Demand for data centres is booming, and private equity is set to be a major player on the supply side. Deal flow in Asia has been relatively anaemic for two years. That will reverse soon

There’s a counterintuitive outcome developing in the data centre space: As project costs balloon and technical hurdles mount, data centres are becoming more attractive to a broader range of investors.

Much of this is driven by a rise in traditional enterprise and retail demand for computing capacity, which has been amplified in the past 18 months by the advent of generative artificial intelligence (AI). The effect is arguably exaggerated in Asia, where data centre penetration is relatively low versus North America and Europe.

Globally, the trend has sent power requirements soaring and prompted facilities to be larger with new cooling and data processing technologies. Such is the increase in power and capacity demand, old sites cannot simply be retrofitted. New ones must be built.

These massive, business-critical projects – the so-called hyperscale facilities – can require billions of dollars to properly scale out. As their expense, indispensability, and technical challenges accumulate, scale has become an important differentiator, and the always ambiguous risk profile of data centres has become even more inclusive.

Opportunities are expanding at both ends of the risk spectrum, with pure real estate developers and private equity firms alike expected to team up with hyperscale customers and their dedicated infrastructure partners. There is also plenty of scope for co-investment by institutional LPs.

Private equity is well positioned in part because after spending the past decade building out environmental, social, and governance (ESG) capacities, it now speaks the language of sustainability.

Clean energy and energy-efficient operations are increasingly requisite of electricity-guzzling hyperscale development. In addition to having the skillsets to improve back-end technological systems, PE can better engage internet and AI counterparties and facilitate energy supply partnerships through portfolio connections, often wind and solar farms.

The asset class is also viewed as a good fit for data centres’ riskier new profile. This includes the ability to assess a project’s overall business soundness in technical, commercial, and real estate terms across a four to six-year ramp-up period for new developments.

“Private equity platforms are well placed to address these needs based on not only their attractive financial cash flows but their ability to understand the operational metrics, alongside a committed and credible off-take,” said Michael Habboush, KPMG’s Singapore-based deal strategy lead.

“If you look closely at the platforms that private equity has established, they are operator platforms. They have technical, commercial, and real estate people within those businesses. We think they’re going to play a major role in both the development of operations and the deal landscape.”

Real estate services provider JLL adds underlying macro dynamics around geopolitical tensions and customer segmentation to the factors attracting different risk appetites to data centres. These too will bring in a broader mix of private equity players, to a point.

“Infrastructure PE shops and the real assets divisions of global and regional PE firms have featured prominently in this first development phase of the modern data centre industry,” said Jason Brown, a senior manager for Asia Pacific alternatives and capital markets at JLL.

“We expect more corners of the PE universe to enter the industry but perhaps less so VC investors given how asset-heavy, capital-intensive this part of the IT value-chain is.”

Deal dynamics

The main counterpoint to this outlook is that PE hasn’t had much to buy recently. Four industry professionals described the current oligarchy of operator-developers in Asia as reluctant to sell. Many of these groups were built up with private equity capital or have in-house PE operations of their own. Digital Realty, Equinix, and GLP are among the most referenced names.

Essentially, these scaled operators want to scale even further, and investors conscious of the economies that come with widespread operations take comfort in that critical mass. Amidst the stasis – and perhaps pending consolidation – the opportunity to invest in proven, de-risked operators is therefore shrinking.

According to CBRE, a real estate services provider and investor, direct data centre investment in Asia Pacific collapsed from about USD 4.1bn in 2021 to USD 1.4bn in 2022 and then fell to USD 1.1bn in 2023. This is partly attributed to the technical and financial difficulties in underwriting hyperscale budgets but most squarely pinned on a lack of assets for sale.

Still, CBRE predicts that about SGD 15bn (USD 11.1bn) of data centre assets in the region – mainly single-asset opportunities rather than platforms – will come to market in the next three years. And evidence is already mounting to this effect.

Perhaps most tellingly, CBRE’s data for 2023 excludes two large pending transactions. In September, KKR agreed to acquire a 20% stake in Singtel’s Southeast Asian data centre business for SGD 1.1bn. The prior month, Bain Capital agreed to privatize Chindata Group, a US-listed data centre player it took public three years ago, for about USD 3.2bn.

“Even with Amazon, Google, and Microsoft, some of the biggest companies in the world, the capex is getting unsustainable. There’s an opportunity for more traditional real estate groups, sovereign wealth funds, and insurance companies to start building and developing data centres,” said Tom Fillmore, an executive director focused on Asia data centres at CBRE.

