Going deep for subsea cable investment returns

Data InsightInside Infra 25 May

Going deep for subsea cable investment returns

Subsea data cables are being strung across the world’s ocean floors at a breakneck pace, with compound annual growth rate estimates ranging from 12.5%-20% over the next several years.

Much of that development is being funded by so-called hyperscalers — big telecoms and tech giants including Amazon, Microsoft, and Google owner Alphabet. But there are opportunities for infrastructure investors to take part in the space as well, and fund managers who play their cards right can earn returns of 12%-14% — or higher — according to several sources.

However, pitfalls abound for those who jump into the subsea market without doing their homework. Rapid advances in data transfer technology and over-building on popular routes have sent per-gigabyte data transfer prices crashing by 15%-20% per year. This rapid price deflation makes it difficult for investors to model revenue in some cases, according to an infra fund manager.

“The commercial dynamics of this market are not predictable,” said the fund manager. One of his vehicles’ investments in a subsea cable on a popular route “hasn’t been a smooth ride”, he said.

But investors that target niche routes or meet unique needs with solutions that aren’t easily replicable by competitors can generate solid, predictable returns, according to the fund manager and other sources. “You cannot blindly just invest in a subsea cable network, as each asset, market, and region is different,” said Oscar Tylegard, director at UK-based infrastructure fund manager 3i Group.

Upward trajectory

Private investment in subsea data cables has been spotty in recent years. After jumping to a high of USD 1.17bn in five closed transactions in 2019, activity dipped to USD 310.8m in four transactions in 2020, and then rebounded to USD 634.9m in six transactions last year, according to Infralogic data.

Estimates of the size of the subsea data cable market range from USD 12.68bn in 2020 (Mordor Intelligence) to USD 14.1bn (Research and Markets), with growth estimates for the next half-decade ranging from 12.8% (Research And Markets) to 14.3% (ReportLinker) — though Tylegard thinks the actual growth rate may be higher than those estimates.

The drivers of this growth should come as no surprise: Ever-growing demand for bandwidth-heavy Internet applications including Cloud computing, video conferencing, streaming and gaming; demand for new data centers in low-cost locations to accommodate these applications and cryptocurrency mining; and campaigns to extend Web coverage to parts of the world that currently lack connectivity.

The growth and activity are focused on no-brainer routes, such as trans-Atlantic connections between the US and EU. Permits to build on such high-profile routes are easy to secure, but because there are so many competitors, subsea cable operators have little leverage to set prices.

“Commoditization is the reason pricing goes down,” said Gil Santaliz, CEO of NJFX, a subsea cable landing station operator in New Jersey. “It’s a toll road business.”

3i has made two subsea cable investments that avoid commoditized routes, according to Tylegard: Tampnet, which provides connectivity to industrial installations, ships and planes in the North Sea and Gulf of Mexico; and Global Cloud Xchange, which operates cables connecting the Middle East and Asia with Europe and North America.

Tampnet, which 3i and Danish pension fund ATP acquired in 2019, is an example of a network that meets unique needs. The cables provide connectivity to offshore oil, gas and wind operations, as well as to ships at sea and jetliners crossing the ocean, according to Tylegard. The thesis of the investment is, in part, that such offshore infrastructure lacks reliable Internet connectivity that enables real-time sensors and video monitoring — improving operational efficiency, he said. And, it can’t be easily replicated by a competitor.

Global Cloud Xchange, which 3i has agreed to acquire but not yet closed, owns unique landing stations and cables that are difficult to reproduce, particularly in the rapidly growing Middle East and Asia, according to Tylegard. GCX’s network does include trans-Atlantic and trans-Pacific routes, but the meat of its network runs from Europe through the Middle East to Asia and Australasia, according to the company’s website.

The unique cables and landing stations — infrastructure on the shoreline where subsea cables connect to network equipment and on-shore fiber — also position GCX to partner with hyperscalers looking to secure new connections in these regions, according to Tylegard, “I think you will see a lot more partnerships.” 

Growth drivers

There are two basic business models for subsea cables: lease contracts, in which a customer pays for a certain amount of annual capacity for a specific number of years; or a defined right of use — in which a customer makes what is essentially an equity investment in the cable, giving it the right to a certain amount of capacity indefinitely.

Finding underserved routes or filling unique unmet needs that can’t be easily replicated by competitors isn’t easy, the sources said. According to the fund manager, growth in capacity is outstripping demand, making it hard to find viable investments. But investments in underserved routes can still earn solid returns, the fund manager said.

He suggested routes connecting Nordic countries as prime for more investment, given growth in data centers located in the region. More than USD 2bn in privately funded data center transactions closed in the five Nordic nations in 2021, which was by far the largest year on record, according to Infralogic data.

Tylegard pointed to the Middle East as attractive for subsea data cable investments due to substantial growth in the adoption of cloud computing. The region’s data center market is expected to grow at a rate of 12.4% per year over the next five years, according to ReasearchAndMarkets.

While data price compression is occurring as capacity grows, equipment costs are falling at the same time, according to Santaliz. The sheer volume and growth of demand for data will support more investment, Tylegard said.

Another driver of future demand will be a growing desire for redundancy, Tylegard said. For some customers, having access to only one or two subsea fiber cables is insufficient, he said: They want multiple cable options in the event one or more cables is severed.

“Redundancy’s going to be an increasing focus going forward,” Tylegard said.

Investors may also face competition from banks looking for more control over their data, according to Santaliz.

The fund manager seems likely to sit the market out for a while, citing the difficulty of predicting data prices. Tylegard declined to specify 3i’s plans, other than to say it likes the overall digital infrastructure space and expects more subsea fiber cable opportunities going forward.

“We are obviously always looking for opportunities to deploy more capital in the right situation,” Tylegard said.

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