Higher Interest Rates Should Slow Digital Infra Investing

If interest rates remain high, or climb, for an extended period, transactions in the digital infrastructure space are going to slow down, since many deals are financed using borrowed money. The only issue is “how much will the deal flow slow?” 

The other issue is “how long will higher interest rates prevail?” Lower interest rates enable more transactions. 

Since the beginning of 2022, the private equity industry has finalized 92 data center transactions representing  $41.5 billion in deal value,, according to PitchBook data through August 25. 

Global Switch, which manages 13 data centers across Europe and Asia-Pacific, appears ready to join that list. According to Bloomberg, EQT, KKR and PAG are the final bidders for that asset. 

The $15 billion take-private of CyrusOne by KKR and Global Infrastructure Partners is by far the largest PE-backed data center deal this year.

Separately, Time dotCom has said it will sell part of its data center business to DigitalBridge. The sale of AIMS Data Centre appears to be part of a bigger expansion effort in Southeast Asia in conjunction with DigtalBridge. 

Between 2015 and 2018, private equity provided 42 percent of deal value in the data center sector, according to Synergy. Between 2019 and 2021 private equity share of the total deal value rose to 65 percent. 

In the first half of 2022, private equity deal reached more than 90 percent, according to Synergy analysts. 

But higher interest rates  should slow the pace of dealmaking, since debt is used to finance the deals, and debt is becoming more expensive. 

The longer term issue is exit strategy. Virtually all private equity assets are sold over a period ranging up to six years or so. So who are the eventual buyers? Public companies who prefer to operate businesses longer term, institutional investors with a longer time horizon or some strategic buyers, in some cases. 

Two decades, the quip often made was  that a software startups exit strategy was “we sell to Google.” In principle, hyperscalers could be buyers, though it seems more likely they also could be anchor tenants in markets where leasing makes more sense than building or buying. 

More Hybrid Digital Infra Coming?

Virgin Media O2 has begun construction of the XGS-PON network that will replace its hybrid fiber coax network. The move is perhaps notable for a few reasons. It is one of the world’s largest cable companies to adopt FTTH when expanding service beyond its current footprint. 

Some might see the move as a swap of FTTH for HFC. That is not the case. Virgin Media O2 is staying with HFC where it already is operating networks. 

But it will use FTTH to build a new wholesale FTTH network in areas it does not presently serve. In those areas, Virgin Media O2 will be an anchor tenant on a wholesale network half owned by InfraVia Capital Partners. 

Liberty Global and Telefónica will share ownership of half the venture. The new wholesale facilities will serve up to seven million premises that will not overlap with VMO2’s existing network. 

The new move is a continuation of the hybrid philosophy: both HFC and FTTH; copper and optical media; facilities-based competition but also facilities sharing; network ownership versus wholesale. 

As the cost of continually upgrading access facilities--mobile or fixed--continues to climb, there are likely to be additional efforts to “go hybrid,” and rethink the value of owned and leased capabilities. 

Traditionally, network ownership has been seen as a source of competitive value. Expensive access facilities provide business moats. These days, the capital investment required in a competitive setting increases the amount of risk for investing in fully-owned facilities. 

In markets where competition means a reduction in potential revenue by 40 percent or more (two facilities-based contestants), or in markets where a single wholesale network is available to all contestants, the value of facilities ownership is diminished. 

A monopoly provider might reasonably expect to get take rates close to 95 percent or more. Two competent facilities-based contestants will tend to split the market, each getting 40 percent to 50 percent of the installed base. Share in wholesale-based markets will be even more dispersed. 

Under those conditions, even if ownership confers some advantages, the magnitude of the advantage diminishes rapidly when two or more facilities-based providers compete. 

In the decades to come we might see even more of a shift to “facilities light” forms of competition, as service providers tweak their business models to protect profit margins. Along the way, new perceptions of what drives the highest value might develop. 

Already, the traditional business value of facilities ownership seems to be lessening.

Is It Time to Stop Harping on "Digital Transformation?"

