By Michael Knott, Yaroslav Stetsenko and Gary Taylor

How changes in macroeconomics are affecting deal flow and investment

The triple threat of inflation, interest rate increases, and recession is having a stifling effect on digital infrastructure (DI) deals, with European transactions down by over 40% in the second half of 2022 compared to 2021. There is also evidence that processes related to fibre, data centres, and towers are taking longer and/or stalling on the back of misalignment between seller and buyer value expectations as we go through this “adjustment phase”.

These macroeconomic factors are not only impacting digital infrastructure, with many other sectors being worse hit. However, there is evidence to suggest that infrastructure investors specifically have been shifting investment and focus away from DI towards other infrastructure asset classes.

Exploring the reasons for this, Roland Berger believe that investors feel DI assets are, relatively speaking, more exposed to inflation risk. However, although all three DI asset classes typically have CPI adjustments built into contracts, operators’ ability to pass these through on a full and continuous basis is less than proven. Of the subsectors within DI, this is particularly true of fibre, where there is evidence that fibre/broadband prices have not been keeping pace with inflation historically (even when it was low). Despite regulatory considerations, this can ultimately put pressure on wholesale prices as well. It is not surprising, therefore, that of the three DI sub-sectors, the biggest fall-off in H2 2022 deals is in the fibre space.

Understanding macroeconomic scenarios — as well as navigating the valuation impacts on digital infrastructure assets — is not a trivial exercise and will be crucial if DI deal levels are to be sustained in 2023.

Macroeconomics

The war on Ukraine, coupled with other global factors, has led to a “triple threat” of macroeconomic factors which are constraining investment and M&A activity: inflation, interest rate rises, and GDP slow-down. Widespread inflation began in the second half of 2020 as economies began to work their way out of the pandemic, yet global supply-chains were broken. Inflation accelerated through 2021 and 2022, largely driven by energy price rises, and in the UK, for example, inflation peaked at over 11% in October 2022. This persistent and rapid increase in inflation has led central banks to increase interest rates across the Western World, with the Federal Reserve, for example, rising the fed funds rate to over 4% by the end of 2022. This, coupled with an economic slowdown and many economists forecasting potential recession, has added significant risk to M&A activity.

M&A activity

As an asset class, infrastructure investments have often been seen as relatively “recession proof”. Whilst that may be true, evidence suggests that infrastructure investors perhaps do not see all infrastructure sub-sectors as equals in this regard. The current (unique) macroeconomic environment appears to have put more stress on DI (traditionally consisting of towers, fibre, and data centres) compared to other infrastructure asset classes. We can see this in the data below, where European transaction volumes associated with DI for the second half of 2022 were down over 40% compared to H2 2021.