Investors Focused on Data Center Sector

tesh

Tesh Durvasula of Quality Technology Services speaks at last week's Tier 1 Hosting & Cloud Transformation Summit in Las Vegas.

There's no mistaking it: The data center industry is hot. Data center stocks are outpacing the broader market, and there's been a flurry of acquisitions and IPOs amid strong interest from investors - especially from the private equity sector.

The change in the industry's fortunes was clear at last week's Tier 1 Hosting and Cloud Transformation Summit in Las Vegas, as noted by industry veteran Tesh Durvasula. "It used to be that at this conference we were all trying to prove our relevance," said Durvasula, the Chief Marketing and Business Officer of QTS. "This year, half of the room is filled with finance guys looking to give us money so we can grow our businesses."

The data center industry has been one of the most resilient performers during the economic downturn, buoyed by the relentless growth of the Internet, and the capacity for IT operations to help streamline costs for budget-conscious companies.

Sector's Strength Attracts Capital
"It's been a phenomenal year," said Mark Thorsheim, managing director of DH Capital. "Traditional businesses are all stagnant in terms of growth. Despite a challenging economy, these businesses are still growing. That's why private equity is looking at the data center sector."

That interest has translated into a flurry of acquisiton activity. ViaWest, SoftLayer and Peak 10 have all been acquired by private equity firms, while data center REIT Digital Realty Trust bought the 365 Main portfolio of companies.

All told, there have been 19 deals with a total valuation of about $4.5 billion in the data center and hosting sector in the first nine months of 2010, compared to six acquisitions with a value of $94 million in the same period last year, according to Thorsheim.

Pent-Up Demand
Some of those deals reflected pent-up demand as potential acquirers gained better access to capital. "What you're seeing is three years of inventory of companies who wanted a liquidity event," said Doug Webster, Managing Director of Signal Hill Capital.

The improved availability of funding has been seen across stock, debt and private equity markets. This week we are likely to see the first of at least three scheduled initial public offerings for data center companies, as CoreSite Realty is expected to launch its IPO. The Telx Group and Interxion have also filed papers to conduct IPOs.

"You're starting to see public capital markets really embrace the data center sector," said John Hendon, Director at Stifel Nicolaus Weisel.

"The private equity investors have been interested in this industry for the past three to five years," said Paul Stapleton, Managing Director of Media Venture Partners. "I also think the debt market has improved. A lot of new players are interested in offering debt capital."

More Consolidation Predicted
Investment bankers, industry executives and analysts all see more consolidation ahead. Some industry observers have noted the fact that private equity firms have been sellers as well as buyers. ABRY Partners sold CyrusOne earlier this year, while Oak Hill Capital has been selling parts of its stake in TelecityGroup. But both of those deals involved long-term holdings that were sold at substantial gains.

"Someone asked me if the smart money is getting out," said Hendon. "That's not the case. Some players may be taking money off the table reinvesting. Welsh Carson (which just bought Peak 10) and Oak Hill are smart money. They like the returns from this industry."

"Valuation has clearly moved up rather nicely," said Stapleton. "The multiples that are being paid today are up, but they are very rational. They make sense to investors, and are supported by the businesses."

Peter Hopper, the president and co-founder of DH Capital, says valuations are unlikely to subside as a substantial pool of investors chase a shrinking number of targets. "A lot of capital is trying to get to work, and it's not a huge industry," said Hopper.