On October 21, Equinix (EQIX) reported solid 3Q 2009 results (see
Company’s P/R and
Seeking Alpha conference call transcripts), but the real news was
the announcement of the acquisition of Switch and Data (SDXC), a move which gives a completely different shape to the industry.
First, let’s go through some of the metrics we usually check every quarter to analyze the Company’s performance:
· Equinix raised 2009 annual revenue guidance to $877.5 million (midpoint) and adjusted EBITDA guidance to $397.5 million (midpoint)
· Cash gross margins for the quarter were 64%, down from 65% the previous quarter but up from 62% the same quarter last year, and despite incurring approximately $5.4 million of expansion costs in the quarter. In the U.S. cash gross margins were 68%
· Both revenues and EBITDA increased 7% over the previous quarter
· Net cabinet additions were 400 in the USA, 200 in Europe, and 100 in Asia Pacific
· 281 10 Gig ports were reported on the Equinix Exchange (26 additions in the quarter), with traffic reaching a peak of 365 gigabit per second, a 7.4% increase over the previous quarter
· A steady increase in MRR (monthly recurring revenue) per cabinet, with US reaching $ 1,910 (a 0.9% Q/Q increase), Europe now at $ 1,116 (10.6% Q/Q increase) and Asia at $ 1,437 (4.9% Q/Q increase). As usual, we point out that results in foreign currency (reported in US$) may be impacted by currency fluctuations. On average, a 4% quarter-over-quarter increase, with the global MRR per cabinet now at about $ 1,552
· MRR and cabinet churn rate was 2.3% and 2.2% respectively, consistent with guidance expectations for the quarter
· Pricing still strong throughout all markets, with new services (interconnection, etc.) being driven in the existing cabinets
· booked half of the cabinets that recently churned in the Silicon Valley, replacing (our speculation) the revenue lost, as these contracts were made at a much higher price (former wholesale contracts)
In a quick visual way, here is what Equinix achieved in what has been one of the most challenging economic environments:
As we noticed at the beginning of this article, the real news was Equinix decision to acquire its strongest competitor in the US market, Switch and Data, a real changer for the industry. Although Equinix did not disclose much information about returns, post-integration strategies or synergies achievable, most of the conference call Q&A section and comments in the press afterwards were centered on the deal.
As a small joke, we may now say that we got an answer to our previous, rhetorical question “Equinix vs. Switch and Data: Which Is the Better Network Neutral Colocation Company?”. What both Companies told us with this move is: the combination of the two.
Our previous Seeking Alpha article probably remains useful for a quick comparison between the two Companies, and may now be read with a different approach.
We can also add some answers to our article: Equinix: Planning Further Expansion? - the Company’s strategy wasn’t obviously limited to just adding new centers, but more ambitious.
Also as a side note, we previously mentioned Equinix and Switch and Data together also in our Seeking Alpha article Insatiable Demand for Colocation Services, which might now be a useful read to examine one of the most interesting synergies achievable by the combination of the Companies, as both are very active in the financial vertical, especially in the New York area.
And lastly thanks to Switch and Data that mentioned a couple of our articles in its “In the news” section.
A quick list of reasons why this deal makes a lot of sense:
- Given the structure of the deal, Equinix is spending only $ 137 million in cash to acquire some strategic data centers (including markets where it would have been quite challenging to build a presence both in terms of time and money) that give a much needed expansion capacity, especially in some locations (Switch and Data occupancy was about 60%)
- The new, combined Company becomes overnight a 1 billion player – and given the experience that the Equinix management team has shown also in very difficult times, they will certainly be able to leverage this strength in the capital market
- A lot of synergies are possible between the Companies, with savings on the SG&A side and a greater potential for the sales force (including offering a direct presence in Europe and Asia, while Switch and Data had so far just a reseller agreement for Europe)
- Equinix succeeded in excluding a competitor from doing the same move (it will now virtually be impossible for a foreign competitor to acquire a decent footprint on the US, or for a domestic Company to consider the acquisition of Switch and Data as a way to get a listing)
A look at the two combined Companies:
As underlined in this presentation sheet, Equinix succeeded in getting an immediate presence in some key markets – Toronto (Canada), Seattle, Atlanta, Miami and Denver. We wouldn’t anyway, be surprised if the Company decided, in the longer term, to get rid of some less strategic presences, the same way they did for Honolulu after the Pihana acquisition in the past.
Here is a different approach to the combination of the Companies, from an interconnection point of view (both pictures are taken from the Equinix presentation of the SDXC acquisition):
Additional presences in the US – more color
Equinix needed to expand in Dallas, where the Company has actually missed fulfilling customers potential, and Switch and Data brings inventory in the market, as well as a few others.
It is interesting, however, to notice that Equinix will not stop any planned expansion plan (from the conference call, Seeking Alpha transcripts): - Ilya Grozovsky - Morgan Joseph
- With the acquisition of Switch and Data, will any of your internal domestic expansion plans get shelved or anything like that? Or does everything continue as planned?
- Stephen M. Smith - CEO
- So the specific answer to your question is currently we have no plans to stop any of the announcements that we've made.
