I Like Equinix, The Tenant, Not So Much The Landlord
As many of you know, I cover all of the Data Center REITs and I have recently
written on a few of them: QTS Residential (QTS), CoreSite Realty (COR), Digital
Realty (DLR), and CyrusOne (CONE). I have Dupont Fabros (DFT) on my research
list and I plan to take a closer look at this REIT in a few days. One Data Center REIT
that I have not yet covered is Equinix (EQIX).
Many of my followers have asked me to write on this company, but I have been
reluctant to, for a few reasons.
First off, Bill Stoller has done a fine job writing on EQIX and I could not come close
to his quality research. His latest article on EQIX can be found HERE.
Secondly, EQIX is a more difficult REIT to research, as the company invests
globally and has a more complex business model.
Third, EQIX is expensive, and I did not see the use of spending hours researching a
REIT that I had no interest in owning.
However, I decided it was time to “bite the bullet” and complete the loop; now I
can claim that I have covered all of the Data Center REITs.
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Equinix, the Largest Data Center REIT
In September 2012, EQIX announced its plan to pursue conversion to a REIT and
on December 23, 2014, the company’s Board approved the conversion to a REIT
effective on January 1, 2015. In May 2015, the company received a favorable
response to the private letter ruling (‘‘PLR’’) it had requested from the IRS in
connection with the REIT conversion for federal income tax purposes.
Equinix’s platform offers these value propositions to customers:
Global Data Centers: A broad footprint of 150 IBX data centers in 21 countries on
5 continents, 14 million+ gross square feet globally. More than $13.5 billion of
capital invested in capacity, new markets and acquisitions since 1998. Equinix
delivered uptime of 99.9999% across its footprint in 2016.
Interconnection: More than 1,400 networks and approximately 230,000+ cross
connects in Equinix sites. Equinix provides less than 10 milliseconds latency to the
majority of the global markets in North America, Europe, Latin America and AsiaPacific. Equinix enables its customers to leverage an Interconnection Oriented
ArchitectureTM (IOATM) strategy — a proven and repeatable engagement model
that both enterprises and service providers can leverage to directly and securely
connect people, locations, clouds and data — by deploying IT infrastructures on
Platform EquinixTM.
Partners, Customers and Prospects: Equinix sites house a blue-chip customer
base of 8,500+ global businesses. These customers represent a who’s who of
network, digital media, financial services, cloud/IT and enterprise leaders.
Equinix has established a critical mass of customers that continues to drive new
and existing customer growth and bookings. The company’s etwork- and cloudneutral business model also contributes to its success in the market. Rather than
selling a particular network, EQIX offers customers direct interconnection to an
aggregation of bandwidth providers.
The providers in EQIX sites include the world’s top carriers, mobile providers,
internet service providers (ISPs), broadband access networks (DSL/cable) and
international carriers. EQIX’s neutrality also means its customers can choose to
buy from, or partner with, leading companies across its five targeted verticals.
These 5 verticals include:
(1) Network and Mobile Providers (AT&T, British Telecom, China Mobile,
Comcast, Level 3 Communications, Lycamobile, NTT Communications, SingTel
Ltd., Syniverse Technologies, T-Mobile, TATA Communications, Verizon)
(2) Cloud and IT Services (Amazon Web Services, Box Inc., Google Cloud Platform,
Carpathia Hosting Inc., NetApp, Microsoft Azure, Office 365, Salesforce.com,
SoftLayer, Cisco Systems Inc., Oracle Cloud, Datapipe, CloudSigma, VMware
vCloud Air, Workday, Inc.)
(3) Content Providers (Brightroll, eBay, ContentBridge, DIRECTV, Hulu, LinkedIn,
Netflix, Priceline.com)
(4) Enterprise (Anheuser-Busch, InBev, Bechtel, BMC Software, Burger King
Corporation, Caterpillar, Inc., CDM Smith, Chevron, GE, Harper Collins Publishers,
Ingram Micro)
(5) Financial Companies (ACTIV Financial, Bloomberg, Chicago Board Options
Exchange, DirectEdge, Quantlab Financial, NASDAQ, OMX Group Inc., NYSE
Technologies, Thomson Reuters)
The market for Equinix’s offerings has previously been served by large
telecommunications carriers that have bundled their telecommunications and
managed services with their colocation offerings. In addition, some Equinix
customers, such as Microsoft, build and operate their own data centers for their
large infrastructure deployments, called server farms.
However, these customers rely upon Equinix IBX data centers for many of their
critical interconnection relationships. The need for sizable, wholesale, outsourced
data centers is also being addressed by providers that build large data centers to
meet customer needs for standalone data centers. This is a different customer
segment than Equinix serves.
Equinix currently houses more than 1,400 unique networks, including the top-tier
networks, allowing its customers to directly interconnect with providers that best
meet their unique price and performance needs. The company has a growing
mass of key players in cloud and IT services (Accenture, Amazon Web Services,
AT&T, Google Cloud Platform, Microsoft Azure and Office 365, Oracle Cloud, 6
Salesforce.com, SoftLayer, VMware vCloud Air), and in the enterprise and
financial sectors (Bechtel, Bloomberg, Chicago Board of Trade, The GAP, McGrawHill, etc.). EQIX expects these segments will continue to grow as they seek to
leverage its density of network providers and interconnect directly with each
other to improve performance.
