Morningstar DBRS Confirms EdgeConneX Data Centers Issuer, LLC at BBB, Stable Trends

On October 31, 2024, Morningstar DBRS amended this press release to include the Series 2024-1 Class A-2 Term Note rating in the ratings table and updated the relevant disclosure to include the same.

DBRS, Inc. (Morningstar DBRS) confirmed the Issuer Rating, the credit rating on the Series 2022-V Class A-1 Variable Funding Notes (VFN), the credit rating on the Series 2022-1 Class A-2 Term Note, and the credit rating on the Series 2024-1 Class A-2 Senior Notes (collectively, the Senior Notes) of EdgeConneX Data Centers Issuer, LLC (the Issuer) at BBB. All trends are Stable.

The ratings are supported by the Issuer's continued lease up of the data center portfolio and Morningstar DBRS's review of the associated incremental revenue. Since the initial rating in April 2022, the portfolio's annualized monthly recurring revenue has increased to $83 million from $65 million as the Issuer continues to sign new contracts for processing capacity with existing and new tenants, while revenue stability was enhanced with the acquisition of one of the leasehold data centers in the portfolio, turning it into a fully owned property.

Annualized revenue churn from existing customers has been approximately 3% on an annualized basis, which is better than Morningstar DBRS's rating case assumption of 10% annually. Actual annual churn, however, does vary significantly from year to year, underscoring the necessity of the financing structure to withstand annual revenue volatility. Additionally, revenue from new contracts comprise a mix of contracts viewed as more stable long-term service orders, as well as short-term (one- or two-year) service orders or venture-funded customers that have not yet established a track record of profitability. The long-term stability of such latter revenues is uncertain, and Morningstar DBRS takes a conservative stance with respect to these when incorporating into the long-term rating case projections.

KEY CREDIT RATING CONSIDERATIONS
The confirmed credit ratings depend on assumptions regarding the refinancing of the Senior Notes at the Anticipated Repayment Date (ARD). While Morningstar DBRS expects the Senior Notes to be refinanced at the ARD, the principal repayment is subject to refinancing risk because of the high remaining debt leverage and related exposure to actual interest rates at time of refinance. Should inflation flare back up and interest rates remain elevated longer than expected, leading to a greater possibility that the refinance rate will be higher than the rating-case assumption, Morningstar DBRS may take a negative credit rating action.

Morningstar DBRS notes that the additional penalty interest tranche, which will be incurred if the Senior Notes are not refinanced on or prior to their ARD, is fully subordinated to the debt service of the Senior Notes (including the cash sweep) and is therefore not rated with this review. The credit ratings also materially deviate from the principal methodology used as there is no specific provision in Morningstar DBRS' "Global Methodology for Rating Essential Digital Infrastructure" for a very large number of counterparties with shorter-term contracts, many of whom are rated either lower than the project rating or are unrated entities. Please refer to the paragraph on material deviations in the Notes section at the end of the press release.

The Issuer's revenues are directly backed by the revenues from lease contracts and service orders from more than 170 tenants occupying a portfolio of 28 data centers, nine of which are leased from landlords and the remaining 19 of which are under fee-simple ownership. Morningstar DBRS generally views the data center portfolio and the tenant composition positively, with the data center facilities being in strong primary and secondary markets and occupying locations that are well suited for their function as edge data centers. The tenant base largely comprises technology companies, including telecom-related companies, whose relative stability and mature market structure complement cloud-based computing providers. The high growth rates and potential of these providers offset weaknesses, including a still-consolidating industry structure and a weaker or nonrated status of many tenants.

Morningstar DBRS notes that end tenant power occupancy in edge data centers is more vulnerable to variations in end-market demand than hyperscale single-tenant data centers. As a result, tenant contracts for edge data centers tend to be shorter, averaging a four- or five-year initial term prior to renewal options, and therefore more exposed to the risk of nonrenewal as tenants regularly evaluate their data capacity needs in response to the performance of their own businesses.

CREDIT RATING DRIVERS
Conditions leading to a credit rating upgrade are not considered likely at this time.

A persistently elevated interest rate environment leading to a higher probability of long-term interest rates being higher than the rating-case assumptions at the time of refinance could lead to a negative credit rating action.

