glow 1

Digital connectivity is at the heart of the modern economy and will play an even greater role in the future. Marie Kemplay explores the crucial role that digital infrastructure has in supporting that future and how it is being financed.

“Digital infrastructure is the new bridges and roads,” says Paul Lam, strategy and policy officer (digital strategy) at Asian Infrastructure Investment Bank (AIIB). The central role of digital infrastructure in driving the modern global economy, the same way roads and rail networks did in the past, is clear to see.  

From an investment standpoint, “looking at the trinity of digital investments, towers remain a hot investment market. Data centres is booming as well. The same is true for fibre,” says Demetrio Salorio, UK head of global banking and advisory at Société Générale.

Such infrastructure is not only vital for today’s businesses and consumers, but it will be even more fundamental in a future where so-called ‘smart cities’, self-driving cars and other Internet-of-Things technologies are expected to play a role in almost every aspect of our lives.

Mr Salorio adds: “We are seeing other emerging segments too, which will develop over the next decade [in relation to] healthtech, fintech and connected cities. Thinking about electric vehicle charging points and small localised data centres to support autonomous vehicles, and areas that we haven’t even begun to grasp yet. So, this is going to be an even bigger area going forward.”

Governments the world over have already recognised the huge importance of digital infrastructure in supporting long-term growth and economic prosperity, with many publishing strategies around it. The Covid-19 pandemic has made its importance even clearer, accelerating demand for network capacity and connectivity, including in new geographic areas.

Charlotte Kaheru, senior industry specialist in the telecommunication, media and technology (TMT) team at the International Finance Corporation (IFC), part of the World Bank Group, says: “We saw a shift in network usage from downtown in cities to residential areas. Operators had to quickly shift to catering to this new demand in suburban and rural areas. That new usage behaviour has become ingrained.”

Her colleague Germán Cufré, global manager in the IFC TMT team, echoes this view, suggesting that operators have seen year-on-year data traffic increases of 25–50%. “The pressure we have seen on networks coming from that, that’s not going to go away. Data consumption is going to continue going up,” he says.

Digital divide

The pandemic also laid bare the very real impacts of the so-called ‘digital divide’ — the inequalities between those with digital connectivity and those without. “Covid-19 has redefined the digital divide because to keep your kids at school, to continue being an operational company, you need access to cloud services,” says Carlo Maria Rossotto, principal investment officer in the IFC TMT team. “The digital divide, once measured by basic access to broadband, should now be measured by access to connectivity that allows cloud services,” he adds.

Covid-19 has redefined the digital divide because to keep your kids at school, to continue being an operational company, you need access to cloud services

Carlo Maria Rossotto, International Finance Corporation

On the topic of broadband specifically, he adds: “World Bank research points to the fact that a 10% increase in broadband access can boost gross domestic product per capita by 1.4%. [Therefore] the sector is also of strategic importance for the rest of the economy. As you develop effective digital infrastructure, you’re also creating the conditions for digital finance, digital inclusion, government programmes, etc. It is the foundation of the modern competitiveness of nations.”

This view is shared by Mr Lam, who says infrastructure that supports the digital economy “is foundational to digital economic activities, bridging the digital divide and ensuring we have equitable economic growth everywhere”.

If, however, there is a consensus on the importance of this infrastructure, this does not change the complexity and scale of the challenge in rolling it out, and in attracting necessary investment, the world over.

Benn Mikula, co-CEO and managing partner at Cordiant Capital, an investment company focused on digital infrastructure and other emerging categories, is well aware of this. “As governments and societies are focused on tackling the next order of challenges and what infrastructure they will require to do that, a fundamental point is the difference between … first-generation infrastructure and second-generation infrastructure,” he notes. “Where a toll bridge or a power plant had the same use case in 1990, 2000 and 2010, for digital infrastructure, renewable infrastructure and the other kinds of infrastructure we focus on, the use cases are constantly evolving.”

The right approach

Mr Mikula also highlights the importance of creating the right market and regulatory conditions to incentivise telecoms companies and others to invest, saying: “If you don’t make money, then you can’t invest.” He compares the US — where consumer pricing has not been a regulatory focus and has, he suggests, seen greater levels of investment — to Europe, which has prioritised the consumer and lower roaming prices, but suffered underinvestment. “The public policy choices that are taken here can have meaningful and long-term consequences. This is not to say consumer pricing is not important, but it shows how these issues are connected.”

This is a view echoed by Wilhelm Schulz, vice-chairman of banking, capital markets and advisory at Citi, in relation to European telecoms networks that have been “competing primarily on price, which does make the economics challenging in terms of being able to recoup investments”.

