12/09/13 10:10:34 AM
FOCUS STOCK OF THE WEEK
EQUINIX, INC. (EQIX)
EQUINIX, INC. : (EQIX)
This week's Focus Stock of the week is Equinix, Inc. (EQIX: $165), which carries S&P Capital IQ's highest investment recommendation of 5-STARS, or Strong Buy. EQIX is the largest global network-neutral data center operator, with what we consider to be an unmatched network of customers that use EQIX to gain access to other tenants to exchange critical data, often with very low latency requirements. This massive network effect both attracts new customers and yields steady growth from existing customers. We expect EQIX to benefit from favorable technology trends, including growth in global Internet traffic, accelerating cloud computing deployments, and rising mobile usage. In addition, we see high barriers to entry, upside from site expansion, and earnings visibility from a highly recurring revenue base. Meanwhile, EQIX's planned conversion to a real estate investment trust (REIT) in 2015 should provide additional benefits, in our opinion.
We believe EQIX will generate double-digit organic revenue, EBITDA and EPS growth in 2014 and 2015 from a combination of capacity expansion (measured in cabinets), increased cabinets billing, and higher average revenue per billing cabinet. We forecast revenue growth of 13% in 2014 and 11% in 2015. The EQIX model has high operating leverage and thus, high incremental margins. While we forecast incremental expansion costs for new capacity, we think EBITDA margins will expand in both 2014 and 2015. Overall, we estimate the company will grow EPS at a three-year compound annual growth rate of 30%.
We like EQIX's disciplined expansion approach. The company has a track record of quickly filling new capacity in its data centers. Since 2010, EQIX has increased global selling capacity by 31%, from 86,600 cabinets to 113,800 as of September 30, 2013. Importantly, its capacity utilization rate has remained between 74% and 81% throughout this expansion, and is currently at 77%. The key to this success, in our view, has been measured data center buildouts in markets where there is sufficient demand to justify expansion. Further, by expanding in small phases, the company has been able to avoid overbuilding capacity, maximizing its return on investment. EQIX has a long history of completing new data center expansions, with quick time periods to reach breakeven cash flow, healthy IRRs, high gross margins, and strong returns on investments.
EQIX leverages the diversity of the over 4,400 companies that collocate within its data centers, including cloud and IT service providers, content providers, digital and social media companies, enterprises, financial companies, and network and mobility service providers. We believe it has been successful due to its global footprint, high-quality data centers, dynamic business ecosystems created by its network-neutral model, the cost savings it offers customers versus building their own data centers, and the high level of support and knowledge of its technical staff.
Global customers benefit from the ability to purchase worldwide data center services from one operator with a high level of local market knowledge and high-quality facilities. As of September 2013, over 60% of recurring revenue was from customers deployed across multiple regions. Further, the number of customers deployed across its three key regions (U.S., Europe and Asia) grew 23% in the third quarter of 2013 versus the year-earlier period.
Finally, with roughly 75%-80% of EQIX's recurring revenue from customers deployed across multiple metropolitan markets, it is clear to us that most of the company's customers use its data centers in multiple markets. As more new customers move to EQIX, the ecosystem grows and becomes more attractive to existing and new customers, in our view. EQIX seeks to use these strengths to continue expanding its data center footprint in both select existing markets and new markets where demand is evident. We expect the company to continue to seek cost-effective expansion strategies, including acquisitions of existing data centers, investing in local data center operators and building new data centers.
Equinix, Inc., founded in 1998 and headquartered in Redwood City, California, is a data center operator that provides physical connection locations for over 4,400 companies to directly connect with their own customers and exchange data. As of September 30, 2013, EQIX had 99 data center locations in 31 markets. In the third quarter of 2013, 59% of revenue was from North America, 25% from Europe, and 17% from Asia-Pacific. EQIX provides power, floor space, security, and cooling for its customers, which place their own equipment inside EQIX facilities. EQIX does not sell equipment or network services and thus does not compete with its customers. The data centers are all connected by fiber routes built by telecom providers that pay EQIX monthly fees to house points of presence within the company's facilities to sell network services to other EQIX customers. Customers also pay for each megabit (Mbp) of traffic exchanged within the data centers through cross connects or exchange ports. We believe the unique aspect of EQIX's business model is the availability of over 900 different networks within its global facilities. EQIX has built a substantial global customer list across many verticals, including enterprise, financial services, cloud and IT services, carriers (both network and mobile), and content providers. For customers with business models that require exchanging large volumes of data with numerous different entities with low latency, we believe EQIX data centers provide cost-effective and reliable locations in most major markets. We view this network-neutral approach as a key differentiator for EQIX and a key barrier to entry.
