Internet Only Goes Up

by Overheard Wall Street May 1, 2023

Outline:

Intro
Industry
Equinix
- Intro
- Bull Case
- Risks
- Valuation/ Key Metrics
Conclusion

Intro

Why do big players on Wall St and high-frequency traders all have offices near NYSE? Well, apparently length matters, at least sometimes.

In this week’s issue, we cover the intriguing data center business and our interviewer's top pick: Equinix.

Data centers arise from the need of storing your favorite Netflix shows, your last IG story or all your 500 new emails for the day. 5 billion Snapchat videos and photos are shared per day. That’s a lot of data that needs to be stored somewhere... in the cloud -> which is a data center.

Previously, companies had their own head of IT deal with all the headaches, cables and providers… but then players like Equinix arose in the space to centralize the service. Companies could focus on their own operations while data center providers could provide efficiencies and reach economies of scale by specializing in the installation, integration, and maintenance of these refrigerator-sized machines, which just like them, need cooling too.

Industry

At a macro level, there is an explosive demand for data that is doubling every year. The driver? High bandwidth activities such as video streaming, shift to 5G, and rise of connected devices as we shift to the internet of things.
Enterprises still maintain 70-80% of their workloads on-premise though the majority of the new workloads are being developed on the cloud, 69% of companies are either starting a shift or considering a shift to the public cloud, which is driving the demand for data center facilities all over the world.
With Covid-19 and remote work dynamics, businesses are prioritizing digital transformation as a way of gaining competitive advantage.

There used to be 5 public data center companies until last year, now there are only 2 left (Equinix and Digital Realty).

Equinix
Digital Realty
QTS (bought by Blackstone in 2021)
CoreSite (bought by American Tower in 2021)
CyrusOne (bought by KKR in 2021)

Equinix

Intro

Equinix is a data center operator, structured as a real estate investment trust (REIT). Their key service offering is colocation – leasing rack space for customers to place servers and other cloud computing equipment, while providing cooling, power, and security.

Their second major line of business is interconnection services, where customers pay for each megabit of traffic exchanged within the data center among carriers, enterprise customers, and the public cloud through public and private peering.

Equinix has 244 data centers that span across 6 continents, 69 metros (nice) in 30 countries (46% Americas, 32% EMEA and 22% Asia Pacific). They service over 50% of Fortune 500 companies.

The company is the best positioned within the data center industry given it’s the largest retail data center provider and the most interconnected – 40% of listed cloud edge nodes are in Equinix, next best Digital Realty at 14%.

Product Mix

75% - IBX Data Centers. Customers are billed for space and power consumed, xScale data centers, usually built to suit hyperscale customers.

18% - Interconnection solutions. Equinix cross connects between two customers in the same data center and within the same client across their worldwide data centers to support customers' global operations. Interconnection business is expected to grow at 50% over the next few years as companies increase their global footprint.

6% - Edge and professional services.

Revenue Mix

As of Q1 2022.

Bull case

Secular tailwinds prevail. EQIX remains well-positioned to capture the ongoing wave of demand, as cloud migration continues and enterprise customers leverage cloud architectures as a critical element of their IT needs.
Premium name: #1 name brand in data centers, premium “retail service” offering, enterprise customers to largest cloud service providers (AWS etc.)
Global leader in interconnection, network dense and carrier-neutral platforms is unrivaled across the data center sector. Broad geographic scale supports the company’s strong colocation business as customers choose to deploy across multiple metros.
Appetite to further scale through M&A. EQIX continues to scale and strengthen its footprint through strategic M&A. It recently expanded to India and South Korea, as well as opportunistically acquired some of its leased real estate.
Predictable operating expenses - > with predominantly a fixed cost structure, the company offers attractive upside potential.

Risks

Core growth tapering: EQIX’s organic revenue growth from colocation has moderated over time, due to:
- The pressures of increased competition
- Difficult comps from years of premium rent growth and increased scale
- Customer migration to wholesale facilities
Inorganic growth has become less appealing: EQIX has been an active acquirer, closing 15+ acquisitions over the last 20 years. Increased competition for assets has changed this dynamic, narrowing the spread vs. EQIX’s cost of capital; EQIX’s large asset base and purchase of higher multiple deals geared toward “protecting the moat” have also moderated.
ESG standards: EQIX aims to be carbon neutral by 2030 which will require an aggressive green financing plan.
Lease expirations with renewals at higher market prices: A failure to renew a lease could disrupt business operations, and harm customer relations.
Regional competitors consolidate to become global key players.

Key Metrics/Valuation: (as of premarket 5/10/22)

Revenue Growth

• 77 consecutive quarters of revenue growth - longer track record than anyone else in the S&P 500.

• High recurring revenue business model: ~ 95% of revenue recurring and ~90% of bookings from existing customers.

Constant dividend growth:

Debt Optimization

Equinix has a BBB rating and a net leverage ratio of 3.8x but EQIX pushed its debt maturities out on the yield curve. They have only a modest amount due in 2022, then nothing due until 2024. The weighted average borrowing rate on their debt is only 1.72% with a weighted average maturity of 9.3 years and 95% of the debt having fixed interest rates. They've started to borrow in other currencies, which makes sense for a REIT with a huge global presence, but the majority of their debt is still in dollars. In a nutshell, they have done a great job of growing and locking in cheap debt.

Metrics

Current Share price: $654.19
Wall St price target: $818.23
Market cap: $59.54B
2021 Revenues: $6.40B
EV/NTM Sales: 9.7x
EV/NTM EBITDA: 21.0x
Wall St 24 Analysts valuation breakdown:

Conclusion

Bear markets tend to drag everything down. Equinix is down 25% YTD but remains a fundamentally strong business with secular tailwinds (internet demand) expected to drive the company forward for years to come.

Equinix has superior global reach, advantaged access to scaled digital ecosystems, the world’s largest and most advanced interconnection platform and a distinguished track record of service excellence.

REITs tend to be relatively recession-proof given the nature of their operations with most tenants signing long-term contracts. With secured recurring revenue, no material debt expiring, and expansion mindset, EQIX provides a solid base for navigating this bear market.

Sources