M&A trends in the data centre market
During the past five years, digital infrastructure M&A has focused heavily on data centres. Data centre M&A activity remains on an upward trend, while private equity involvement in edge data centres is burgeoning. This article sets out STL’s views on data centre M&A in the US and Europe for 2023, and explores criteria to be considered by private equity houses active in this space.
This article explores the following 3 trends in M&A for data centres:
1. Investment value and number of deals to continue to rise
2. Private equity is increasingly turning to edge data centres
3. Strong headwinds will continue to meter expectations
Data centre investments have soared since the pandemic
Investments in data centres were in decline between 2017 to 2019, but have since been followed by steep growth over the past three years. It reached nearly $200bn by end of 2022 , with nearly half of that volume concentrated in the last two years. Nevertheless, the average deal size for data centre transactions nearly tripled from $80m in 2018 to approximately $235m in 2022.
In 2021, the global number of data centre investment deals peaked at 215, showcasing investors’ appetite to grab share in the rapidly expanding digital infrastructure sector. The total value of M&A investments in 2022 remained nearly the same as the year before, largely driven by growing private equity interest. The slowdown in M&A activity during that year was a result of general market conditions and interest rate hikes, particularly in North America and Europe.
Despite an overall hit in the global M&A activity during the first quarter of 2023, driven by high interest rates, rising inflation and general market volatility, STL Partners anticipates demand for data centre investment to remain relatively insulated from the broader market.
Data centre M&A activity globally
Source: Synergy Research Group
Digitalisation and economic pressures to offset data centres are driving demand
The reason for the growth in M&A activity is due to anticipated increasing demand for cloud computing and data centre services and the growth in the availability of data centre assets. On the latter, we are seeing the rise of edge data centres. Hyperscale data centres remain important, but future demand requires low latency solutions that minimise latency, jitter and enable real-time automated responses. As demand for edge data centres grows, we are seeing larger players start to acquire smaller facilities, as well as consolidation, as some current players look to expand their portfolio, e.g. AtlasEdge recently acquired DC1.
On the demand-side, three key trends are driving this:
1. Digitalisation of business activities, including the use of Artificial Intelligence (AI);
2. Economic pressures on businesses creating a focus on reducing IT costs;
3. Increasing use of streaming and internet services globally.
1. Digitalisation of business activities, including the use of AI
The growth in digitalisation, through broadband connectivity and adjacent technologies (e.g. IoT, data analytics and software-as-a-service) have already created a surge in cloud IT solutions. The rapid rise in AI – catalysed by ChatGPT in early 2023 – has further fuelled the demand for data centre services as enterprises consider the potential to manage operational technology (OT), as well as IT, using third-party infrastructure. Businesses are also using more video-based applications, e.g. video calling, augmented reality support for field engineers, remote-control of machines, drone inspections, etc. which are increasing enterprises’ bandwidth and computing demands.
2. Economic pressures on businesses creating a focus on reducing IT costs
2023 has seen a material economic downturn, particularly in Europe. For many enterprises, this has resulted in a significant effort to reduce costs across the business, including IT. This has provided a further boost to the automation of business processes but also encouraged enterprises to explore co-location and cloud solutions in place of managing applications on-prem in their own data centres.
3. Increasing use of streaming and internet services globally
The growth in consumer internet services globally, particularly in huge, growing markets, such as India and China, continues unabated. Social media and cloud gaming continue to drive data usage, with video experiences becoming richer and more interactive (think TikTok).
An increasing majority of M&A investments comes from private equity
Private equity has been pivotal in the recent development of the data centre industry, seeing most data centre investments as “safe havens”, and typically deploying capital through larger funds that have longer term investment horizons compared to those of the broader private equity space .
In 2020, private equity accounted for 55% of the value of total data centre closed deals in the year, rising to 66% in 2021 and 91% in 2022. Since 2018, private equity funding has grown by 50% year-on-year, on average, reaching $44 billion in total value in 2022.
Data centre M&A activity by investor type
Source: Synergy Research Group
One of the most notable investments recently was the acquisition of CyrusOne by KKR and Global Investment Partners in 2021, as well as in 2022, the acquisition of Switch by DigitalBridge and IFM in a deal worth $ 11bn, representing the largest deals seen so far. Blackstone acquired QTS for $10bn in 2021 on another large-cap deal.
Private equity firms are not only investing in traditional data centres but also in edge data centres, which represent a novel investment domain. Noteworthy transactions in the edge data centre sector within the last five years encompass EQT Infrastructure’s purchase of EdgeConnex for $2.5bn in 2019 and, more recently, Brookfield’s acquisition of Data4, a French data centre company.
Potential headwinds to look ahead
Recent changes to the macroeconomic environment, along with the nature of the data centre industry, create a number of “watchouts” for investors looking to enter the data centre market.
To begin with, the disruption to the construction market and supply chains can considerably hinder the data centre building process. As uncertainties in the supply chain are anticipated to continue for at least the next 12 to 18 months, the planning and costs of these projects are significantly affected. Nevertheless, the industry is expected to adjust by adopting practices, such as procuring pre-assembled components and maintaining inventory to expedite the construction process. It is likely that such processes will be standardised in the long term, possibly within the next 10 years.
Increasing regulation is being imposed on data centres due to their significant energy and water consumption. It is projected that data centres will contribute approximately 4% of global electricity consumption by 2030. Consequently, to ensure sustainability in the sector and reduce its impact on carbon emissions, more regulatory measures are anticipated to be introduced in 2023. As a result of tightened regulations and energy concerns, sustainability has become a key trend for data centres globally and it is looking forward to being increasingly self-regulated and making strides to improve as an industry. Read more about digital infrastructure and sustainability here: Digital infrastructure investment: Unveiling 2023’s M&A landscape.
Finally, the data centre market often requires significant capital investment, creating challenges for some new investors, especially when considering the high cost of land and the intense competition in acquiring it. However, it is worth noting that, although recent trends have favoured large-scale data centre projects, there is now a growing presence of smaller, edge data centres that support the increasing demand for computing generally.
Despite headwinds that could potentially impact the M&A activity across the data centre market, STL expects that data centres will remain a driving force of digital infrastructure investments over the next 3-5 years. It remains to be seen whether further consolidation will be driven at both private equity and corporate level.
For further reading, STL has been following investments in the broader TMT and digital infrastructure space (see our previous articles TMT M&A trends and outlook and Digital infrastructure investment: Unveiling 2023’s M&A landscape), and in 2022 we launched our Edge Investments tracker.
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