“These groups are happy to write huge cheques, work with customers, and expect a much lower return profile than the incumbents. They’ll build these huge hyperscale campuses with private equity firms and get a much better return than they’re used to. It also solves for private equity because they’ll get a huge amount of equity out the door.”

The most dramatic illustration of this point is AirTrunk. The Australia-based data centre developer, majority-owned by Macquarie Asset Management and Canada’s PSP Investments, is now progressing a AUD 15bn (USD 9.9bn) sale process. It was reportedly considering a AUD 10bn IPO as recently as September.

The company – which operates data centres across Australia, Japan, Singapore, Malaysia, and Hong Kong – is currently fielding offers from The Blackstone Group and DigitalBridge alongside IFM Partners, according to AVCJ sister publication Infralogic.

Their interest in the space is well-established. Blackstone launched its first Asia-focused data centre platform in 2022 and is said to have committed to USD 300m of initial projects in India. DigitalBridge partnered with Australia’s Aware Super last July to invest in renewable-powered data centres. It teamed up with IFM for the USD 11bn take-private of US data centre player Switch in 2022.

Scarcity value

Meanwhile, Bloomberg reported that Singapore’s ST Telemedia Global Data Centres (STT GDC) has invited Blackstone, Apollo Global Management, KKR, and Stonepeak Partners to submit bids. The Temasek Holdings-owned data centre operator is active across China, North, South, and Southeast Asia. This is said to be part of a USD 1bn round ahead of an IPO as soon as 2025.

“We’re backed by Temasek, which obviously has very significant financial horsepower, but that doesn’t mean we wouldn’t look to other sources. We’ve not been short of approaches,” said Jonathan King, STT GDC’s CIO and chief strategy officer, referring to media reports on the capital raise as “rumours.”

“Within our business, some of our businesses, where the barriers to entry are even higher, a month or two doesn’t go by without somebody approaching us, particularly in a market like India where we’re the number-one player with over 30% market share. Replicating that from scratch is nigh on impossible.”

The best example of a private equity investor pulling this off in Asia is arguably Warburg Pincus, which has invested about USD 1bn in regional data centres since 2017. The commitment is spread across three platforms: Bohao in China, Evolution Data Centres in Southeast Asia, and Singapore-based Princeton Digital Group (PDG), which spans China, India, Southeast Asia, and Japan.

PDG and Evolution were established by Warburg Pincus. Ellen Ng, the private equity firm’s regional head of real estate, sees building data centre platforms of scale from scratch as increasingly challenging but still the most accessible inroad for PE given increasing competition and market consolidation in the next several years.

Bohao was backed as an existing operation in 2022, and Ng believes similar deals in China are still feasible where there is investor willingness. She is generally bullish on the outlook for building out Warburg Pincus’ existing portfolio but acknowledges entering the sector for the first time is much more difficult than only two years ago.

“People are starting to realise that this sector requires integrated skillsets from power procurement to operational expertise, and many projects were announced but not executed,” Ng said.

“When you talk about AI, that type of demand is a completely different game from traditional cloud. The size and scale of power and capital requirements needed to satisfy AI demand – along with a tougher financing environment – has led some players to pause and think about whether they have the capacity and capabilities to take on some of these projects.”

Warburg Pincus is tracking significant anecdotal interest in ex-China markets, notably Japan, where PDG has plans to commit USD 1bn. CBRE tallied almost USD 1bn in Japan data centre investments in 2023, taking up the vast majority of the Asia total and exceeding the previous four years of Japan investments combined.

Malaysia has otherwise emerged as a relative hotspot, especially the southern state of Johor, which shares a maritime border with Singapore, a massive potential off-take market with few resources to support its own needs. PDG acquired land last year for a USD 450m data centre project in Johor, its first in Malaysia.

Power plays

US-based Vantage Data Centers, a hyperscale developer launched by Silver Lake in 2010 and backed by DigitalBridge and AustralianSuper, recently committed USD 3bn to a Malaysian build-out. In addition to strategic proximity to Singapore, it flagged a more reliable electricity supply – increasingly the key bottleneck in data centre rollouts.

Raymond Tong, president of Asia Pacific at Vantage, singled out the Green Lane Pathway initiative by TNB, the largest local utility, as a critical factor. “This programme enables data centres to be connected three times faster than normal delivery time, reducing the implementation period from 36-48 months to just 12 months,” Tong said.

