The Future is Now - AI Deals Dominate TMT Sector

What sectors are currently dominating TMT deals, and what are you seeing on the ground from your clients?

AI, of course, is central. You would be hard-pressed to find a company in the sector where AI is not part of the narrative. While there is a focus on efficiency, structural and transformational changes are also driving interest in AI. The investment pouring into developing large language models (LLMs) and the necessary infrastructure like data centers and fiber-optic connection is substantial - unequalled, in my experience. It's clearly a dominant force.

But AI is not the only driving force. Digitalization across almost everything - from media and entertainment, advertising, and new product and service creation, to gaming, betting, and sports content sharing - it’s all going digital, globally. And then, managing the significant volumes of data generated by all this has brought cyber-security to the forefront, which is paramount for both traditional and digital businesses.

Tech, in general, is really taking the lion's share of growth, though media and telecom are also growing, albeit at a slower pace.

What is driving investment in AI at the moment?

The vast majority of AI investments - probably about 80% - is driven by large tech companies, known as the “hyperscalers”. Geographically, the US is dominant, representing about 80% of AI deals today. This is only going to expand.

The hyperscalers are investing heavily in building the necessary infrastructure, but they can't grow fast enough on their own. As a result, you’re seeing a lot of co-investments with third parties, such as private equity firms and infrastructure funds. This ranges from financing a single data center to portfolios of companies. Single financings often start as traditional project finance with club loans, and then, once the assets reach a break-even point, they’re refinanced in the public markets at better rates.

More interestingly for portfolios, companies are raising what they call warehouse facilities. These serve to fund the equity into a subsidiary (known as a Devco) which holds data centers at different stages of maturity, targeting the high-risk development phase. Project debt is raised on top of these warehouse facilities. This funding helps finance the Devco assets. Once the assets are stabilized (i.e. established, revenue-generating assets) and buyers lined up - often investors seeking stable, yield focused returns - they are switched into a StableCo and the debt is refinanced through public markets using asset-backed securities and the like.

Sustainability is also a key factor. Data centers, especially, require a lot of water, electricity, and land, and investors are painfully aware of this. ESG-related ratings, covenants, and goals are increasingly scrutinized.

Beyond the hyperscalers, are we seeing a trend towards consolidation among smaller companies?

Yes, we are. As soon as a start-up with a great idea emerges, there may be several interested buyers. Many new approaches include software-as-a-service (SaaS) and AI-driven applications. Valuations are often high, and based on future growth expectations which may or may not materialize. However, there is a lot of capital chasing credible assets to build wider platforms and fund them to the next stage.

What risks are you seeing when it comes to TMT deals?

Geopolitics are an obvious risk, as are regulatory environments that are not consistent globally. The U.S., Europe, and China, for example, all have different approaches, and you may, dependent on the geographical scope of the transaction, need to comply with all jurisdictions. There’s also the concern about data leaving a country and not being managed in a safe environment. This influences the choice of investment locations - acquisition targets are often not necessarily the most resource-efficient ones, due to geopolitical and regulatory constraints.

When it comes to cyber-security risks, there’s a need for solutions. Telecom operators are hiring cyber teams or buying companies to complement their existing capabilities. Companies are developing state-of-the-art new ways to counter the increasing sophistication of malicious actors using AI. Human creativity works for both good and bad, so strong cyber safety networks are increasingly vital.

Is AI important when it comes to financing and M&A activity?

One hundred percent. A company tapping the markets without mentioning AI will probably find it hard to gain attention. We're seeing a clear impact on valuations for AI-driven assets. However, the narrative has to be credible and real, not just a story. Clarity on potential use cases is becoming more important. Capital is flowing towards AI on both debt and equity markets because the expected benefits - economies of scale, scope, efficiencies, and transformative abilities for business models - are potentially immense.

Looking ahead 12-18 months, what headwinds do you foresee in deal-making and financing?

Geopolitics is probably the biggest one. Derailing inflation, interest rate outlooks, shifts in the US dollar's role as a reserve currency, and geopolitical conflicts could all be potential destabilizing factors.

Another headwind is that we're still in the very early stages of investment for AI and digital infrastructure. Any hurdles in any of these models could spill over and impact others.

Innovation brings the risk of obsolescence and massive friction that can reinvent business models. Those of us who remember the internet boom of the 1990s can recall the many phenomenal-sounding valuations and business models that never materialized.

What makes you most excited about the next 12-18 months in this space?

This sector is as vibrant as it gets; I can’t think of a better one to be in right now. It is extraordinary what’s happening daily: new developments and new utilizations of AI by clients. It's an amazing time to be involved.