Mike Harder: I think the first thing to understand in digital infrastructure lending is, as soon as you think you understand it, it’s already moved on you. It’s an evolving space. It’s action-packed. It’s a great space to be in if you’re a lender and you’d like creative lending structures. I think it’s an awesome space.
I still think demand for digital infrastructure is going to remain strong if you look at the growth outlook for the data center world alone. There’s going to be needs for fiber and infrastructure and financing to build all the data centers needed, if you believe the estimates, to be built out like there. I think the core thing that underpins all this is the utility-like nature. I keep saying that over and over, but we’re becoming very utility-like here in digital infrastructure.
Jeff Johnston: That was Mike Harder, credit supervisor at CoBank, regarding the dynamic and fast-paced nature of the digital infrastructure financing market. Hi, I’m Jeff Johnston, and welcome to the All Day Digital podcast, where we talk to industry executives and thought leaders to get their perspective on a wide range of factors shaping the digital infrastructure market. This podcast is brought to you by CoBank’s Knowledge Exchange group.
The amount of money being poured into the digital infrastructure market is truly unprecedented. Data centers get all the headlines, given the enormous amount of capital being deployed by the hyperscalers to build out the country’s AI infrastructure. But beyond that, internet service providers are also spending aggressively.This activity has led to new financing structures, some of which have more leverage than what the industry typically sees.
At CoBank, Mike sits in the middle of all these deals, so I thought it would be helpful to bring him on the podcast to understand what is really happening in the world of digital infrastructure financing. Without any further ado, pitter patter, let’s see what Mike has to say. Mike Harder, it’s great to see you. Welcome back to the podcast. How have you been?
Harder: Oh, I’m back again, man. You couldn’t get rid of me so easily. Very glad to be back with you again, Jeff, in these exciting times here.
Johnston: Well, not as glad as I’m to have you back. Thanks for carving out some time. I know you’ve got a lot going on, but thrilled to have you on. I want to talk about, call it digital infrastructure or broadband financing. I think that’s what we talked about last time, and that was almost two years ago, believe it or not. Lots of changes, I think, that are going on in the industry right now, so I wanted to spend our time focusing on that. Let’s just start off here, Mike, at a very high level. How would you characterize the current state of the digital infrastructure financing market?
Harder: Yes, it’s going fast. I’ll say that right now. Some of the stats being thrown out there is the digital infrastructure debt market is massive. AI debt-driven surge right now that’s happening in the world with deal volumes nearly doubling in the past year, like over $200 billion. I’ve seen numbers like that tossed out, and it’s just exploding right now. Obviously, that’s being driven by the demand for digital infrastructure. For data center capacity, all these things are all converging at one time here, driving the incredible need for debt capital, as well as equity capital, to finance all these builds.
One of the things we’ve really been observing, as a banker, we’ve seen some shift away from some of the traditional debt/commercial banking markets, some of these loans are being refinanced into the leveraged loan market, which is a highly leveraged-- a lot of debt. In addition to that, we’ve seen over $30-plus billion of leveraged loans being put into direct lending, which is a hybrid away from a traditional debt bank. It’s like an infrastructure fund or an insurance company type thing. We’re seeing a shift to private credit, who’s coming in with stronger, longer tenors, typically. Because they aren’t so regulated, they can get away with a little bit of looser structures.
They’re definitely filling some of the funding gap because there’s a lot of demand going out there. Obviously, in my world, we see a ton of the buzzword, I think you’ve talked about it in the past, is the ABS, asset-backed securities market, which data centers are a huge driver in that world. It’s just an obscene amount of money being put into those builds right now. We’re also seeing other forms of digital infrastructure being funded.
The unfortunate byproduct of an influx of debt into any market is you’re starting to see a lot of providers, they’re all competing for the same lending dollars, so you’re starting to see looser credit documents, looser terms, as you’re seeing loan-to-cost structures, which are advancing money on a certain advance rate, almost like a borrowing base, if you will. You’re advancing dollars against capital being spent.
I’ll say for every dollar spent in capital, we will give you 50 cents on that. That’s a new structure that we’re seeing out there in the market, these loan-to-cost structures, which is becoming more and more in vogue right now. They’re governed by some different types of covenants because these structures typically do not generally have enough cash flow to service the debt over the first couple of years.
Johnston: Something you said, Mike, I want to go back on. You talked about the competitive nature of the market from a lender perspective. I think you mentioned infrastructure funds are playing a more active role with direct lending and so forth. Why do you think that is? Why is, all of a sudden, this space become such a competitive space? I think on the data center side, it’s probably somewhat self-explanatory, but my guess is it’s beyond just the data center market.
Harder: I think, like I said before, a lot of the traditional banks, commercial, corporate banks are restricted in how much leverage they can put out there, or they’re restricted by how much loan-to-value they can put out there. For a data center, for instance, it requires more capital if you have a higher loan-to-value based on the lending. Same thing with a fiber deal, if you’re higher levered, it’s going to trigger all sorts of additional monitoring, additional scrutiny if you’re highly levered.
