Digital 9 Infrastructure (DGI9) is a good example of a fund which has been caught up in the global market rotation despite impressive underlying fundamentals and long-term thematic tailwinds – by Andrew Courtney

At its heart, the company offers targeted exposure to digital infrastructure, which leverages cleaner, greener power. This provides the foundation for the rapidly accelerating digital transition, known colloquially as the IoT.

Investments are spread across data centres, fibre, and more traditional wireless networks and the primary focus is on assets that are already operational, typically with established medium to long term contracts in place. Within this, the company has struck a nice balance between reliable revenue generation and high growth upside which should come with relatively low risk given the secular nature of its investment themes.

The company completed its IPO in February 2021, a period defined by broad market optimism surrounding the vaccine rollout and the general economic reopening. Coming out of the first year of COVID, investors were keen to deploy capital, with the value of IPOs in the UK more than 250% higher than their pre-pandemic levels (2019 vs 2021).

DGI9 was a benefactor of this to the tune of £300m which, while short of its £400m target, was an impressive result and was followed quickly by two successive raises over the next 12 months. This brought total proceeds close to £750m, £462m of which was deployed over the rest of the year.

The speed with which this capital was invested was equally impressive and despite sentiment touching close to euphoria during this period, management were able to acquire a number of assets at very reasonable multiples with initial investments in Aqua Comms and Verne Global providing an excellent platform of cashflow positive assets to build from. They have since deployed all the capital raised since IPO, with £605m deployed in 2022 alone.

The largest of these, worth £231m, was in Verne Global and this was quickly followed by a £71m additional payment in response to accelerated customer demand for Verne. The company is a highly scalable data centre platform powered by 100% baseload renewable energy which offers unique benefits.

This cornerstone investment immediately added value with revenues growing 80% year on year to $37.8m and EBITDA rising to $22m through 2021. With margins close to 60%, the company’s EBITDA multiple fell from an already competitive acquisition price (considering sector comparisons) of 20x to c.15x. Verne has continued to outperform over the ensuing period, and cash flow is expected to accelerate further as pre-sold data centre capacity comes online, highlighting both the resilience of its revenues in the face of global market volatility and the long term potential in the space.

Another notable investment for DGI9, and its largest, taking up 27% of GAV, is Arqiva, the only national terrestrial television and radio broadcasting network in the United Kingdom. While the investment does not provide the same level of excitement factor as an Icelandic data centre, or undersea fibreoptics, the company is a cash generation machine, providing impressive, reliable, and inflation linked cashflows along with solid capital growth upside.

Headwinds related to interest rate swaps have clouded short term profitability, accounting for roughly £47m in additional costs over the past year. However, absent these payments, DGI9’s operating cash flow dividend cover would move from 0.4 to around 1.3 and management expects this to improve further going forward thanks to Verne’s profit outlook and the optimisation of DGI9’s other assets.

The performance of DGI9’s two largest investments have helped drive an annualised total return of over 10% for the last two years (although it’s worth noting that the 2022 return included a 6p dividend that was not fully covered by operating cash, as touched on above).

But despite this solid performance, the shares have collapsed, and the discount has continued to widen. At the beginning of 2022, shares traded at a 8.1% premium and have since fallen to a discount of almost 40%.

The departure of the investment team in November 2022 was the initial trigger for destabilising the share price. However, this should not undermine the long-term potential of the fund in our view, particularly given the underlying strength of the company’s assets.

The company has also been a victim of the wider market rotation away from growth stocks, and the fear that rising interest rates will drive down valuations across the infrastructure sector. However, If anything, the company’s recent performance has vindicated DGI9’s investment approach which limits exposure to more risky assets that are not yet operational, targeting companies able to generate both top and bottom-line growth.

The de-rating of some sectors of the economy in the face of higher interest rates is certainly justified, particularly in areas such as unprofitable tech, however it seems harsh, as the current discount would suggest, to lump DGI9 in with this basket.

Not only are they generating stable cash flows (EBITDA was £206 on revenue of £409m), the company’s valuation remains attractive with an EV/EBITDA multiple well below the MSCI ACWI index, and on par with the traditionally value focused UK market.

There are certainly risks, as with any investment, and it would not be a surprise to see the shares remain under pressure as markets continue to grapple with higher interest rates and inflation. Another challenge for management going forward will be to ensure they are able to balance the need for continued growth with the optimisation of the company’s existing assets.

On balance however, these risks seem skewed to the upside, and in contrast to its share price, the company’s performance over its short life so far leaves us confident that its shares can recover. While multiples may need to be adjusted in some sectors of the market, reliable, long term cash flow ought to define valuations going forward.

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