Guest comment by Alina Osorio

Driven in part by population growth, digitalisation, decarbonisation and nearshoring, niche asset categories are reaching the mainstream. These categories, which range from small modular nuclear reactors to grid-level energy storage, hydrogen to hyper-efficient waste management systems, are part of how governments and private enterprise are tackling large national or regional imperatives to buttress national security, de-risk supply chains and grow economies.

Subsea fibre systems to support the international transfer of data is one such niche hard asset category available in the mid-market that has recently captured the attention of institutional capital. As a platform in a wider infrastructure portfolio, it has the potential to be a cycle-agnostic diversifier in a sector that is attractive because it is stable and, in certain markets, undersupplied.

Alina Osorio

From a macroeconomic standpoint, as well, subsea cabling provides a critical means of transmitting large volumes of data. The technological superiority of fibre is clear: nearly all of the world’s data traffic – estimates range between 95 and 99 percent – flows through subsea fibre optic cables. Other options to connect disparate land masses separated by bodies of water are limited, and fibre continues to vastly outperform satellite connectivity in terms of volume, speed, data integrity and economics. Without it, the international economy would grind to a halt.

And yet, the capital required to build and support the infrastructure underpinning the transport of increasingly voluminous and complex workloads are often not enough to move the needle for large-cap players. This creates a distinct opportunity in the mid-market – lower thresholds to investment ultimately offer proxy exposure to the ‘data boom’ through subsea fibre cabling.

So, must it surely follow that an investment in subsea fibre would precipitate outsized returns?

As critical as this infrastructure is, institutions looking to mid-market opportunities as a means of accessing nationally significant assets need to be mindful that what makes these assets resilient – and profitable – varies greatly by geography and situation, as well as by how actively they are managed. They are not merely large-cap ‘lite’. How they operate profitably is not so much a feature of their yield and covenant profile, but a genuine understanding of who they are serving and how they are maintained, upgraded and scaled.

In other words, simply being relevant to national security or economic growth does not make an investment opportunity secure or imbue it with the potential to grow. Essential does not automatically mean irreplaceable, especially considering the rate of technological progress we’re experiencing. Investors must be attuned to these nuances in order to preserve capital, appreciating that – in asset categories like subsea cabling and data transmission infrastructure – technology never stands still for long.

Other more mature subsectors have instructive lessons here – not least the promise of strong returns that were, in some cases, undone by complacency. Examples of this can be found in the earliest telephone cabling, and in the famous case of substitution away from whale blubber and toward fossil fuels as a form of oil for lamps. In these instances, the inertia and lack of operational foresight from a ‘sit and wait’ style of management allowed perfectly good companies to lose ground to disruptive entrants and eventually fall away, bringing with them the retail and institutional shareholders, governments and bondholders who had entrusted them.

Active asset management

Investors should be mindful of the signs that active asset management is being applied – particularly in the mid-market space, where a higher volume of opportunities equates to a greater likelihood of competitive tension. And here, we would suggest three guiding principles to make an informed decision.

First, whether an asset is on land or beneath the sea, there should be an acknowledgment that the ‘moat’ is made up as much by the product’s inelasticity of demand as it is by supply. The assertion that some infrastructure categories are ‘sound’ because they are undersupplied is only half the picture. The full version is a stress-tested investment hypothesis built on how assailable demand is at any given time whether that’s due to new entrants or emerging technologies.

It follows that, at its core, there should be an essential service. Ideally, at the time of acquisition, there would be low competition and a remote likelihood of new entrants underpinned by high barriers to operational expertise, which lends to – but isn’t ultimately responsible for – the defensibility of contract profile and customer mix. Often in these instances, we will see a strong precedent of pricing power or inflation linkage that bolsters the defensive nature of the revenues.

Second, in our assessment, there must be clear avenues to diversify these revenues. Actions to evaluate the moat should be coupled with interventions to prevent the erosion of market share by maintaining and deepening the relevance to end-users. This could be in terms of product offerings to broaden customer relationships, but also carrier and customer neutrality to remain agile in an ever-changing landscape.

Assiduous asset enhancement often plays a proportionately larger role in mid-market investments than in the case of big-ticket projects – and this is fundamental to long-term success. Our third guiding principle is to evaluate whether there are opportunities to prosecute value-add initiatives that grow the network, capture additional market share, establish a dominant position, rationalise excess costs and optimise the capital structure.

Here, professionalisation will take on greater importance to value potential, especially where there is an opportunity to unburden an investment of legacy infrastructure and refocus on what will drive the future. And any capital deployment or strategic planning must be made with an eye toward securing stable and predictable revenue in order to secure the free cashflow needed to enable reinvestment.

Not just a matter of size

Mid-market infrastructure therefore is not simply a pool of investments with similar characteristics to large-cap projects but on a smaller scale. Understanding the asset management and operational environment these companies face and supporting them through intensive phases of expansion and transformation is as important as understanding the supply profile.

In Europe and the US, we have positions in multiple niches of the data infrastructure mid-market, including subsea cabling. While the opportunity in growing these networks constitutes part of a competitive edge, being closer to the assets and their executive management teams to assist with their organic and inorganic scaling is what creates long-term value in a context of ongoing market evolution and overlapping systems seeking to disrupt established ones.

Because from our experience, the competitive landscape will change. But it’s how we actively prepare to seize the opportunities this creates that matters.

Alina Osorio is president of Fiera Infrastructure, a global mid-market infrastructure investment firm, headquartered in Toronto