When you go into a direct lender or fund who’s also providing loan funds, they have less regulation. They have basically no regulation on what kind of deals they can put out there. These things are becoming very utility-like. These alternative lenders and providers see the value. These fiber providers are certainly selling-- If you’re pure play fiber, you’re selling for 15-plus times multiples, sometimes higher even. I think that the non-traditional lenders see those valuations and are lending on those higher valuations, which, love it or not, that’s just the way the market’s drifting right now.
Johnston: Well, that’s helpful. It seems like a hot space, so that’s good. It’s good to hear. I guess, Mike, if you’re looking out for the next one to three or five years, you can pick a timeframe here, what kind of major trends are you watching out for? Then part of that, too, is, these trends or how do these lending structures or financing strategies, how do they look different between smaller rural operators and larger regional operators, if you will?
Harder: That’s a great question, I think, because that’s part of what we do here at CoBank. We are very focused on rural broadband, and that’s part of our mission. Starting out with the small rural providers, they are continuing to need capital to build out their networks. With a smaller provider, you’re definitely trying to stave off obsolescence. Meaning, if you aren’t big enough to keep growing and to offset any decline, say you have a legacy copper telephone business, for instance, you need capital to build fiber because you’re losing those wireline customers. The same as a cable company is losing traditional cable TV customers.
You need to be building out your network to a fast broadband-focused customer base, and these smaller guys definitely need to do that. I think fixed wireless and fiber and these smaller providers, the combination of the two, wherever it is economically viable. I think on these smaller guys, traditional cash flow transactions, none of the spicy stuff that I talked about before is really going to be happening in these smaller rural deals.
Your private equity will continue to remain interested, though, in this space because this is where you can see potential strong growth opportunities with existing providers, overbuilding their existing networks with better speeds, and edging out into rural areas, which typically have very strong customer acceptance rates. When I say that, it’s like typical area. You may see 30% of your passings may take the service, but in these rural areas, you’re going to get north of 60%.
On the larger providers, I think we’ve seen it already. We’ve seen the mega deals out there: Verizon-Frontier, Bell Canada-Ziply, Zayo-Crown Castle. Those have been the mega deals. We’ve seen big wholesale deals with these joint ventures coming into vogue, like Gigapower, Metronet, Lumos, you name it, where there’s a joint venture and core anchor tenant taking wholesale deals. Anyway, that’s the larger market.
Like we talked about before, I think these larger players will continue to look into the smaller players as roll-ups from an M&A perspective, as acquisition targets, really. They’ll be looking for financing for those as well. These larger providers are going to continue to push structures from a creativity and from a leverage perspective. It’ll be fun being a banker for the next five years.
Johnston: Bankers can get creative. It’s exciting because there’s different ways to structure deals and support growth and support our customers. I like that. I think we’re seeing a little bit more of it. Some companies out there, just generally speaking, are getting a little bit more aggressive on some of the adjustments that they’re making around non-GAAP EBITDA adjustments and things like that. You see companies do this all the time, both private and public. It’s nothing new. I get the sense that companies might be getting a little bit more aggressive in terms of how they account for some of those non-GAAP items and push the envelope maybe a little bit from a risk perspective. I guess, one, is that true, even true? Two, what do you think is going on there?
Harder: I think, like we talked about before, the amount of interest in digital infrastructure is attracting capital from all sorts of places, from bank markets, from infrastructure funds, from infrastructure lenders, infrastructure equity funds, and everything in between. Various types of debt capital markets are very available to them now. Debt markets, on a whole, are getting more aggressive.
What that means for us in the traditional banking markets, where you’re looking at EBITDA as cash flow that can essentially repay and service the interest on your debt, these competitive pressures are pushing the need for additional adjustments, look forward adjustments, if you will, to how we define EBITDA. When I say that, what some of the typical add-backs may or may not look like, you’re looking at things like, they call this typically the marketing EBITDA of a company versus the actual EBITDA.
Banks certainly look at the actual EBITDA, what they use for cash flow, that’s typical. Sometimes you can have these covenant structures and these loan structures where they’re adding back certain things like booked-but-not-billed add backs. Sometimes new market losses, where a company goes into a new market and they haven’t quite established a mature business yet, so there’s certain non-recurring costs associated with going into those markets.
There’s also creative ways of these adjustments and add backs. Like I said, if you put a bunch of bankers in the room, they’re going to get creative eventually on these structures. Some of this is definitely creeping into the lending world, into the loan documents that we’re seeing. I think bankers are smart and credit people are smart. They continue to look at the actual cash flow availability, but it certainly does increase, say, for instance, if you’re looking at a traditional leverage ratio, which is your debt to your EBITDA or debt-to-cash flow.
