Back in March of 2022, private equity giants KKR and Global Infrastructure Partners completed a $15 billion acquisition of CyrusOne, a Dallas-based firm that provides data colocation services. The transaction caught dealmakers’ eyes. Read below to find out more.
A multi-billion deal for a warehouse business designed to ensure that IT infrastructure and cloud services are running smoothly? Talk about a Mega-Bite.
But the deal is part of a trend that experts say is just beginning. The data center industry saw an increase from $12.6 billion to $43 billion in total deal volume from 2021 to 2022 and many say this volume will continue to grow in the future.
Digital transformation has been a focus for private equity for some time now. From SaaS to IoT to Social Media, deals have been bountiful in these sectors. But all of these companies, and many more, rely on data centers like the ones CyrusOne provides, for a stable platform as they scale. Private equity is jumping on this opportunity.
As the analog world continues its digital transformation, M&A in the data center industry grows more alluring. Whether it is the physical real estate housing a data center, operating a service across the cloud, or even specialized subsectors like data center cleaning services, these areas are all up for play among financial sponsors. Many players in the space express a limitless possibility for future investment as any supporting or related service could be considered critical in nature.
Ed Diffendal, a managing director and co-head of private infrastructure in the Americas at Partners Group says data centers sit at the core of many tech-focused investment strategies. The assets represent essential infrastructure that enables consents and data processing at high speeds in close proximity to end-users. Additionally, theses sites service a wide range of customers from small enterprise deployments to large-scale campuses for major cloud providers.
“Digital transformation has fueled the proliferation of data traffic globally and increasingly more use cases are demanding significant computing capacity at low latencies, including for IoT, social media, AI, virtual reality, and smart city automation,” says Diffendal. “These data requirements can only be serviced by data center infrastructure, and for cloud customers, by scaled and highly resilient data center infrastructure.”
Data centers are enabling the cloud and digital transformation that has been grabbing headlines in the media. Whether it is in the form of migrating enterprise information technology infrastructure or platforms into a cloud environment; these services are reliant on a fixed location with servers that can handle the load.
There are different permutations of cloud environments out there, but most notable are the hyperscalers or large cloud service providers. These firms, such as Amazon Web Services, Google Cloud, Microsoft Azure or the IBM cloud, offer computing and storage of data processing at an enterprise scale. Amazon and Microsoft control over 50 percent of the market, according to Statista. Other competitors of scale include Oracle, Tencent, Digital Ocean, Akamai, Linode and Kyndryl, which was spun out from IBM in 2021.
“We see broad-based interests from a range of institutional investors across the IT services continuum,” says Seth Morganstern, managing director at Stout, a Chicago-based investment bank. He notes that the large addressable market for private equity investment in data centers and the related services stems from offering like IT services, added reseller systems integrators, IT managed services and digital engineering.
There is even opportunity beyond technology itself. In November, Angeles Equity acquired Data Clean LLC, a contamination control and removal services firm. The Des Plaines, Ill.- based firm services data centers and other telecom firms.
Valuations for this sector continue to rise. According to Pitchbook, there were 87 private equity investments in the data center market during 2022, which is above the trailing 5-year average of 79 transactions per year. Similarly, looking at private equity deal activity in cloud services saw deal values rise from $13.4 billion to $31.9 billion.
In November, Diffendal’s Partners Group acquired EdgeCore Digital Infrastructure, an owner, operator and builder of hyperscale data centers. The Broomfield, Colo.-based firm builds and commercializes data centers for cloud, Internet and technology firms. Similarly, LLR Partners-backed Salute Mission Critical, a data center services provider out of Missouri, acquired both Iconicx Critical Solutions, a provider of commissioning, testing and consulting services for data centers, and AMS Helix, a project management and sustainability services provider for data center customers.
“This migration into the cloud is driving a lot of needs for data centers in terms of the ability to have that underlying availability for servers, storage and networking and to provide users with that same end user experience,” says Morganstern.
“It’s also a lot of the Software-as-a-Services,” Morganstern says. “If you think about some of the larger SaaS platforms out there, they’re delivering their applications through cloud environments and those environments need to live somewhere and they’re living in data centers. That’s really at a high level some of the macro themes in the market and private equity has paid attention to that because we’re talking about markets that are sizable and growing at significant rates.”
The opportunity is sizable in part because it touches so many sectors within technology, so the customer base is endless. SaaS applications, managed service providers, and in-house firms managing their own IT infrastructure all rent space at data centers.
Diffendal says the sector’s “net new” infrastructure demand is expected to grow at double-digit CAGR in the near term. Additionally, infrastructure capital has gained interest given the long-term contracts with high quality counterparts that underpin data center deployments. He says that typical customers like Fortune 100 firms are shifting from on-premise IT infrastructure to cloud infrastructure to support scale and growth and need data center operator expertise to aid in the transition.
Some examples of such deals include OceanSound Partners-backed DMI’s acquisition of Ambit Group, a provider of data analytics, cybersecurity and mission support services for the U.S government, and Berkshire Partners’ investment in MedOne, an Israeli provider of data center infrastructure and hybrid cloud services to technology firms and government entities.
“Key financial characteristics of these platforms often include long-term contracts with highly creditworthy clients, annual escalators to hedge against inflation, pass-through costs for major expenses like power for the servers, and high Ebitda margins,” says Diffendal. “Oftentimes, these platforms have significant operating leverage and are able to build, commercialize, and scale with limited additional SG&A burden. This enables substantial capital deployment potential for successful teams in a modular basis, at attractive unit economics.”
Morganstern says that there is a big impetus for buyside firms to realize the efficiencies from a cost perspective and take advantage of a growing marketplace. Hyperscale providers like AWS and Google are growing at 30 to 40 percent, vastly expanding the potential for the sector.
“I think that while there’s economic uncertainty over the near term, there is very much a bullish tone as you think about medium term and longer-term prospects for the data center market, including these services and the groups that are operating in that sector,” he says. “The private equity community thinks about the ability to gain exposure into the longer-term digital transformation theme, and there’s multiple layers to tap into that potential.”
