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Having the foresight to see trends, future opportunities and challenges is part of the foundation of any successful investment team. Lately, there has been a lot of talk about Data Centres (DCs) in the investment world, and for good reason. We are at the cusp of what is set to be a huge technological infrastructure build out, boosted by the prospects of artificial intelligence (AI) and a completely new way for humans to leverage data.
Computing power is not a new concept but having it as centralized, large-scale infrastructure through DCs is. With the advent of cloud technology, companies can now rent computing power from someone else instead of managing it on their own premises. Massive amounts of computing power made possible by DCs is a key foundation in generating and deploying artificial intelligence.
With this in mind, Juliana Faircloth, Vice President and Portfolio Research Manager, and Evan Chen
Associate, Portfolio Research, of TD Asset management Inc. (TDAM) recently published an article titled Investing in data centres: a revolutionary technology or a bubble? The article discusses the dynamics and implications of DCs and how they have morphed into something that is an increasingly an important aspect of our economy and the investment world.
A bubble or still a long runway?
What is great about the article is that it breaks down the investment conversation about DCs into two arguments: there being evidence of it being a bubble or just the early stages of a massive technological build out (not a bubble). The various rationales discussed included:
Evidence of a possible bubble
A tendency to overbuild - Drawing parallels from prior bubbles provides useful insight from the past. For example, the railway mania in the U.K in 1840s or internet bubble in the U.S. in 1990s/2000s suggests societies tend to overbuild new technological infrastructure¹. This can also be the case for DCs.
We may be over-valuing already - Bubbles occur when financial market reality detaches from economic reality and there may be instances where we are seeing this already. This is evidenced in companies with a very small exposure to the DCs supply chain that have been re-rated materially as a “data centre play”.
We may be over-hyping AI - There is a possibility that we are overhyping AI and what the future looks like from a technological standpoint. One way we may be overhyping AI is that there hasn’t been any sort of revolutionary app yet. If AI growth does not materialize to the levels many feel it reach, the need for DCs can slow.
Not a bubble
We are spending productively - Hyperscaler investment in cloud infrastructure has grown at a 25% compound annual growth rate (CAGR) since 2015 and that has contributed to cloud revenue growth at a 40% CAGR. This is clearly productive spending with a return².
We underestimate the potential of new technologies - Society often underestimates the potential externalities of new, revolutionary technologies like AI. Again, using rail and internet as examples, it was not conceivable in the early days of rail and early days of internet that externalities would extend well beyond the intended use case.
We are limited by bottlenecks - Demand for DCs is currently outstripping supply and there are bottlenecks in the supply chain that limit explosive growth and overinvestment. Some of these bottlenecks include labour, electrical equipment, power, permits and environmental permits.
A generational opportunity
DCs are generational infrastructure and are the backbone to the AI buildout. From an investing standpoint, there are real implications for all asset classes whether its real estate where data centres have been one of the best performance industry groups, or infrastructure where renewable power assets stand to benefit from growing demands on the grid. There is a broad range of sectors and business models that stand to benefit from this trend.
Be sure to check out the full article for all the great insights.
¹ Source: 1. Andrew Odlyzko “Collective hallucinations and inefficient markets: The British Railway Mania of the 1840s”; 2. “Doug O’Laughlin “Lessons from history: The Rise and Fall of the Telecom Bubble”; 3. Green Street “Global Data Centre Outlook”
² Company Filings, TDAM.
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