Bernstein: Data center contracts shift: Power availability determines demand as cloud tenant guarantees shrink

Why does the timing of power availability matter more than total planned capacity?

Legal experts interviewed by Bernstein believe power remains the biggest constraint on near-term development. Power available within 12 months is most valuable, followed by power available in 12 to 24 months; beyond 48 months, it generally lacks commercial appeal.
A campus with 400 megawatts of planned capacity may still be highly valuable even if only 100 megawatts can be delivered within 12 to 24 months, provided there is a credible path to securing the remaining power: customers can start operations first and expand gradually.
Meanwhile, regulatory changes in the United States are occurring mainly at the local level. Community acceptance and changes in local rules also influence developers’ assessments: projects must comply with current requirements and account for the possibility that rules change during construction.

Large transactions are usually tailored individually. Major cloud providers often use contract templates that favor themselves and may contain termination-for-convenience rights; the experts believe such rights weaken the ability to finance custom-built facilities and sell assets and should generally be removed in negotiations.
More common termination triggers include loss of the path to securing power or failure to meet agreed development milestones; delays may also trigger rent-free credits or agreed damages. Specific terms depend on project size, customer type and the parties’ bargaining power.
Expansion, rights of first offer on leases, purchase and renewal rights also affect the future use of a campus. If developers give tenants too much control, they may limit future development options.

The experts say that nearly all new data center deals involving emerging cloud providers require credit enhancement, including prepaid cash, letters of credit or third-party guarantees, to help projects obtain financing.
Over the past year, guarantees have shifted from covering the entire lease to providing limited protection. For example, a guarantor may cover only 80% of the construction loan rather than all rent; the developer’s equity investment and the unguaranteed portion of the loan remain at risk.
Guarantees also typically decline linearly over the initial lease term, reducing protection over time; guarantors are increasingly asking for the right to take over the site and power after assuming liability under the guarantee. Whether existing credit support can be retained when a lease is assigned is also an important condition for its financeability.

The experts expect some emerging cloud providers may fail over the next 1 to 3 years: their data center leases may last as long as 15 years, while customer contracts may last only days or months, and even stronger contracts typically last only 1 to 3 years.
The experts give an example: if construction costs 10 million dollars per megawatt and effective credit protection equal to 30% of the cost has been secured in advance, then, if the tenant fails and the owner can quickly recover the facility, the owner’s effective cost can fall to 7 million dollars per megawatt, making the facility more price-competitive when re-leased.
This outcome depends on the structure of the protection and the speed of recovery; in addition, a facility customized for the original customer may require modifications when re-leased.

The interviewed experts have not yet seen a slowdown in deal activity, but have observed that participants are more cautious and more concerned that counterparties may be speculators. The creditworthiness of some guarantors has come under scrutiny, and this is already affecting bidding choices for new deals.
The experts expect demand over the next 3 to 5 years to expand from training campuses in remote areas to smaller inference facilities in urban and suburban areas. One expert has observed that midsize operators have shifted toward large projects after being acquired, while some remaining providers lack power, reducing the number of competitors for local capacity.