Image credit: Schroders, created using DALL-E AI tool, OpenAI.com, using phrase “A digital art impression of investors studying data centres in the metaverse”
2022 delivered a dramatic reset for investors who had enjoyed a largely uninterrupted bull market since 2009. Central banks finally dispelled the supportive 'lower for longer' interest rate narrative that had driven equity valuations ever higher, having reluctantly concluded that inflation was spiralling out of control. The US Federal Reserve (Fed) hiked their Fed Funds Rate faster and further than anytime in modern history, attempting to offset the inflationary forces of full employment, log-jammed supply chains and an energy crisis, following Russia's invasion of Ukraine.
This was a challenging backdrop for any company, with investors reassessing the value of future cash flows due to a dramatic increase in financing and energy costs. There were few places for investors to hide; high growth technology companies and capital intense real asset companies were certainly not immune to the recalibration. Despite suffering a valuation de-rating, digital infrastructure cash flows showed resilience due to their long lease terms, explicit linkages to inflation, solid balance sheets and well managed cost structures. 2022 delivered record bookings and low customer churn for many digital infrastructure businesses, despite rapid declines in economic confidence.
Sub sector outlook
We are optimistic about the outlook for digital infrastructure companies in 2023, as new technologies amplify the demand drivers that support leasing. Despite the structural demand for digital infrastructure increasing, as the digital economy grows, the key reason for our constructive outlook today is the depressed valuation of listed companies in the sector.
We expect investors to gravitate towards the defensive characteristics of these companies as economies slow and cost pressures ease. Well-seasoned operators such as Equinix (data centres), Cogent (fibre) and American Tower (towers) have historically proven they can grow revenues and dividends during periods of recession . The structural tailwinds that have supported these businesses over the past decade remain in place, whilst digital connectivity is now firmly a non-discretionary cost item for most users; businesses are moving to cloud-based IT architectures to cut costs, consumers are demanding ubiquitous connectivity as their lives move online and governments are boosting productivity by digitising their economies.
Global mobile network data traffic (exabytes / month)
Source: Schroders, Ericsson Mobility Report 2022
Tower cash flows enjoy inflationary boost
With leases often indexed to trailing 12 month Consumer Price Indices, we can expect accelerating organic revenue growth for international tower companies in 2023. This contract structure gives towers one of the most predictable growth profiles in the digital infrastructure sector and is supported by improving pricing power at mobile network operators (MNOs), the main tenants of towers. Their continued roll-out of 4G services in emerging markets and 5G in developed markets should supplement tower growth in 2023. Tower operators pass on the majority of their energy and maintenance costs to MNOs and enjoy strong access to debt capital markets, due to the high credit quality of their tenants. We believe that this winning formula will shine through in 2023, against a backdrop of weaker GDP and earnings growth across the wider economy. We think that tower growth in emerging markets shows most promise, with data traffic set to grow at 25%+ per annum from 2022-2028, according to forecasts by Ericsson .
We expect data centres to deliver strong rental growth
Data centre operators continued to positively surprise the market in 2022 with another year of record bookings, driven by cloud computing tenants. These pre-committed leases on new facilities will start to generate revenue over the next 12-24 months providing good visibility to data centre developers. At the same, a shortage of future land and power capacity in major markets is likely to moderate new supply, which will serve to increase occupancy and rental rates on existing facilities. Gartner recently forecast that the public cloud services market could grow by a further 21% in 2023 . In addition, we believe that artificial intelligence (AI) tools will begin to play a more visible role in the digital economy, requiring more data centre capacity. ChatGPT is just one of many examples we could give: "As AI technology continues to advance, it is likely that the computing power required by AI systems will also continue to increase" (quote from ChatGPT, via OpenAI.com).
Fibre providers will play a pivotal role in bridging the Digital Divide
Broadband internet providers will remain focussed on delivering gigabit+ internet speeds to businesses and consumers in 2023. We think that Fibre To The Home providers will gain market share from traditional cable networks, with consumers taking advantage of better value offerings as they seek to reduce spending amid the cost-of-living crisis. Fibre is the unifying technology that connects the digital economy; factories, hospitals and offices will seek to upgrade their internet capacity in order to deploy novel technologies. We are also just beginning to see Low Earth Orbit satellites join the race to connect the third of the world's population that still has no internet access (a staggering 2.7 billion people ). We expect satellites to play an increasing role in global security and the fight against climate change in 2023, as new launches improve coverage and communication capacity.
Fund outlook in 2023
We think that the fund will deliver a positive return in 2023, with the market refocussing on the resilient demand profiles and discounted valuations of companies in the portfolio.
Recession probabilities have unfortunately risen around the world. As central banks begin to see demand destruction leading to a moderation in inflation, they should start to take their foot off the rate-hike accelerator pedal. A more stable inflation and interest rate backdrop should set the stage for positive digital infrastructure earnings growth to drive share price performance.
The reset in valuation multiples has left many high quality publicly-listed digital infrastructure companies trading well below their historical averages. This is in contrast to lofty valuations in some privately-funded acquisitions; a division that is not sustainable. If the gap persists, we would expect further privatisations of public companies, with private funds taking advantage of the arbitrage available. Despite pockets of outperformance in 2022, including in India and Indonesia, emerging markets with greater recessionary insulation could attract further investor flows in the year ahead.
With uncertainty high, we will maintain a well-balanced portfolio of high quality companies that are well placed to benefit from the structural growth in digital infrastructure.
 Source: company financials accessed via Refinitiv
 Source: Ericsson Mobility Report, November 2022, https://www.ericsson.com/en/reports-and-papers/mobility-report/dataforecasts/mobile-traffic-forecast
 Source: Gartner, October 2022, https://www.gartner.com/en/newsroom/press-releases/2022-10-31-gartner-forecasts-worldwide-public-cloud-end-user-spending-to-reach-nearly-600-billion-in-2023
 Source: ITU, November 2022, https://www.itu.int/itu-d/reports/statistics/facts-figures-2022/
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