Colony Capital today reported Q4 2020 earnings and provided investors with its thoughts on the key digital infrastructure investment themes for 2021 and how it plans to deploy capital into these investments, be it through its investment management private equity vehicles, Digital Colony Partners I and II, or directly on its balance sheet.

The company underscored that it is a global digital infrastructure REIT, focused on converged networks. Colony Capital differentiates itself through a unique series of solutions that are focused on next-generation mobile and internet connectivity for customers.

Overall, customers of digital infrastructure no longer make their purchasing decisions based only on one segment of digital infrastructure. Increasingly, customers want to lease a combination of digital infrastructure such as towers, edge compute, fiber, and small cells. Therefore, it is increasingly important, to be able to offer customers the entire ecosystem of digital infrastructure assets. A converged solution.

Colony Capital Digital Infrastructure Converged Networks

Key digital infrastructure investment themes, such as 5G networks, which we discuss below, are driving the need for converged solutions. Therefore, understanding how to deliver solutions for customers across multiple verticals of digital infrastructure is a critical success factor. Ultimately, a combination of digital infrastructure is needed for 5G networks to perform from a speed, latency, and reliability perspective.

Digital Infrastructure Investment Themes

Below are the four key areas of opportunity and investment themes in digital infrastructure that Colony Capital is pursuing in 2021. Moreover, these secular trends which include 5G technology, the Internet of Things (IoT), cloud computing, and edge computing, are all being accelerated by COVID-19. In turn, this drives higher growth for digital infrastructure.

Colony Capital Digital Infrastructure Investment Themes

5G Technology

5G is a profound and transformative shift for mobile networks globally. To that end, $1.1tn in new capital expenditures will be spent between 2021 and 2025, deploying these next-generation networks.

Many of Colony Capital’s portfolio companies are already having discussions with customers on 5G opportunities. Indeed, certain companies like Vertical Bridge in towers, have already signed new master lease agreements related to 5G deployments. Moreover, 5G is a global theme, with 5G technology being a growth driver for Colony Capital portfolio companies in North America, South America, Europe, and Asia.

Internet of Things (IoT)

Internet of Things networks and connections are growing rapidly. In 2020, global Internet of Things devices reached 20 billion connections. Indeed, over the next 4 years, global connections are projected to increase 4x to 80 billion total connections. Furthermore, by 2030, global connections are anticipated to increase 25x from today’s levels to 500 billion connections.

Importantly, the Internet of Things (IoT) is transforming the way in which connections are defined. No longer are connections simply consumer-to-consumer (C2C) connections or business-to-consumer (B2C) connections. Notably, device-to-device (D2D) connections are becoming equally or more important for the Internet of Things (IoT).

Cloud Computing

The cloud service providers and other hyperscale customers are core to the growth of digital infrastructure going forward. Specifically, cloud infrastructure capital expenditures globally will increase to $88bn per year for 2021. Indeed, this is a 14% year-over-year increase in global spending from customers like Amazon Web Services (AWS), Microsoft Azure, and Google Cloud. Colony Capital foresees strong growth in its hyperscale data center businesses around the globe, to support these key customers.

Edge Computing

Edge computing and its growth impacts a significant number of Colony Capital’s businesses (e.g., DataBank). Overall, 1.6 million servers will be placed on the edge by 2028. Indeed, this will represent 10% of all cloud workloads globally, which is an increase from only 0.2% currently. Given that applications need to move closer to consumers, devices, and enterprises, the digital infrastructure must follow in proximate locations.

Digital Infrastructure Capital Sources

For clarity, Colony Capital distinguishes its Digital Investment Management (IM) business from its balance sheet (also known as Digital Operating). Firstly, Colony Capital’s investment management business primarily consists of its two private equity funds, Digital Colony Partners I and Digital Colony Partners II. Secondly, Colony Capital’s balance sheet investments in digital infrastructure are currently DataBank and Vantage Stabilized Data Centers (Vantage SDC).

Colony Capital Digital Infrastructure Investments

Between its balance sheet and investment management business, Colony Capital has assembled a global portfolio of digital infrastructure equating to $30.0bn in assets under management (AUM). Indeed, Colony Capital has invested these funds across 19 distinct portfolio companies, which globally represent 16k+ owned towers, 100+ data centers, 130k+ fiber route miles, and 38k+ small cells.

