Show me the money

Show me the money

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Capacity’s Natalie Bannerman examines the role of private equity in investing in subsea cable infrastructure in the Latin America and the Caribbean regions.

Private equity’s interest in digital infrastructure has increased massively over the last few years, with names like DigitalBridge Group, KKR & Co, Macquarie Group, 3i Group and Digital 9 Infrastructure, regularly making headlines. But this kind of investment activity mainly occurs in the North American and European markets. In particular, subsea cables in Latin America and the Caribbean are either led by government initiatives, operators/carriers, or in few instances, with the involvement of hyperscalers.

So why is the private financing and investment industry seemingly less interested in becoming involved in this type of digital infrastructure in these specific regions?

Dr Ranulf Scarbrough, the former chief executive of Avaroa Cable Ltd and now and independent consultant, says that although Latin America region and the Caribbean are close to each other, they are very different business cases.

“Subsea cables are huge capital expenses over long periods of time. You need a lot of eyeballs to make them pay,” he says. “So little Caribbean islands with small populations don’t have many people to share them across.”

This is compared to Latin America, where some countries, such as Brazil, have very big populations, and others, such as Puerto Rico and Cuba, are the opposite. This is why in the Caribbean governments are stepping in, not unlike in the Pacific, where Scarbrough has had similar experiences during his time as CEO of Avaroa Cable, in the Pacific.

“There’s [in the Caribbean] what we call market failure, in that you can’t make a business case to get a financial payback as a private operator,” says Scarbrough. “But the governments say, ‘But what’s going to happen to our economy and society if we don’t do something?’ So, they then step in to try and make something happen with, potentially, government funding.”

Similar stories have played out in parts of the United Kingdom during the ongoing fibre rollout, and in places like the Cayman Islands, where a lot of subsea cables were built in the 2000s, during a gold rush when telcos were making lots of money on voice revenues.

Now the over-the-top service providers are leading the charge, and there are calls for the private sector to replace the cables laid in the last decade, even if they are not generating revenue.

Capacity also spoke to Daniel Torras, partner at Altman Solon, a global technology, media, and telecom consultancy firm, who shared similar opinions to Scarbrough’s.

“Private equity investments in subsea systems in Latin America and the Caribbean have historically been few and far between. That said, there have been notable investments, including Partners Group’s ownership of Seaborn, which dates back to 2015, when the original investment in Seabras-1 was made,” he says.

Torras also points out that KKR retained a 40% stake in Telxius between 2018 and early 2022, after exiting the investment.

In the third quarter of 2022, Stonepeak, an infrastructure-focused private equity firm, acquired the Latin American assets of Lumen Technologies, that included terrestrial fibre and data centres, and subsea cable.

One of the more long-standing private equity investments is BTG’s ownership of GlobeNet, which dates back to 2013.

“While [in Latin America] private equity investments in undersea systems have been limited, investors tend to look more favourably at diversified assets servicing the larger markets in the region, where much of the demand originates and where hyperscalers are present,” says Torras.

After Covid-19 proved the criticality of digital infrastructure, Scarbrough says that interest from private equity has increased, with more proposed systems between North America and South America in the works. But he believes it is more likely that cable owner/operators would branch off a cable to serve a Caribbean nation, as this is “probably more financially credible that building a whole system itself”.

Another thing to consider is that the long queue for cable-laying resources is another obstacle to new systems. While there was an oversupply of cable-laying ships during the dotcom boom, a hiatus in ship construction followed the dotcom crash.

Macroeconomic factors may also have had an effect on this ongoing shortage, and may also be affecting the subsea financing landscape, especially private equity investments.

According to Torras, the “higher cost of capital, a weaker economic outlook, and a complex political environment in much of Latin America, have led to a slowdown of investments in the latter part of 2022”.

“This isn’t specific to subsea cables in Latin America, but to the entire infrastructure space globally,” says Torras. “Inflation is a less relevant factor in subsea compared to terrestrial wholesale and retail fibre, but it might help temper price declines somewhat in the near term.”

Similarly, Scarbrough notes that while costs are going up, so too is the cost of borrowing.

“When you sit down and crunch the numbers on these business cases, for example, $100 million over 25 years. It’s not unusual for private sector investors to be looking for 10% to 20%. If that’s on $100 million from 10% to 20%, you’ve got to find $10 to $20 million a year just to service investors, before you’ve had the operational costs and everything else.”

Another factor to consider, according to Alberto Arellano, manager of telecom solutions for Latin America at IDC, is “the price of the equipment” and, interestingly, the telco regulatory environment which “in some countries, the creation of a company dedicated to the fibre infrastructure requires permits and special considerations”.

Using countries such as Chile as examples, he says the process for getting permits for constructing new infrastructure is more agile than other countries, as result the interested private equity firms, cable builders and operators face less resistance in carrying out their construction and development plans.

Conversely, in countries such as Mexico, the lack of homologation, different conditions, requirements and permits of each state greatly hinder development.

“The digital agendas of federal administrations are a key point for potential private equity investors, who use this as a compass in their consideration if a country is attractive or an investment key pole,” he says.

Interestingly, the telecoms monopolies prevalent in the Caribbean that resulted in high prices, also pose their own set of challenges for regulators and barriers for private investors wanting to build there.

“I think the regulators have struggled to have the capacity to get the outcomes that they want, which is low prices, wide coverage and to regulate those monopolies effectively,” says Scarbrough.

From a geopolitical standpoint, subsea infrastructure is increasingly being used as pawns in intergovernmental disputes: in 2022, the Nord Stream gas pipeline was severed, during the UK-EU Brexit negotiations France threatened to cut the power off the Channel Islands, and the British government has announced plans to build two cable protection ships to defend subsea strategic assets.

“Latin America, historically, has been a little bit more volatile politically, and the Caribbean has, mostly, been a little bit more stable,” says Scarbrough. “I think countries and cable investors are beginning to understand it’s a big threat if something happens to this infrastructure.”

Despite all the headwinds, both the Latin American and Caribbean markets remain lucrative for subsea cable investment, albeit lower than other digital infrastructure assets.

“The subsea market by itself commands lower valuation multiples, compared to other digital infrastructure assets,” said Torras. “The reason for this is that top-line revenue growth tends to be more modest, in the low-single digits year-on-year, despite very fast demand uptake. Steep price declines – historically between 15% and 35% annually depending on the system – usually offset much of the demand growth.

“In addition, the threat from hyperscalers building their own infrastructure and inking shorter-term contracts have contributed to the lower valuation multiples.”

As far as opportunities, Torras says that demand in Latin America and the Caribbean is “growing very rapidly, with strong fundamentals driven by rapid fibre broadband uptake and continued investments in 4G and 5G, as well as increased data centre activity”.

“All these positive market developments will fuel international capacity requirements,” Torras says. “In addition, some of the new hyperscaler activity will provide opportunities for private equity partnerships or drive new fund creation.”

In the long-term, digital infrastructure as a whole will continue to be an attractive area for private equity.

Torras believes “there continues to be appetite for digital infrastructure, even if investors are more selective in the opportunities they pursue”. He expects investment activity will recover in 2023, compared to the latter part of 2022, which “saw a decline from the height of the 2020-2021 period”.

According to Arellano, some countries in Latin America already represent a third of the total investment in new fibre infrastructure, which “is proof of the relevance they have today for the ecosystem”.

He adds that over the next five years, joint investments will continue to increase, and will account for more than half of investments in Asia, North America and Europe.

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