During my last thesis on Equinix (NASDAQ: EQIX) at the beginning of June, I had warned investors that it was not “business as usual” and that the REIT’s management did sound utterly optimistic about the company’s ability to get more customers onboard during the first quarter’s earnings call. This was in contrast to executives in other companies who were showing realism in view of COVID-induced reality.
Now, one of reasons for third quarter earnings missing expectations was that churn rate, which is the rate at which customers switch to another provider being higher in the Americas. In fact, two big customers left the company earlier than expected in one of the recently acquired datacenters.
Figure 1: Price and FFO performance.
Data by YCharts
However, taking into consideration earnings across all regions, Equinix did make progress, and my aim is to dissect the revenues further in order to identify any potential loophole going forward.
I also provide users with an indication of the valuations bearing in mind that past stock actions of datacenter REITs have tended to move in sync with tech stocks given that they house many of the public cloud’s IT infrastructure.
Dissecting the revenues
Coming back to the churn suffered in the Americas (north and south America), the executives have downplayed the customer loss saying that “both deals that wouldn’t have met our commercial hurdle in terms of deals we would have done in terms of our focus on really ecosystem-centric interconnection oriented footprints.” They also expect to fill the space vacated soon and with more profitable customers.
Another reason provided for the loss was the Americas market being choppy for a few years, but that a return to normality is expected for the fourth quarter and next year.
Figure 2: Performance in the Americas
Continuing further, there have also been impacts from COVID-19.
First, some customers as a result of going out of business will not be able to pay the cabinet rental charges. Consequently, the company expects to write down about $10 to $15 million on EBITDA for 2020.
Additionally, there have been cases of customers having difficulties accessing datacenter premises, resulting in an inability to perform deployments due to social distancing measures. This was particularly the case in the second quarter and to a lesser extent in the third one. Here, the knock-on effect on the revenue line is estimated at $20 to $30 million.
Now, $10-30 million out of a total revenue of $1.52 billion and EBITDA of $737 million is peanuts, and continuing on a positive note, the company is geographically diversified.
In this respect, both revenues and EBITDA increased for the EMEA (Europe Middle East and Africa) and Asia Pacific regions and managed to offset the decline seen in the American market. The company’s top-line and bottom-line have progressed steadily and were up both on a quarter-on-quarter and year-on-year basis.
Figure 3: Overall revenue, EBITDA and AFFO.
Looking deeper, it’s the non-recurring part which consists of cabling and cabinet installation works which has benefited from a more significant increase of 3.4%. This is the result of remote hands services whereby it’s Equinix’s own staff that have to perform the works as a result of the customer’s team not having been able to access the site due to coronavirus-led social distancing measures. For this matter, Equinix’s datacenters being strategic assets in most countries where it operates, the company’s staff is issued with special access permits.
Now, one of the reasons that datacenters are classified as strategic assets by governments throughout the world is that they hold valuable data from key stakeholders of the economy.
Figure 4: Revenue mix per-sector and per-geography.
Therefore, in addition to the server and routing equipment, datacenters like Equinix have a responsibility to protect the data of its customers, which include many big names.
Some investors may be aware of the security incident involving ransomware impacting Equinix’s internal systems on Sept. 9, 2020. As a result, the company took immediate action to address the incident and law enforcement officials were notified. Fortunately, the incident had no impact on operations or service offerings.
According to an update provided in October, the company said that only data from its own systems was compromised and that “although some information accessed without authorization included internal references to Equinix customers, the data contained no sensitive information on customer operations or other material customer information.”
Still, Equinix came close to disaster because a data leak from its customers would have had serious consequences like reputation loss, lawsuits and even customer switching to alternative providers. Also, the company’s operations could have been crippled by ransomware causing losses of billions of dollars.
Now, to address such security threats, the company does have firewalls as well as intrusion detection systems in order to screen logs and unusual traffic patterns together with antivirus software to protect servers. Also, it’s most likely that the vulnerability originated in one of its customer’s equipment.
Given the company’s acquisition spree in order to maintain revenue and FFO growth rates, it’s in the process of continually acquiring data centers throughout the world. Hence, it’s important to ensure that IT security standards are harmonized across all facilities to protect the data.
In this case, the company complies with IT industry’s security standards, such as ISO 27001, SSAE16 and PCI-DSS. Also, audit certificates are provided by qualified third-party auditors.
Looking further, Equinix’s Security Operations Center’s (“SOC”) team conducts real-time surveillance and monitoring on a 24×7 basis, 365 days a year, and as a result, early discovery of security incidents is made possible to improve security level.
Therefore, the company has appropriate tools and processes to mitigate risks and now I look at how the company is positioned with respect to the competition.
Differentiation and growth drivers
The main product differentiator for Equinix is interconnections or network connections within a country and across continents. In this case acquisitions are not only about gaining additional footprint and cabinet market share but more importantly, it’s about making more interconnects. The company now has a total of more than 386,000 interconnections, and during the third quarter, an incremental 8,500 interconnects were added.
This is very high compared to competitors.