Investment Management (IM) – Digital Colony Partners II

In terms of new capital formation, Colony Capital has raised $4.2bn through the first close of Digital Colony Partners II, its private equity fund. Overall, Digital Colony Partners II is targeting a final close capital raise of $6.0bn by the end of 2021. Notably, Digital Colony Partners II has already exceeded the Digital Colony Partners I total fund size of $4.0bn. Moreover, Digital Colony Partners II is currently the largest dedicated digital infrastructure fund in existence.

Colony Capital is already deploying capital from its Digital Colony Partners II fund. To-date Digital Colony Partners II has closed three investments in the fund. Additionally, the fund has a further three investments under exclusivity, which are platform investments.

Investments made through Digital Colony Partners I and II (i.e., the investment management business) are more growth-oriented than balance sheet investments made at Colony Capital. Additionally, these private equity fund investments do not have a current cash-on-cash yield, and many are characterized as platforms. Therefore, investments made through Digital Colony Partners I and II are in businesses built to grow.

To capture this growth, Digital Colony is investing fresh capital into its portfolio companies. Specifically, Digital Colony is developing new, ground-up, towers, data centers, and fiber route miles. Therefore, these investments typically do not produce the current cash-on-cash yields that digital infrastructure REIT investors desire.

Scaling Co-Investment Opportunities

Colony notes that one of the benefits of having a larger fund for Digital Colony Partners II (i.e., $6.0bn target), as compared to Digital Colony Partners I (i.e., $4.0bn) is the ability to pursue larger transactions. This is because Digital Colony can scale up its co-investment opportunities for its Limited Partners (LPs). Indeed, with a larger fund size, Digital Colony is able to access a deeper pool of Limited Partners (LPs) that may have an interest in a particular investment opportunity.

As a case study, Digital Colony’s Vantage Data Centers (North America) and Vantage Europe have experienced tremendous growth in their respective markets. However, as the Vantage platform starts pursuing data center opportunities elsewhere around the globe, such as in Asia or the Middle East, the company will need more capital. In turn, Digital Colony will continue bringing in strategic co-investment capital that has local knowledge of those respective geographic markets. Importantly, Colony anticipates that it will raise a significant amount of co-invest capital during 2021.

Digital Infrastructure Owner Partnerships

Partnerships with customers is a significant investment theme for the Digital Colony Partners II private equity fund in 2021. Whether the customer is a hyperscale company, cable company, or wireless carrier, all of these companies own digital infrastructure assets. Additionally, all of these companies desire a more efficient way to own and build their digital infrastructure.

When considering where to deploy the $4.2bn+ of capital in Digital Colony Partners II into new investment opportunities, the firm is assessing how it can build closer relationships with its customers. Indeed, this strategy has two purposes. Firstly, Digital Colony can help customers relieve themselves of stranded capital, in the form of digital infrastructure. Secondly, Digital Colony can build digital infrastructure for customers to help them achieve their visions for 5G technology, the Internet of Things (IoT), cloud computing, and edge computing.

Overall, Digital Colony’s current pipeline of deals includes working with customers on specific investment opportunities to capitalize on these themes. Indeed, Digital Colony’s partnership focus is borne out of evolution. For example, recent towers precedent M&A transactions are trading at multiples of 30x+ tower cash flow (e.g., InSite Wireless), which Colony considers too high.

Balance Sheet – Colony Capital

Colony Capital’s strategy for deploying balance sheet capital is to focus on acquiring assets that are yield-driven, REIT-qualifying, and which offer downside protection. Specifically, Colony Capital wants to deploy balance sheet capital into investments that help build a more predictable earnings stream. Therefore, these balance sheet investments must produce the current cash-on-cash yield that investors desire from the balance sheet of a digital infrastructure REIT.

Current Digital Infrastructure Investments

In 2021, Colony Capital targets adding one new digital infrastructure asset to its balance sheet, which is in addition to its two existing holdings. Through its balance sheet, Colony Capital currently owns a 20% interest in DataBank, and a 13% interest in Vantage Stabilized Data Centers (Vantage SDC).

DataBank – Updates

In February 2021, DataBank completed the acquisition of zColo, a portfolio of 44 data centers from Zayo Group, for total consideration of $1.4bn. As part of this deal, Colony Capital invested $145m to maintain its 20% ownership interest in DataBank.

Currently, DataBank operates 64 data centers, representing 138 megawatts of power capacity. Collectively, these data centers comprise 1.2 million sqft, in the United States and Europe, supporting over 3k customers.

