Value Add, or Core-Plus, Will Get More Attention in Digital Infra

Eventually, in virtually all phases of the computing, connectivity and software businesses, competition for any product or service eventually shifts to value add. The reason is simply that in highly-competitive markets, value-added benefits are one way to create distinctiveness while counteracting the pressure to compete on price.

Value-add also is a strategy used by firms to boost valuations. And we are likely to see more efforts in that regard in the digital infrastructure business. Investors call that a "Core-plus" strategy.

Even as digital infrastructure continues to gain a place in alternative asset portfolios built around infrastructure, the near term climate is challenging. 

In some parts of the digital infra investing business, the emphasis already has shifted to value creation, driven by near-term headwinds that put pressure on both financial returns and limit exit opportunities. 

Multiple compression also is slowing deal volume, as buyers and sellers cannot agree on valuations. 

source: BCG

Private equity markets have gotten tougher, squeezed by higher interest rates and inflation. That should apply to digital infrastructure as well, translating into fewer deals, smaller deals, some distress sales and more consolidation within the industry. Fewer exits also will happen, in some part because the initial public offering window has closed, eliminating a possible exit path. 

And, as always, rising interest rates have an inverse relationship to asset prices. Just as the costs of financing have risen, asset values have plunged along with financial returns. 

So it’s a buyer’s market, once sellers have adjusted to multiple compression and buyers have prepared for volatility. 

 

source: PwC. 

As happens with other markets, a shift in asset multiples leads to disagreements over valuation that mean fewer deals. Some believe reduced deal flow and assets under management for infrastructure could still grow by 2025, suggesting that a rough period is likely in store for 2023. As has already been the case, profits likely will be harder to come by, in the meantime. 

Value-creation mechanisms should differentiate above-average and average returns, says PwC.