Four data center stocks, Equinix Inc. (EQIX), CoreSite Realty Corp. (COR), Iron Mountain Inc. (IRM) and InterXion Holding NV (INXN), could be positioned to sharply outperform the broader market in the coming years as the industry experiences a second leg of growth. Positive drivers for the market include a forecasted 25% increase in data-center traffic through 2021, as well as a 50% jump in annual spending by mega-customers such as Amazon Inc. (AMZN) and Cisco Systems Inc. (CSCO).
“The big macro trend is digital transformation,” said Charles Meyers, CEO of Equinix. “Companies are evolving into a cloud-first world, and that is a major driver of our business.” Data centers are crucial to digital growth, given their use as the hubs and spokes of the internet. Corporate customers lease data center space based on their power needs in order to to exchange and store data, connect to cloud providers, and access the internet, per Barron’s.
Retail Data Centers
Equinix, CoreSite and InterXion all focus on “retail” data centers, which are network-dense campuses by which companies lease out space to exchange information and access cloud providers like Amazon, which also runs its own data centers. Wholesale centers, on the other hand, which focus on storage and networking for large companies and hyperscale customers, have less attractive leasing rates, according to Berenberg Capital Markets.
Iron Mountain, primarily a document-storage REIT, has began to leverage its corporate relationships to move into data centers. Income-oriented investors may also like the stock’s 6.9% yield, versus the REIT average of 3.8%.
Risks Facing Data Center Providers
While the data center space is booming, headwinds remain, including the threat of major cloud providers building out their own data centers, thus taking business away from third-party sites. The growth of “software-defined” networks also puts the market at risk, offering server space without the need for physical cables in a data center. Meanwhile, slowing demand may threaten these high-flying stocks, with reports from semiconductors including Intel Corp. (INTC) and Nvidia Corp. (NVDA) signaling weaker demand for chips used in data centers, adding to remarks from tech giants like Microsoft Corp. (MSFT) and Facebook Inc. (FB) indicating strong, yet slowing 2019 capital expenditures.
Headwinds aside, Berenberg’s Nate Crossett argues that data center stocks are “trading at some of the best levels since late 2015.” He notes that data centers trade at 94% of net asset value, versus 100% for REITs overall, while they go for 18 times estimated 2019 adjusted funds from operations (AFFO), a REIT measure of operating cash flow, versus 20 times for the industry overall. Berenberg expects data centers to grow AFFO at a 10% rate from 2019 to 2020, compared to 6% growth for all REITs forecasted over the same period.
InterXion, one of the largest European data-center companies, has managed to win a significant share of the interconnect businesses, operating out of key cities including Frankfurt, London and Paris. Leveraging those bases, InterXion has succeeded in selling its hyperscale capacity to large customers.
“The hyperscale customers want to be on those interconnect platforms,” said Cowen & Co’s Colby Synesael, per Barron’s. “That’s a unique advantage to win those deals,” he said, adding that an expansion of its data center in Marseille, France, is a “huge home run.” Synesael is upbeat on InterXion's opportunity in the European market, which he suggests is less tapped than the U.S.
While InterXion shares trade at 17 times enterprise value to Ebitda, representing a premium to the industry, the company expects to increase Ebitda by 16% in 2019 and grow revenue by 15%, well above the industry’s median forecast.
While the December downdraft also hurt many of these stocks, their longer profile is formidable. Equinix, for one, has soared nearly 170% in 5 years, while the S&P is up by roughly 52% over that same period. Moving forward, companies' burgeoning need for data - and data centers implies that this growth may not end anytime soon.