Google parent Alphabet taps muni market in first for hyperscalers

An upsized nearly $1.2 billion prepaid energy deal connected with Alphabet, Google's (GOOG) parent company, priced Thursday, a first for a hyperscaler to tap the muni market and a sign that other tech companies could follow.

Alphabet was the funding recipient for the deal, issued by the California Community Choice Financing Authority and underwritten by Goldman Sachs (GS).

The bonds carry the Moody's Aa2 rating, tied largely to Alphabet's Aa2 corporate rating.

The strength of Alphabet's credit ? it's also rated AA-plus by S&P Global Ratings ? and the company's widespread recognition contributed to strong investor interest, resulting in over 10 billion in orders from around 100 accounts, according to market participants.

Furthermore, the deal "hit the bullseye" for many investors with a mid-double-A-rated credit and around 100 basis points over "something else that you could buy in California," said Jamie Iselin, head of the municipal fixed income team and a senior portfolio manager at Neuberger Berman.

The $1.1 billion nine-year maturity "came at +103, was bumped 12bps, and then traded up another 22bps on the break," said Birch Creek strategists.

The success of the prepaid energy deal could create an inflection point where other large hyperscalers ? operators of massive data centers designed to support the extreme demands of cloud computing and artificial intelligence ? use them as a financing tool to secure their long-term energy needs, said Kyle Gerberding, director of trading, a portfolio manager and partner at Asset Preservation Advisors.

"It's not unexpected when you look at the needs that [hyperscalers are] going to have from a power and energy and gas standpoint. I wouldn't be surprised if we see some other folks now follow along," such as Amazon or Microsoft (MSFT)," he said.

These hyperscalers have massive AI needs, with several firms projecting $5 trillion in global infrastructure, data center and power investments for AI by 2030.

There have already been sizable deals from hyperscalers in the corporate market this year, including Alphabet's $84.75 billion equity capital raise last week.

The muni market could also serve some of these needs, especially for data centers, as prepaid energy deals are poised to double or even triple in the coming years, driven in part by rising power demand from data centers, according to a Morgan Stanley (MS) report.

Prepaid energy deals are all about the tax exemption, said Sweta Singh, founding partner and portfolio manager at City Different Investments.

"It's [about] taking advantage of the tax-exempt market, and it's the payment fees, the swap that is happening, where the financing is tax-exempt and the procedure in a taxable way, so that part is a clever way of them approaching the market," she said.

With prepaid energy deals, hyperscalers can access cheaper energy in the muni market than issuing in the corporate market, Gerberding said.

This would only contribute to the explosive growth prepaid energy deals have seen over the last several years.

Prepay issuance through the end of May is up 94% year-over-year, rising to $15 billion, according to J.P. Morgan strategists.

In this particular deal, Pioneer Community Energy, as a local electricity provider and project participant, assigns power purchase agreements to Goldman's commodities trading arm J. Aron under the assigned electricity contracts, said Jeff Lipton, The Bond Buyer's market intelligence analyst.

The deal allows Pioneer to "lock in a long-term electricity supply purchased at a discount to the spot market, hedging against commodity price volatility and reducing overall energy supply costs," he said.

The deal carries the green bond designation, verified by Kestrel, because it finances the acquisition of renewable and carbon-free electricity.

PFM Financial Advisors is municipal advisor on the deal. Orrick, Herrington & Sutcliffe is bond counsel.

Prepaid deals can provide attractive yields and additional spread tax-exempt bond investors look for. And a higher interest-rate environment allows for wider spreads between taxable and tax-exempt rates, attracting financial sector guarantors by providing a cost-effective funding mechanism.

As the prepaid sector evolves, "it's worth asking whether all prepaid deals should be viewed the same way, or whether investors should differentiate based on the underlying obligor," said Eve Lando, a portfolio manager at Thornburg Investment Management.

In the $1.2 billion deal, Alphabet served as the funding recipient, a role typically held by banks and insurance companies.

That distinction becomes more important as large companies like Google (GOOG), Meta, and Amazon "explore prepaid structures to help finance major data center projects through the tax-exempt market," Lando said.

"Diversifying prepay participants with different types of guarantors is a good thing and I suspect continued market acceptance will pave the way for further expansion of the energy prepay structure," Lipton said.

Going forward, performance "could diverge based not only on the underlying bank and its credit rating, but also on the type of obligor behind the deal, whether it's a bank, a life insurance company, or potentially even data center-related issuers in the future," Lando said. "The market is reaching a stage where investors are beginning to differentiate within the sector."

In the short term, especially with strong credits like Alphabet, the market will be excited for the diversification possibilities that this offers, Iselin said, noting this deal could lead to an acceleration and spending related to AI.

However, questions remain about how much prepaid power issuance will come to market, given the deal's success, and how much bigger the sector is going to become in terms of indices, he noted.

"It's doubtful the muni market can handle, especially if we get into an outflow cycle, the type of debt growth seen from these hyperscalers in the traditional corporate bond market," Iselin said.

"Part of the great thing about the muni market is it does adjust to changes and supply/demand dynamics," and the mass entrance of tech companies is still in the early stages, as there has only been one deal that did "extremely well," Iselin said.