First, there is Digital Realty Trust (DLR) which only recently ventured into the interconnection business with its acquisition of Interxion and launch of Platform Digital in 2019. Also, there is Switch (SWCH) which has been active in the interconnection space for longer but does not have the scale of Equinix whose top 14 metros (datacenter hubs) have over 10,000 interconnections each.
This growth has been driven by work from home, video streaming, and enterprise cloud connectivity with Internet exchange (Equinix internet switching platform) seeing peak traffic of up to 43% year-over-year.
Second, Equinix Fabric benefited from WFH, eclipsing the $100 million in annualized run rate with over 2,300 customers across a wide range of industries and geographies.
Figure 5: Equinix Cloud Exchange Fabric
The Equinix Fabric enables rapid connection of a customer server to the public cloud of the three cloud providers including Microsoft (NASDAQ: MSFT), Amazon (NASDAQ: AMZN) and Google (NASDAQ: GOOG) (NASDAQ:GOOGL) or private clouds. As cloud adoption becomes more of a secular trend, Equinix should continue to capture on-ramp business.
Third, through the Packet acquisition, the company has the possibility to offer bare metal services in the same way as virtual servers are provided by public cloud companies as an IaaS service.
Finally, overseas expansion should accelerate growth.
In this context, the EMEA and APAC regions were the fastest-growing ones by revenues on a year-over-year basis at 16% and 11% respectively followed by the Americas region at 5%.
In addition to its powerful IBX proposition with focus on interconnection oriented footprints, Equinix works closely with the big public cloud providers and technology partners like VMware (VMW). This partnership is one of the ways it’s able to sell cabinet footprints.
Valuations and key takeaways
According to fourth quarter guidance, revenue should increase by $43 million (mid-point of 29 and 49) with respect to Q3-2020 including those obtained from part of Bell Canada’s asset excluding Ottawa.
On the other hand, Q4-2020 EBITDA guidance should experience a 6% decline from what was produced in the third quarter due to a number of factors including higher maintenance costs, utility fees being higher and additional staff costs. This should be partially offset by higher customer collections.
Moreover, the company ended the quarter with $2.7 billion of cash on the balance sheet with $4.6 billion in the revolver. The net debt leverage ratio remains at 3.3 times annualized adjusted EBITDA with the main reason being acquisition of Bell Canada’s datacenter assets.
Also, the company intends to launch another ATM program for $1.5 billion which should reduce debt to equity ratio currently at 130. Still Equinix generates a formidable level of cash with that total cash per share value of 29.7 which is more than DLR by eight times and dwarfs Microsoft’s by $11.
Figure 6: Comparison with peers.
On the other hand with Revenue Per Employee trailing everyone else, the company needs to do more to integrate functions in all of its subsidiaries across the world. To this effect, while datacenter operations remains a labor-intensive business, more needs to done in optimizing productivity when comparing with DLR, another specialized REIT.
Now, given that Equinix will have access to the huge Indian market through the GPX acquisition in Q1-2021 with the latter also serving as a critical foundation for Pan-Indian expansion, annual growth rates should benefit.
Figure 7: Growth in Asia-Pacific plus India.
Additionally, the company should get a lot of traction from companies in Asia and the Pacific region with the formation of the world’s largest trading block a few days ago.
Therefore, revenue growth should move higher to the 8%-10% range, and more importantly, acquisition synergies and addition of higher-margin interconnections also should help net margins climb to the 10% range in 2021 from 8% currently.
Hence taking into consideration the trailing EV/Sales metric, my long-term target price for Equinix would be $825-830.
This 10% upside from the current $755 share price is also justified by the data factor and this is the reason I included Microsoft in the comparison table.
Here, investors should realize that Equinix is not only an infrastructure play with power systems, cabinets and network infrastructure but also is a data play. In this case, similarly to safe lockers where confidential documents are stored, Equinix’s cabinets now house vital corporate data throughout the world and these need to be protected both physically and against internet-based hackers.
For this matter, while it’s customers who own the data, it’s Equinix which is the custodian.
Also, petabytes of transaction data worth billions of dollars’ worth of equity trades processed every day go through Equinix’s IBX exchange. For this purpose, the company has a site in New Jersey in Secaucus where it hosts a 340,000-square foot data center enabling transactions data to be exchanged by more than 6,300 companies.
Now, there has recently been some talk about a financial transaction tax possibly being imposed by the state of New Jersey which both Equinix and trading companies are actively opposing.
This tussle between New Jersey lawmakers and Wall Street executives as well as the rotation from tech to value companies should cause volatility in Equinix’s share price with the $727-$730 level being reached in the December- January period. Also, fourth quarter earnings which are forecasted to be lower despite FY-2020 guidance being raised should add some fuel to the volatility.
Therefore, Equinix is more a long-term play with a good margin of safety made possible through the current downside.
In the meantime for those who hold the stock, with yearly Fund from Operations varying from $2.1 to 2.2 billion and a trailing Cash Dividend Payout Ratio of 42.75%, dividend payments at a yield of 1.41% are safe.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: This is an investment thesis and is intended for informational purposes. Investors are kindly requested to do additional research before investing.