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Transcript13 lines
- [00:01]
A
Welcome to Thoughts on the Market. I am Vishi Tirupatoor, Morgan Stanley's Chief Fixed Income Strategist.
- [00:06]
B
I'm Vishwas Bhatkar, Head of US Credit Strategy.
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C
And I'm Carolyn Campbell, Head of Consumer and Commercial ABS Research.
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A
Today we'll talk about the feedback and pushback we've received on the data center financing note we wrote a few weeks ago. It's Tuesday, August 19th at 10:00am in New York. In the weeks since we published our report on bridging the data center financing gap, we were met with a wide range of investors to discuss the key takeaways from our report. We projected that meeting the data center demand requires something like 3 trillion of capital expenditure by 2028. And we projected that about half of this funding will come from hyperscaler cash flows, with the rest financed through different channels of the credit markets. So Vishwas, some of the skeptics invoke comparisons to prior CapEx cycles, particularly the late 1990s telecom boom, that deals did not quite end well. How would you respond to that skepticism?
- [01:00]
B
The 1990s telecom capex cycle certainly came up in a lot of our meetings. It was the last time we arguably saw a capex cycle of this magnitude. I think the counter to this is that there are some very important differences versus what we saw then versus what we expect. Most importantly, the CapEx cycle back then was largely financed on corporate balance sheets and we saw a pretty significant uptick in debt issuance and leverage. Also through the 1990s the names the companies that were spending were mid to low credit quality and not cash rich. That's very different from the hyperscalers that are in the center of the AI spending. And these companies are very cash rich and their credit ratings range all the way from AAA to high single A, so very much at the top end of the spectrum. In addition, we are quite optimistic about AI monetization, both the timeline and the magnitude. Some of this has already been valid through second quarter earnings. We also think financing will be done through multiple channels going forward and it won't largely flow through to corporate debt. In fact corporate debt issuance is actually a pretty small number of how we think this 3 trillion number will be met. And the private credit piece that we have talked about a lot in this report we think is likely to be skewed towards IG ratings in many cases backed by contractual cash flows from credit worthy tenants. So the risk in some ways could come from the sub investment grade non hyperscaler type tenants. And that's an Important theme to be watching, but by and large this cycle is very different in our view from the late 1990s.
- [02:33]
A
Caroline Another pushback is that the market will be overbuilt and won't be able to refinance in say, five years.
- [02:40]
C
Yeah, Vishy, this is a really big concern, particularly for securitized credit investors. We're starting to see some of the ABS and CMBS deals look to refinance even this year, and that will pick up as time goes on and these deals hit their five year maturities. However, the biggest challenge to building new data centers in the US today is access to power. Our equity research colleagues have identified a 45 gigawatt power bottleneck in the US and we think this should keep the market structurally under supplied of power and slow down the pace of construction, really limiting that overbuild risk. Thus, we expect that the churn in the vacancy rates will actually remain quite low in the medium term. And so while it's a concern that in the long run that these data centers will decline in value, for now we don't see that to be a primary concern.
- [03:25]
A
Carolyn Another concern we heard is that the investor demand will not keep pace with the supply, particularly in securitized credit. We also heard about the tenant quality, that tenant quality is a major concern in underwriting these deals. So how would you respond to those two points?
- [03:40]
C
Right, I mean, within ABS and cmbs, we don't think supply is really the limiting factor. We think it will come on the demand side for why we think that this market will grow to about 150 billion by 2028. However, our discussions with investors and the data that we've seen suggest that while there are a few big accounts that have been active in the ABS and CMBS space so far, many have yet to allocate meaningfully, preferring perhaps even other esoteric so far. And so we think that as the supply grows, so too will the number of accounts and the size within which they're participating. That being said, the market is already starting to price in a higher risk of tenant weakness. We've started to see deals with a lower proportion of IG or greater exposure to AI names more price meaningfully wider than those deals that are almost entirely IG and are more for colocation and enterprise. Ultimately, there will be winners and losers in this new AI industry. And so the diversification across region and across tenant type, exposure to residual cloud and enterprise businesses, and the proportion of IG and non AI tenants in these deals will be very important. As we assess the risks of ABS and CMBS deals.
- [04:47]
A
Vishwas Any way we cut it, the scale of investment here is pretty large. Would this scale of investment divert capital away from public credit?
- [04:55]
B
I certainly think that's a possibility and maybe even a risk over time, but probably skewed towards the back half of our forecast horizon, which goes through 2028. I think for the public credit market, the next few quarters supply should be largely manageable and demand has been and should stay quite strong. But if you look a few quarters out, insurance demand has been very critical to what's supporting credit right now. If interest rates go lower, some of these insurance inflows could slow down. And we've also talked about insurance allocations that are shifting towards private and securitized credit at the expense of corporate credit. So slowly you could say supply needs rise. We have about 800 billion of financing that needs to be met by private credit while inflows slow down. So I wouldn't view this as a fundamental risk for public credit, but but certainly a reason why credit spreads may not stay as tight as they are over a period of time.
- [05:51]
A
So ultimately our projections are based on the transformative potential for AI and the role of data center financing to enable that. This is a high conviction view. As we have said elsewhere, we are not too wedded to the specific size estimates in the broad constellation of financing channels. The point we want to drive home here is that credit markets will play a major role in enabling AI driven technology diffusion. As always, there will be winners and losers, but data center financing as a theme for credit investors is here to stay. Thanks for listening. If you enjoy the show, leave us a review wherever you listen and share thoughts on the market with a friend or colleague today.
- [06:34]
D
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