Johnston: Let me ask you something just as a follow-on to that. Do you think, in light of the competitive nature out there from a lending perspective, do you think this whole EBITDA adjustment narrative is really a function of CFOs going, “A lot of people want my business because this is a hot space”? As a result, that might be giving them some leeway, some latitude to be able to be a little more liberal with some of these EBITDA adjustments. Is that at all related or am I barking up the wrong tree there?
Harder: No, I think that’s pretty spot on, Jeff. There’s a lot of competition to take over lead banking, arrange your positions in large syndicates. That’s a huge spot because that’s where the fees, you typically see the higher fees when you’re lead arranging or leading a syndication of other banks. If you can market a transaction that has greater flexibility, I think CFOs see that.
Now, I don’t think it’s irresponsible to accept these greater multiples of debt now, mind you, granted it’s sort of a little bit of “trickeration,” if you want to call it that, whatever you want to call it, but window dressing, however you want to describe that. I think banks see the reality of the real cash flows, and we’re leaning heavily into now what the multiples are for valuations. These all-fiber deals are really garnering very strong multiples from an enterprise value basis for M&A takeover multiple perspective, debt banks and debt providers as a whole are willing to accept higher leverage.
Johnston: Hey, let’s shift the conversation a little bit. I’d like to get your perspective on private equity sponsor market. They were, obviously, very aggressive in M&A post-COVID. We saw a lot of PE sponsors being active in the market then. I think it’s cooled off a little bit. From a CapEx financing perspective for some of these PE-owned operators, I would just love to get your thoughts on how is that going? Are you seeing PE sponsors lean into debt financing for CapEx, or do you see them continue to put equity, their own cash into the business to finance the capital? I’m sure it’s a combination of the two. Anything interesting going on there that you have to share?
Harder: Oh, definitely. Always interesting to see what the equity guys are looking to do in this space. You get the Blackstones and DigitalBridges and Brookfield and Blue Owls of the world. We’re always looking to invest less equity and rely more on debt, because from an overall cost of capital perspective, the debt is cheaper. In today’s competitive debt market, your debt costs are a lot cheaper than what it would cost to provide equity.
We’re seeing the loan-to-cost metrics get pushed up, loan-to-values get pushed upward. I think just, again, it’s a competitive dynamic. Specifically in the fiber world where I tend to play a little bit more, we’re starting to see some of these transactions where it’s a company that’s not necessarily at mature stage. You would typically see the equity would be the sole provider of capital financing in these situations.
However, given the influx of capital out there, equity guys are inviting the debt guys to come play in some of these “startup transactions,” if you will. Say a company is looking to build fiber to several different communities out there and they’re a year or two in, they’re for looking potential bank lenders to help partner with them where you would typically see 100% equity financing. They’re asking guys to come in at 40%, 50%, 60% of the capital necessary to spend to build these networks.
That’s some of the things we’re starting to see on the sponsor side. None of these structures have really been tested. I think we’re still placing a lot of reliance on good partners within the sponsor realm. Like I said, there’s still a lot of capital out there and the sponsors are still very bullish. Rightly so, they’re taking advantage of banks and other debt providers wanting to invest and ride alongside them as they build these newer markets and these new companies from scratch.
Johnston: Hey, Mike, listen, this has been great. We’ve covered a lot. I appreciate you coming on and sharing all this great insight. Before we wrap it up, I just want to give you an opportunity to share any closing thoughts or things we didn’t talk about that you think is important to mention before we say goodbyes.
Harder: Yes. Well, I think the first thing to understand in digital infrastructure lending is, as soon as you think you understand it, it’s already moved on you. It’s an evolving space. It’s action-packed. It’s a great space to be in if you’re a lender and you like creative lending structures. I think it’s an awesome space. The trajectory, we’re starting to see valuation metrics from a multiple perspective peak out. We’re also seeing new valuation approaches, too, in the market, which is interesting. How do you value a passing? How do you value a subscriber?
Just narrowing down so much into the individual subscriber and how much value you can place on that is really a fascinating trend that we’re seeing as well in the market. That’s really pushing our debt markets to be more creative, to provide more flexibility. I still think demand for digital infrastructure is going to remain strong. If you look at the growth outlook for the data center world alone, there’s going to be needs for fiber and infrastructure and financing to build all the data centers needed, if you believe the estimates, to be built out there. I think the core thing that underpins all this is the utility-like nature. I keep saying that over and over, but we’re becoming very utility-like here in digital infrastructures.
Johnston: Let’s leave it there, Mike. Thanks again for your time today. This was super helpful. I appreciate it.
Harder: Awesome. Great to be with you, Jeff. Thanks.
Johnston: A special thanks goes out to Mike for being on the podcast today. I think my main takeaway after talking to Mike is the competitive nature of the financing market. There remains strong interest on the part of banks, infrastructure funds, and PE sponsors to gain exposure to this market. Of course, with all this competition, CFOs have the opportunity to get more creative in how they finance their operations.
Hey, thanks for joining me today. A special thanks goes out to my CoBank associates, Christina Pope and Tyler Herron, because without them, there wouldn’t be an All Day Digital podcast. Watch out for our next episode.
