How real estate cos should and shouldn't do data centers

AWS server farm at Tnuvot  credit: TG Productions
AWS server farm at Tnuvot credit: TG Productions

Three recent sales of data centers businesses by Israeli real estate companies illustrate the challenges, and the different approaches.

Real estate company Azrieli Group announced a huge deal last week whereby it will sell its 32% stake in Dallas-based Compass Data Centers to Canadian investment fund Brookfield Infrastructure Partners and the Ontario Teachers’ Pension Plan, for NIS 3.2 billion.

Azrieli Group is not alone. This is the third deal in the past year in which developers from Israel have sold stakes in companies that build data centers (and that are also active in Israel). Just last month, the Papouchado family's Red Sea Group, which deals in the hotels and real estate business, sold the controlling stake in Serverfarm, which it set up in the US, to Canadian insurance company Manulife for over NIS 2 billion. Serverfarm is building a data center at Bnei Zion for Google and Bezeq International, and has plans for at least two new data centers in Israel.

In July last year, it was the Livnat family (owner of haulage and logistics company Taavura) that sold 49% of Israel’s oldest data centers company, MedOne, to US private equity firm Berkshire Partners, for over NIS 700 million.

In all these cases, the Israeli sellers sold their holdings at high multiples on their original investments and on the companies’ results, and made handsome exits (Azrieli Group reported an expected NIS 1.3 billion pre-tax gain, and an annual return in shekel terms of 40%).

The series of deals is not coincidental. Most of the data centers companies that have grown here began as a niche market that steadily expanded. In the past, this suited families like Papouchado and Livnat, but now, the hunger for artificial intelligence and products like ChatGPT and cloud computing has generated very high demand, dictating exponential growth in costs, mainly because of the need for more and more expensive processors.

This means annual investment of hundreds of millions of dollars to construct new data centers and maintain existing ones. For families like Papouchado and Livnat, which are in inter-generational transition, it’s a heavy outlay. This is why, in their cases, the shares were partly sold to a foreign private equity or growth fund that specializes in injecting capital to grow an existing business.

Dispute over construction of Amazon data center in Israel

The case of Azrieli Group’s sale of its shares in Compass Data Centers is different. As far as is known, the background to that sale was differences of opinion between the two companies because of delays in the construction of the data center for Amazon Web Services (AWS) in Israel. "Globes" has learned that construction at the three AWS data center sites in Israel carried out by Compass Data Centers and Exyte was delayed more than expected because of technical problems to do with planning and installation of the electrical and cooling systems, and that AWS recently had to announce a postponement of the launch of its Israel cloud region from the first half of 2023 to the third quarter.

AWS undertook to the Israeli government to launch its Israel service region as part of its win in the Nimbus cloud tender for hosting government computing activity at an Israeli computing installation. AWS currently serves government units from servers located in Europe and the US, and this represents a risk for some government information, chiefly for private information on Israeli residents and information relating to the security services.

Like Amazon, Microsoft has also postponed the launch of its cloud service in Israel, but since it lost in the government cloud tender, it is under less pressure. Google, which won the tender together with AWS, launched its Israel region at the end of last year, based on the EdgeConneX data center in Petah Tikva and the Serverfarm and Israel Infrastructure Fund data center in Moshav Bnei Zion.

Google’s cloud activity in Israel is, however, smaller than that planned for AWS, such that the delay in the launch of the AWS region has consequences for all the government ministries and public bodies that want to transfer their computing to the cloud and to benefit from the growth of artificial intelligence.

Although Azrieli Group sold its stake in Compass (in which it was a minority shareholder and was not involved in management) it has not given up on the growth in server farms, in which its main holding is Green Mountain, which operates in Norway (where it is currently constructing a data center for TikTok), Germany, and the UK.

Data centers sites are intended for leasing to large technology companies providing cloud computing services and storage and file management services, under long-term, renewable contracts. Data center companies are measured not just by the square meter but also, in fact mainly, by their power consumption (in megawatts). In Israel alone, dozens of data centers serving the global technology giants operating here have been constructed in the past few years.

Figures published by Azrieli Group in the presentation attached to its first quarter financials, released a month ago, show the fast pace of growth in this field. Last year, worldwide investment in construction of data centers totaled $606 billion, and by 2027 annual investment is projected to reach $1.2 trillion. The technology giants’ revenue from provision of cloud computing services is seen climbing from $167 billion last year to $725 billion in 2027.

Taking over specialist companies the way forward

Azrieli Group entered the data centers industry through takeovers of foreign companies specializing in this area, and that looks like the right way to go about it. Conversely, many real estate companies that went into data centers during the hype period of the Covid pandemic are now facing financing challenges, obliging them to inject more capital into constructing bigger and more powerful data centers. This has brought home to them the big difference between the real estate business, which is measured in costs and returns per square meter, and running a data center that is measured in terms of power output and that requires expertise in energy and power supply.

In this respect, it is interesting to watch the progress of real estate company Europe Israel, controlled by brothers Maor and Snir Malul, which, together with the investment company of singer Omer Adam (PAI Group), linked up with Swiss-based LIAN Group, which holds data centers in Norway, to promote the construction of two data centers in Israel: one in Afula and the other at Kibbutz Tsor’a. The consortium looked for customers for a long time, and eventually managed to find several for the Tsor’a data center, construction of which began at the end of last year and will take until the end of 2024, at an investment of NIS 400-450 million. Construction of the larger and more complex data center in Afula, at a cost of some NIS 1 billion, has been delayed until a customer is found that will commit to leasing it.

Published by Globes, Israel business news - - on June 25, 2023.

© Copyright of Globes Publisher Itonut (1983) Ltd., 2023.

AWS server farm at Tnuvot  credit: TG Productions
AWS server farm at Tnuvot credit: TG Productions
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