Shaky data centre tenants could choke off AI boom

LONDON, Dec 10 (Reuters Breakingviews) - The global boom in artificial intelligence has unleashed a giant wave of data centre construction. Developers are committing vast sums of capital to build facilities capable of powering large language models. For now, banks and other lenders are willing to finance the expansion. However, their confidence rests on a fragile assumption: that the companies renting the facilities remain creditworthy.

The scale is enormous. Morgan Stanley analysts reckon global data centre capacity will need to grow six-fold by 2035 to meet the demands of cloud computing and AI. This translates into an estimated $3 trillion investment in infrastructure between 2025 and 2028. The United States alone will need around 82 gigawatts of additional electricity-generating capacity through 2030 to power the facilities, Goldman Sachs estimates. That's roughly equivalent to all the offshore wind power capacity installed globally.

Much of this historic splurge is being funded by cloud computing giants like Microsoft (MSFT.O), opens new tab, Amazon (AMZN.O), opens new tab and Google, which benefit from vast operating cash flows and strong credit ratings. However, new entrants to cloud computing could account for about 20% of the global rental market for AI-grade graphics processing units (GPUs) by 2030, Goldman analysts calculate . The strains on those upstarts' balance sheets are already beginning to show.

New suppliers like CoreWeave (CRWV.O), opens new tab and Nebius (NBIS.O), opens new tab, often referred to as neo-clouds, are the middlemen of the AI gold rush. They lease data centres, fill them with GPU-heavy clusters, and then rent out the processing capacity to customers ranging from large technology groups to venture-backed AI startups. The neo-clouds' rise has helped to quickly scale up the supply of computing. But it has also concentrated credit risk around the developers that build the data centres. These companies tend to borrow heavily to finance construction, now backed by long-dated leases from neo-cloud tenants.

The financing mechanics leave little margin for error. Developers pay for the construction costs with a mix of common equity and substantial amounts of debt from banks and private-credit lenders. Infrastructure investors often provide preferred equity or mezzanine capital above common equity, earning fixed returns. The residual risk sits with the developer and, ultimately, its creditors.

The neo-clouds that rent the data centres reduce their risk by signing take-or-pay contracts with their biggest customers, ensuring they receive payment whether or not the capacity is fully used. Nevertheless, there's a timing mismatch. While client contracts typically run for four to five years, the neo-cloud provider will usually lease a data centre for 15 years or longer, leaving it on the hook if customers flee.

This model is very different from the projects backed directly by cloud computing giants, also known as hyperscalers. Facilities leased to Microsoft or Amazon benefit from those companies' robust balance sheets and diversified revenue streams, allowing them to access cheaper financing, although a recent rush of borrowing by peers from Google owner Alphabet (GOOGL.O), opens new tab to Meta Platforms (META.O), opens new tab is testing bondholders' appetite. When the tenant is a less financially robust intermediary, however, developers have to pay more for debt.