Are Fund-Backed Colos Stable Enough for Your Long-Term Workloads?

Using a colocation service provider for your critical infrastructure is serious business, and one of the primary selection or monitoring criteria is financial and operational stability. When your publicly traded colocation SP goes private, they stop disclosing their financial and operating metrics, and that might be a bit unnerving for some customers.

In July we published “Colocation: Private equity acquisitions may pose a market risk” on the Omdia research website. Raul Martynek, CEO of DataBank, a digital infrastructure investment company owned by DigitalBridge, told me the article was provocative and he respectfully disagreed. While DigitalBridge uses private equity money, it identifies itself as a digital infrastructure investor or infrastructure fund.

Recently, Raul spoke with me and shared some deep insight about infrastructure investors and the colocation market.

Differences Between Private Equity and Digital Infrastructure Investors

Digital infrastructure investments are the physical building blocks of the modern internet and include cell towers, data centers, fiber, small cells, and edge infrastructure.

It’s key to understand private equity investor types: The words “private equity investor” can mean a great many things but being an infrastructure fund investor is a very specific type of private equity investing.

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Many private equity companies invest on short-term horizons and look to exit investments in roughly five years with double digit returns perhaps at 20-30% internal rate of returns (IRR). Martynek points out that infrastructure fund investors have a much longer-term investment horizon of 15 years or more and target returns in the high single or low double-digit range, say 8% to 12%.

Different investors seek different types of risks and returns, and an infrastructure fund’s long-term investment horizon is primarily due to the:

Another benefit is that the long-term investment horizon eliminates the short-term thinking that can be an issue for public companies as their decision making is often driven by Wall Street expectations. It is difficult for organizations to develop and execute realistic long-term plans when Wall Street seeks increasingly better return each quarter. In addition, infrastructure funds attract like-minded investors who find the long game with stable returns appealing.

At the heart of this financial dance is the necessity for cost efficient capital funding which has a direct correlation to market competitiveness, and that is part of the secret sauce for delivering shareholder value.

Could the Deep Pool of Capital from an Infrastructure Fund Lead to Runaway Expansion?

Runaway expansion due to infrastructure fund capital is highly unlikely, according to Martynek. An infrastructure fund doesn’t provide blank checks and all incremental investment opportunities are aggressively interrogated. In fact, most companies owned by an infrastructure fund are responsible for operations and expansion financing. The owner fund may participate in and facilitate financing, but their primary role is oversight to assure such things as runaway expansion are avoided.

Low cost of capital is key to competitiveness and, in turn, creating shareholder value. Martynek explains that companies that look like DataBank (mid-sized private colocation companies) are usually funded with various bank debt instruments, which typically come with a blended interest rate of 6% to 7%. (This can be higher in today’s rising interest rate market).

Is a Colo Taken Private at Risk of Poor Ownership?

While this is always possible, Martynek points out that it’s important to understand that infrastructure funds have become particularly sophisticated owners, and, therefore, make good stewards of the companies they acquire.

The difference is that infrastructure assets have particularly high capital demands which is a risk. If there’s one thing investment companies are keenly attuned to, it is managing investment risk while assuring the best odds of long-term success.

Does Going Private Eliminate Transparency?

There is certainly less transparency for a private company particularly on financial details. However, while a private company may not share specific financial details with the world, they certainly work with their customers to provide the operational and financial details they need to make informed purchase decisions.

Oversight is a primary role for infrastructure funds and their investors, so being privately owned by a fund does not lessen oversight and accountability. In fact, Martynek characterizes DataBank oversight as “intense” because they are directly accountable to the fund’s board and their investors. On top of that, Martynek explained that private companies commonly have syndicated bank debt (loans funded by multiple banks called a loan syndicate) and/or securitized debt so they are rated by rating agencies. Their lenders, who count on those rating agencies’ data to make lending decisions, exert additional influence to ensure disciplined decision making.

Is a Short-term Private Equity Investor Company Acquisition Inherently Good or Bad?

Any company considering being acquired needs a significant amount of due diligence to understand the track record of who is courting them. A risk of being acquired by a short-term private equity investor is they may focus on making changes that enhance the financial profile but may diminish the trajectory or vision that made the company successful already. Martynek points out that short-term private equity investors can also take a mediocre company and make it truly great.

So, what are the advantages or disadvantages of choosing a public vs private colocation company? All evidence reasonably suggests that the funding aspects of public vs private colocation SPs are largely immaterial from a customer perspective. While the ongoing reporting transparency of a public colocation SP might be comforting to some, it is only one of many assessment characteristics that are important. Services, support, uptime, and the like, are the type of metrics that assure customers of the stewardship of their critical infrastructure. While a private colocation SPs may not report financial performance metrics publicly, most SPs will honor new or existing customer requests for that detail.

In the final analysis, if your public colocation company is acquired by an infrastructure fund, fear not. Martynek, who’s a well-seasoned executive in the data center business, says that infrastructure funds are arguably the smartest investors in the digital infrastructure sector.

Alan Howard, principal analyst, colocation and data center building, Omdia