Could rising capital costs spark consolidation in the data center market?

• The cost to build data centers is in the millions of dollars per megawatt

• M&A activity or private equity investments are two potential paths to tapping the necessary capital

• The latter is already playing out in the market

It probably comes as no surprise that it costs a pretty penny to build a data center. Upfront costs for the land and building alone these days can easily hit $1 billion – and that doesn’t even count the server hardware that needs to go inside, T5 COO Tom Mertz told Silverlinings. But who has that kind of cash? And could the quest for capital drive consolidation in market as companies aim to meet booming demand for data center capacity?

Let’s start with a quick breakdown.

Data from Statista shows that the cost to build a data center varies significantly from country to country. As of 2022, it cost around $6 per watt in Mumbai, India, $9.79 in well-known data center hub Northern Virginia and $12.36 in Zurich, Switzerland.

But those are just dollars per watt. Data center capacity today is typically measured in megawatts. Given 1 megawatt is 1 million watts, you can basically think of those prices above in the same way. Each megawatt would be $6 million in Mumbai, $12.36 million in Zurich and so on.

Earnings documents from data center builder Digital Realty show the company is accounting for costs to be even higher – closer to roughly $13 million per megawatt – today. It is planning to spend around $4.8 billion to build 365 megawatts of capacity across data centers in North America, EMEA and Asia Pacific markets.

Bulking up

But how many megawatts is normal?

Well, Mertz explained that five years ago, a 50 megawatt data center would have seemed large. But these days, facilities as large as 100 megawatts are starting to seem like small potatoes. If you need a recent example, the nuclear-powered data center campus Amazon Web Services just bought in Pennsylvania can be expanded up to 960 megawatts. That’s an extreme case, but you get the idea.

Quick math (a 100 megawatt data center at $13 million per MW) shows how fast data center costs can run north of $1 billion.

That’s obviously a massive amount of money. And not everyone can so easily get their hands on that kind of cash – or at least not fast enough to keep up with demand, which is forecast to skyrocket in the coming years.

McKinsey and Co. has forecast data center capacity in the United States alone will more than double from 17 gigawatts in 2022 to 35 gigawatts by 2030. And to put that into perspective, there are 1,000 megawatts in 1 gigawatt.

Meanwhile, Gartner predicted the global number of large data centers (those containing 1,000 racks or more) will increase from 1,762 in 2023 to 1,955 by 2027. The most significant growth is expected in the Asia Pacific, North American and Western European markets. The total number of data center sites of any size is expected to jump from 3.43 million to 3.59 million over the same period.

Money hungry

To accommodate the boom, Mertz said he expects a few things to happen.

First, companies that went private may go public again to gain access to more capital. Second, companies may seek out private equity investors or joint venture partners to get their hands on the cash required to keep building. Or, third, there could be consolidation in the market as larger companies swallow up smaller players.

“When people say that we’re going to be developing 35 gigawatts of data centers in the United States, I just take a look at the capital requirements of that and usually the bigger companies win,” Mertz said.

“You’re likely to see a consolidation in the industry because there will be a lot of smaller players that won’t be able to keep up with the demand from a capital perspective," said Mertz.

The second option is already playing out in the market. In 2022, Stonepeak invested $3 billion in American Tower’s CoreSite data center business. Meanwhile, Digital Realty has formed joint ventures with Mitsubishi for data centers in Texas and Brookfield Infrastructure and Reliance Industries for facilities in India. It also created a $7 billion joint venture with private equity firm Blackstone to build data centers in top markets across Europe and North America.

Elsewhere, Equinix has joint venture projects in Australia and Singapore worth more than half a billion dollars each.

Not all paths lead to M&A

So, could consolidation be a next step for data center providers to pool financial resources? Maybe, but there are other routes they could take.

Synergy Research Group Chief Analyst and Research Director John Dinsdale told Silverlinings that after blockbuster eyars in 2021 and 2022, the number of M&A transactions in the data center market dropped 11% in 2023. He noted the value of those deals dropped even more precipitously, from $48 billion in 2022 to around $24 billion in 2023, though this had more to do with the value of acquisition targets than appetite for deals.

Dinsdale said it's too early to know where things will end up in 2024, but he said "so far we've seen two billion-dollar deals close and we're aware of four more similar sized deals that have been agreed and are in the pipeline and waiting to formally close. Beyond that we see two more potential deals that could be huge if they come to fruition." That's on top of the "usual flow of small-to-mid sized deals that continue to close."

Meanwhile, Rebecka Axelsson Wadman, principal at consulting firm Arthur D. Little, told Silverlinings via email strategies like private equity investments, consortium investments and debt raises tend to favor larger data center operators and those with good track records.

But when it comes to smaller and mid-size players, "I think we can expect them to focus growth in lower cost regions/areas that show less of the other restraints besides the direct cost of capital that are in place," she said.

In plain English, that means avoiding pricey data center hubs like Northern Virginia and Silicon Valley in the U.S. where power is limited, labor is expensive and permitting is a hassle and instead focusing on second and third-tier markets like Las Vegas and Reno that are still reasonably close to the aforementioned hubs but offer cheap land and easy access to power. 

Wadman added other regions – like the Midwest in the U.S. – offer access to green energy and are "actively trying to attract data center operators through tax abatements."

"Likely this will prove a more attractive options for smaller operators looking to expand," she concluded. "I can also imagine we’ll see more differentiation/specialization within data centers to optimize" for various latency and compute requirements.

Update 3/11/2023 5:25 pm ET: This story has been updated to include comments from Synergy Research's John Dinsdale.