In January 2016, Equinix completed the acquisition of TelecityGroup, plc valued at
approximately $3.7 billion and in December 2016, Equinix announced that it had
signed a definitive agreement to purchase 24 new data center sites, consisting of
29 data centers across 15 metro areas, and their operations, from Verizon
Communications Inc. (VZ’) for $3.6 billion.
This will be the 17th acquisition in EQIX’s history and is consistent with the
company’s acquisition strategy of extending its platform to new markets and
expanding interconnection density. Here’s how EQIX compares in size with the
other Data Center REITs:
The Balance Sheet
EQIX has maintained disciplined in its capital allocation as a means to
expand the business across regions, while strengthening the global
interconnection platform.
In March the company raised over a $3.4 billion in debt and equity to
complete the financing of the Verizon asset acquisition (and support the
continued demand across each region). This mix of debt and equity allowed
EQIX to preserve its strategic and operational flexibility and maintain current
debt ratings, while providing a highly accretive transaction for shareholders.
(EQIX is rated BB+ by S&P).
EQIX’s unrestricted cash and investments increased to $4.9 billion and the
company expects to fund $3.6 billion to close the Verizon transaction in Q217. EQIX’s net debt leverage ratio (net of unrestricted cash) was slightly
above 4.0x. EQIX expects to return to its targeted leverage ratio of 3-4x net
debt to adjusted EBITDA in the short-term.
For 2017, EQIX expects “as reported” AFFO to be greater than $1.214
billion, a 13% year-over-year increase (despite the incremental $53 million
of interest expense related to the company’s high yield offering). On a
normalized basis, AFFO would be greater than $1.331 billion (an $18 million
increase compared to the prior guidance) demonstrating the continued
strength of the operating model.
On an as-reported AFFO per share basis, EQIX expects to deliver $15.66,
which includes $87 million of incremental interest expense related to the
term loan B and high yield financings, $30 million of integration costs and an
additional 6.1 million shares related to the equity issued in Q1-17.
On a normalized and constant currency basis, EQIX expects AFFO per share
to be $18.33, a share increase of 1.4% over the $18.07 in the prior quarter.
EQIX announced its Q2-17 dividend of $2.00 per share, maintaining the
same level of cash dividend per share. For 2017, EQIX expects to payout
total cash dividends of approximately $612 million, a 24% increase over the
prior year.
One key differentiator: EQIX has a 50% payout ratio, much lower than the
Data Center REIT peers.
But Wait, This REIT Doesn’t Just Own Buildings
When I think about Equinix, it reminds me of two REITs that I recently wrote
about (here on Seeking Alpha).
A few days ago I wrote on Outfront Media (OUT), a billboard REIT that
owns a portfolio that includes more than 400,000 digital and static displays,
which are primarily located in the most iconic and high-traffic locations
throughout the 25 largest markets in the U.S. (see article HERE). I also
wrote on Iron Mountain (IRM), a storage and information management
services REIT, serving 230,000 customers in 45 countries on six continents
(see article HERE).
What do these two REITs have in common with Equinix?
All three of these REITs have higher G&A costs that are necessary to run the
businesses. While they all own real estate (and quality as a REIT), they must
hire more employees in order to generate profits. Here’s a snapshot of
EQIX’s G&A costs:
Another similarity is that these 3 REITs don’t just invest more in operations,
but they own less real estate. Remember that to quality as a REIT a
company must own at least 75% of the real estate or it must derive at least
75% of its income from the real estate.
To qualify as a REIT, EQIX was able to convince the IRS that the shelving
was “real estate”. So EQIX is really more of a TENANT than a LANDLORD (in
the traditional since of brick and mortar).
Here’s how I like to think about it….
Simon Property Group (SPG) is a Mall Landlord (owns brick and mortar) and
Apple (APLE) is a Mall Tenant. While ALPE does generate income inside of
the Mall (owned by SPG), it’s business model could not sustain without the
employees inside of the Apple store.
Similarly, Digital Realty is the “Simon property” in the Data Center REIT
sector and Equinix is the Tenant. As you can see below, DLR has around
3.4% exposure to EQIX, “the tenant”.
I Like Equinix, The Tenant, Not So Much The Landlord
With that same analogy in mind (SPG/APLE), I would much rather own DLR,
the REIT, than EQIX (the REIT), at least based upon the dividend yield
metrics below:
But also, EQIX’s P/FFO multiple is a friggin’ node bleed, as illustrated below:
Clearly, Mr. Market views EQIX to be more of a “tech company” than a REIT,
and that makes sense since EQIX doesn’t really own a lot of brick and
mortar (in the traditional sense). While I find the growth attractive, it’s hard
for me to get my arms around a REIT that looks more like a peer to Google,
Linkedin, or Facebook.
Now you know why it took me this long to write on Equinix, clearly this is a
REIT that looks more like a tech play, than a dividend play. Bill Stoller
summed up his recommendation as follows,
“Equinix still has a short history as a REIT, but now appears to be well
positioned to deliver meaningful annual dividend increases. My sense
regarding an entry point would be to patiently wait for a pullback toward
$340-345 per share to initiate a position at ~20x AFFO per share.”
Given the growth in data, including the data REITs, I’m not convinced that
EQIX shares will pull back to $340. I’m glad I decided to write on this one
though, as it validates my conviction to maintain an over-weight exposure in
Digital Realty, the Simon Mall for Data Centers!