Switch and Data owns data centers in the Manhattan area, while Equinix data centers in the New York metro market are all in New Jersey, with just a peering presence at 111 8th Avenue. This will also mean a strategic advantage for the new combined Company.
The new SDXC North Bergen (New Jersey) data center, as mentioned before, will also strengthen the presence of Equinix in the financial vertical, with SAVVIS and TelX remaining as the main competitors in what is a very important sector - it may be worth adding, in this contest, that, as underlined by Tier 1 Research, pricing is very favorable for data centers Companies with a top quality offering (emphasis added): - ·July 7, 2009
- Tier 1 Research - Telx joins Equinix in winning ISE consortium RFP for low-latency interconnection
- -by Dan Golding
- – the normal interconnection halo effect where cabinet prices may be bumped 20% in highly interconnected carrier-neutral facilities is enhanced significantly when financial low latency interconnection comes into play. T1R believes premiums of 50% or more may be common.
As a further example of the great sense that this acquisition may mean to Equinix, we take the Swith and Data PAIX Palo Alto data center.
This location is the best interconnected exchange in the West Coast, being historically the first commercial one, where the Equinix founders, Al Avery and Jay Adelson, started working a few years ago.
Many network providers from Asia, like Singapore Telecom, do connect here for exchanging traffic with other networks or content providers (you may follow this link to have a look at SingTel public and private peering locations, log in required). Others from Europe, like France Telecom and Telecom Italia, do the same. These networks did also chose Equinix L.A. as a point of presence in California, but are not available in the Equinix Silicon Valley data centers. All of a sudden, Equinix will be able to offer these networks in its mix, without the hard work to convince them to bring their presence into its S. Jose data center.
The same, but for Switch and Data customers, may be said for the Washington DC metro area, where the Equinix Ashburn data center is the best interconnected center in the East Coast.
While the problems of the integration of the two Companies will certainly represent a challenge, the history of Equinix management and their experience with mergers (both domestically and abroad) is a great guarantee that all problems will be properly addressed, and hopefully the potential of this combination will overshadow any road bump that might emerge.
Finally, a few words about Jim Cramer’s comments about Equinix, in his October 23 show.
Here is an abstract of his opinion:
- For Thursday’s “Sell Block” segment, Cramer told viewers they need to sell any data center-related stock while the getting’s still good.
- Cramer said he listened to Intel Corporation’s (INTC) conference call, where the company management said its seeing strong sales for its new family of Nehalem DP processors for serves, which allows companies to replace up to eight of their older servers with just one new Nehalem server. “If companies can now reduce their footprint by 87% that will translate to huge losses for the data centers,” Cramer said. He mentioned that Equinix is about to have eight times more space than normal, and its doubtful the company could lease the extra space given the current troubles in the commercial real estate market. An even worse scenario could happen where companies start hosting their own serves internally, rather than outsource to data centers which are expensive. Cramer said he picked Equinix specifically because of the Switch & Data acquisition. He said the move probably won’t pay off because the future for this business is about to get a lot weaker. He told viewers with an upgrade cycle coming, look for earnings to disappoint at Equinix. “Get out of the data-center stocks,” Cramer said. “I see an industry that’s about to be brought low by new technology, so I think you should sell, sell, sell.”
Luckily, most analysts in the sector have already noticed how poor his analysis of the sector was, so a few quotes will do the job:
· Jim Cramer? C’mon Man! · By- Bob Landström
· Jim Cramer cited the recent Intel earnings call content about the Nehalem processor yielding an 8:1 advantage in server power. Somehow, Cramer did some math to convince himself that every eight servers out there will soon turn into one,… ergo, there is eightfold less demand for data center real estate. If Jim Cramer had any understanding of technology… or even the technology sector in general, he’d have jerked himself back into reality with the recollection of Moore’s Law. Moore’s Law has been in play for decades, is in play today, and will be in play tomorrow. Throughout this time, the demand for data centers has grown to grossly outstrip supply. Is this really the extent of the gray matter behind Cramer’s financial recommendations?
· Perhaps even more fundamental than the point about Moore’s Law is the basic economics underlying the costs of mission critical facilities. Unless Cramer thinks that risk management is also a stale concept, we must acknowledge the demand for secure and highly available computing facilities into the distant future. While in better economic times, there may have been some enterprises with the resources to invest hundreds of millions of dollars in data center construction and operations, but in the current economic times the natural alternative is to buy colocation services. This is one of the fundamental drivers in today’s demand for colocation real estate, and the justification for colocation provider expansions and M&A activity.
· We can excuse the fact that Cramer isn’t able to correctly pronounce Nehalem (or Equinix for that matter). However, if he had spent any time at all in the technology sector this sort of tongue slip would be just about impossible. Furthermore, even if data center space is becoming an unwanted commodity as Cramer led his audience to believe, the shallowness of his analysis is further evidenced by the missed observation that by acquiring Switch and Data, Equinix not only elevates its status as a premier colocation services provider but also strategically defends its turf from any global competitor (by blocking other global providers from gaining a strong US presence).
