Asset-Backed Bonds Are Driving the Global Surge in AI Development

The Unseen Financial Backbone of the AI Revolution

The AI revolution is gaining momentum, driven by the need for vast quantities of data and immense processing power to emulate human thought. Companies worldwide are investing billions in data centers and fiber-optic cables, which serve as the backbone of AI infrastructure. This trend is accelerating the growth of the internet and digital infrastructure, with global spending on data center construction expected to surpass $55 billion by 2030, according to Synergy Research Group.

Interestingly, many of these developments are being financed through the asset-backed securities (ABS) market. Companies in the data center sector often lack substantial capital, prompting them to seek financing through ABS, where they can leverage future revenue from their properties. Frontier Communications, for instance, recently issued a $750 million bond backed by fiber-optic cables, while Switch Inc. raised approximately $940 million through a bond supported by data centers. By the end of 2024, it's predicted that $12 billion will be raised in the ABS market for data centers, fiber, and related investments, as reported by Barclays Plc.

Expanding Digital Infrastructure Investment

Various factors contribute to the surge in data center and fiber investments, including the trend of remote work which has intensified since the pandemic. Erik Falk of Magnetar Capital highlights that while major companies can secure unsecured debt, many others developing computing infrastructure are seeking diverse financing methods. This has led to innovative but sometimes riskier transactions, resembling equity more than traditional debt.

This year alone, $4.7 billion in ABS deals have been backed by data centers, more than doubling last year's figures. Similarly, fiber-backed ABS sales have seen an uptick to $3.5 billion. Noteworthy transactions include Ziply Fiber’s $1.6 billion ABS sale and Zayo Group Holdings Inc.’s plans to enter the ABS market by year-end.

Global Reach of Digital Infrastructure Finance

The practice of using asset-backeds tied to digital infrastructure is spreading beyond the US. Vantage Data Centers recently completed a groundbreaking £600 million securitization of data center assets in the EMEA region, partly to refinance debt at its Cardiff campus. This signifies the tenth securitization for the hyperscale data center operator since 2018, following a €750 million equity raise to capitalize on AI technology growth.

Robert Graham of Schroders underscores the exponential growth potential of the digital infrastructure sector, propelled by AI and cloud computing. The scale of leasing activities has grown remarkably, reflecting this sector's expanding significance.

Increased Fiber-Optic Connectivity

Fiber asset-backeds are also tied to the AI boom and the growing internet connectivity demand. Post-pandemic, remote work and increased device connectivity have surged, necessitating more fiber-optic infrastructure. Nearly all US adults used the internet in 2023, a substantial rise from earlier decades.

Jesse Sable from Mitsubishi UFJ Financial Group Inc. highlights the dramatic increase in capital needs for digital infrastructure developers due to heightened data consumption. While data center ABS issuances have surged in response to growing investment, more unusual assets, like microchips and GPUs, are also being considered for secured debt. CoreWeave Inc., for example, secured $7.5 billion through a combination of loans tied to microchips.

Alternative Financing in the Real Estate Market

Real estate investment trusts, such as Digital Realty Trust Inc., have repackaged their real estate mortgages into bonds sold in the commercial mortgage-backed securities market. Both ABS and CMBS markets provide cost-effective financing options for data center projects generating stable revenues. Graham notes that large public REITs often achieve lower capital costs through unsecured debt rather than securitized products.

The rapid expansion and increasing investment in digital infrastructure over the past few years have made it a crucial focus for investors, with AI and cloud computing driving continued growth and development in the sector.