EQIX has grown both organically and through several key acquisitions. Since 1998, EQIX invested roughly $4.5 billion of capital to add new sellable cabinet capacity, $1.0 billion for maintenance of existing facilities, and $1.8 billion on acquisitions. On the acquisition front, in 2007, EQIX acquired IXEurope for $550 million in cash (adding data centers in France, Germany, Switzerland and the U.K.) and Virtu for $48 million in cash (adding the Netherlands). In 2010, EQIX acquired its largest North American peer, Switch & Data, for $842 million ($137 million in cash, $576 million in EQIX stock, and the assumption of $129 million of net debt), adding 34 data centers in 22 markets in the U.S. and Canada. EQIX expanded into South America with the $83 million cash purchase of ALOG in Brazil in 2011. In 2012, EQIX made two cash acquisitions, adding Ancotel in Germany for $86 million and Asia Tone in Hong Kong for $231 million.
EQIX is one of an estimated 650 companies globally that provide data center offerings. In colocation, EQIX competes primarily with major telecom carriers including AT&T (T 35, Hold), Verizon (VZ 49, Hold), CenturyLink (CTL 31, Buy), COLT, CyrusOne, Level 3 (LVLT 30, Hold), NTT, Qwest and Windstream (WIN, 8, Strong Buy). For customers seeking interconnection service, EQIX offers the choice of hundreds of network service providers in the largest global network hubs, such as New York, Hong Kong, and London. In this segment, CoreSite, Global Switch, Interxion, Telecity Group, Telx, Telehouse and Verizon Terremark are key competitors. Wholesale is not a core strategy for EQIX, but it will sell a large amount of space in one data center to a single customer (usually enterprises and other colocation providers) for select strategic customers that it thinks will be magnets for other new customers. In wholesale, EQIX competes with Digital Realty Trust, DuPont Fabros Technology, e-Shelter and Sentrum. Finally, managed hosting companies that manage hardware for their customers provide an alternative to the do-it-yourself model at EQIX. These competitors include AT&T, CenturyLink, NaviSite, Rackspace (RAX 34, Buy), SunGard, Verizon Business and Verizon Terremark.
The greatest competitors for EQIX are its customers' own data centers. Most enterprises own their own data centers, but many outsource all or a portion of their data center needs as a long-term cost-saving measure. The outsourcing trend is growing, but there is a long sales cycle given the importance of maintaining data uptime and the risks of moving key equipment to new locations.
S&P Capital IQ has a neutral fundamental outlook on the integrated telecommunications services (wireline) sub-industry for the next 12 months, but a positive opinion on select, high dividend-paying companies as well as select niche data center and cloud providers within the sector. Overall, we believe the large integrated services providers will generate stable to improving free cash flow, largely from a combination of broadband growth and continued cost savings. Further, after dividend reductions by several mid-sized telecom companies over the past two years, we believe dividend payout ratios are now at levels that can support current dividends.
We expect EQIX to benefit from what we see as its unique position in the market, strategic locations, sticky customer ecosystem, sales expertise, and the presence of leading global networks within its facilities. Revenue is highly recurring with low churn. We believe EQIX will benefit from healthy expected global IP traffic growth.
We see revenue growth of 14% in 2013 to $2.2 billion and 13% in 2014 to $2.4 billion, driven by steady growth in available capacity (measured in cabinets), cabinets billing, and average revenue per billing cabinet. In total, we forecast a 9% increase in global sellable cabinet capacity in 2013 and a 6% increase in 2014. We forecast global cabinets billing to advance 8% in both 2013 and 2014, yielding global capacity utilization rates (cabinets billing divided by available cabinets) of 75% in 2013 and 76% in 2014. We project average monthly revenue per billing cabinet to increase 7% in 2013 and 5% in 2014.
