Colony Capital (NYSE: CLNY) had a strong Q3 2020, with its stock responding positively. The company continues to make new investments across all four sectors of digital infrastructure, including towers, data centers, fiber, and small cells & distributed antenna systems. Below, we detail Colony Capital’s Q3 2020 achievements, an update of how its growing its assets under management, and dive deeper into how Colony is using DataBank to tackle the growing edge computing investment opportunity.
Colony Capital – Rotation Underway in Q3 2020
Colony Capital is transitioning away from being a diversified Real Estate Investment Trust (REIT), managing real estate assets across many verticals, including healthcare and hospitality. Instead, Colony is positioning itself as a singular platform that is focused exclusively on digital infrastructure. Specifically, digital infrastructure includes towers, data centers, fiber, and small cells & distributed antenna systems.
Rotation Away from Legacy Real Estate – Hospitality
In Q3 2020, Colony Capital signed an agreement to sell its hospitality business. By doing so, Colony achieved positive equity value for Colony shareholders, despite the pressures that face the hotel sector today. In turn, the sale of the hospitality business reduces Colony’s consolidated debt by $2.7bn (see left above). Additionally, the sale also removes the distraction from management of having to operate a non-core asset.
Rotation to Digital Infrastructure – Data Centers
In Q3 2020, DataBank agreed to acquire zColo, from Zayo, for $1.4bn. zColo adds 44 data centers, 13 key interconnect locations, in 23 markets across the United States and Europe to DataBank’s data center assets. Further, the zColo acquisition transforms DataBank into a national scale edge data center operator with 29 Tier-1 and Tier-2 data centers and 64 data centers overall. zColo effectively triples DataBank’s footprint across the United States. Additionally, the combined company will have 30k network cross connects, up from only 6.8k at DataBank currently.
The DataBank acquisition was financed with $145m of Colony Capital’s balance sheet equity. Therefore, Colony maintains its 20% ownership stake in DataBank, post-close. Further, the transaction brings $500m of new co-investment capital, which pays Colony fees and carried interest. Finally, Colony was able to secure over $600m in debt financing to support the acquisition.
Colony Capital – Q3 2020 Update
Colony Capital achieved a number of strategic milestones during Q3 2020 (as seen below). Two of the most notable achievements are expanded upon below. Specifically, these achievements have importance for the long-term positioning of the company.
Strategic Wafra Investment – $400m
In July 2020, Colony formed a strategic partnership with Wafra, which is an investment firm, backed by Kuwait sovereign wealth funds. Wafra made a minority investment in Colony’s Digital Investment Management business worth 31.5% of the management fees and carried interest generated by that business.
Wafra will also fund $130m into certain of Colony’s funds, including:
- Digital Colony Partners Fund I (current fund which Colony is investing out of) – at least $60m of the total
- Digital Colony Partners Fund II (the next fund which Colony is currently raising)
- Colony’s new Digital Credit Fund, which will be the new strategy for Colony Credit Real Estate (NYSE: CLNC)
Wafra also received five warrants to purchase up to 5% of Colony Capital’s shares. These warrants have five staggered strike prices of $2.43 per share, $3.00 per share, $4.00 per share, $5.00 per share, and $6.00 per share, for each warrant, exercisable until July 2026. Therefore, Wafra’s warrants will all be in the money, if the Colony stock price exceeds $6.00 by July 2026.
Wafra paid consideration for its investment in the Digital Investment Management Business of $284m, comprised of:
- $254m in cash; and
- Contingent consideration of $30m to be paid if the run-rate EBITDA of the Digital Investment Management Business is $72m or greater by December 31, 2020
Valuation of the Digital Investment Management Business
Overall, Wafra’s investment implies an $805m valuation of the Digital Investment Management Business. In Q3 2020, the Digital Investment Management Business generated $8.9m of fee-related earnings on a quarterly basis, which equates to $35.6m on an annual basis. Therefore, the implied multiple paid by Wafra on Colony’s Digital Investment Management Business was 22.6x fee-related earnings.
