From Submarine Cables to the Cloud: Navigating the Digital Infrastructure Investment Landscape

Brice: What is the current state of the telecoms & digital market and how do you see deal activity evolving within the digital infrastructure space?

Stéphane: The European digital infrastructure market has been very active for over a decade now and continues to show significant capital inflows driven by the increasing need for digitalization. Having said that, we have seen a noticeable shift in certain segments of the market. In previous years, fiber had been the most active. Following early investments in submarine cables in 2008, Cube has been among the pioneers investing in fiber since 2010. However, while fiber investments had grown slowly and carefully for years, we subsequently observed a ‘rush to fiber’ starting from 2018-2019, further exacerbated by the COVID-19 crisis that amplified the need for high-speed broadband. This exuberance was short-lived, and from 2022, the enthusiasm for fiber has dropped for several reasons. These are mostly linked to the macro environment and debt availability but also to a reassessment of the competitive landscape, penetration and returns prospects in a number of markets such as the UK and Germany.

Meanwhile, other market segments, including data centers and cloud solutions, have gained further traction, fuelled by the ever-increasing need for data storage, data connectivity and the digital transformation of our economy generally. To a lesser extent, they were also driven by the increasing use of IoT solutions, remote working and the energy transition, the latter requiring significant investment to ensure efficient and sustainable processes.

Brice: How do these market conditions currently influence Cube’s decision-making?

Stéphane: Cube has a ‘buy and grow’ strategy across all target sectors and is therefore generally comfortable with significant capex plans. We tend to invest in operating platforms with strong management teams with a view to provide capital and strategic advice and thus support their organic growth. The general market environment, and in particular the debt market, plays a key role in the fiber sector, where significant lender support is required to complement our initial equity investment. From this perspective, the cost of debt and, more importantly, the availability of debt in some markets has played a role in the way we are allocating capital.

With Cube III, as investor risk appetite has reduced, we have de-emphasized fiber whose risk/return had deteriorated and allocated more to other segments of the digital infrastructure space, which are less capex-intensive, have lower volatility and are also more favorably perceived by lenders.

Despite the current challenges, maintaining exposure to digital infrastructure and managing it through the cycles remains relevant for the balance of our funds.

Brice: What are the key elements across the different segments of digital infrastructure that you focus on when investing?

Stéphane: First, it is vital for us to understand the regulatory environment and competitive dynamics when assessing a project. For example, when it comes to fiber projects, it is important to understand the local market environment – whether this is a concession-based business, similar to Covage in France in which we had invested in 2011, or if this is a market with full competition and no regulatory protection, or a de facto monopoly.

The second factor is market demand. We must assess the ramp-up risk on top of the deployment risk that we are underwriting in this type of projects. As mid-market ‘buy and grow’ investors, market demand analysis is especially important because we have to invest relatively early in the sector, ahead of larger investors and, sometimes, ahead of mass adoption and penetration.

Finally, the quality of management and leadership is of the utmost importance to us. It is key to the success of our ‘buy and grow’ strategy. Therefore, we tend to partner with entrepreneurs and managers and seek to implement the right long-term incentive schemes to align their interests with those of our LPs. This helps us provide not only capital but also advice and have a shared strategic view of the business throughout the investment period.

Brice: How would you describe the risk profile of digital infrastructure assets and how does it contribute to the overall risk/return profile of the funds managed by Cube IM?

Stéphane: In terms of portfolio construction, our digital infrastructure strategy provides more growth and value creation potential but also more volatility than other sectors we typically invest in. We try to strike the right balance between more mature yielding assets, for example renewable power generation or regulated public transport, and new types of assets in the digital infra space.

Our greenfield Connecting Europe Broadband Fund (CEBF) is a more structured product with several national promotional banks as core investors, such as the European Commission and the European Investment Bank. The fund has an additional stated objective that is supported by an EU policy of bringing high-speed broadband to underserved areas.

Brice: Given the hyper-competitive deal landscape in recent years, how do you source investment opportunities and how do you differentiate yourself?

Stéphane: During the gold rush to fiber assets, valuations in the sector had reached very high levels making it even more critical to originate proprietary investments. We tend to prioritize off-market opportunities that we source through our own networks and industry relationships and, as far as digital infrastructure is concerned, we have generally focused on early-stage assets, entering fairly new market segments ahead of the crowds. This, in turn, tends to reduce the competitive pressure we face from other investors.

We do not have mega funds that require very large equity tickets, so we can be selective and create partnerships with the management team, who are often also the founders or the founding family of the business we invest in. This is important because if you present a growth project to the owners of an asset, it can shift the focus from just maximizing the price on entry to increasing the value creation at our joint exit. This makes a significant difference in terms of competitive pressure and the entry price for those assets.

It doesn’t mean that we will never participate in auctions: we can do so very selectively when we have a specific angle and a high probability of succeeding without overpaying.

In summary, we seek to source proprietary deals, below the radar of our larger peers, and grow the assets to make them visible and attractive to such larger funds and strategics.

Brice: What do you expect to see in the coming year in terms of deal activity in the digital infrastructure space?

Stéphane: M&A activity in the sector is driven by its capital intensity and inherent economies of scale. As access to debt funding has generally become more difficult and onerous, we can expect consolidation moves, notably in the fiber market, in the coming months as operators will seek to compensate for the slower penetration and higher funding cost by extracting operational and financial synergies. Some of the large telcos that had been heavily relying on cheap debt to fuel their rapid growth are now being forced to deleverage and divest assets.

International expansion remains a pivotal catalyst for mergers and acquisitions, notably for data center operators who are strategically enhancing their portfolios through acquisitions. This approach complements organic expansion and the development of new facilities, responding to the escalating demand for computational power and storage solutions. This demand has been propelled by the rapid advancement of generative AI technologies and the enduring digital transformation of the global economy.

A notable impediment to M&A activity within the digital arena is the discrepancy in valuations between prospective buyers and sellers. This gap is a reflection of the market’s ongoing recalibration to the shifting macroeconomic landscape. Concurrently, a contingent of investors is opting to keep their dry powder, strategically awaiting opportunities to acquire undervalued assets amidst this adjustment phase. The gradual increase in transaction volumes in the sector suggests that this adjustment phase is well progressed now.