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In the past few years, we have seen a 45% per annum growth in enterprise IP traffic and steady, ongoing demand for more fibre, more data centres and more towers (the “holy trinity” of digital infrastructure). Underpinning this growth is the inexroable shift to a digital life with e.g. 35 percent in HD video and 40 percent annual growth in mobile data. In the Enterprise domain, we are witnessing 15 percent  to 20 percent annual growth in Cloud workloads to support database/analytics, ERP, compute and collaboration.

What is next for digital infrastructure developments? Where are we in the cycle? How does the industry scale up, what business models are emerging, and what will the next generation of digital infrastructure look like?

At an  event for TMT leaders we explored critical topics and developments facing the digital infrastructure industry in the coming years:

  • Yannick Leboyer, COO at Zayo, shared his views on what is currently driving demand on digital infrastructure and the potential role of software.
  • Oliver Bradley, Managing Director at Macquarie, provided a true investor insight, having looked at a vast number of digital infrastructure investment opportunities.
  • Our third speaker provided a macro deal perspective, including how they are evolving.

The S-Curve

In many ways, we are just at the start of the digital infrastructure S-Curve with tremendous growth to come. Data centres are a hot commodity, driven by demand for data connectivity as customers transfer more and more enterprise workload to the cloud. Many customers seek more than one route for connecting to data centres to avoid any downtime, which in turn grows demand for fibre optic routes.

The slow progress of UK fibre deployment is largely attributable to a fragmented market made of small, local alt-net players and lare telco operators struggling with the high capex costs of national-scale roll-outs. However, we expect fibre infrastructure to grow both in the B2C and the B2B space as growing players are benefitting from scale effect and the market undergoes consolidation.

Small cell deployment is growing in Europe, despite pricing pressure on the value chain. Towers have seen heightened investment activity over the past decade due to being perceived as an easier, albeit capex-heavy, asset class to manage

Deployments scale up to meet rising demand

For Yannick Leboyer at Zayo, fibre demand is largely driven by three factors: new data centre construction, new subsea landings, and tower and small-cell deployments.

A driver of data centre investments has been customers’ increasing trust in cloud connectivity. As enterprise workload in the cloud continues to grow, uptime has become so critical that anything less than 100 percent connectivity is now unacceptable. The implications are two-fold: many customers are now wanting multiple routes for connecting to data centres, and new data centres are being built further away from the traditional data centre hubs due to the power constraints associated with “always on” service.

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In response to rising demand for alternate routes, new subsea landings have emerged. While Marseille remains a key landing site, longer routes connecting to the large infra hubs of London and Frankfurt have started from Lisbon and Genova to shift some of the traffic demand that the old landing sites are now struggling to serve. On land, new routes are being built not only to connect these subsea landings to data centre hubs, but also to connect the suburbian data centres to city centres. In 2020, we saw such new routes that connect new locations to traditional hubs emerge in the form of the Manchaster-London or the Schipol-Central Amsterdam lines.

Small-cell deployments in Europe are constrained by pricing pressure across the value chain. Compressed ARPUs pose a challenge of achieving the lowest cost to serve – which is at odds with investing in new fibre and connectivity deployments. One solution is to leverage existing ducts from the incumbents, as is available from Orange or from BT. The cost to deploy in these ducts is a lot lower than building new routes.

In terms of the shift towards software and associated services, from a fibre and infrastructure standpoint, there is a more immediate and pressing change underway.  That shift is the development of API based ecosystems between operators: real-time data feeds enabled through API’s allow for instant quotes, alarms and order placing to achieve better efficiencies.

New markets have new needs, old markets have new needs

The most interesting markets for Oliver Bradley at Macquarie are the ones where fibre deployment is not organised. Geographies such as Greece or parts of Eastern Europe, where fibre has been deployed but not organised or updated, are where we can see a lot of growth potential. Because the market in mature regions is highly competitive, investors are increasingly looking at exotic locations to generate returns through new fibre deployments.

For a long time, only large operators in the UK could afford to build fibre due to high costs of deployment. Although in recent years infrastructure fund-backed alt-nets have started to gain traction by increasing fibre penetration in local, niche markets, we now might ask the question – will they be able to scale up?

In a post-Brexit landscape, labour and production capacity may not be the critical issue, but rather the HQ staff itself. Alt-nets are facing increasing struggles with attracting talent below the senior manager level, which can impede their ambitions of growth. Another challenge is the access to ducts and poles: although the UK (years after other mature markets like Spain or France) has now mandated that the incumbent, BT, give access to its ducts and poles, the location and quality of ducts is often little known. As a result, even if the rights to access are given, the physical access will pose a challenge for providers looking to use them.

Changing deals and dealing with changes

One speaker said they see deal activity in this sector measured in concurrent waves. In the past years, there has been a lot of activity on the tower side, largely due to the investor and debt perception that it’s an easier asset to manage. Telco digital infrastructure deals have seen a big ramp up in the form of MNO tower carve-outs (Orange Totem, Vodafone Vantage), driven by the increasing capex burden upgrading the towers pose for operators.

It remains to be seen if towers will always be seen as an “easy asset”. The market is constantly evolving through deal innovation, and there is a level of comfort required to be able to generate value through tower carveouts. Asset class evolutions, such as value chain integrations with active equipment suppliers, can make things more complicated which both investors and operators will need to adjust to as the Pan-European tower consolidation trend continues.

From a fibre standpoint, Fibre-to-the-home (FTTH) has been the largest point of investor interest recently, driven by regulatory and supply considerations. National and Europe-wide legislations and subsidies have been launched to encourage fibre roll-outs, however, operators are often constrained by the amount of capex investments required for these – and the cash-flow generation inflection points are yet to be seen for this capex-heavy work in the UK. As a result, a number of funds are now looking to deploy more capital or form joint ventures with fibercos to deconsolidate the asset heavy vehicles. The scalability of remaining markets in the UK and Germany provide a buffer for these funds to play due to the scale effect and the expected consolidation between alt-net players. On the Fibre-to-the-business side, we are also to see more activity in the dark- and lit-fibre space as people are getting more comfortable with the asset class.

For data centres, activity has been more muted on a single asset class-basis in Europe, compared with the US or Asia. However, the way Laurence sees it, it’s only a matter of time until it ramps up, with supply likely to come from carveout assets of telco operators.

The mind-blowing money in multiples

Overall, valuation multiples are simply incredible in the digital infrastructure space. Just two years ago, 15-20x EBITDA for towers were shocking, and now the market is supporting 22-25x, and in some deals even touching a multiple of 30. This goes hand-in-hand with debt market developments, where the new norms are raised from multiples of 4-5 to north of 7x.

For fibre, multiples are a bit more restrained: for FTTH, the norm is more single digit than double. On the data centre side, although deals are much more US-focused, European EBITDA multiples are often around the 22-25x mark with a lot of investor activity.

What’s next?

The next steps for serving fibre and infrastructure demand will likely involve software as a service (SaaS) considerations, API integration for real-time quotes and orders, and entering adjacent markets to fibre / tower to enable efficiencies.

Demand for digital infrastructure in the European and the UK markets will continue to grow over the next decade, and we remain ambitious of its position as an attractive investment asset class. Whether it be smaller disruptors or large incumbents, making it or breaking it in the sector will depend on the ability to digest changes and respond proactively as the business models continue to evolve.