Vantage Stabilized Data Center Portfolio (Vantage SDC) – $200m Investment
In October 2020, Colony alongside third-party capital, invested $1.36bn for a ~90% equity interest in Vantage Data Centers‘ portfolio of 12 stabilized hyperscale data centers in North America. Thus, Vantage SDC, overall, was valued at $1.5bn. Further, Colony Capital’s balance sheet investment is ~$200m, representing a ~13% ownership interest.
Vantage SDC is Colony’s second significant balance sheet investment (after DataBank) in a digital operating business. Therefore, this transaction once again emphasizes Colony Capital’s rotation towards digital infrastructure investments.
Colony Capital – Fee Earning Equity Under Management (FEEUM) Growth
As of September 2020, Colony Capital had $46.8bn of total assets under management, of which $23.3bn was dedicated to digital infrastructure. Excluding, Colony’s digital balance sheet investments, the company manages $22.2bn on behalf of third-party investors (as seen below).
Of the $22.2bn of total digital assets under management, only $8.6bn of those assets generated fees (as seen above). Thus, the Digital Fee Earning Equity Under Management was $8.6bn at the end of September 2020 (as seen above).
The attribution as to why only ~38% of the Assets Under Management are fee-earning is primarily driven by:
- Separately Capitalized Portfolio Companies (former Digital Bridge): which include Vertical Bridge and ExteNet
- Co-Investment (Sidecar) Capital: which includes a portion of Zayo, Vantage Data Centers and DataBank
This means that significant portions of these capital sources do not have fee-paying limited partners (LPs).
Colony Capital – FEEUM as of Q3 2020
Referring to the chart above, $2.3bn of net Fee Earning Equity Under Management (FEEUM) was raised year-to-date. This represents the increase from $6.8bn of FEEUM at the end of 2019, to $9.1bn of FEEUM pro forma Q3 2020. Specifically, this increase to FEEUM is primarily driven by the following contributions:
- $700m from third-party co-invest capital for the acquisition of Zayo
- $310m from third-party co-invest capital for the acquisition of Vantage Europe
- $600m from third-party co-invest capital for the acquisition of Vantage SDC
- $500m from third party co-invest capital for the acquisition of zColo by DataBank
Colony Capital – Edge Opportunity
Edge computing is a critical component of technologies like 5G. Moreover, edge computing is facilitating the convergence of compute, storage, and networking. Colony Capital outlines what it sees as the edge opportunity below.
Exponential Growth in New & Emerging Use Cases (Top Left Quadrant)
Compute has continued to grow rapidly over the last 10 years. What has been underappreciated, is the exceptional growth in demand that is yet to come. In the next 5 years, artificial intelligence systems will move out of the test rooms and Internet of Things applications will be deployed. Machine-to-machine communications underpins use cases for Artificial Intelligence, the Internet of Things and cloud computing, which will cause compute (i.e., data center) demand to rapidly increase.
Pushes Demand Back to the Edge (Top Right Quadrant)
Where does this demand for compute come from? Increasingly it is coming from the edge. Indeed, that notion has never been more prevalent than it has been during COVID-19.
The edge is mobile, and is relevant for the consumer and enterprise customer to interact with the network in real-time. Overall, the edge is not a short-term trend, but rather a multi-decade cycle. Inevitably, compute will migrate from “centralized computing” back to a “distributed computing” model, at the edge of networks.
Forcing Changes in Network Architecture (Bottom Right Quadrant)
That shift to “distributed computing” is already forcing changes in network architecture. Specifically, because new use cases require lower latency, faster speeds, and better device efficiency. New applications do not have time to send all their data back to a central location, because this would increase latency too much. Instead, the data has to be processed in real-time. This means compute resources need to be close to the end user. Indeed, this is truly the definition of the edge.
Driving Strong Growth in Edge Server Deployment (Bottom Left Quadrant)
Ultimately, these trends will drive strong growth in edge server deployment. Over the next 8 years, edge servers will support 10% of cloud workloads globally, which is an increase from just over 1% today. That translates to over 1.5 million servers sitting in edge data centers around the world. In turn, this edge opportunity is a significant growth driver for Colony’s portfolio companies including DataBank, and the transformative acquisition it made with zColo.
