Wall Street Debates How to Value Data Center Stocks

A favorable feature article in Barron's can lift some stocks with a "Barron's Bounce," while a tough critique will also be felt in the markets. Last Saturday Barron's followed up on a slide in Rackspace shares by taking a critical look at the methods used to value data center companies on Wall Street. That kicked off a series of articles in the financial press and blogosphere debating the merit of data center investments. Here's a review of this week's action:

Adjusted for Reality, Neither Rackspace nor Equinix Shine - Barron's Tiernan Ray focused on the use of adjusted EBITDA: "Investors have cooled a bit on some of the best-known data-center REITs, such as Digital Realty Trust (DLR) and Dupont Fabros Technology (DFT). Their stocks are down 6% and 4%, respectively, this year, on results that failed to sustain the magic. And that makes one wonder about the data-center names that aren't REITs, but that investors like to think of as if they were. Cases in point: Rackspace Hosting (RAX) and Equinix (EQIX), both of which are way overvalued on the basis of reported earnings and that, given their massive investment costs, make little to no actual cash profit."

Will The Sun Keep Shining On The Cloud Storage REITs? - Seeking Alpha's top-rated REIT blogger, Brad Thomas, follows up on the Barron's critique, and sees value: "In all likelihood two new data storage companies will convert to REITs soon and the massive 'brick and mortar' data-lords will almost triple the size of the sector. Rackspace Hosting (RAX) and Equinix (EQIX), with markets caps of $8.09 billion and $10.93 billion respectively, will likely enter the REIT-dom as both companies look to exploit the favorable tax friendly structure. It's plain to see the benefits for converting to a REIT structure as Mr. Market has rewarded both data companies for the mere suggestion of being a REIT. The same has been true for other REIT wannabes. I suppose that's great for yield-hungry investors who are looking for added diversification in the form of sustainable rental income that is paid out in the form of dividends. But let's take a closer look at the two new players in data-dom and see if there's a reason to reserve a seat, in advance, for the flight to REIT-dom."

Data Centers Vs. Hosting Providers: Why The Distinction Is Critical For Investors - At Minyanville, Fil Zucchi says the distinctions between business models is getting lost in the valuation debate. "As pointed out in a research note by Stifel Nicolaus, Barron’s makes no distinction between 'data centers' and 'hosting companies.' But understanding the difference is critical accurately valuing the stocks. The former lease 'physical space' where customers can place their servers, and the data center supplies power, cooling systems, and storage facilities. In the case of 'hosting companies' such as Rackspace, it may or may not own the real estate in which the servers reside, but in any event its primary business is to 'lease' its servers to clients who want to host their websites without having to manage the IT infrastructure. From a valuation standpoint, the distinction is critical."

What has the market had to say since the Barron's article? Shares of Rackspace closed at $54.98 Wednesday, down from $58.96 at Friday's close, a decline of 6.7 percent. Equinix ended yesterday's session at $215.62, down 3.9 percent from Friday's close of $224.48.