He adds: “The European infrastructure market as it currently stands is fairly inefficient. For instance, consumers do not necessarily need a choice between different fibre networks, but we see that in every European country there are multiple networks.”

Bénédicte de Giafferri, global head of real assets at Natixis Corporate & Investment Banking, highlights the current regulatory approach taken by France as a positive example, and just enough to ensure that in critical areas there is not too much competition (which would undermine the incentive for investment). It has not, she says, directly imposed rules preventing operators from competing with existing fibre networks, but engaged where needed.  

Nathan Luckey, senior managing director at Macquarie Asset Management, also calls out “the French approach” as “probably the best example of how ‘smart intervention’ can achieve good policy outcomes, and without a loss of competition”. He explains: “They divide the country into different types of region, starting with cities where no real intervention is needed, to the very rural areas where there is an acceptance that the government needs to step in to give more backing to investment.”

Increasing digital connectivity is a commonly articulated governmental policy goal. Mr Luckey says his organisation’s position on the regulatory approach needed to ensure a wide infrastructure rollout, including in more challenging areas, “has consistently been that while in a lot of areas it will work to let the market work itself out, in more rural areas, particularly, you are going to need some sort of interventionist approach to make sure everyone gets the level of service [required]”.

Usage versus coverage

The challenges of increasing digital connectivity also vary by geography, and bespoke approaches are needed. As Mr Cufré observes, in relation to internet access in emerging markets “usage is by far a bigger issue than coverage”.

He cites statistics from telecoms industry trade body, GSMA, which “puts the number of people that are not accessing the internet at about 3.2 billion, which is close to half the global population. But, of those, only 600 million don’t actually have network coverage.” He argues that more pressing challenges can be a lack of content in local languages or dialects, devices being shared between multiple people, or the affordability of devices or services to access the internet. He says: “We could continue building pipes and towers, but if we don’t provide affordable handsets, if people aren’t able to pay for a data package, or if we don’t have networks that are reliable enough to allow artificial intelligence to facilitate usage by people that don’t know how to read, we will not be able to support digital economies at scale in emerging markets.”

Mr Cufré’s comments lay clear some of the perhaps unforeseen complexities in this area. Infrastructure more broadly is often considered to be a relatively straightforward asset type, but Ms de Giafferri suggests that for governments, companies and investors looking to engage with digital infrastructure it is vital to have access to the right knowledge. She says: “It’s an area where expertise is key because of the wide variety of transactions, even within one area, such as fibre transactions — competition, regulatory considerations and contractual arrangements always vary. It requires something of a tailor-made approach for each transaction.”

Mr Mikula illustrates this issue by describing the complexity, even within just the category of data centres. “There are hyperscale datacentres, wholesale datacentres, edge datacentres, interconnected datacentres … you have upwards of half a dozen ecological niches serving different use cases. And it is the same when it comes to fibre and tower configurations.”

He adds: “Second-generation infrastructure has a much more evolutionary aspect to it. From an investing point of view, this requires a good measure of expertise. For governments and companies this is critical, as it’s highly complex. I think investors also increasingly understand this, but if you take generalist infrastructure investors that have been in a reasonably static asset class, they’re on a learning curve that we expect to continue.”

Defining infrastructure

Although digital infrastructure remains an area of relative specialism, it is an area where investor interest is increasing.

Oliver Bradley, a managing director at Macquarie Capital, says: “You would struggle to find an infrastructure fund that doesn’t have digital infrastructure as a core part of what it’s trying to do. It’s now one of the main pillars alongside transportation and energy transition.”

However, Mr Lam observes that some debate remains around exact classifications. “At the moment, there is not a common understanding about how to classify these assets. That can create challenges for infrastructure funds and pension funds, because when they draft an investment management agreement, they have to be very clear which asset classes they will invest in. If there is a lack of consensus about whether digital infrastructure is infra, whether it’s real estate or private equity, that’s going to limit liquidity and the market.” However, he adds that he is optimistic this is improving.

He also believes this debate will continue and take in new categories, as what is considered ‘essential infrastructure’ and what digital assets are deemed to have ‘infrastructure-like qualities’ changes over time. “I think infrastructure definitions will probably evolve in the next 10–20 years. Economically, infrastructure is a network asset that generates value … by enabling other economic activities to be built onto it. And in that definition, many of the internet platforms that we see today, e-commerce platforms, for example, to some extent are infrastructure.”

