Vantage Data Centers has lined up more than $1.125 billion in financing, which it will use to build new data centers as it continues its national expansion. The money was raised using securitization financing, an approach that allows Vantage to pay lower interest rates on its debt, which reduces its costs as it seeks to compete in the industry’s largest markets.
Vantage will use some of the funds to pay off its existing bank credit facility. When combined with equity commitments from owner Digital Bridge, the financing provides Vantage with more than $500 million to invest in new data center campuses in Santa Clara and Northern Virginia. CEO Sureel Choksi says the company may also expand into new markets.
The use of securitization financing enabled Vantage to issue notes with an investment grade rating of A- from Standard & Poors. Companies with an investment grade credit rating can borrow money at attractive rates, while companies with lower ratings are perceived as more risky and typically pay higher interest rates.
Until now, Digital Realty has been the only leading data center specialist with an investment grade bond rating from S&P. In a capital-intensive business like the data center industry, the cost of money matters. Lower rates translate into fatter profit margins, which can also provide companies with leeway to compete on pricing.
This can be particularly important in markets like Northern Virginia, where Vantage will compete against virtually every major provider of wholesale data center space – including Digital Realty, which is the dominant player in Ashburn’s “Data Center Alley.”
Why A Securitization Financing?
This was the first time a data center company has used securitization financing, in which a company creates a security based on the creditworthiness of a specific pool of assets, rather than the entire company. In this case, Vantage was able to issue debt notes backed by cash flow from their operational data centers, which are leased by some of the world’s largest and most credit-worthy companies.
“Three quarters of our revenue comes from investment grade tenants,” said Choksi. “Fundamentally, what this allows us to do is to finance separately the assets of the business that are generating income from those in development.”
Stabilized cloud data centers filled with tenants have different revenue and costs than dirt fields for future construction, Choksi said. A bank credit facility has to acknowledge this broader, blended risk.
Although securitization is new to the data center sector, it has been used to fund growth in the wireless telecom tower business, where Digital Bridge is an experienced operator.
“Digital Bridge has a tremendous amount of expertise as an innovator in the securitization market,” said Choksi. “We leveraged their expertise with this tried-and-true model that a number of wireless companies had used, and applied it to the data center industry.”
Securitization is not without controversy, owing to its misuse in creating risky mortgage-backed securities that played a role in the financial crisis of 2008-9. The history of securitization in wireless towers has a very different profile than the abuses in residential lending markets. The Vantage offering is an example of how securitization is most effective in highlighting the credit-worthiness of assets, rather than obscuring it.
Strong Interest from Investors
Vantage was initially funded by private equity sponsors and debt, including a bank credit facility that started at $100 million and grew to $900 million, not all of which was tapped. This week’s financing retires the credit facility, and creates a variable funding note with $225 million of capacity. Combined with an equity investment from Digital Bridge, the funding provides Vantage with more than $500 million to invest.
Choksi says the investment grade rating of the offering will allow Vantage to pay an interest of about 4 percent, considerably less than the prior rate on its credit facility. The Vantage note offering was secured by six data centers (including five in Santa Clara and one in Quincy, Washington) that total 596,250 gross square feet and approximately 66 megawatts of power.
Investors and rating agencies responded positively. “We believe wholesale data center leases generally have the same key credit risk factors as single-tenant triple-net leases,” said Standard & Poors, which noted that the credit of Vantage’s tenant base helped offset the limited history of the company and asset class.
Vantage CEO Sureel Choksi: We were thrilled with the strong response from investors for this offering.Click To TweetChoksi said the $1.1 billion offering was 10 times oversubscribed, meaning that investors were willing to buy as much as $10 billion worth of the notes. Vantage discussed the offering with more than 45 investors, reflecting how a securitization financing has the potential to widen the pool of funding sources.
“We were thrilled with the strong response from investors for this offering, which we believe speaks both to the high quality and growth prospects of Vantage’s business,” said Choksi.
Securitization or JVs?
The borrowing strategies of data center developers may seem esoteric compared to other aspects of the cloud computing business. But the Vantage transaction, along with the recent sale of the Dallas Infomart to Equinix, is shining a spotlight on how data center operators might use existing properties to generate cash to fund future growth.
The Vantage transaction is the first securitization in the data center sector, but developers have used other strategies to leverage the value of stabilized buildings, most notably through joint ventures. In 2013 Digital Realty formed a joint venture with Prudential in which it sold an 80 percent interest in a portfolio of nine fully-leased data centers. CyrusOne has considered similar transactions.
Investors and analysts are focused on the potential for joint venture transactions in the wake of the Dallas Infomart sale, in which Equinix paid a premium price of $800 million. Last week Wall Street analysts pressed several public data center REITs about the valuation for the Infomart, and whether it suggests an opportunity to tap the strong market for data hubs.
“There’s an awful lot of capital coming in market, and clearly we’re seeing some pretty big valuations out there,” said Scott Peterson, the Chief Investment Officer at Digital Realty. “We’re going to take a deep dive in our portfolio a little later this year and we’re going to look at assets where essentially we’ve created all the value we can create, and look at whether it would it make more sense to redeploy that capital somewhere else in our portfolio. I think, it would be reasonable for us to bear that in mind as we review the portfolio later this year.”
As for securitization financings, Choksi said Vantage has put a structure in place so it can issue additional notes as more data centers are built and filled. “We’ll come back to the market to upsize as the business demands,” said Choksi.
Will this be a trend? Choski says that not every data center REIT is well-positioned for securitizing its stablized assets.
“We’re on the simpler end of the spectrum, because we own all the underlying real estate, and sign long-term contracts with Fortune 500 service providers and cloud tenants,” he said. “These factors were what made us interesting. I think there are some unique aspects to Vantage. We’re the first to do it, but we may not be the last.”