As traditional core infrastructure assets face COVID-19 related headwinds, digital infrastructure assets such as data centres and telecommunications networks - which are benefitting from the shift to remote working, online business and ongoing digitisation - have piqued the interest of pension funds and other investors.
But while digital infrastructure has much in common with traditional core infrastructure, it raises a number of unique risks that investors need to consider.
A traditional core infrastructure asset produces cash-flows to equity owners that are forecastable with a reasonably low margin for error. It also possesses certain characteristics, such as operating within an established and stable regulatory environment, maturity in operation beyond the start-up phase, protection against inflation and minimal risk of obsolescence or disruption by new technologies.
Cash flows for traditional core infrastructure assets are underpinned by long-term revenue contracts or concession entitlements. The assets tend to have monopolistic characteristics and are protected by strong barriers to entry (whether regulatory, contractual or market driven). Examples include electricity transmission infrastructure, airports, toll-roads and ports. The investment characteristics of core infrastructure suit long-term investors such as pension and superannuation funds, whose liability profile is similarly long-term.
Digital infrastructure, on the other hand, refers to the assets that support the digital economy. Examples include fibre networks and satellites that support internet connections, telecommunication towers that support mobile phone connectivity and data centres that support cloud computing services and data storage. Over time, it is likely that digital infrastructure will evolve to incorporate less tangible assets such as digital registries, exchanges, computer software applications and databases.
Impact of COVID-19
Investors seeking exposure to core infrastructure faced headwinds even before COVID-19, including intense competition for asset ownership and lower regulatory allowances. The impacts of the pandemic have only added to this pressure.
Government restrictions on physical movement and the subsequent declines in patronage and usage is negatively impacting returns on traditional core infrastructure assets. At the same time, COVID-19 has tested (and demonstrated) the importance of efficient, fast and reliable communications networks and other digital infrastructure.
Throughout the pandemic, digital infrastructure has proved to be recession-proof, while other markets continue to be volatile. In fact, 'macro' thematics - such as the growth in cloud computing and Internet of Things (IoT) applications, and geopolitical tensions increasing national security concerns - are likely to drive significant growth in digital infrastructure investment. Following a host of mobile phone tower transactions in Europe over the last few years, it also seems likely that there will be a reasonable number of digital infrastructure assets coming to market. One factor driving these transactions is the need for mobile phone carriers to release capital from their towers and data centres to re-invest in spectrum and network equipment for 5G mobile networks.
Data centre operators are also in need of significant capital funding to invest in the rollout of data centre networks, meaning there should be no shortage of greenfield and brownfield investment opportunities. Down the track, there is also the possible privatisation of the nbn, which would be the most significant investment opportunity to date in Australian digital infrastructure.
Considerations for investors
Investing in digital infrastructure raises a number of unique risks. Core infrastructure investors should consider the following:
- Technology obsolescence. The period of the
investment needs to be considered in terms of the threat of
technological obsolescence, not just the physical life of the
asset. By its very nature, technology is always evolving. This
means digital infrastructure is inherently exposed to technological
disruption. For example, there is speculation that communications
networks in regional locations may be disrupted by low earth
satellite constellations, which can provide a broadband internet
connection at a lower cost.
- Unique regulatory risks. Like core
infrastructure, digital infrastructure tends to be highly
regulated, but in unique ways. For example, telecommunications
carriers have unique powers and immunities to enter land and
install infrastructure without the consent of the land owner or
occupier. These powers can impact the ability of a
telecommunication facility or tower owner to leverage its assets
and need to be well understood. Increasing scrutiny of technology
monopolies by regulators also poses a risk. For example, the
Australian Competition and Consumer Commission
(ACCC) has been vocal in its concerns about a lack
of regulatory structures to manage competition issues with PEXA
(Australia's electronic property transactions platform).
- Sophisticated technology customers. Cash flows
from some digital infrastructure assets are secured by contracts
similar to those used for traditional core infrastructure. For
example, customers of data centres tend to require long-term tenure
rights (usually between 10-20 years) given the high costs of
installing and relocating ICT equipment. However, data centre
customers (such as Amazon Web Services) are sophisticated, with
significant negotiating leverage and prescriptive contractual
requirements. For example, Hyperscaler data centres will often
require full carbon offsets for data centre power to meet the
commitments technology companies have made regarding the reduction
of carbon emissions.
- Uncertain data ownership rights. Protecting
ownership of data assets can be difficult given that data does not
sit comfortably as either a tangible or intangible asset. There is
also conflicting case law on whether copyright subsists in a
database. Privacy law reform and increasing scrutiny from the ACCC
and other regulators is starting to encroach on the freedom to
commercialise data assets that include personal information. For
example, the Consumer Data Right will require businesses in the
financial services, energy and telecommunications industries to
share data assets with competitors.
- Strict security obligations. Given current
geopolitical tensions and increasing cyber risks, an area of focus
for Government is the ability of foreign powers and malicious
actors to disrupt or extract data from critical digital
infrastructure. The Government is legislating to ensure there is oversight by FIRB into all foreign
investments, regardless of value, in certain digital
infrastructure businesses. There is also regulator scrutiny
throughout the life of these assets. For example, owners and
operators of communications infrastructure are subject to onerous
cyber security obligations, including the telecommunication sector
security reforms (TSSR), which provide the
Critical Infrastructure Centre powers to oversee and direct the
security of communication systems and services.
Digital infrastructure plays an integral role in the broader economy, and will continue to be an area in which long-term investors will participate. The challenge for core infrastructure investors is to understand the unique risks at play in the technology and communications sector, which has been undergoing a combination of evolutionary and revolutionary changes.
This article is part of our publication Continuity Through Crises: Perspectives on business risk, resilience and recovery in uncertain times. Read more here.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
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