Tier 1 Research also wrote an interesting comment to Cramer’s opinion:
· T1R Insight: Cramer blows it with call on Equinix
· Cramer's main argument is that there is an Outside Context Problem – some change in the business or operating conditions that no one (except he) can see coming. In this case, he claims that Intel's more powerful processors – up to eight times more powerful than previous processors – will run Equinix and other firms like it out of business. That's because Cramer believes that Equinix customers will simply be able to swap out eight existing servers for one new, Intel-powered server. Well, here's why he's wrong:
- Cramer stated that firms like Equinix are square-footage based. That's wrong – the datacenter's primary metric is power. While Intel's new chips are power efficient, one of its new chips does not take the same or less power than one of its old chips – it takes more. They are more efficient on a per-processer-cycle basis, but we're talking about a much smaller savings, not 8:1. Datacenters are power-limited, not space limited, and they sell based on power.
- Cramer doesn't understand the real issue is virtualization for server consolidation, not processors – processors are simply a supporting technology. And, in the case of enterprise datacenters, there is some significant server consolidation, which has extended the life of those facilities. But colocated servers tend to be far more utilized, so that consolidation of underutilized servers is a lesser factor than in the enterprise.
- Users are demanding more processor power. The folks at Intel are not fools – they aren't putting themselves out of business by allowing customers to purchase one unit instead of eight. Instead, they are doing what they have always done, which is to increase the power of their existing processors in order to meet user demand. That user demand for processor power (and storage and network) has been increasing steadily for years on the desktop and in the server. Cramer's mistake is to think processing demand is static rather than increasing – snapshots in time are dangerous.
- The processors that Cramer is referring to are the very highest end and most expensive bits of silicon that Intel has on offer – they are not general-purpose or mass-market processors. There will be no 'step-function' or wholesale replacement because those chips are just too expensive and will be for some time. By the time they aren't, the customer demand for more processor power will have caught up – and then some, to judge by the 10 or 15 times that this same sort of transition (between processor families) has occurred in the last 30 years. What's different this time? Nothing.
- Cramer sees Equinix as purely a server farm, ignoring the true engine of its business: interconnection. The need to inexpensively interconnect at high speeds with low latencies is what drives customers to Equinix. In addition, a significant portion of Equinix's space is filled by non-server equipment, including routers, switches and, increasingly, storage. Again, Cramer's simplistic analysis fails.
· T1R doesn't do many stock picks, but here's one: take advantage of the sheep following Cramer to make strategic buys. They have a very short memory, so the counter-Cramer trading strategy doesn't have a long life, but if you can strike quickly, it's a good idea.
· T1R's position is that there is a long-term secular trend toward third-party datacenter services, recently accelerated by the capital crunch: enterprises don't have the money to build their own datacenters and are increasingly turning to folks like Equinix. CEOs and boards are increasingly unwilling to fund large-ticket datacenter capital projects. The assertions made by Cramer that datacenters are becoming smaller and easier to run are contradicted by empirical evidence.
Rich Miller, at Data Center Knowledge, also wrote a similar comment, in his article There’s A Village Somewhere Missing an Idiot, which also has a link to Cramer’s video, for those who missed it: - “Get out of the data-center stocks,” Cramer told viewers. “I think the data center industry is in decline. I see an industry that’s about to be brought low by new technology, so I think you should sell, sell, sell.”
- New technology?
- Which new technology? Cloud computing? Believe it or not, he means Nehalem processors. Cramer notes that on Intel’s recent conference call, the company touted strong sales for its new family of Nehalem DP processors for servers, one of which can “take the place of eight to nine older-generation servers.” Cramer did some math, and concluded that data centers will soon be seven-eighths empty.
- “Data centers like Equinix will still have all this extra space on their hands that they’ll have no idea what to do with, thanks to Intel’s revolutionary server technology,” said Cramer. “These new servers go a long way towards making the data center model obsolete.”
- Moore’s Law wasn’t invented yesterday. Processors have been getting faster and more powerful for decades without fundamentally altering the demand for data center space, which is driven by a profound, long-term shift toward the Internet and digital business models. That isn’t likely to change anytime soon. Nehalem processors will allow companies to do more with less, but they’re not going to empty out all the data centers.
A more realist view is given by this article from the Wall Street Journal, which resumes the real trends in the industry: - Demand for commercial data centers like the ones operated by Equinix is expected to rise 13% in 2009, according to Tier1 Research. But commercial data center capacity is rising only about 5% per year.
- That's because it takes about 18 months to build a data center, says Daniel Golding, an analyst at Tier1, and the facilities can cost more than $100 million each.
- Buying Switch &Data lets Equinix "expand their footprint extremely rapidly," says Mr. Golding. He adds that using stock to make the deal is a smart move because "you can't pay a construction company in stock."
As we have been saying many times in our articles about the sectors, these trends (demand much higher than supply, record occupancy at existing facilities, credit crunch limiting new builds, outsourcing as a trend, etc.) are what an investor should look at, without listening to other superficial comments.
With this move, Equinix has positioned itself to strengthen its leadership and increase market share, while continuing to achieve a higher growth than the sector – one of the few growing ones in this current economy.
Disclosure: Long EQIX
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