Wednesday, February 18, 2009

Equinix 4Q results: “a slow down in decision making, particularly from new customers”

Equinix (EQIX) reported 4Q and full year results on February, 11.

The headline we've used mirrors what the market has perceived as the main outcome of the call, together with the information that the Company was lowering, because of that, 2009 guidance, by roughly 2% [a $16 million haircut at midpoint, due in part to currency fluctuations (roughly $ 3 million)].

Given the fact that historically the Company has always exceeded expectations, and that this is the first time since the Internet bubble burst that guidance is revised downward, the 10% decrease experienced by the shares after earnings can be easily explained. The price is now below $50 as we write.

Growth Y/Y is still forecasted in the 20% range, a very sound number in this economic climate, but lower than the organic 38% growth experienced in 2008, and some reasons to be more conservative about the dynamics of the sector were introduced at the conference call.

As a side and final comment on this matter, Equinix has always gotten the majority of its new orders from the existing customer base (up to 80%), so this inertia in decision making (if limited mainly to new customers) might not really represent a big scare for the Company. However, it must be noted that the number of new customers in the quarter (110), is the smallest experienced this year (ranging from 144 to 178 previously). A new metric to follow closely in 2009, to see how this specific number develops, but may be not time to panic yet about a deep slow down in potential growth for the Company.

Before digging more into the numbers, we'll also add a few comments introducing a “we were wrong” section, related to our Earnings Forecast, previously published on Seeking Alpha.

We had predicted that Equinix might need to start planning new centers in Ashburn (Washington DC metro) and Silicon Valley – on the contrary, three new expansions in different locations were announced: Chicago (downtown, in what is known as CHI2), Los Angeles, (the unused portion of LA1), and Hong Kong (HK 1 phase IV).

These are “small size” expansions (we would probably call them fine tuning the potential of the assets), that will still add some 900 cabinets in the 4Q 2009 (as a reminder Equinix experienced an average net add of about 1,400 cabinets every quarter, in the USA and Asia, in 2008).

As to the Washington, DC and Silicon Valley markets, these were the comments made during the call (transcripts available from Seeking Alpha):

Mark Kelleher - Canaccord Adams

Could you just tell us where you stand with capacity utilization in the U.S.?

Stephen M. Smith (Equinix CEO)

Sure. Today, the simplest way to think about it:


D.C., we're in good shape. We have plenty of capacity in D.C. for the foreseeable future; I'd call it out to four quarters worth of visibility for the full year.


Silicon Valley we're in good shape.

The only way we have to try to explain our thinking is that we never thought that Equinix was out of space right now, but as greenfield builds require about 12/18 months, and given the recent success rate in these markets, we did expect that a proper planning had to be put in place (and announced) well ahead of actually being out of space. Unless the Company experiences a complete change in demand, we still expect some sort of expansion announcement probably in the second half of the year for these locations. This was not ruled out during the call (emphasis added):

Stephen M. Smith

Number three, on the CapEx front our $325 to $375 million plan includes approximately $285 million of announced expansion and ongoing CapEx and includes the three expansions we announced today. There's also approximately $40 to $90 million in our guidance for potential expansion projects that we're contemplating but have not yet committed to. Said differently, our CapEx guidance can still absorb incremental expansion announcements up to $90 million without requiring us to increase our capital guidance.

The competitive landscape is also interesting (this is also taken from the conference call):

Manuel Recarey - Kaufman Brothers

You talked about the supply constraint that's out there. Is there any particular geographic areas or markets that are more constrained than others?

Stephen M. Smith

From our inventory, Manny?

Manuel Recarey - Kaufman Brothers

More from a market perspective where you'd see, I guess you'd end up seeing better pricing holding up just due to the supply being more constrained.

Stephen M. Smith

Yes, I'd say we've seen some builds slow down or get stopped in certain markets, like in the Silicon Valley and in the D.C. area, in and around call it our peer group space. It certainly has an effect on capacity between retail and wholesale business.

In particular, in the Silicon Valley two Companies, Dupont Fabros and Terremark, announced their decision to delay their expansion plans, due to lack of capital available – this is taken form a recent article on Data Center Knowledge:

Terremark Delays Santa Clara Project

Terremark (TMRK) has decided to delay construction on its planned data center in Santa Clara, Calif., saying it will instead focus its development budget on its booming business at its data fortress in Virginia, the NAP of the Capital Region.

Terremark’s planned expansion on Corvin Drive is the second major data center project in Santa Clara sidelined by capital constraints related to the credit crunch. DuPont Fabros Technology (DFT) halted development of a $270 million data center in Santa Clara in October after it was able to borrow less than it hoped to fund the project.

The postponements are likely to mean a tighter market for data center space in Santa Clara, which has been the busiest area in Silicon Valley due to low power rates from the local utility, Silicon Valley Power. While there is no immediate space crunch, the mothballing of the two projects eliminates at least 200,000 square feet of data center space that was to arrive in 2009 .

Terremark’s decision will leave fewer choices for companies seeking substantial chunks of data center space in Santa Clara. The only new inventory slated to come on the market in the city in 2009 is a project being built by CRG West. The 50,000 square foot first phase of the three-building campus is scheduled to be finished in the fourth quarter of 2009. Of existing inventory, Digital Realty Trust (DLR) has wholesale data center space remaining in two of the seven buildings it owns in Santa Clara.

Both Terremark and DuPont Fabros (DFT) say they remain enthusiastic about Santa Clara, and hope to eventually complete their projects. ”This is in no way a reflection of the Santa Clara market, but a decision to manage our capital efficiently,” said Terremark CEO Manuel Medina.

In spite of these negative aspects, we still believe that Equinix delivered some good numbers, and a few metrics are worth a second look.

