Powering Progress Episode 2 – Financing at Scale: Structured Capital for AI and Data Center Portfolios

Aubrey Bishai [00:00:13]

Welcome back to Powering Progress, a podcast series exploring the infrastructure, energy, and market dynamics shaping the next generation of data centers and AI development. I’m your host, Aubrey Bishai, Chief Innovation Officer at Vinson & Elkins.

Our conversation focuses on how the market is underwriting these developments and what financing structures are emerging as the AI infrastructure landscape continues to evolve. So Eamon, how are lenders underwriting power availability and off-take risk?

Eamon Nolan [00:00:54]

Thanks, Aubrey. Normal project finance rules still apply here for a lot of these financings. It might be a new asset class, or at least a new asset class at the scale we’re talking about, but it’s still drawing on pretty tried and true principles of financing. And so some of that is a little bit real estate financing, some of it’s project financing, some of it frankly is a little bit corporate financing, but all the normal underwriting rules apply.

And so as it relates to power availability, most of the lenders that are financing the data center side of the business are doing so pretty much on a standalone basis. And what I mean by that is that they’re expecting the data center landlords not to be taking any real power risk, and for that power risk to be being passed through to the tenants, as opposed to a situation where the data center might be responsible for delivery of all the power.

Now, that I should clarify is very specific to the behind-the-meter structures. And so as I think touched on some of our other podcasts in this series, there are different ways to stand up these very large data centers. Some of them are behind the meter, which means they have their own power generation on site, and some of them are in front of the meter, which means they’re reliant on grid connections. Obviously, if there’s a grid connection required for this, then that is going to be the responsibility of the landlord in most structures. They’ve got to go and actually procure that interconnection and secure the electrical supply from the utility or the grid.

Aubrey Bishai [00:02:34]

So when you think about the assets then, should assets be financed individually or at a portfolio or platform level?

Eamon Nolan [00:02:43]

The historical financing approach in data center world was to have what we refer to as a Devco facility. It’s not a unique debt product for data centers, but certainly very popular in that space. And really it’s sort of a borrowing base style financing, where data center developers can pull together a portfolio of current and future data centers. So, they range from just really having a lease signed and maybe some site control arranged, all the way through to assets that we refer to as being stabilized, which means that they’re generating revenue under the applicable lease.

That historically worked well because we didn’t have data centers being financed or built at the scale of CapEx that we’re seeing today. You talk about those historical data centers, maybe it was sort of somewhere in the 0 to 50 megawatt range. What we’re talking about here, obviously in this new world of data center financing, is very large scale, 1 gigawatt plus data center buildings or campuses that are being constructed.

When you look at those structures, because of the scale of the CapEx, it is more common to have separate financings for each of your individual data center buildings and each of the leases that are being attached to those buildings. Again, there’s lots of different ways that things are being done. There’s been some very large dual asset project financings, one in particular, which was a Meta campus that was around $30 billion for two different campuses. But more common approach at the moment is really to have single asset project finance for these very large campuses.

Aubrey Bishai [00:04:26]

So we’ve certainly been understanding that these projects are very complex. How are construction risk and timing delays addressed in financing documents?

Eamon Nolan [00:04:37]

So lenders have been a little bit more conservative than perhaps in other asset classes around some of the risk of delay. A traditional project finance structure would typically allow in the offtake agreement for the customer, the offtaker, to have a termination right on its offtake if the project is not constructed by a long stop date.

The capital markets for data center world have effectively turned to rejecting that approach. And for the most part, particularly at the larger scale CapEx projects, we’re not seeing any termination rights for delays in delivery. So construction delays that attach to the landlord — what we’re more commonly seeing is what’s referred to as self-help remedies, whereby the tenant is able to step in and actually take over the construction to the extent of any delay. And that’s proving to be a solution that the capital markets are much more willing to finance at these very big tickets.

Obviously, there’s a lot of risk allocation embedded in the data center lease itself for who has to do what and by when. And it’s not to say the landlord does not have obligations to deliver certain parts of the infrastructure along with the data center hall kind of ready to be operated. But it’s the consequences there that the financing markets have really pushed on, and we’ve seen a big push away from that tenant termination and right for delay.

Aubrey Bishai [00:06:15]

How flexible is the financing for expansion or future recapitalization?

Eamon Nolan [00:06:23]

I think expansion and future recapitalization probably need to get bucketed slightly differently. So expansion is an important piece of this. As you look at some of the very large campuses that are publicly out there, some of them have an incredible capacity for growth and additional expansion on the site. And so they might be starting with a 500 megawatt or a one gigawatt project and have secured sufficient land in the vicinity and potentially have the ability for additional power generation to be built on site.

Substantial expansion is going to make a lot of sense. Rather than trying to wait for everything to be ready and signing up lots of tenants, obviously you need that flexibility in there to be able to expand in the future. Frankly, the project finance markets and capital markets generally obviously are encouraging of that. They are in the business of lending and they want to see more projects done.

So the expansion ability is kind of what you’d see in most project finance arrangements or just large scale infrastructure projects, which is take an LNG facility or a power generation facility. If there is the ability to in the future expand, you have some customary protections in there for the lenders, basically that the new project won’t adversely impact the existing project. But outside of that, there is almost always pretty broad flexibility for the sponsors to be able to embed future expansion projects.

I think that’s one feature that the refinanceability point is very important because the project finance debt markets may not always be the right product, particularly for longer term debt on data center halls. These are asset classes that once built and operating are really very bond-like in terms of the cash flows, and so prone to the issuance of a bond or securitization, because you’re really securitizing a cash flow stream that’s tied to an investment grade tenant. That’s a very steady, stable income and a good product for institutional investors to be wanting to be exposed to.

They’re obviously mostly only interested in that product once the construction is significantly de-risked and the asset is stabilized, which means it’s generating rent and those cash flows are able to be predicted with a high degree of certainty. So the refinance point is the much broader pool of opportunity. There are different structures out there, ranging from single asset bonds to securitized asset flows to stable codes where you kind of put a big pool of stable assets together and then might do an issuance on the back of that. So there’s lots of different ways to attack the refinancing issue, but sort of long term project finance debt is not really the solution for that.

Aubrey Bishai [00:09:26]

Thank you, Eamon, and thanks to everyone for listening to Powering Progress from Vinson & Elkins. For more insights on AI infrastructure and the forces shaping the data center economy, visit velaw.com.