Moody’s has dealt a blow to the growing trend for hyperscalers to use leasing deals to shift hundreds of billions of dollars of data centre liabilities off balance sheet, with the ratings agency warning that companies using that financing route risk a “material” deterioration in their credit profiles.
The candid opinion, which criticised “limitations” in hyperscaler disclosures that “may not show the full picture” of their liabilities, puts the ratings agency at odds with its closest rival, S&P, over what has become one of the most popular ways of securing data centre capacity.
Alphabet, Amazon, Meta Platforms, Microsoft and Oracle doubled their lease commitments to US$969bn last year, according to Moody’s. But more than two-thirds of those commitments are yet to be included on their balance sheets – meaning investors may not be fully aware of their financial exposure, it said.
The appeal of leasing has gained traction following an opinion from S&P in October that allowed Meta to shift the cost of building its Hyperion data centre in Louisiana off balance sheet by raising the US$27.3bn of debt needed through Beignet Investor, a special purpose vehicle jointly owned with Blue Owl Capital. That meant it avoided any direct impact to its credit profile, despite the potentially costly guarantees it made to the SPV.
When asked why Moody’s was now taking a more conservative view around such transactions more than four months after the Meta-Blue Owl deal had taken place, David Gonzales – one of the authors of the February 23 opinion – pointed to the hyperscaler’s disclosures around the deal released earlier this month.
The opinion also comes after Meta's auditor EY raised red flags about the way the deal had been accounted for. The auditor said it had been “especially challenging” to assess whether the SPV ought to be consolidated onto Meta's balance sheet. While it eventually signed off on the transaction, it nonetheless flagged it as a "critical audit matter" in its report.
“The accounting at this time under the current rules is not in line with the expected economics of this transaction,” Gonzales told IFR, adding that other issuers could be affected. “These structures are unique and we plan to continue to evaluate potential adjustments on a case-by-case basis.”
Rising debts
The disagreement between two of the world’s leading ratings agencies over how to treat these deals comes at a crucial juncture for the industry, with the five hyperscalers currently rated by Moody’s and S&P set to spend more than US$650bn this year – and even more next year – in the race to develop the leading AI model.
Leasing deals, which allow hyperscalers to outsource the construction costs and practicalities of building data centres, are expected to play a huge role. But the opinion from Moody’s will now give many hyperscalers pause for thought amid the risks that such structures could have on their ratings.
“We foresee a material increase in adjusted debt and lease-related cash outflows for these companies in the coming years,” Gonzales and his colleague Alastair Drake wrote in the opinion, adding that the agency could make “non-standard” adjustment to debt calculations to reflect the true liabilities.
At the centre of the disagreement is how to account for lease extensions. Historically, the initial lease on data centres tended to be for periods of 10 to 15 years. But fears over chips becoming obsolete quickly, coupled with uncertainty over whether AI as a business model will be profitable, has driven the length of these initial leases down to as short as four years.
To make these shorter deals economically viable for the third-party landlords and SPVs building the data centres and raising the money to finance construction, more recent deals have been structured with options to renew after the initial lease ends – and, in the case of Meta and other deals, a pledge to make the landlord whole if leases are not renewed.
Under US accounting rules, hyperscalers aren’t required to account for lease renewals until they are “reasonably certain” they will happen, which may not be until just before the lease is renewed. The “residual value guarantees” given to landlords also don’t have to be accounted for unless they are “probable”.
Moody’s said current accounting rules make company disclosures around these deals “opaque”. The ratings agency said that it stands ready to make “a quantitative debt adjustment” to reflect the true nature of the liabilities when making its credit assessments on the hyperscalers taking out leases and making guarantees.
“While leasing the assets reduces the companies’ upfront capital investments, having a significant amount of leases will also reduce the companies’ financial and operating flexibility, particularly if there is a rapid change in industry conditions,” wrote Gonzales and Drake.
Different view
S&P, which was hired by Beignet Investor to provide a credit analysis of the structure, has taken a different view about how to account for such deals.
It said that, while the criticality of sites such as the one in Louisiana to Meta’s business “is normally a reason to consolidate” such liabilities onto its balance sheet, the way that the Beignet deal was structured gives the hyperscaler sufficient optionality to warrant not consolidating.
Crucially, S&P also attaches zero value to the residual value guarantee. That is because – in its view – the market value of the data centre is sufficiently high that Meta would not be required to make any payments to Blue Owl even if it did not take up new leases.
“We currently do not make a debt adjustment for the RVG due to significant headroom between the RVG and a third-party appraisal value,” S&P wrote in October in its opinion about the deal. “We will continue to monitor and could adjust that over time regardless of accounting treatment.”
S&P did not respond to a request for comment.
Headaches
While the Moody’s opinion is unlikely to immediately threaten the ratings of Alphabet, Amazon, Meta or Microsoft, which have low debt levels and plenty of headroom, it could create a headache for Oracle, which is just two notches above junk and has faced an investor revolt over debt levels.
“Historically, these companies were very cash generative and didn’t need debt markets to finance capex,” said one technology analyst at a large bank. “But given the amounts they are now spending, they have negative free cashflow – hence the need to bring in these third parties.
“Why else would they be doing these things? They simply want to get the cost of building these projects off the balance sheet. If the structures no longer work, then that creates a huge headache because it means they’ll have to do much more of this stuff on the books.”
Bankers will also be frustrated by the opinion, not least because it could make complex financings such as the Meta deal – which attract much higher fees because of the complexity involved – potentially much less attractive.
They say Alphabet’s decision to tap the sterling and Swiss franc bond markets during its recent US$31.5bn-equivalent bond sale was an indication that hyperscalers are already nervous about the amount of debt they need to raise in the years ahead – hence the need to tap non-core markets.
If the Moody’s opinion closes off an alternative avenue of financing, that could cause problems.
“The Beignet deal and the recent Alphabet deals show that these companies are very much aware of the wall of financing that is to come,” said a San Francisco-based banker. “Those deals were about building optionality to scale up their financing. If one of those channels closes, that isn’t good.”
