|Shares Out. (in M):||39||P/E||41.0x||27.0x|
|Market Cap (in $M):||3,468||P/FCF||15.6x||13.0x|
|Net Debt (in $M):||865||EBIT||289||341|
Thesis: Equinix (EQIX) owns a portfolio of high-quality, difficult to replicate colocation data centers (DC). EQIX established the colo market and maintains a great reputation which has allowed it to develop larger and denser network and peering connections than competitors. This "network effect" creates significant barriers to entry and pricing power. The company currently benefits from numerous tailwinds including internet and broadband video growth, enterprise outsourcing to save costs, cloud computing, a DC market supply / demand imbalance and significant and attractive international growth opportunities.
I believe EQIX will earn $8.00 in recurring cash flow (CFO - MCX) per share in 2011 compared to $5.00 per share in the last twelve months. Importantly, only $1.50 of that growth comes from price increases or capacity expansions. The remainder is the result of increased utilization of existing facilities and announced expansions which have high pre-lease rates. Specifically, my model assumes they will grow their data center portfolio by 10% while increasing utilization by 5% to 88.1% from 83.1%. As a result, I believe the stock will trade at $125 per share giving upside of 50%. If pricing remains flat through 2011 and EQIX does not add any additional capacity they will still be able to grow recurring cash flow per share from the $5.00 to $6.50 in 2011 by filling out capacity in existing centers and leveraging their fixed cost base.
Business Background: Information on the internet travels between users and websites on networks connected by data centers in a system resembling the hub and spoke airport structure. Internet traffic, networks and data centers are analogous to passengers, planes and airports. Similar to passengers making a connection at an airport, internet traffic (passengers) may have to change networks (planes) in order to get to a desired destination. The place where information makes its "connection" to a different network is in collocation data centers. Similar to the airport hub and spoke system, some colo data centers are critical hubs which connect to hundreds of networks, while others are spokes that may only contain a few networks. EQIX is the leading provider collocation space in critical hubs which provide access to the greatest number of network connections. EQIX collects a toll for allowing customers to locate servers in their network rich data center environment. Its locations are scarce and their network density is difficult to replicate providing barriers to entry and pricing power. As internet traffic continues to grow the amount of "passengers" needing to change "planes" will increase substantially. EQIX's control of the greatest amount of scarce internet "hub" real estate will allow them to increase the number and amount of tolls they charge for a long period of time.
In the early 1990's major data centers were controlled by telco's like Verizon and AT&T which used them primarily as a means of driving traffic on their networks. For example, if a company needs to send information from a Verizon network user in New York to a AT&T network recipient in San Francisco, they would put a server in one of Verizon's data centers and run a costly local loop to connect with AT&T's data center where they would have to lease additional space for another server.
In the late 1990's Equinix was created as a network neutral collocation data center to solve these problems. Equinix aggregated multiple networks into its data center which allowed customers to choose the cheapest or fastest networks, rid themselves of redundant servers and eliminate costly local loops. In addition, the close proximity of servers allows customers to directly interconnect or peer with servers from other companies which saves cost and improves network efficiency.
EQIX's network density gives it a competitive advantage:
Equinix (EQIX) today owns a portfolio of high-quality, network neutral collocation data centers in every critical internet transfer point. As the company that developed the colo market, their network and peering connections are larger and denser than any competitor. Similar to a financial exchange acquiring adequate liquidity, it is difficult for data centers to acquire a critical mass of networks and peering connections but once established the critical mass is difficult to take. This "network effect" creates barriers to entry and pricing power where would be very difficult for any competitor to replicate.
Network Effect: EQIX is the market share leader in global interconnections (peering) at 45.2% with the closest competitor at 25.1% and collocation data centers at 7.5% compared to the closest competitor at 3.8%. EQIX should continue to increase their market share in both areas as they compete against non-network neutral data centers (VZ and T), competitors who are capital constrained (Terremark, Savvis) and others who provide services which often compete with customers (Switch and Data).
Attractive Returns on Capital: An average data center takes between 12 to 24 months to build and 3 to 5 years to lease as tenants require data centers to reserve space for expansion. As a result, the return on capital seen in the financial statements, with CapEx of around 50% of revenues, is not indicative of the real returns EQIX is getting on their investment. Below are three examples, one from each major region, of the returns EQIX will get on their capital once the facility is fully leased. The IRR's are also attractive once taking into consideration the phased lease up. For instance, we estimate EQIX will generate an unlevered 18% IRR and a levered 34% IRR on their Frankfurt data center using conservative assumptions.