If one defines digital transformation “as the integration of digital technology into all areas of a business resulting in fundamental changes to how businesses operate and how they deliver value to customers,” you can see why it is so hard to measure. 

DX affects “all” of the business; produces “fundamental change” in “operations and value” creation, it often is said. How often does any single technology change or program affect “the whole business?” How often does any technology program produce “fundamental change” in operations or value creation? 

Also, by that standard of “fundamental change,” many industries arguably already have achieved most of the value of DX. If “value for customers” is correlated with “how we make our money,” then content businesses and many retailers already have succeeded, for the most part. They sell online; they fulfill remotely; they handle customer interactions online. 

CaixaBank Research

 

Many other industries, such as marketing, consulting and research, likewise largely rely on online processes and fulfillment. Other industries possibly cannot pursue “fundamental transformation.” 

The qualifications, such as saying DX “will look different for every company,” only highlight  the problem. DX requires technology, to be sure, but also cultural change. And how do you measure that? 

Some might say DX requires a “culture of experimentation; a willingness to fail or an ability to successfully challenge older ways of doing things.” Some of us would say success in any single one of those areas will succeed only about 30 percent of the time. 

So what people often do not expect is failure. And there is no reason to believe any single effort at some part of DX will succeed more often than three times out of 10. 

source: BCG 

The e-conomy 2022 report produced by Bain, Google and Temasek provides an example of why DX is so hard to define or measure. Literally “all” of a business, all processes and economic or social outcomes are linked in some way to applied digital technology. 

And what we cannot precisely quantify or measure is hard to track or monitor. If one thinks of DX as simply the latest description of “applying digital technology” to processes, then one also understands why there actually is no end point. We simply keep evolving our technology use over time. 

source: Harvard Business Review 

We should not expect people and organizations to stop talking about “digital transformation.” But maybe we shouldn’t listen quite so much. 

Yes, by all means continue to experiment with new ways to apply internet, communications and  computing technologies to improve operations, product value and customer interaction capabilities.

You know, like we always have done.

Politicians Pile Onto Twitter, But Everyone is Cutting Lots of Jobs in Tech

Within a matter of days in November 2022, Twitter fired half of its workforce (3750 people), Amazon and Meta both cut over 10,000 jobs in mass layoffs. Other firms in technology, applications did the same. Asana cut 97 jobs. Zendesk sliced 350. Salesforce laid off 950 people. Stripe got rid of 1100. 

One month before, F5 laid off 100 workers; Microsoft 1,000; Oracle 201; Intel 100. Cuts were made by tech firms in the months prior to October as well. 

Many companies also instituted hiring freezes.  Globally, an estimated 200,000 tech workers have lost their jobs already, and more should be expected, as firms brace for a business slowdown of significant magnitude. 

source: Trueup

The point is that big layoffs are happening everywhere, as business leaders prepare for a recessionary environment. Only Twitter seems to be generating politician calls for action, which illustrates the political nature of such views.  All the other layoffs--business adjustments leaders have taken because they expect harder times--are ignored. 

Only Twitter generates ire and calls to “do something.” And that shows, more than anything, the politically-motivated nature of the calls for action against Twitter.

Fixed Wireless is the Clear Early Example of New 5G Revenue

At the moment, 5G fixed wireless is the clear contributor to new revenue sources earned by 5G networks. No other use case has produced the volume of new revenue. 

Revenues from 5G fixed wireless, in the near term, will dwarf internet of things, private networks, network slicing  and edge computing, for example. 5G fixed wireless might, in some markets, represent as much as eight percent of home broadband revenues, for example. None of the other sources is likely to hit as much as one percent of total revenues in the near term. 

The center of gravity of demand for 5G fixed wireless is households In the U.S. market who will not buy speeds above 300 Mbps, or pay much more than $50 a month, at least in the early going. T-Mobile targets speeds up to 200 Mbps. 

Verizon fixed wireless service plans also suggest that existing Verizon mobile customers are key targets. In the meantime, there is 4G fixed wireless, which will have to be aimed at a lower-speed portion of the market, albeit at about the same price points as 5G fixed wireless. 