Vantage Stabilized Data Centers (Vantage SDC) – Updates

Vantage SDC represents a portfolio of 12 stabilized U.S. data centers that Colony Capital acquired from Vantage Data Centers (owned by Digital Bridge). Furthermore, Vantage Data Centers continues to develop new data center facilities.

As customers lease these Vantage Data Centers properties and they become stabilized, they will generate attractive cash-on-cash yields. Therefore, Colony Capital anticipates it will continue to add hyperscale data centers to its balance sheet by selling them from Vantage Data Centers to Vantage SDC.

Overall, Colony Capital thinks that stabilized hyperscale data centers are the ideal asset to own on its balance sheet. To this point, Colony indicates that it will add more hyperscale data centers to its balance sheet in 2021.

Future Digital Infrastructure Investments

Colony Capital also considers portfolios of towers, with average tenancies of 1.5x or more, are ideal assets to own through its balance sheet. Additionally, dark fiber (or wholesale fiber), which has the security of long-term leases, with durations between 10 years and 25 years, are assets that Colony Capital is targeting for its balance sheet.

Long-Term Digital Infrastructure Investments – Permanent Capital

Increasing investor appetite for digital infrastructure investments has led Colony Capital to many conversations with institutional money managers about forming permanent capital solutions for digital infrastructure. Simply put, investors want to invest in digital infrastructure in a permanent way.

One solution to this desire is Colony Capital investing through its balance sheet since it offers the permanency desired. For example, Vantage SDC is a case study whereby Colony Capital invested in the company through its balance sheet and then brought in long-term Limited Partner (LP) co-investors. Specifically, Vantage SDC attracted long-term institutional investors including pension funds and sovereign wealth funds into its capital structure.

Overall, Colony Capital plans to create more investment management opportunities to fit the desire for permanent capital and core capital in digital infrastructure.

Financing Digital Infrastructure Investments – Securitizations

Colony Capital’s team has significant experience in securitization financing across all digital infrastructure segments. Specifically, Colony Capital portfolio companies have completed securitizations in the digital infrastructure segments of towers, hyperscale data centers, enterprise data centers, and small cells.

Cellular Towers – Vertical Bridge and Mexico Tower Partners

In cellular towers, Colony Capital’s portfolio companies have done multiple securitizations, including Vertical Bridge in September 2020. Moreover, Colony Capital completed the first securitization of cellular towers in Latin America, through Mexico Tower Partners.

Hyperscale Data Centers – Vantage Stabilized Data Centers (Vantage SDC)

Colony Capital portfolio companies were the first companies to ever complete a hyperscale data center securitization. Subsequently, Colony Capital’s portfolio companies, in aggregate, have done four hyperscale data center securitizations. Most recently, in October 2020, Vantage SDC raised $1.3bn in securitized notes at a blended interest rate of 1.8%. The deal’s purpose was to refinance existing debt, extend debt maturities, and lower the company’s overall cost of debt.

Enterprise Data Centers – DataBank

In February 2021, DataBank priced a $658m offering of securitized notes at a blended interest rate of 2.3% primarily to refinance existing debt. Indeed, this transaction also served to extend DataBank’s debt maturities and lower its overall cost of debt. Specifically, the securitized notes have a 30-year tenor, with a 5-year Anticipated Repayment Date (ARD) date (i.e., optional prepayment date). Additionally, the securitized notes reduce DataBank’s borrowing cost by $17m per year.

Over five years, savings from reduced borrowing costs of these securitized notes adds $87m of free cash flow to DataBank. In turn, this enhances the company’s earnings, but importantly, allows the company to re-invest that capital into growing its business.

Additionally, DataBank closed a $100m variable funding note (VFR), allowing it to continue financing new construction at attractive interest rates.

Overall, DataBank’s securitization effectively, puts a permanent capital structure in-place for the company. Importantly, the transaction also represents the first securitization in the enterprise data center sector. Indeed, Colony Capital views the DataBank transaction as a case study for future low-cost financings of its balance sheet investments.

Mary Zhang covers Data Centers for Dgtl Infra, including Equinix (NASDAQ: EQIX), Digital Realty (NYSE: DLR), CyrusOne, CoreSite Realty, QTS Realty, Switch Inc, Iron Mountain (NYSE: IRM), Cyxtera (NASDAQ: CYXT), and many more. Within Data Centers, Mary focuses on the sub-sectors of hyperscale, enterprise / colocation, cloud service providers, and edge computing. Mary has over 5 years of experience in research and writing for Data Centers.


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