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Data Center Financing: Not for the faint of heart

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Bernard Cobb
Portfolio Lead, Modular Data Centers

HP Critical Facilities, Americas Region

 

Return on assets is generally a good indication of the ability of a company to invest in generating revenue and profitable assets.  Debt to equity shows balance sheet strength, as it indicates the risk exposure a company has to changing interest rates.  These two indicators are somewhat intertwined, because a company can be at risk of eventual insolvency if its cost of borrowing exceeds its return on assets.  Ultimately, cash should be considered king.  Net Cash inflow is always viewed positively, while net cash outflow is not.

 

Because of this, most companies want to minimize initial capital investment on assets that are not direct revenue generating.  Even for those assets that are revenue generating, companies often explore ways to minimize large initial capital investments, choosing instead to match cash outflows with cash inflows from revenue.  Add any risk, uncertainty, or speculation to expected revenue cash inflow, and the need to minimize initial capital investments is amplified.

 

This industry trend is especially true within the data center world.  Whether the data center is a revenue generating asset, as with public cloud or hosted service providers, or is simply considered a cost of doing business asset, capital invested in a data center facility almost always reduces or restricts capital available for other activities.   If the data center is not a revenue generating asset, then those same return on asset and debt to equity ratios are detrimentally affected – and this ultimately impacts how management is measured.

 

Most organizations may have capital and operating budgets for their facilities separate from their IT, however, capital tied up in a facility is not available for IT investment.  In today’s business environment, with technology changing as fast as it does, organizations cannot afford to have their capital tied up in a facility. 

 

Project financing or leasing of certain equipment may appear to alleviate initial cash flow concerns, but they are still debt, requiring debt servicing, that impacts an organization’s overall ability to finance other activities.  Project financing and equipment leasing   generally carries a higher cost of borrowing than do traditional lenders, as well.  Organizations will turn to these forms of financing when they already have challenges obtaining financing at a reasonable rate, or have exhausted other financing means.

 

Certain industries however, simply have no other choice.  This is especially true when their data center is their main source of revenue.  Capital investment always has to occur before revenue can be earned -- with a rapid time to market -- so the revenue stream can begin immediately.  If debt is used to finance the data center, then the company has to ensure that the net cash inflow is enough to   cover the cost of borrowing, and recover the capital investment in as short a timeframe as possible. This position is critical so they can further explore and invest in expansion.  Any delays in time to market, or an insufficient short term revenue stream can have devastating implications for an organization. 

 

The reality is, before a data center is built, the capital investment may be known; how much revenue the data center generates -- and when it will be received – typically isn’t. If the aim is truly for IT to show positive impact on the balance sheet, surely the industry needs to also consider a way to include the data center facility in that model.

 

Bernard Cobb has over 20 years of experience in business consultancy and project management.  Since 2007, he has been a Critical Facilities Trusted Advisor, building business cases, managing the design and/or overseeing the build of both small and large data centers throughout Canada, the US and parts of South America.  He had managed data centers spreads from 50kW to 20MW solutions, and his experience end-to-end has given him a unique perspective within each facet of the decision-making process.

 

Mr. Cobb began his career in venture capital, working to prepare companies for their Initial Public Offering (IPO) or merger/takeover.  He was an acting Chief Financial Officer of an expanding petroleum engineering company, and upon their successful merger with a European energy services company, he returned to business consulting, engineering project management and critical facilities consulting.

 

Presently Mr. Cobb is responsible for HP’s Americas Consulting portfolio of Modular Data Center solutions.

Comments
Robert Levesque2(anon) | ‎08-19-2014 10:42 PM

Mr Cobb;

 

What kind of EBITDA multiple is it normally used to finance the growth of a Data Center operations?

TS_Guest 3 weeks ago

Thank you for asking, Robert.

 

There is no consistent rule that can be applied everywhere in the world.  However, I would suggest that Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) is not the most relevant metric.

 

We have seen co-location providers in a number of countries experience financial difficulties after building their data center – because their charges for Interest and Depreciation are based on the entire capacity they built – and not on the amount that was sold.

While EBITDA is generated from the capacity they sell – Net Earnings and Net Cash flow are negatively affected because of empty or unused capacity.  That variance between EBITDA and Net Income/Net Cash – is a key indicator to capital markets of otherwise inefficient use of capital.

 

Very rarely are co-lo providers able to sell 100% of their planned capacity, before they open their doors to the public – so there is always a significant mismatch in capital deployment at the beginning of deployment.

There are also only so many times that they are able to go to capital markets to raise either equity or debt financing.  No one wants to go to the market with key indicators showing inefficient use of those funds as this affects the cost of that capital.

Obviously this is a more significant risk in countries where there are higher interest rates or where greater restrictions on capital exist.

 

The same economic situations exist for the enterprise user as well. Although revenue is not always directly tied to data center usage, they still pay interest and depreciation.

 

This is what made HP’s announcement of its “Facilities-as-a-Service” so unique.  There is no required investment in empty space or unused capacity in hopes of future growth.  Customers come to HP as an ownership partner – so there is no need for additional debt or equity financing.  HP then provides dedicated DC capacity to the customer as the customer needs, for the customers own use that the customer operates themselves.

Because this is a service, there are no financing charges and no depreciation (both of which are after EBITDA charges).

 

Whether for the co-lo provider or the enterprise client, net cash outflow is then tied to on-going data center usage and is then more aligned with EBITDA.

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