L&G: Data developments and the importance of digital infrastructure
This article was originally written in Dutch. This is an English translation.
It is tempting to think of the internet as some kind of magic. You turn on your computer, connect to the Wi-Fi and there you go – mysteriously connected to the rest of the world via invisible radio waves.
By Matteo Colombo, Managing Director of Digital Infrastructure, Asset Management, L&G, and Bart van Coeverden, Client Director Benelux, Asset Management, L&G
But of course wireless connectivity is not magic. It is made possible by transmission towers, fibre-optic networks and data centres – the infrastructure that transports, processes and stores data.
We see digitisation as a ‘megatrend’ that is changing the global economy. Against this background, related infrastructure is of crucial economic importance and an enormous amount of capital is needed to support this infrastructure.
It is predicted that $500 billion will be needed for data centre infrastructure alone in the next five years. [1] For all digital infrastructure combined, this would amount to $2,700 billion by 2030.[2] This will enable global internet connectivity, extensive fibre-optic networks, greater 5G coverage in the EU and the US, and the construction of the necessary data centres.
Growing digital world
When we say that the world is ‘digitising’, we are talking about the long-term structural growth of digital services and activities. This is now accompanied by short-term trends, causing subsectors of the digital world to grow rapidly.
End-user spending on cloud services – an indicator of the growing demand for digital infrastructure – is currently showing a compound annual growth rate (CAGR) of around 20%[3]. Expenditure on artificial intelligence (AI) – the darling of the media over the past 18 months – is expected to have a CAGR of 27% in 2026[4]. It is even estimated that corporate spending on AI will exceed $1 trillion in the coming years [5].
These trends mean that more and more data is being created at a rapidly increasing pace. Data creation has a CAGR of approximately 21%[6], driven by the application of technologies such as AI and the increasing acceptance of services such as video streaming.
This growing amount of data requires more digital infrastructure for processing and storage. Masts are needed to connect to personal devices – such as smartphones – and to exchange data. Fibre-optic networks are needed to send data back and forth.
The more data-intensive processes there are, the more infrastructure is needed. If you have ever asked yourself, ‘What would we do without smartphones?’, then you already have some understanding of the importance of digital infrastructure. And you are not alone – five years ago, the sector still represented one-tenth of all infrastructure investments. Now it already accounts for more than one-fifth[7].
Critical infrastructure
The importance of digital infrastructure is emphasised by the fact that several national governments have labelled the sector as ‘critical’. In September, for example, the United Kingdom designated data centres as Critical National Infrastructure (CNI)[8]. This equates digital infrastructure with energy and healthcare infrastructure and labels it as crucial for the functioning of the economy.
Governments worldwide are setting aside money for digital infrastructure. In the US, for example, the Infrastructure Investment and Jobs Act of 2022 set aside funds to address the country's ‘digital divide’ by expanding broadband networks. The UK and the EU have similar initiatives to rapidly expand broadband to rural areas with poor coverage.
Data sovereignty – the desire of countries to have control over where their data is processed and stored – is another part of this issue. Research indicates that this is an important topic for companies switching to the cloud, with European IT leaders willing to pay extra for local storage and processing of sensitive data[9].
However, in relation to its population, Europe has a shortage of data centres. More European data is stored in the US than in Europe itself.[10] The desire to ‘repatriate’ the data could therefore give an extra boost to the digital infrastructure in the region.
Investment implications
The obvious conclusion is that digital infrastructure benefits from long-term trends. The potential returns make the asset class even more interesting for potential investors.
Digital infrastructure has the potential to offer investors the upward trend associated with mega-cap technology stocks, but without exposure to individual companies. Instead, this potential can be realised through exposure to the ‘real assets’ that directly support the technology sector.
In general, these assets can offer investors stable and predictable revenue streams. Customers are often the large blue-chip technology companies, with long-term contracts – and therefore cash flows. The increasing relevance of technology such as AI is making the customer base more diverse. Digital infrastructure is not purely dominated by Big Tech, although these companies still make up a significant portion of the clientele.
Given the high importance of these assets for data-intensive companies, cost increases can often be passed on to customers. We have seen this in the inflationary environment of the past 24 months, with data centres in particular being able to offset rising costs with price increases. It is interesting to note that revenues from digital infrastructure have remained stable across all market cycles.[11]
In our opinion, private markets can also play a crucial role in supporting investments in digital infrastructure. The lead time to develop these assets is often years. In addition, they are unlikely to be profitable during the development period, which usually makes it difficult to obtain financing on the public markets. Patient capital – the type you find in private markets – could therefore continue to play an important role in financing digital infrastructure in the initial growth phase.
[1] McKinsey & Company, as of September 2024
[2] L&G estimate, as of October 2024
[3] Grand View Research, as of May 2024
[4] International Data Corporation, Worldwide AI, March 2023
[5] Goldman Sachs, as of June 2024
[6] High Data Growth and Modern Applications Drive New Storage Requirements in Digitally Transformed Enterprises, IDC whitepaper, sponsored by Dell Technologies and NVIDIA, July 2022
[7] Preqin as of Q1 2024
[8] Gov.uk, September 2024
[9] Europe B2B Cloud Survey: Data Sovereignty Rules‘, Morgan Stanley Research, 27 February 2024
[10] European Data Centres to Grow 5x by 2035’, Morgan Stanley Research, 27 February 2024
[11] L&G research, 2024
|
Summary Digital infrastructure, such as transmission towers and data centres, is crucial for the growth of the digital economy. The demand for digital infrastructure is increasing due to trends such as cloud services and AI, with annual expenditure growing between 20% and 27%. Governments consider digital infrastructure to be critical national infrastructure and are investing in it. Investing in digital infrastructure offers stable income, driven by long-term contracts with large technology companies. Private markets play a key role in financing digital infrastructure during the growth phase. |
|
Disclaimer Past performance is no guarantee of future results. For professional investors only. The value of investments and the income from them can fall as well as rise and the investor may get back less than the amount originally invested. The information in this document is for information purposes only and does not constitute investment advice or a recommendation or offer to buy or sell any securities. The above information is provided on a general basis and does not take into account the circumstances of individual investors. Any views expressed are those of LGIM as of the date of publication. Not for distribution to persons resident in any jurisdiction where such distribution would be contrary to local law or regulation. |