|Frankfurt||Hong Kong IBX||Chicago IBX 4|
|Sq Ft||130,000||Sq Ft||32,000||Sq Ft||19,400|
|Cost of Facility||30,000,000||Cost of Facility||17,000,000||Cost of Facility||-|
|Upgrade CapEx||20,000,000||Upgrade CapEx||-||Upgrade CapEx||10,000,000|
|Total cost of Facility||50,000,000||Total cost of Facility||17,000,000||Total cost of Facility||10,000,000|
|Total Cost per Cabinet||15,152||Total Cost per Cabinet||30,909||Total Cost per Cabinet||16,667|
|Current Rev Per Cab||13,235||Current Rev Per Cab||17,328||Current Rev Per Cab||17,725|
|Current EBITDA Margin||42.9%||Current EBITDA Margin||55.3%||Current EBITDA Margin||52.3%|
|EBITDA per Cab||5,674||EBITDA per Cab||9,582||EBITDA per Cab||9,270|
|Total EBITDA||18,724,812||Total EBITDA||5,269,911||Total EBITDA||5,562,210|
|Interest (50% leverage at 4.5%)||2,250,000||Interest (50% leverage at 4.5%)||765,000||Less Rent Expense||970,000|
|Less Maintenance CapEx||3,300,000||Less Maintenance CapEx||550,000||Less Maintenance CapEx||1,200,000|
|ROIC at capacity*||25.7%||ROIC at capacity*||22.6%||ROIC at capacity*||35.4%|
|Return on Equity at capacity**||42.5%||Return on Equity at capacity**||36.2%||Return on Equity at capacity**||51.3%|
|* Returns assume 100% capacity at current regional rates|
|** ROE assumes 35% tax rate, 50% leverage (consistent with current balance sheet) and 4.5% interest rate which is current weighted average|
Pricing Power: EQIX has been successful in continuing to raise prices despite current economic conditions. Pricing, which was flat in 1Q09 due to the economy, has started to rise especially in constrained markets (downtown Chicago, New York and Asia). In addition, contracts which have historically been one to two years in length are now being signed for two to three years with low to mid single digit annual price escalators giving the business more stability.
Critical Locations: EQIX leases or owns highly critical network real estate. For example, EQIX has real estate at a critical switching location in Chicago which allows it to offer clients access to 87 different networks. This high network density cannot be replicated allowing EQIX to get the outsized returns in that facility as seen above. Many of these critical locations either are low on space or power capacity giving EQIX significant pricing power as demand continues to increase.
Reputation: Over the last five years EQIX's data centers have been up for more than 99.999% of the time (which allows about 5 minutes of downtime a year) a record no competitor can match. Considering many servers in collocated data centers are considered "mission critical" to their organization their reputation is an important issue. EQIX's reputation is demonstrated by the fact that ~80% of its growth comes from current customers.
Fully Funded: As of 6/30/09 EQIX had almost $600 million in cash on the balance sheet and in 2009 should generate cash flow from operations in excess of $300 million. As a result, EQIX can be opportunistic with its cash as evidenced by their recent purchase of a Frankfurt data center from a distressed seller. In addition, many of its competitors have delayed or cancelled projects as they were not able to secure financing. For example, Terremark delayed a California data center project in October and Dupont Fabros suspended a Virginia project in November.
Colocation Data Center Demand Drivers:
Internet and Broadband Video Growth: While it is hard to accurately predict how much internet traffic will grow over the next few years, we can say with a high probability that internet traffic will be significantly higher. This is due to increasing broadband penetration, larger files sizes and increased internet video usage. As global internet traffic grows EQIX will collects higher tolls and be able to continue to generate high returns on capital.
Outsourcing: Data centers are very capital intensive, with the average center costing $1,300 per square foot to construct. The average data center cabinet occupies approximately 30 square feet meaning it costs almost $40,000 per rack to build out capacity. This is before purchasing servers and paying for costs associated with high levels of security and reliability. As a result, the economy has increased the number of companies who are considering outsourcing their data center needs as executives push the IT department to reduce CapEx and OpEx with outsourced data centers being a primary beneficiary.
"The economic meltdown has caused the decision process to change around data centers because higher management does not want to spend the CapEx. IT departments always want to own their assets but now management is forcing them to do more outsourcing." Tech consultant
Supply / Demand Imbalance: The colo market is still young and fragmented with many small private companies. These competitors, along with most public colo providers, have lost access to capital causing cancellations of projects or a lack of new builds despite growing demand.
Colocation is critical for everyone: Even when a company reaches a critical mass where they can build their own data centers they still keep equipment in EQIX's data centers to be able to access the network and peering rich environment. For example, EQIX has significant customer relationships with Google and Yahoo.
CapEx Cuts: The six US publicly listed data center companies 2009 CapEx guidance implies a 53% cut from 2008 levels. This lack of new investment at a time of increasing demand will lead to a favorable market for data center companies for at least the next 12 to 24 months.
Asia: Much like the US in the early 2000's, Asia is dominated by telco run data centers that only offer one network. Additionally, the market is very fragmented making assessing the quality of the data centers difficult. As such there is heavy demand for high quality network neutral data centers in certain markets. The demand is evidenced by Asia currently having the highest utilization rate of any EQIX region while also carrying the highest margin. Other anecdotal evidence includes EQIX's Singapore build out being sold out within 3 months when it was planned to last three years and double digit price increases for high quality space. Reportedly Verizon Business had tripled prices within the last year in certain markets with tight supply. Asia currently represents only 13% of EQIX revenue compared to the US at 63%.
Stressed Sellers: Some private companies entered the colo space in recent years and built speculative data centers at high leverage levels without a solid operational reputation. Customers were wary of putting mission critical servers with these untested companies which will likely result in some of these properties coming to market in the next few years. EQIX's available capital will allow it to invest in these opportunities as evidenced by their recent purchase of a 130,000 square foot data center in Frankfurt for $30 million. The company will be able to build 3,300 cabinets at the location after an additional ~$15 million in CapeEx. When fully leased using current rates the facility will generate close to $17 million per year in EBITDA for an ROIC of almost 40% not considering future price increases.
Note: EQIX has a high short interest do their debt primarily consisting of convertibles.
|R-FCF per Share||3.78||5.03||5.77||6.90||7.98||9.12|
EQIX continues to annouce better than expected quarters driven by high utilization and pricing power. As EQIX announces more expansions to deal with the colo market undersupply the stock price with appreciate to a level that more accurately reflects their outlook for growth.