Up to this point, Verizon 4G fixed wireless, available in some rural areas, offers speeds between 25 Mbps and 50 Mbps. That might appeal to consumers unable to buy a comparable fixed network service. 

By some estimates, U.S. home broadband generates $60 billion to more than $130 billion in annual revenues. 

If 5G fixed wireless accounts and revenue grow as fast as some envision, $14 billion to $24 billion in fixed wireless home broadband revenue would be created in 2025. 

5G Fixed Wireless Forecast
	2019	2020	2021	2022	2023	2024	2025
Revenue $ M @99% growth rate	389	774	1540	3066	6100	12,140	24,158
Revenue $ M @ 16% growth rate	1.16	451	898	1787	3556	7077	14,082
source: IP Carrier estimate

If the market is valued at $60 billion in 2021 and grows at four percent annually, then home broadband revenue could reach $73 billion by 2026.

		2022	2023	2024	2025	2026
Home Broadband Revenue $B	60	62	65	67	70	73
Growth Rate 4%
Higher Revenue $B	110	114	119	124	129	134
source: IP Carrier estimate

If we use the higher revenue base and the lower growth rate, then 5G fixed wireless might represent about 10 percent of the installed base, which will seem more reasonable to many observers. 

Assuming $50 per month in revenue, with no price increases at all by 2026, 5G fixed wireless still would amount to about $10.6 billion in annual revenue by 2026 or so. That would have 5G fixed wireless representing about 14 percent of home broadband revenue, assuming a total 2026 market of $73 billion.

If the home broadband market were $134 billion in 2026, then 5G fixed wireless would represent about eight percent of home broadband revenue. 

Fixed wireless might be even more important elsewhere in global markets.  

Critics are correct that 5G fixed wireless--at least in the medium term--has capacity limitations compared either to fiber-to-home or advanced hybrid fiber networks. But it also is true that the home broadband market has a value segment for whom fixed wireless seems to be in demand. 

According to the latest data from Leichtman Research Group, during the third quarter of 2022, some 825,000 net new home broadband accounts were added in the U.S. market. But the two major fixed wireless service providers--T-Mobile and Verizon--added 920,000 net accounts during the quarter. 

Fixed Wireless Services, Third Quarter 2022
Fixed Wireless Supplier	Total Accounts	Net Additions
T-Mobile	2,122,000	578,000
Verizon	1,063,000	342,000

source: Leichtman Research Group

Total cable industry net adds were about 39,000, while telcos collectively lost about 136,000 fixed network accounts. 

During the third quarter, about 22 percent of U.S. customers bought service at speeds of 200 Mbps or below. In other words, perhaps a fifth of the home broadband market is willing to buy service at speeds supported by fixed wireless. 

source: Openvault  

Predictably, supporters and detractors offer the expected defense of advantages and weaknesses. Cable operators note the bandwidth limitations. Verizon and T-Mobile point to the ease of installing and price advantages. In some cases fixed wireless might actually be faster than the other alternatives available from other local home broadband providers. 

Critics do correctly note that fixed wireless home broadband is carefully marketed in areas where new 5G networks have spare capacity. That capacity will disappear as 5G adoption increases, the critics say.

But Verizon and T-Mobile might argue they have ways to boost capacity over time, as 5G networks are used more heavily and as bandwidth demand keeps increasing. Higher-capacity millimeter wave spectrum is the obvious early answer. 

Longer term, Verizon and T-Mobile are likely to explore ways to add fiber to home coverage as well. For Verizon, that means finding new says to secure FTTH capacity outside its historic fixed network footprint. For T-Mobile, that means getting into FTTH for the first time. 

Up to this point, T-Mobile has been focused on areas where there is less competition, such as rural markets. 

Verizon’s geography is the roughly 80 percent of U.S. homes outside Verizon’s fixed network service territory, as well as its own mobile customer base, who are encouraged to bundle fixed wireless with existing mobile service. 

