Just like eight-track players, VCRs and Atari 2600s, your computer's hard drive could be meeting its tech-maker in the sky. As more companies and consumers use the web to store videos, music, photos and other data, individual hard drives could become a thing of the past. This trend of "cloud computing" or web-based services that store your digital files and remotely offer access through an internet browser or downloadable applications is growing rapidly. Microsoft (Nasdaq:MSFT) estimates that, within a year, more than 90% of its software and products will be based on cloud-related products and services. This tectonic shift in the way we think about computing will have portfolio implications as well. While the trend is still in its early stages, the long term thesis is good.
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A Head in the Clouds
Anybody who has ever used Gmail or uploaded photos to SnapFish or Flickr has used cloud computing. As retail consumers adopt smartphones and use apps for everything from music-sharing to finances, as with Intuit's (NASDAQ:INTU) new Mint service, cloud computing will continue to grow. Coming out of one of the worst recessions in history, the corporate sector has place more emphasis on cost controls. Offsite cloud-based services are an easy way to facilitate cost savings while still increasing productivity. Its expansion will continue further as faster broadband and 3G & 4G wireless technologies are adopted.
For investors, the sector offers many opportunities. Companies like Rackspace Hosting (NYSE:RAX) or funds like PowerShares Dynamic Networking (NYSE:PXQ) have surged on the promise of the technology. However, all that video streaming, social networking, digitized health records and financial information is causing another issue: Storing that data. It's in that data storage that investors may find the best way to play the growth cloud computing. According to Tier 1 Research, demand for data center space will increase nearly 14% this year and 16% in 2011. However, the supply of storage is estimated to only increase by just 6% and 7%, respectively. This supply and demand imbalance will lead to higher profits for companies who own and lease data centers.
Analysts at Jeffries estimate that utilization rates for Datacenter REITs will rise well above their current rate of 80%. This will have an effect on rents similar to lower vacancy rates for apartment buildings. Funds From Operations (FFO) for Data REITs are expected to grow by 46% per annum through 2012. This dwarfs the FFO growth estimations for shopping centers (3.7%) and for apartments (12.3%). On top this, Datacenter REITs trade for an average 14.5 times FFO versus nearly 17 for the broad REIT measures like the iShares Dow Jones US Real Estate (NYSE:IYR).
Investing in Software as Service Centers
With cloud computing still in its early growth stages, there is potential for just as many losers as there are winners. Investors wanting to lay a wager on the growth of the sector, but who prefer a safer play, may want to bet on the datacenter owners. Here are a few picks.
Digital Realty Trust (NYSE:DLR) is the world's largest wholesale data center provider and operates more than 95 different centers across North America, Europe and Asia. As the only server-farm REIT with an investment grade rating from all three major reporting agencies, Digital Realty has managed to grow its FFO by 21% annually since its inception. Shares of the REIT are currently trading well below their 52 week highs and yield a treasury beating 4.9%.
Smaller REIT DuPont Fabros Technology (NYSE:DFT) currently yields only 2%, but analysts expect the company to more than double its dividend by 2012. Partnering with companies like Yahoo (NASDAQ:YHOO), DuPont Fabros operates eight different datacenters across the U.S and is currently constructing two more.
Finally, after going public about a year ago, CoreSite Realty Corporation (NYSE:COR) has added nearly two million square feet of data center space across the United States and nearly 600 customers to its mix. In the last quarter, CoreSite realized an 18.6% increase in rental rates on renewals. This should help boost and grow its dividend over time. Shares of the REIT currently yield 3.3%.
Analysts predict that cloud computing could be the one of biggest innovations in the tech sector since the birth of the PC. As internet traffic is set to triple by 2014 to 64 exabytees per month, the datacenter REITs are poised to be a backdoor player in the growth of cloud computing. Investor's looking for both growth and dividend, should give the sector a look. (To learn more about REITS, see What Are REITs?)
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