FINANCIAL OUTLOOK
The financing structure features debt service coverage ratio (DSCR) profiles, as calculated based on Morningstar DBRS's rating-case assumptions and revenue haircuts, with a minimum DSCR of 1.46 times (x), and a refinance minimum DSCR at the 5.5-year mark of 1.30x; Morningstar DBRS's rating case incorporates the constraints and challenges of the project. Morningstar DBRS views the metrics, combined with the soft refinance nature of the debt in which a failure to refinance does not lead to a default but rather to a cash sweep where all cash after expenses and interest payments are swept to repay principal, as supportive of a BBB credit rating. In the exceedingly unlikely event that the Sponsor does not refinance the debt for the full duration to legal maturity, cash flows of up to 17.5% lower than the rating-case assumptions (which include the assumption that none of the leasehold data centers remain in the portfolio past their ground-lease expiry dates in the mid-2030s) are still sufficient to fully amortize debt.

CREDIT RATING RATIONALE
The BBB credit rating is underpinned by (1) expected stable cash flow deriving from long-term lease payments to the data centers and minimal lease churn to date, notwithstanding the increased susceptibility to variations in end market demand; (2) the expected resiliency and sticky nature of the revenue stream owing to the particularly critical and strategic nature of edge data centers to tenants' business operations; and (3) the strong and favorable debt package to noteholders. Morningstar DBRS notes that the debt and security package offers protections to noteholders typically expected of a well-structured project finance transaction. The primary constraints on the rating include (1) re-leasing risk of each lease at various intervals, subjecting the Issuer to the risk of either tenants opting out of their leases or obliging the Issuer to grant concessions as an inducement for tenants to remain; (2) leasehold data centers, where approximately 16% of revenue is derived from data centers that are leased by the Sponsor, as opposed to fee-simple owned, and exposing the project to risk of nonrenewal by the landlord when the leases expire; (3) risks related to technical obsolescence or the deterioration of competitive position; and (4) lower-rated or unrated counterparty entities.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance factor(s) that had a significant or relevant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings (August 13, 2024) https://dbrs.morningstar.com/research/437781.

RATING DRIVER ASSESSMENT AND FINANCIAL RISK ASSESSMENT (FRA)
(A) Weighting of Rating Driver Factors
In the analysis of EdgeConneX, the Rating Driver factors listed in the methodology are considered in the order of importance.

(B) Weighting of FRA Factors
In the analysis of EdgeConneX, the following FRA factor listed in the methodology was considered more important: minimum DSCR.

(C) Weighting of the Rating Driver Factors and the FRA
In the analysis of EdgeConneX, the FRA carries greater weight than the Rating Drivers.

Notes:
All figures are in U.S. dollars unless otherwise noted.

Morningstar DBRS applied the following principal methodology:
-- Global Methodology for Rating Essential Digital Infrastructure (April 15, 2024),
https://dbrs.morningstar.com/research/431172

Morningstar DBRS credit ratings may use one or more sections of the Morningstar DBRS Global Corporate Criteria (April 15, 2024;
https://dbrs.morningstar.com/research/431186), which covers, for example, topics such as holding companies and parent/subsidiary relationships, guarantees, recovery, and common adjustments to financial ratios.

The following methodology has also been applied:
-- Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings (August 13, 2024), https://dbrs.morningstar.com/research/437781

The credit rating methodologies used in the analysis of this transaction can be found at:
https://dbrs.morningstar.com/about/methodologies.

A description of how Morningstar DBRS analyzes corporate finance transactions and how the methodologies are collectively applied can be found at: https://dbrs.morningstar.com/research/431153.

Morningstar DBRS materially deviated from its principal methodology when determining the ratings assigned to the Issuer Rating, the Series 2022-V Class A-1 VFN, the Series 2022-1 Class A-2 Term Note, and the Series 2024-1 Class A-2 Term Note as there is no specific provision in "Global Methodology for Rating Essential Digital Infrastructure" for a very large number of counterparties, many of whom have contracts that are shorter term in nature (although with provisions for multiple renewals upon expiry), and many of whom are rated either lower than the project rating or are unrated entities. The methodology generally assumes a single counterparty or small number of counterparties with long-term contracts, minimal re-leasing risk, and generally high credit quality. The credit ratings address this by stressing historical default and contract nonrenewal rates by an appropriate factor, noting that historically for this Issuer and for the sector generally, nonrenewal of contracts are manageable given the critical nature of the service that the data center offers to the counterparty; as well, the credit rating team believes that new customers will be available to contract for capacity and services in the case of either nonrenewal or customer default.

The credit rating was initiated at the request of the rated entity.

The rated entity or its related entities did participate in the credit rating process for this credit rating action.

Morningstar DBRS had access to the accounts, management and other relevant internal documents of the rated entity or its related entities in connection with this credit rating action.

This is a solicited credit rating.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. Morningstar DBRS trends and credit ratings are under regular surveillance.

Information regarding Morningstar DBRS credit ratings, including definitions, policies, and methodologies, is available on https://dbrs.morningstar.com or contact us at info-DBRS@morningstar.com.

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