We forecast EBITDA growth of 11% in 2013 to $894 million, with an EBITDA margin of 41.5%, down from 42.7% in 2012 due to higher stock compensation costs, foreign currency headwinds, REIT conversion costs, and growth investments. However, we expect long-term margin expansion from revenue growth and high incremental margins. In 2014, we forecast 15% EBITDA growth to $1.0 billion with an EBITDA margin of 42.2%.
We look for operating EPS of $3.07 in 2013 and $4.29 in 2014, up from $2.80 in 2012. In 2013, we expect higher interest and depreciation charges, but lower taxes.
We forecast cash from operations of $607 million in 2013 and $844 million in 2014, with capital expenditures of $572 million in 2013 and $659 million in 2014. Importantly, we project 71%-74% of capital spending will be for new capacity builds, with only $164 million of maintenance capital spending in 2013 and $174 million in 2014. While we expect the company to continue expanding to meet rising demand, we also believe the company will generate substantial free cash flow from its existing locations.
Given the substantial cash flow generated from its data center facilities, we use discounted cash flow analysis as our underlying valuation methodology. Our DCF-based 12-month target price of $220 assumes a weighted average cost of capital (WACC) of 9.8% and a 2.5% terminal growth rate.
EQIX currently trades at an estimated 2014 enterprise value/EBITDA multiple of 10.5X. At our 12-month target price of $220 per share, EQIX would trade at a projected 2014 EV/EBITDA multiple of 13X. We believe our target valuation is supported by our estimated 14% three-year EBITDA growth rate. Further, we believe EQIX's valuation should benefit from the expected improvement in shareholder returns should the company complete its conversion to a REIT in January 2015.
Our view of EQIX's corporate governance is favorable. We are encouraged that the company has a largely independent board, with seven of the nine current board members (78%) classified as independent under NASDAQ listing standards. Further, the Audit, Compensation, Nominating and Real Estate Committees of the board consist entirely of independent directors. All independent directors receive automatic grants of restricted stock units (RSUs) which we believe further aligns the interests of both the board and shareholders. Finally, the positions of Chief Executive Officer and Chairman are held by separate individuals. Having a Chairman that is not an officer or member of the management team improves the ability to exercise oversight over management, in our view.
Risks to our recommendation and target price include the loss of key customers, technological changes, competition, economic pressures, pricing pressures, foreign currency fluctuations, and higher debt leverage. In addition, increased power and cooling requirements could reduce the amount of available sellable capacity and any potential power outage could damage the company's reputation for reliability. Industry overcapacity could result in lower peer pricing and impact future growth. Finally, the failure to convert to a REIT in January 2015 could adversely impact the share price as we believe many of the benefits of this planned conversion are baked into the current valuation.
We see compelling upside potential for EQIX shares and believe the company is well positioned to benefit from positive technology trends with its unique business model. EQIX is the largest global network-neutral data center operator, with locations in the top global traffic hubs in numerous markets in the U.S., Europe, Asia, Australia and South America. EQIX leverages what we consider an unmatched network of customers to attract new customers and reduce churn, yielding steady recurring revenue growth from its data centers. The company provides mission critical services for the major providers of telecom services, Internet, cloud, digital and social media content, and financial services. The location and dense network availability in these data centers allow EQIX customers to provide seamless and low latency services in best-in-class facilities.
Overall, we see numerous positive trends driving our bullish thesis on EQIX, including healthy demand from growth in global Internet traffic, accelerating cloud computing usage, and a much greater consumer reliance on mobile applications. We also see high barriers to entry, upside from site expansion and rising average monthly revenue per cabinet billing, and earnings visibility from a highly recurring revenue base. In addition, we believe EQIX's planned conversion to a REIT in January 2015 will provide incremental benefits to shareholders as well.
S&P Capital IQ's views on stocks are constantly re-evaluated. Please refer to our most recent publication on this stock to see our current view.