Revenues increased in all areas:

  • US was up 5,8%

  • Asia was up 11,3%

  • Europe was up roughly 11 %, on a same currency basis, although it shows a decline of 4,6% in US currency (as we underlined in our forecast, the main issue being the decline in value of the British Sterling in the quarter)

Absent this FX impact, Equinix would have well exceeded consensus for the quarter.

Keith D. Taylor

On a constant currency basis, assuming we kept our currencies constant with the average rates in effect during Q3, our Q4 revenues would have been $198.8 million or 8% greater than our Q3 reported revenues.

A few comments during the call supporting our analysis:

Stephen M. Smith

In our European market our financial performance beat our expectations for the quarter and the year, despite the unfavorable impact of currency fluctuations. Our capacity for growth in this region is generally good in all markets, with expansion activity in London, Paris, Amsterdam and Frankfurt, all of which are on track at this time. Many of our competitors also continue to expand, but with much smaller projects, leaving us better positioned for growth.

Jonathan Schildkraut - Jefferies & Company

A couple of questions on year up. You know, revenues contracted quarter-over-quarter. What happened here? Was this just primarily currency headwinds? And maybe if you could quantify the currency headwind as it applied just to Europe, that would be helpful.


Keith D. Taylor

I think it's very appropriate that you bring up the European matter. If we adjust for the currency impact, I think, as everybody knows, the impact of the sterling in Q4, it was a very dramatic movement and, for that matter, Euro, but Euro was a little bit more stable. Had we not seen the sterling depreciate so quickly, the average rates that we used for the quarter close would have had us increasing on a neutral basis 11% quarter-over-quarter, so substantial growth. So the growth that you saw in Asia, we're seeing the same equivalent growth rate on a fundamental local basis in Europe as well, 11%.

What is also interesting about Europe is the nice increase in margins achieved: cash gross margins were 57% in the 4Q 2008, compared with 49% in the 3Q 2008 and 39% one year ago.

Other sources also seem to indicate that the market in Europe remains solid – this is taken from a recent press release by Tariff Consultancy Ltd:

Data Centre Rack pricing increased by an average of 8.5% across Europe during 2008, with more price increases forecast for 2009

The latest Data Centre Price Tracker survey of 14 European countries reveals that average per Rack pricing rose by 8.5% during 2008. Countries that saw the highest per Rack price rises in 2008 include Portugal (30%), Denmark (24%) and France (17%).

In all countries Data Centre operators are raising prices as newly furbished space is introduced to the market and are introducing new types of Rack product which reflect the costs of providing enhanced power which increases the average price per rack. The main price determinant for a Data Centre operator is now the cost of power rather than the actual physical space cost.

Looking forward into 2009 it is likely that there will continue to be moderate price increases in most countries. Data Centre operators continue to report strong customer demand despite the downturn, as enterprises continue to outsource their IT infrastructure to a third party provider as the cost of managing their in-house facility continues to rise.

"Although there is an economic downturn taking place, there is no immediate sign of a slowdown in demand for Data Centre space," commented Margrit Sessions, Managing Director of Tariff Consultancy Ltd. "Strong customer demand is buoyed by the outsourcing of non-core activities and continues to support the development of new Data Centre space. This demand also allows the operator to selectively raise pricing across all of the main European markets, and we anticipate that average pricing will continue to rise," Sessions added.

Digital Realty Trust (DLR) also came out with similar comments on its February, 17 P/R:

Digital Realty Trust, Inc. (NYSE: DLR - News), the world's largest wholesale datacentre provider, has released the results of a new study of the datacentre market in Europe that assesses the datacentre plans of European companies and the trends that will shape the datacentre industry in the near term. The study, which succeeds the one Digital Realty Trust released in early 2008 about the European datacentre market, is based on a detailed survey of senior decision makers who are either directly responsible for datacentres or influence significant decisions related to datacentre operations at large European organisations. The research was conducted for Digital Realty Trust by the respected research firm Campos Research and Analysis.

Key findings of the new study include:

  • More than four out of five companies surveyed are planning datacentre expansions within the next two years.

  • More than a quarter of surveyed companies are actively planning immediate datacentre expansion projects that are commencing in 2009, and 69 percent of companies are planning projects that will commence in 12-24 months.

  • Compared to last year's survey results, there has been a 117 percent increase in the number of firms that will seek more than 2,500 square metres for their datacentres, indicating that the scope of datacentre projects has grown significantly.

  • Compared to last year's survey results, there has been a 22 percent increase in projected average datacentre space requirements from 1,300 square metres to 1,600 square metres - a significant increase that will impact the balance of supply and demand for datacentre space in European markets.

"Despite the dramatic changes in the economic climate, this year's results indicate that an even larger proportion of European companies are planning datacentre projects. Moreover, these projects are bigger by every measure," said Bernard Geoghegan, Senior Vice President at Digital Realty Trust who oversees International Operations. "These trends corroborate what we are continuing to hear from so many of our customers - that datacentres have become critical corporate assets that ensure competitiveness in difficult times and that will drive growth when economic conditions improve."

Back to a few highlights from Equinix results:

  • while lowering revenues, EBITDA guidance was reaffirmed, confirming the operating leverage of the business;
  • pricing is still holding well all over most markets covered by the Company;
  • churn is still forecasted in the 2% range per quarter, in spite of the challenging economy;
  • cabinets pricing and MRR are still trending nicely toward the targets fixed by the Company;
  • Europe is showing some signs of increase in the interconnection business (that will take a while to develop, as it did in Asia, but will positively impact margins);
  • pipeline is still described as strong, although it remains to be seen at what pace it will be translated into additional orders;
  • expansion is basically on track, and fully funded.

We still remain positive on the long term potential of the sector and Equinix in particular, especially toward 2010 and after, when colocation might experience a stronger demand and little supply.

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