The point is that the near-term market is substantial for both T-Mobile and Verizon in “out of region” geographies. For T-Mobile that is 100 percent of U.S. homes. For Verizon that is about 80 percent of U.S. homes. 

Will Digital Infra Privatization Rates Slow?

Higher interest rates affect most parts of any economy. What we will have to see is the impact on digital infrastructure ownership in the near term. If interest rates climb to five percent or more, it is going to affect the payback model for taking digital infra (towers, data centers, distribution networks) private.

The wave of private equity purchases of formerly public infrastructure from service providers would slow. How much slower is the issue, and for how long. Observers do not expect five-percent (or higher) interest rates for the long term, but activity will hinge on the level of rates and their duration. 

In fact, the whole digital infra privatization business has been fueled by near-zero “real” interest rates. Inflation rates also matter, as they affect “real” interest rates. For the whole class of “alternative” infrastructure (power utilities, roads, airports, oil and gas, renewable energy and data centers, towers and fiber infrastructure), expected returns have been dropping, and specific returns for digital infra might arguably be closer to five percent than 10 percent. 

source: McKinsey 

But that is why five-percent interest rates slow activity. If the expected return is five percent, borrowing costs are five percent and inflation rates are high, investments no longer make sense. 

The point is that it would not be unexpected to see a slowdown in digital infra privatizations for a while. The business case--with higher interest rates--does get worse.

Comcast Expects 10-Gbps Downstream Upgrade to Cost "Less than $200 Per Passing"

Comcast says it can initially upgrade its network to eventually handle symmetrical 10-Gbps internet access (supporting 10 Gbps initially) for “less than $200 a home passed,” according to Elad Nafshi, Comcast EVP and chief network officer. 

It is a nuanced statement. 

That initial upgrade cost includes revamping networks from low-split to mid-split, including changes to active and passive network elements when necessary to support an upgrade to DOCSIS 4.0 10-Gbps downstream bandwidth. Upstream will increase to perhaps 1 Gbps. 

Significantly, Comcast’s initial deployment does not require full fiber distribution, but can accommodate as many as four amplifiers in cascade. 

That means the upgrade to 10-Gbps downstream service can be done without upgrading the whole network to fiber, which uses passive coaxial cable only for the last 100 feet or so of drop cable. 

Upgrading to symmetrical 10-Gbps service will require replacing all the radio frequency amplifiers. Typically, Comcast has built out fiber to an optical node, then delivered signals to home using a string (cascade) of up to four amplifiers running on coaxial cable. 

In the first stage of DOCSIS 4.0 deployment,  most of Comcast’s facilities can continue to operate with fiber distribution to a node, then retain as many as four RF  amplifiers for service to homes. There are huge cost implications for retaining that capability, since Comcast can continue to use the in-place amplifiers and coaxial cable. 

Future “Node + 0 amplifier” networks will transition to Full-Duplex (FDX) DOCSIS, to significantly increase the upstream bandwidth to multi-gigabit speeds, such as symmetrical 10-Gbps service. But that also will require deploying a full fiber network, using coaxial cable only for the drops. 

The first step will be a shift to a 5-MHz to 204-MHz upstream bandwidth and 1218 MHz downstream bandwidth, supporting a 1 Gbps upstream tier and multi-Gbps downstream. In the following illustration, blue frequencies are available for downstream traffic, while red frequencies are available for upstream traffic. 

As usual, the upgrades can be implemented incrementally, in stages, with incremental capital investment. . 

source: Comcast 

Then overlapping bidirectional spectrum from 108 to 204 MHz can be activated. that eventually increases up to the full 108-MHz  to 684-MHz FDX limit. In that implementation DOCSIS 3.0 can be supported up to the 1002 MHz limit and legacy DOCSIS 3.1 to the 1218-MHz limit.

The point is that Comcast still believes it can upgrade its bandwidth over time to symmetrical 10-Gbps service while remaining the low-cost provider compared to rival fiber-to-home networks.