale data center companies because it provides a greater quantum of capital at effectively a lower rate," he said.

Kingsley Ong, secretary general at the Asia Pacific Structured Finance Association, an expert in securitization, and a partner at the law firm Eversheds Sutherland, said part of the advantage in securitization is that firms with poor credit ratings can use it to raise capital as though they had top, investment-grade ratings.

Vantage did this when in 2018 it raised $1.1 billion in the first ever securitization by a data center operator. Credit ratings agency Standard & Poors gave the securitization scheme a rating of A-, a high enough investment grade rating to attract investments from risk-averse, wealthy investors such as pension funds. This was despite the fact that Vantage itself had a limited track record at the time, and the data center industry was considered risky because it had a short history, said S&P.

If a company with a rating of BBB attempted to secure financing by issuing bonds on the capital market, Ong explained, those would be rated BBB as well, meaning the financing would cost the firm about 10%-12% per annum. If the same firm had AAA assets (such as the long-term lease contracts that wholesale data center operators hold with high-rated customers like the big cloud operators), it could sell shares in their income as securities and have them rated AAA, at about 3%.

Data centers, like the credit card companies that were among the first securitizations in the 1980s, ordinarily do not make enough money from their customer leases to build more data centers, said Ong.

"If you just sit and wait for the lease payments, that's it, because you only have enough for one building," he said. "If you could securitize it, you would be able to get up-front, 10 years lease cash payments. You can then use the cash to create other investments. You build a second building, and then a third. You would build market share. If you only have one building, there's only so much you can do.".

One financier involved in US data center securitizations who didn't want to be identified, told Data Center Knowledge, "Access to efficient capital is a key component to success in a capital intensive business. If you are able to deploy capital more efficiently at a lower cost, it means you can either do more or you can pass savings to your customers. Either way it's an advantage."

He said interest rates had been much lower in Europe than in the US, so bank capital was attractive, but non-securitized capital was by definition less efficient.

"In a macro-sense, more efficient capital is an advantage. And because the securitization market exists in the States, you can capitalize on that advantage," he said.

Europe's Interxion said last year it favoured a takeover by US data center giant Digital Realty because it would get cheaper capital with the latter's investment grade rating. Interxion executives told analysts last year it aspired to an investment-grade rating, saying it had no difficulty raising money, but had long been trying to cut its cost of debt. S&P had responded to its recent efforts by increasing its rating to a BB. Amazon demonstrated what the greater clout could do early this month when it its investment grade rating earned it reportedly historic low interest rates on $10 billion it raised by issuing corporate bonds.

According to Ramachandran, who recently helped banks harmonize EU rules to make securitization more feasible, data center firms wanting better-rated debt would have a better chance of finding it in the US where capital markets are more mature. US institutional investors understand and like securitized paper assets, and are permitted to hold them, he said. Whereas in Europe, fewer investors had appetite for them, so there was simply less money for it, and it therefore took even more effort to raise it, so fewer companies turned to it. Europe was more reliant on traditional bank finance for capital.

Rob Plowden, head of Eversheds Sutherland's US data center practice, said banks are limited in the amount of debt they can supply because they can take on only so much risk. Data center operators might raise 60%-70% on the value of their assets from a bank, but 80% from spreading the risk around by securitizing them.

George Rogers, an advisor with asset manager Stepstone Group and a former VP at Digital Realty, said until recently it was difficult for data center companies to use their assets as collateral for any sort of debt. Financiers didn't understand the data center business and viewed data center assets as if they were conventional real estate -- only much more expensive per square foot and with lease income measured not in square feet but kilowatts.

He said this changed when the cloud business started to boom and investors started to see data centers as an investment grade asset class.