September 7, 2021

My guess is that when you ask most mainstream institutional investors what they think digital infrastructure looks like, in actual physical form, they’ll probably trip off a list of visualizations including mobile phone towers, data centers, and finally, everyone’s favorite, hard hat workmen laying urban cable – in recent years they might even mutter about satellite dishes and low orbit constellations. But I’d wager that very few would get excited about sub-sea cables which is peculiar because one of the most successful IPOs of recent years in this space is that of D9 Digital Infrastructure is in large part, currently, a sub-sea play via its takeover of Aqua Comms. This successful and profitable business owns a bunch of assets including trans-Atlantic cables including America Europe Connect-1 (AEC-1), America Europe Connect-2 (AEC-2), and CeltixConnect-1 (CC-1). It’s also just announced an investment in a new cable into the middle east out of Europe.

If I were charitable, I suppose one could forgive the markets ignorance of sub-sea by way of taxonomy. Perhaps investors pigeonhole sub-sea cable as part of a wider fiber play which consists of a number of segments including long-haul (terrestrial and subsea) linking countries and cities together, as well as metro rings (the backbone network within a city) plus customers favorite, FTTP, (running from the metro ring to houses and businesses). And while we’re on that taxonomy point. one might also assume that terrestrial fiber might be a more attractive option because…well…it’s on land! That makes the process of laying cables and getting permissions and worrying about technology upgrades that much easier. So, if as an investor you’ve bought into the idea of all those exponential growth curves in data usage, better to focus on terrestrial and not be too bothered with all that tricky stuff involving water.

I say tricky because sub-sea sounds more than a tad challenging, and I’m not just talking about the obvious challenges of laying a cable in the deeps as well as repowering said fiber every 20 to 30 kilometers. Terrestrial cables typically have complicated rights of way issues to navigate. And if all that isn’t bad enough, experts such as Thor Johnson at D9 warn that backlogs and waiting times for the construction of new sub-sea projects is getting longer all the time. Whereas waiting for the cable supply and then installation would typically take two to three years, Johnsen reckons its now closer to three to four years and growing all the time.

Lurking in the background though is a more practicable challenge: the corporate structure of the sub-sea industry. Traditionally, the funding model for sub-sea has involved big consortia of telco businesses and carriers. The end result is a legacy network where many of the old cables, especially in the all-important Atlantic circuit, are nearing retirement or in need of extensive modernization to allow greater capacity.

That said, despite all these obvious challenges, sub-sea as one segment of the fiber market seems to be growing fast, as are most other digital infrastructure platforms (to be fair). Many of the most important sub-sea cables (at least in terms of capacity) have been built within the last five years. And some routes already look busy.

Take for example the all-important trans-Atlantic routes. At the last count, there were 18 cables going across from the US or Canada to Northern Europe (and especially the UK). D9 owns two of the more well-known cables AEC 1 and AEC 2 but many of the other owners have familiar names such as Vodafone, Tata and Google. Which of course reminds us of an essential fact – that sub-sea markets tend be highly concentrated in terms of ownership, much more so than long haul terrestrial fiber.

The majority of digital data carried via sub-sea today tends to be from a handful of giant companies such as Google, Amazon, Microsoft and Facebook. Rather than relying on the traditional model (telecom consortia) for access to subsea cables, these organizations are deploying their own sub-sea cables. They are doing so to cut costs and expand control and, as a result, the scale and pace of this deployment is significant. According to one industry insider, at the moment more than two-third of digital data moving across the Atlantic is on private networks owned by Google, Microsoft, Amazon or Facebook.

This all leads to one important point: that the sub-sea business is increasingly a scale game played by large operators who can a) afford the capital overlays and then b) continuously upgrade to allow for ever more data traffic.

Both of these trends can be glimpsed through the example of Google. According to Submarinenetworks.com, Google currently has either a stake or privately owns 14 undersea cables,  mostly in consortiums run by the likes of Aqua. Many of the most important span the Atlantic but the data giant has also expanded into other routes such as the Middle East-Africa-Asia route which until recently did not have a Google (or Facebook/Microsoft) cable on it, so one was announced. Soon thereafter, Google announced a project to traverse the Mediterranean and then wrap around Africa.

The technological upgrade path is also clear. Google’s first undersea cable, the Unity system, as part of a consortium across the Pacific, was ready for service back in 2010 and had eight cable pairs with system capacity of just 8 Tbps. The most recent cable, Equiano, which is 15,000 kilometers in length and connects Portugal to South Africa, has 12 pairs but a gigantic capacity of 240 Tbps.

Given this race to scale (and the need to modernize) and link up vast global networks, it’s arguably something of a surprise that there are still niche players such as Aqua in the business, competing against rivals such as Telxius (part of Telefonica) and GTT.

D9, for instance, through its Aqua business, has investments in a number of transatlantic lines: AEC 1 is their first cable with six fibers with four sold to a variety of corporations while another pair is leased, leaving one available pair. D9 also runs AEC 2 across the Atlantic plus AEC 3 which is imminent, coming on shore in Cornwall, UK.

The revenue stack for these independent operators is varied. Some pairs are leased on long term 15-to-20-year deals with the OTT Big Data plays; most of the FAANGs (Facebook, Amazon, Apple, Netflix, Google) seem to be Aqua customers. But mixed in with these (probably lower margin) revenue streams, there’ll also be shorter duration deals in the one-to-five year range for data hungry customers, especially those in the second tier. For example data hungry players such as Akamai and Disney.

This increasingly complex ecology of infrastructure players – traditional carriers battling it out with Big Data vendors and independents playing all sides – becomes even more interesting in certain geographies. One insider tells me that the most interesting competition at the moment is either in shorter haul interconnector cables (for example, UK to the Nordics) or into specific regional markets, with India topping most lists.

And there’s one final observation on this competitive ecology that worth noting: “Amazon and AWS don’t seem to be as active as we’d expect in this market currently. They seem happy to buy capacity rather than lay their own cables,” one industry consultant tells me. Given Amazon’s vaulting global ambitions, I can’t imagine that state of affairs will continue for much longer.

That mention of Amazon though should act as a warning to bigger institutional investors interested in this space. Some investors I talked to admit they like the space but as a result of this competitive landscape tread cautiously around it. Says one: “We’d argue that a sub-sea fiber on a heavily competed route with few customers, poor contract terms and looming competition would naturally be less interesting than a long-haul fiber route with strong customers on good contracts, solid growth potential (new laterals and new customers) and limited opportunity for a competitor to find rights of way.”

Specialists like Aqua/D9 will of course disagree and point to the extraordinary growth in demand across the planet, with new routes opening all the time. They also remind us that even the old routes will need upgrading soon, but one is left wondering whether the sheer scale of capex needed for the next phase of sub-sea modernization might be a challenge too far even for deep-pocketed institutional investors.