Unfortunately this write-up is not as detailed or well-formatted as my past write ups. This is due to 1) The depth of background already laid out by skca74’s excellent write-up from 1 year ago 2) My need to meet my annual idea minimum on short notice. It is my goal to only post timely and high-return stocks, but unfortunately this is easier said than done in a trending market. I hope you understand.

Investment Thesis

Equinix is a compelling opportunity to invest in a secular growth story with a catalyst occurring within the next 6 months as the company converts to a REIT. Equinix is a proven best-of-breed investment within the data center space and is set to benefit from the strong trends of internet 2.0 and cloud computing.  

History & Background

Equinix is a global data center provider with deep expertise in operating exchange platforms.  The company boasts over 100 data centers in 32 major metro areas across 15 countries in 5 continents.   It delivers over 131,000 cross connects to its 4,500 customers worldwide.  EQIX hosts 450+ cloud service providers and connects over 975 network service providers.  This allows enterprises and cloud service providers a vast range of vendors to provide a myriad of network services.  Since 1998, they have invested over $7B+ in their data center infrastructure platforms.  Unlike most wholesale data center providers, Equinox operates a network-neutral business model.  They offer their customers direct interconnection to a myriad of bandwidth providers, rather than focusing on selling a particular network.  The providers in their sites include the world’s top carriers, internet service providers, broadband providers and international carriers.  Neutrality basically means, that their customers are free to choose from or partner with, the leading companies within these five targeted verticals.  These include:  (Directly from their 10k)

Equinox generates revenues by providing colocation, related interconnection, and managed IT infrastructure offerings on a global platform.  Colocation is a generic term for literally meaning you are co-located within the same building or space.  Revenue is generated by renting storage space, operations space, cabinets and power for customers colocation needs.  Interconnection offerings include the cross connects, as well as switch ports on their exchange.  The cross connect exchange provides a scalable and reliable connectivity that allows customers to exchange traffic directly with the service provider of their choice.  Equinox also provides managed IT infrastructure services which allows its customers to leverage and maximize the resources that their IBX data centers provide.

Historically, the data center market was largely served by the big telecommunications carriers, which essentially bundled their telecommunications and managed services with their collocation offerings.  In addition and in the more recent past, large enterprises like Microsoft built and operated their own data centers.  These are typically referred to as server farms.  In an interview in 2012, Steve Smith, the CEO had this to say about his business model:

Equinox operates a high moat business due to the nature of their data center locations, extensive IT offerings, reliability, low latency and neutral interconnection hubs for cloud and IT service providers, content providers, financial companies, enterprises, and network service providers.  Equinox is not a limited choice option, like so many other hosting/colocation companies.  Currently, 95% of their revenues are recurring and churn last quarter fell from 3.7% in Q1 2013 to 2.3% in Q1 2014.  This highlights the stickiness of their business model.  Management has provided over 10 years of revenue and EBITDA growth and adjusted EBITDA margins of 46%.

They compete based on the quality of their IBX data centers and their ability to provide a one-stop global solution in the Americas, EMEA and Asia-Pacific locations, the performance and diversity of our network-neutral strategy, and the economic benefits of the aggregation of top network and business ecosystems under one ecosystem. The industry has been trending towards a model where there has become a large need for contracting with multiple networks due to the uncertainty in the telecommunications market, customers’ increasing power requirements, enterprise customers’ increased use of virtualization and outsourcing and the continued growth of broadband from mobile applications.

Cloud Computing – Secular Growth

As the cost of technology continues to drop, humans are becoming more connected and devouring more data.  In order to keep pace with our worlds thirst for instant connectivity and software,  enterprises and consumers are increasingly turning to the cloud.     CAGR on Cloud data center traffic is expected to be 35% 2013-2018, this compared to traditional data centers at about 12% CAGR.  In 2013 Cloud IT spending reached $56B, this is expected to grow to $137B by 2017, a 25% CAGR.  Many Fortune 500 companies are already migrating to the hybrid cloud.  There are currently 1200+ Cloud service providers and IT service customers within their platform.  Interconnection is a very big deal within this category, which the other providers simply cannot match.  It improves latency and drives application performance.

Equinox is on the forefront of this ever-changing landscape within cloud and has one of the most robust platforms on the market.  In 2014, a major part of their strategy has been on capturing this opportunity.  Equinox will capitalize on this opportunity by hosting the infrastructure for these cloud providers at its centers and providing its customers private links to those providers.  These providers will be the best of breed cloud participants, such as Amazon Web Services, Microsoft Windows Azure and IBM-owned Softlayer.  It is important to note, that most enterprises today are not using one cloud based provider.  That is why their hybrid cloud exchange along with a carrier neutral data center will be such a growth driver within this space.  Currently, their cloud exchange is available in 19 markets and growing.  As of last quarter, AWS has committed to 7 exchanges by year-end and Microsoft Azure has committed to 16 by year-end. 

Just recently, NetApp announced they had entered into an agreement with Equinox to enable their private storage solutions within the Microsoft Azure platform on the Equinox cloud exchange.  Along with the announcement Equinox and NetApp delivered test results revealing that the data throughput between NetApp Private Storage customers and Microsoft Azure rose by an average of 36 percent when the two services were connected via the Equinox Cloud Exchange instead of via public networks.  We are moving into an era, where every millisecond matters more and more.  Performance really does matter.  Cloudfare, the leading web performance and security company just announced a partnership this month.  Coudfare processes an astonishing 300 Billion page views every month for over 1.5 million customers worldwide.  The biggest factors for their decision include; superior performance, closer proximity to their customers, quality of service and reduction in latency.  No other data provider could provide the global scalability and content delivery system like Equinox can.

REIT

Last June, an IRS working group was formed to challenge the feasibility of Iron Mountain converting to a REIT. This placed considerable pressure on stocks that currently made known their intention to convert.  This weighed heavily EQIX’s stock price and has caused the stock to lag until recently.  Moving forward we believe EQIX has a 95% chance of REIT approval. We believe this for 3 reasons:

1)       A recent white paper from the US Treasury offers guidance for the first time since 1969 as to what constitutes a REIT. In our opinion, the question of whether EQIX falls in consideration for a REIT is now confirmed. The complete white paper can be found here:

https://s3.amazonaws.com/public-inspection.federalregister.gov/2014-11115.pdf

2)       On 6/25/14 Iron Mountain was granted a PLR confirming its REIT status.  Shares soared that day +20% on heavy volume.

3)       EQIX already has a number of peers who have converted to a REIT. Among these are CORE, CONE, DFT, and DLR.

Sell side research has yet to widely discuss the US Treasury white paper. Accordingly, Wall Street estimates have yet to conduct a re-rate in valuation and modeling that will grant benefit to EQIX’s REIT status.  We believe EQIX conversion to a REIT will serve as a linear-event that offers the stock 20% upside over the next 6 months.

Valuation

We believe that in EQIX can deliver 2016 AFFO of $20.10 based on $2,977MM of sales.  Using a multiple of 15-17.5x, we believe EQIX can be worth between $286.50 to $334.25. At today’s closing price $217, this would garner upside of 38% to 62% + dividends.