He adds: “From a financier’s perspective, the definition of infrastructure could be narrower. To institutional investors, what matters is whether an asset generates a steady cash flow (i.e. steady yield, fixed-income like) and has prudent contractual arrangements and a structure with low market risk in place. In the future, I don’t see why we can’t structure some of the foundational, baseload digital and data services that are widely being utilised across the economy as an infrastructure asset class.”

Repurposing assets

Structural changes within the telecoms market have also been driving transactions for several years. Where telecoms companies have been spinning off assets, such as towers, to raise capital on the basis that these assets have greater investor appeal than the underlying incumbent telecoms companies themselves. “Taking assets out of telecoms companies such as towers, fibre and datacentres has been much more advanced in the US, while Europe has been behind. But over the past five years, we have seen a wave of activity, which has been accelerating,” says Mr Schulz.

“It initially started with towers, but we are now seeing it with fibre,” he adds. “It hasn’t happened much yet with datacentres, but that is coming. These are assets that tend to be favoured by risk-averse investors who want a specific profile that wouldn’t be possible via investing in an incumbent. Investing in the assets is a more straightforward investment story compared to the broader incumbent company.”

The current economic climate has also increased the relative appeal of this segment, he believes. “What’s driving this is a low interest rate environment and a strong appetite for these assets, which already have one steady customer and also have the potential for additional income, if more companies come on board and use that infrastructure,” he says. “That becomes a more likely possibility if the infrastructure is owned by a neutral party rather than a competitor.”

Mr Luckey observes that “the pandemic further accelerated the desire of infrastructure investors to invest in digital, which has proven again that it is not cyclical with the broader economy. Unlike, say, transport investments, which were impacted by lower passenger numbers. So, for investors looking for diversity in their portfolio, and assets that are not cyclical, it’s a very attractive space.”

Although the large number of players in certain markets has arguably limited short-term returns, Mr Salorio says it does imply the possibility of future consolidation. “There is [a] potential gain, which is consolidation. For example, in the UK, there are many different groups deploying fibre, and although no one knows for certain what will happen in the future, there may be consolidation in this sector that would provide an additional ‘cherry on the cake’ for investors thinking about potential exit planning,” he says.

“So far,” he continues, “this has been a segment dominated by banks, using project finance techniques,” but believes it “is maturing and approaching the stage where there will be more disintermediated bond financing, where investors are tapped more directly. Initially this will be refinancing of existing projects that have already run for a number of years, with established cash flows, and this will enable them to get good ratings. Increasingly we do expect to see this.”

The future of infrastructure

Looking to the future, as our reliance on digital technology — which inherently requires energy use — increases, squaring this with environmental objectives is also going to be a major area of focus.

As Mr Lam observes, “At first glance, digitalisation seems to be straightforwardly decarbonising, but that’s without considering the displacements. Telecom towers consume a lot of power; datacentres consume even more. There is a temptation to think these new solutions are an easy answer to old problems, but new technology also comes with its own pain.” He says the AIIB builds in consideration of the environmental and social impact of investments in these areas.

Overall, I believe it is a virtuous trend to be relying more on digital networks

Bénédicte de Giafferri, Natixis

“Overall, I believe it is a virtuous trend to be relying more on digital networks” as opposed to international travel for meetings, says Ms de Giafferri, who takes a relatively optimistic view. But she adds: “It is important to keep in mind ensuring that the underlying assets are as green as possible. Datacentres are the most energy-intensive part of the system, but if a datacentre is using ‘green’ energy then it can be ‘green’. It also depends on the efficiency of datacentres.”

There is generally agreement that datacentres are the most energy intensive part of this equation, and probably the most important area to address. “Data consumption, per se, is energy intensive and that is a big challenge,” says Mr Bradley. “One of the areas being looked at is making datacentres more efficient; but the ‘holy grail’ will be to directly connect data centres to renewable energy sources, which isn’t easy.”

He adds: “One of the critical things about datacentres is that they can never be switched off — and wind and solar farms aren’t able to provide that consistent level of supply. Another issue is that the back-up power systems are reliant on battery-powered diesel generators. The battery technology itself at present is not at a level where it is particularly efficient or can power a large datacentre for very long. I think it will improve, but we’re not there yet.”


All fields are mandatory

The Banker is a service from the Financial Times. The Financial Times Ltd takes your privacy seriously.

Choose how you want us to contact you.

Invites and Offers from The Banker

Receive exclusive personalised event invitations, carefully curated offers and promotions from The Banker

For more information about how we use your data, please refer to our privacy and cookie policies.

Terms and conditions

Request a demonstration to The Banker Database

Join our community

The Banker on Twitter