Edge Compute – Deployment Types
In order to visualize the edge better, it is helpful to categorize it by its three different forms. The three types of edge deployments are i) C-RAN hubs, ii) data centers (e.g., DataBank), and iii) containers at towers.
(1) C-RAN (cloud-Radio Access Network or centralized-Radio Access Network) Hubs
C-RAN hubs offer the marriage of mobility, and applications moving closer to the edge of carriers’ networks. Ultimately, this reduces latency and gets close to the carriers’ customers, thereby enhancing the customer experience.
Colony Capital has 680 C-RAN hubs owned, built, or managed, primarily through ExteNet. These C-RAN hubs are hosting edge compute and Colony has been active in this space for the past 3 to 4 years.
Additional examples of C-RAN hubs take the form of the cloud service provider partnerships with the carriers. For example, AT&T and Microsoft Azure have partnered. Additionally, Verizon and Amazon Web Services (AWS) have partnered. Finally, T-Mobile also has a series of partnerships which it has not publicly announced yet.
(2) Data Centers (e.g., DataBank)
DataBank is building edge data centers in Tier-2 and Tier-3 markets, i.e., not in the core city-center, traditional Tier-1 locations. Example of these cities include Overland Park (Kansas), Plano (Texas), and Bluffdale (Utah). These data centers are in periphery markets, just outside of large cities. In these edge markets, workloads are shifting further out towards the suburbs.
COVID-19 is driving an increase in demand for these types of edge facilities. In turn, bigger workloads are shifting to edge facilities. This presents an opportunity for companies like DataBank to continue developing these edge facilities because it fits nicely between colocation and hyperscale, in terms of capacity. These edge workloads and leases fit in the “gap”, offering between 0.25 MW to 1 MW of power capacity, for these secondary and tertiary markets.
(3) Containers at Towers
Container-based edge compute takes the form of placing smaller, container-based edge compute facilities closer to, or at the base of the cellular tower. As an example, Vertical Bridge is the fourth largest tower company in the United States and has partnered with a number of different data center companies (including EdgePresence), to trial having data centers at the base of its towers. Overall, this business model remains the most unproven, as compared to the C-RAN Hub and Data Center strategies.
Colony Capital – DataBank and the Edge
With regards to the edge opportunity, Colony Capital has already made an investment in this space through its portfolio company DataBank, which made an investment in a company called EdgePresence.
DataBank announced that it has made a $30m strategic investment in EdgePresence, an owner and operator of multi-tenant, modular data centers, providing space, power, bandwidth, and interconnection across key United States markets. EdgePresence’s Edge Data Centers are modular, purpose-built data centers, comprehensively and compactly designed. These facilities include critical power, monitoring, physical security, and cooling. Specifically, these data centers are situated in targeted locations at the base of cell towers, key real estate, and enterprise campus locations.
EdgePresence’s Edge Data Centers will enable DataBank to colocate its customer workloads at the “far edge” to further reduce latency and improve performance for select applications. This modular capability complements and expands DataBank’s edge strategy.
Overall, DataBank is executing on the next-generation of converged networks. Specifically, the zColo acquisition gives DataBank a scaled national footprint with on-ramps to global Internet traffic. Additionally, EdgePresence and their modular data centers located at the base of cellular towers, gives DataBank access to what is known as the “far edge”. These are both very important deals that sync DataBank’s profile with the demand for edge computing.
Vertical Bridge Partnership – Connecting the Dots
EdgePresence is also partnering with Vertical Bridge, one of Colony Capital’s other portfolio companies to deploy their micro data centers at the base of Vertical Bridge’s towers. At present, EdgePresence has data centers at 12 Vertical Bridge locations. However, Vertical Bridge has tower locations in over 9.0k locations across the United States, demonstrating the potential further partnership opportunity between the two companies.
Colony Capital – Companies Owned at Q3 2020
Colony Capital’s companies operate and manage ~350k sites, >140k route miles of dense metro fiber, >40k small cell nodes and >95 data centers globally. As seen below, the company continues to make new investments across all four sectors of digital infrastructure, including towers, data centers, fiber, and small cells & distributed antenna systems.