Description

Long Switch Inc. (NYSE:SWCH) or Pair Switch with EQIX

Mkt. Cap: $6.3B/ Price $26/ EV: $8.3B / Div. Yield 0.8%

Company Description

Switch Inc. ("SWCH") was founded in 2017 and is based in Nevada. The entity focuses on multi-tenant data centers and interconnectivity in the United States. Specifically, SWCH focuses on Exascale data centers focused on enterprise clients migrating from on-premise infrastructure. The portfolio has 16 data centers in operation (16mm SF) providing up to 15,88 MW of power.

Investment Thesis 

There has been a constant amount of M&A in the  data center space. On November 15, 2021, both Cyrus One and Coresite Realty were purchased by KKR and American Tower in two separate deals for USD $15B and $10B respectively.

Less sellside coverage and smaller scale operations relative to other US public data centers allowed SWCH to fly under the radar but after these two transactions, the data center universe shrunk down to really only 4 names (EQIX, DLR, DBRG, and SWCH). Given the insatiable appetite for data centers by private capital, the market quickly looked for the next M&A target. SWCH quickly became the name to focus on as EQIX was too large, DLR's portfolio was lower quality, and DBRG's portfolio is messy with former corporate governance issues.

Given the precedent valuations recently paid for these assets, SWCH's high growth rate, strong portfolio quality, small size, and ESG focus makes SWCH the next likely takeout candidate at a price of at least $30. Absent of a takeout offer from the plenty of capital looking at the data center space, SWCH as a standalone entity is still deserving of a premium multiple relative to its peers due to its high growth rate and portfolio characteristics. With increased volatility in the macro environment and a to date lack of preference for growth names, SWCH can be paired with one of the larger slower growing names to isolate the M&A angle to the business.

Higher Quality Portfolio, Higher Growth Rate, Same Valuation?

SWCH boasts the highest FFO growth in the data center space and has been able to achieve double-digit organic revenue growth >15% vs. larger US data center peers averaging 8% from 2018- 2021. SWCH's 3-year organic AFFO per share growth was 13.4% from 2018-2021 vs. 9.6% for EQIX. This level of organic AFFO growth is consistent with what management is guiding in their 5 year outlook. Another recent example of how fast SWCH is growing relative to their peers is shown in their recent Q4/21 earnings, in which their QoQ EBITDA growth was shown to be 12% vs. EQIX at 0%. For the full year the growth in EBITDA was 22% vs. 10% respectively.

SWCH's smaller size helps move the needle on growth but it is also attributed to their higher portfolio quality. SWCH have been able to sign major FAANG logos/ big brand names i.e. Ebay, Tesla, Google, Sony, Cisco, Paypal, Dell, etc. in high quality facilities in faster growing secondary markets with lower power costs and lower taxes. Examples of some of their major markets are Tahoe, Grand Rapids, Atlanta, Austin, and Las Vegas. SWCH's portfolio is also 100% run by renewable energy since 2016 which should attract ESG investors to the name and drive cost benefits i.e. SWCH Nevada has energy costs 68% lower than Los Angeles/ San Francisco. Recently, S&P has implemented a new ESG rating and among 180 issuers, SWCH was the only one to get an E1 rating (the highest).

All these benefits should garner a premium but since SWCH has just recently gotten attention. SWCH trades at a forward 23E EV/EBITDA multiple of only 21x roughly the same as EQIX and the subsector median. It can easily be argued that SWCH should garner a premium. Note CONE and CORE were bought out in the high 20x to 30x. At a 27x forward EV/EBITDA multiple, this implies a share price of $35 in the private market (+35% upside).

SWCH 1 Year Spread to EQIX

Fund flow to SWCH as investors speculate the next takeout candidate while maintaining exposure to a faster growing data center REIT has increased the spread relative to EQIX with more room to run. Scarcity value is driving this spread wider.

Risks

• Uncertainty from the tax receivable agreement could create a potential overhang but market has looked passed this for now
• Generally a little more volatile in terms of std. deviation from peers
• Core campus in Las Vegas accounts for 63% of revenues. But management is consciously diversifying this out

Catalyst

• Pursuing REIT conversion January 1, 2023
• Elimination of the tax receivable agreement
• Development pipeline acceleration
• Large leases signed