Global M&A trends and risks
Powerful new forces shaping in the M&A landscape
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United Kingdom | Publication | June 2021
Over recent years there has been a growing focus by infrastructure funds and other investors on digital infrastructure as a distinct asset class, which has in turn led banks and other financial institutions to follow suit. Initially, this was primarily related to towers, but in the past couple of years we have seen a broader application to fibre/broadband investments, data centers and other digital infrastructure opportunities (such as cable and satellite).
With the impact of Covid-19 combined with a growing governmental focus on improving connectivity, this is expected to accelerate. Digital assets will become increasingly important to support the growth of Smart, sustainable cities; the shift towards remote working; increased connectivity; and the digitization of company operations such as supply chains.
As part of this series of guides, we set out below some key considerations for financing data centers based on our extensive global experience advising infrastructure investors, developers and lenders on such matters.
Financings in this sector are certainly far from commoditised, however there are key themes and issues underpinning sponsor and lender considerations in each case. An understanding of these issues and the various options, flexibilities and alternatives available is vital in order to arrive at an appropriate and balanced position that addresses both borrower and lender sensitivities.
Financings for data centres can be structured on a number of bases, such as on a project financing basis, real estate financing basis or receivables financing basis, depending on the development stage or level of operating maturity of the asset.
For the purposes of this guide, we have focused on financings of a single asset on a project financing basis. Financing on a project finance basis is compatible with operators seeking to achieve off-balance sheet limited recourse financing.
Single asset vs multiple assets
We have seen single asset financings, but also financings where a portfolio of greenfield data centre projects was financed on a cross-guaranteed and cross-collateralised basis. In a portfolio financing the development risks in connection with the data centre being constructed can be offset by operational revenues of other datacentres within the borrower’s portfolio.
Greenfield projects vs brownfield projects
Greenfield - the developers/operators require loan facilities to fund the design, construction, operation, management and maintenance.
Brownfield projects – we have seen financings where the developers/investors required loan facilities to fund (i) the acquisition of a data centre operator owning an existing data centre and/or (ii) the expansion of an existing data centre.
In the recent transactions we have been involved in, financing was in each case provided by a syndicate of commercial banks (as opposed to e.g. institutional investors or alternative credit providers).
The borrowers were mostly special purpose vehicles incorporated by major international developers and operators of hyperscale campuses. Most of these are well-established players in the market, active in many different regions across Europe and the US. Most of these developers/operators are backed by private equity, including large infrastructure investment funds.
The offtakers (or tenants) are in typically global hyperscale customers, e.g. Google and Microsoft. In some cases these hyperscale customers are the anchor tenants using a large part of the available capacity whereas the remaining capacity is leased to other (smaller) tenants.
Offtake contracts – representing the sole source of income of a data centre project, the offtake contracts are critical from a lenders’ perspective.
A due diligence review is performed by technical and legal advisers, identifying any risks (e.g. early termination rights for the offtaker).
A key question is what the lenders will require in terms of the offtake structure. A single anchor tenant may be sufficient but lenders may also require the contracted capacity to be above a certain threshold, potentially requiring additional offtake contracts to be in place as a condition precedent to funding as well.
Lenders will typically require the offtake contracts as well as offtakers themselves to meet certain pre-agreed criteria, including with regard to their creditworthiness. We have also seen a test being built in whereby the weighted average offtake contract tenor must remain above a certain number of years.
Accordion facilities – we have seen an uncommitted accordion being included (i) in order to establish a framework for additional debt capacity to be used for the construction of additional data centres or (ii) for the expansion of capacity of the relevant existing data centre.
Maturities - the tenor of the loans ranged from 5 years to 7 years.
Amortisation - repayment is very often structured such that only a small portion of the debt amount is amortised (e.g. 10 – 15%), with a significant bullet repayment at maturity. Usually, no repayments will need to be made during the construction phase, which typically lasts 2 years although this depends on the development stage of the project at the time of financial close.
Cash sweep - in most transactions, there is a cash sweep mechanism whereby excess cash flow must be used to prepay the debt. The cash sweep can be linked to certain events, including where the distribution tests (i.e. criteria which need to be met in order for the borrower to be able to make dividend payments) are not met for a number of consecutive periods. We have also seen cash sweeps whereby a certain percentage of “excess cash” is applied towards prepayment on an annual basis. The percentage of excess cash to be prepaid normally increases over time (e.g. 25% in year 1, 50% in year 2, 100% from year three onwards) so as to promote refinancing.
Debt Sizing - sizing of the facilities is tied to the financial model and a gearing ratio, with gearing limitations typically requiring equity contribution of between 20% and 30% of the total spend. The tenor and projected revenues generated by the key offtake contracts are obviously very important factors.
Security package and guarantees
Security – this will typically include all assets of the borrower/operating company (including key contracts, insurances and account balances) and all shares of (and shareholder loans into) the borrower/operating company.
Guarantees - we have seen guarantees being granted by the sponsor to cover any project cost overruns. This is however not a standard feature in project financings – it is requested by lenders in cases where the contingency budget for the construction and development is deemed insufficient by the lenders’ technical adviser. Also, we have seen financings whereby the granting of a parent company guarantee was contingent on non-fulfilment of certain important conditions subsequent. For example, the borrower was obliged to procure the granting of a parent company guarantee in case the building or other permits were not in place before a certain date.
Financial covenants - the following financial covenants are typically included:
Keep well letters and SNDAs - key offtake contracts are often entered into with local subsidiaries of the offtaker. These subsidiaries may not be sufficiently creditworthy from a lenders’ perspective. The sponsor and the lenders therefore often require that the relevant parent company of such subsidiary provide comfort to the sponsor and/or the lenders that it shall ensure that its subsidiary shall have sufficient funds to comply with its payment obligations. This is typically done through a so-called keep well letter. Not all hyperscalers are sympathetic to this requirement, in which case lenders are forced to accept mitigating structures.
Similarly, the global hyperscalers may refuse to enter into SNDAs (subordination, non-disturbance and attornment agreements) with the lenders. An SNDA is an agreement between the offtaker and the lenders (represented by a security agent acting on their behalf) to establish a direct contractual relationship between the offtaker and the financiers. In short, the lenders commit towards the offtaker to avoid interference with the offtaker’s use of the data centre (non-disturbance) as much as possible, including in an enforcement scenario. In turn, the offtaker will be under an obligation not to terminate the offtake contract without giving the lenders prior notice (e.g. 90 days) and the opportunity to “step-in”, meaning that the lenders are being granted some time to remedy the issue at hand with a view to keeping the offtake contract in place.
Nina Varumo is a freelance portrait and documentary photographer based in Stockholm. A recent project of hers Kvinnor till sjöss (‘Women at sea’) is on ongoing photo series highlighting the working life of female seafarers in order to change the stereotypical image of what and who is a seafarer.
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