It’s difficult to overstate the electricity impediment for modern data centres serving generative AI workloads; a ChatGPT search is said to use 10x as much power as a Google search. At least 40% of this power consumption goes toward electrical cooling systems for overheated server racks.

Vantage solves for this through a combination of advanced cooling technologies, especially liquid cooling, but also including liquid-to-chip and closed-loop chilling systems. For its high-rise data centres in Hong Kong – which are particularly susceptible to overheating – it employs energy-efficient servers, hot-cold aisle containment, and modular air cooling, among other techniques.

JLL refers to liquid cooling as the transformative step in data centre efficiency. Other approaches such as alleviating energy consumption through the use of parallel and advanced data processing algorithms are less sound. How either option adds up long-term is yet to be determined.

“Looking at it through a sustainability lens, whilst coding improvements may offer processing runtime efficiencies, they should nonetheless require more computing power delivered in the same unit of time and thus the effect on the overall energy efficiency of such technology does not appear decidedly better,” JLL’s Brown said.

“Liquid cooling technologies, of which there are a few variants, are offering significant operating energy consumption reductions relative to traditional air cooling. The lifecycle carbon footprint including the supply chain and its own embedded carbon footprint of these liquid cooling technologies compared to air-cooling is less clear as of now.”

Less talked about supply chain challenges in the hyperscale era include access to long lead-time equipment such as generators and substations, as well as basic engineering, procurement, and construction (EPC) resources. In some markets, like Japan, EPC relationships take time to cultivate and should be factored into data centre plans in the same way as negotiating power access.

Securing access to long lead-time equipment is best solved by leveraging global networks where they exist. Vantage and DigitalBridge, for example, tap their respective global portfolios to buy equipment in advance where it’s available and then redeploy it in the region in need.

Niche opportunities

This is not to say that only global PE firms can participate in the latest data centre wave, especially where they have niche know-how and networks.

STT GDC’s King has observed situations where small investors have zeroed in on a specific link in the value chain such as sourcing land and connecting it to the power grid. The investor doesn’t have the wherewithal to build and operate a data centre, but it can make a handsome return speeding up the process for a larger player.

“The industry is morphing, maybe because there’s so much capital trying to find a way, maybe because that aspect [access power] didn’t used to be a huge challenge,” King said. “Now you need different experts who don’t know anything about data centres but are good at working with power authorities and planning. The industry is shifting as we go along, which certainly keeps on your toes.”

Private equity will also have to stay on its toes in terms of due diligence. Speaking at the Infralogic Investors Forum Australia last March, Gordon Hay, a partner at Morrison & Co, noted there was risk in believing that the rising tide of data centre demand would lift all boats.

Hay sees data centres as more heterogeneous than other digital infrastructure assets. At the same time, he interprets rising power and technological requirements as a sign that older facilities will see accelerated redundancy.

“Asset selection is really key, understanding the differences in assets in this category to understand who should be getting their fair share and more of that undoubtedly large growth outlook. It’s not going to be everybody,” Hay said.

“You might think owning a data centre platform is great. Usage is going up, customer demand for space is going up. Yes, but they’re looking for specific things, and we’ve seen a step change in the criteria that sophisticated buyers want. It’s accelerating the end of life for some of the older stock. Buyer beware.”

James Chern, a managing partner and CIO of Singapore-headquartered Seraya Partners, identifies three critical aspects of a high-quality data centre in Asia that all boil down to a customer-centric approach: operational excellence, sustainability, and AI readiness.

Seraya, founded in 2020, brands itself as the first Asia-based independent PE player focused on next-generation infrastructure. The firm closed its debut middle-market fund in December, raising USD 800m, calling it the largest vehicle of its kind in the region. The first data centre investment is Empyrion DC, which develops and operates green hyperscale facilities in North and Southeast Asia.

Chern defines operational excellence in terms of adhering to globally recognised industry standards as well as local regulations, specifying data security frameworks ISO 27001 and PCI-DSS as examples. Sustainability is best demonstrated with renewable energy connections and advanced cooling, as well as water efficiency. Both dovetail with AI readiness.

“With AI boosting the growth of compute-intensive GPU servers, high-quality data centres will be designed to scale up and down flexibly to meet the growth of AI requirements while still catering to ongoing enterprise needs,” he said. “Such compute demand will fuel growth for data centre operators who can design their cooling technologies and data centre builds to be scalable and flexible.”

[Editor’s note: Paragraphs 29 and 31 have been amended to more accurately reflect the comments of Ellen Ng, Warburg Pincus’ regional head of real estate.]