DCK Investor Edge: Understanding the Changing Landscape for Data Center Investors

The Ukraine/Russia conflict spiraling toward an invasion (which could impact the price of oil and natural gas), and a US inflation rate running the hottest in 40 years (with the US Federal Reserve’s anticipated "hawkish response" to raise interest rates multiple times in 2022), are currently two of the most powerful forces impacting the pricing of publicly traded equities and the bond market.

Additionally, US/China trade tensions, the semiconductor shortage, and Covid pandemic-related supply chain issues remain a drumbeat in the background. These macroeconomic challenges continue to overshadow the quarterly results and annual guidance that normally drive price activity for publicly traded companies.The two global giants in the data center industry, Equinix (EQIX) and Digital Realty (DLR), each reported solid results last week.

Stoller Fig 1

YChart created by author

However, Mr. Market didn't seem to care one bit.

A changing data center landscape

In the midst of the Covid pandemic – and related share price volatility – three of the "smaller" publicly traded US data center REITs have been gobbled up by private-equity and other institutional players during the past year. Ironically, each of these multi-billion take private deals were done at a premium to the publicly traded price at the time.

The first announcement was QTS Realty (QTS) being taken private by a Blackstone (BX) fund for a premium over 20 percent. This deal was announced the first week of June 2021 and closed at the end of August, a very fast cadence. In addition to a solid portfolio of data center assets, powered shells, and land, Blackstone picked up a strong management team, and significant intellectual property – the QTS Service Delivery Platform, or SDP.

Related: Blackstone’s $10B Deal to Buy Data Center Giant QTS: The Context

It also set off a feeding frenzy by other institutional investors where management teams exhibited a "FOMO," or fear of missing out mentality.

The next two dominos fell quickly.

CoreSite Realty (COR) being taken private by global cell tower giant American Tower. American Tower (AMT) is one of the largest publicly traded REITs, so announcing the transaction in November, and then closing the deal in late December 2021, was a relatively "small bite" for AMT to digest. CoreSite had a history of developing and operating connectivity-focused data centers, with its crown jewel being the One Wilshire facility (and adjacent buildings), with support media and content delivery in Los Angeles, CA. This M&A deal underscores one of the evolving data industry trends, "converged digital infrastructure."

CyrusOne (CONE) was then the proverbial "last man standing," but not for long. On November 15, 2021, just a few days after the AMT/COR deal was announced, well-known private-equity giant KKR and infrastructure giant Global Infrastructure Partners (GIP) announced a deal to acquire CyrusOne and take the company private for just over $15 billion, including debt. This transaction is scheduled to close prior to June 30, of this year – and would represent the largest data center acquisition, ever.

Three other options for investors

The publicly traded data center options for US REITs changed rapidly at the end of last year. Here are three other options for retail investors to consider: Switch, Inc. (SWCH), DigitalBridge Group, Inc. (DBRG), and while not a pure-play on digital infrastructure, Iron Mountain, Inc. (IRM) continues to ramp-up its data center business.

Stoller Fig 2

YChart by author

These are three very different options.

Investor edge

Switch, Inc. has a unique portfolio of data center assets and land holdings. CEO and founder Rob Roy has a massive number of patents and patents pending, so you can't consider Switch without understanding the related intellectual property. Switch "MOD" data center design is unique, and there is also a communication purchasing cooperative, another one-off.

The largest Switch data center campus, founded over 20 years ago when Roy bought out the Enron Broadband assets, is located in Las Vegas, Nevada. The next largest campus, (and potentially one of the largest collection of data centers in the world), is in Reno, Nevada. Additional campuses are in Grand Rapids, Michigan, and Atlanta, Georgia. The most recent pin in the map is adjacent to the Dell corporate campus in Texas. No other US-based data center operator has this footprint.

Additionally, Switch currently pays a small dividend, but does not operate as a REIT. Management has guided to a REIT conversion, as of January 1^st, 2023.

DigitalBridge Group is the vision of CEO Marc Ganzi, who has spearheaded a now completed transition of assets, from an undifferentiated collection of industrial, healthcare, and hospitality lodging assets (part of the former "diversified" REIT, Colony Capital – previously run by Tom Barrack). Many of those assets were acquired as part of an ill-fated merger with NorthStar Realty.

Related: Colony Leads $1.2B Equity Investment in Vantage Data Centers

Ganzi, over a couple of years (during a global pandemic), has managed to sell the non-digital assets, reduce balance sheet debt, reduce G&A expenses, and pivot toward a converged digital infrastructure business model, which also includes a massive Investment Management portfolio, (fee-based assets under management, or AUM), in addition to on balance sheet interests in a carefully curated collection of over a dozen portfolio companies, including: Vantage Data Centers, DataBank, Zayo, as well as Cell Tower assets.

Iron Mountain is clearly the best known of these three options. However, it isn't always thought of as a data center player. During the past few years, IRM has quietly grown its data center portfolio, and has considerably increased both the scale of leasing based upon total MW, and the contribution to the company bottom line.

Best known for its legacy document management business, including both long-term storage, and document services. Iron Mountain also has a fleet of vehicles (think logistics) and has been a major player in Enterprise data center magnetic tape updates and safeguards these critical back-ups.

Iron Mountain has the largest number customers, (by far) of any company in the data center business. As of 2020, over 95% of Fortune 1000 companies use Iron Mountain's services to store and manage their information. Notably, many IRM shareholders are attracted to a dividend yield that is north of 5 percent.

I plan to explore each of these investing options in far more detail for DCK readers going forward.