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

In what would be the biggest acquisition of a data center business ever, Blackstone has agreed to take QTS Realty Trust private for $10 billion.

There is little reason to doubt the transaction will close as expected, sometime in the second half of the year. Blackstone offered a 21 percent premium over QTS stock’s June 4 closing price to QTS common shareholders, and, as RBC Capital Markets pointed out in a research note, the data center provider is unlikely to find a higher bidder during the 40-day “go-shop” period baked into the agreement.

It’s clear why the deal is good for QTS shareholders. It’s also relatively clear why Blackstone wants to invest in one of the top players in a market that’s projected to continue growing into the foreseeable future. It’s less clear why the acquisition is good for QTS, the business. As customary, its executive team is staying quiet following the deal’s announcement.

Pleasing Shareholders

One of the most common ways you’ll hear executives explain a decision to go private is the pressure to report growth every quarter. This pressure can be especially heavy on data center developers whose business relies to a great extent on hyperscale cloud platforms as customers. Hyperscalers drive roughly 40 percent of QTS’s revenue, according to its Q2 2021 investor presentation.

Big hyperscale leases can be unpredictable, while the real estate and facilities necessary to secure those deals require a lot of upfront investment. A hundred-million-dollar investment may not start generating returns for a year, and even then, it may not reach its full return potential right away. The stock market doesn’t have that kind of patience, while private institutional investors often do.

Selling the company is also likely a way to give shareholders a good immediate return on investment. Before the Blackstone deal was announced, QTS’s stock hadn’t managed to regain the record high of about $72 it reached at the end of last July on investor optimism about pandemic-fueled demand for digital infrastructure, Jabez Tan, head of research at Structure Research, pointed out. As of Tuesday afternoon, it had been holding steady at north of $78 since the announcement on Monday.

Given the massive correction earlier this year across virtually all the stocks that boomed in 2020 thanks to the pandemic – everything from Zoom to Peloton to Twilio – combined with the current worries of potentially looming inflation and a tapering of federal economic stimulus, going private could be a good way for QTS to hedge against the risk of shrinking public-market valuation, Tan said.

RBC estimates that Blackstone’s offer represents a 25x 2021 QTS EBITDA multiple.

The acquisition would also help with QTS’s substantial debt, Alan Howard, principal analyst with the Omdia Cloud and Data Center Research Practice, pointed out. (Omdia and DCK are both owned by Informa.) As part of the agreement, Blackstone agreed to assume the data center provider’s debt.

“It looks to me like the Blackstone deal will be good to them from a debt management standpoint,” Howard said.

The International Opportunity

Besides alleviating the quarterly reporting pressure, an acquisition by Blackstone could better position Overland Park, Kansas-based QTS to fill one big gap in its current competitive position: a lack of meaningful presence outside of the US.

“There’s a wave of hyperscale demand that’s entering both Europe and Asia,” Tan said. Having focused largely on big US markets, QTS isn’t well positioned to ride it, he explained.

The company has virtually no presence in Asia. It entered Europe in 2019, acquiring two data centers in the Netherlands, but its competitors (the most comparable one being CyrusOne) have larger footprint and runway in Europe, Tan said.

Meanwhile, Structure’s projected average annual growth rates in Europe and Asia for the next five years are 13 percent and 15 percent, respectively, compared to under 7 percent in North America.

Blackstone could provide QTS with the capital necessary to go after the opportunity in international markets. The investment firm already has a track record of data center deals outside North America. The most recent example was its acquisition of a $150 million stake in 21Vianet, one of the largest Chinese data center providers.

In 2019 Blackstone sold the Australian data center operator DCI Data Centers to Brookfield Asset Management. In 2017 it acquired a stake in Ascenty, a Latin American operator that was later sold to Digital Realty.

Among its other investments are a minority stake in GI Partners, a major US-based private equity player in the data center market, and a joint venture with Corporate Office Properties Trust, in which Blackstone took ownership of multiple data center shell buildings in Northern Virginia, likely occupied by AWS.

QTS’s Strengths

QTS is one of five publicly traded US-based data center REITs. The four that will remain if the Blackstone deal closes are Equinix, Digital Realty, CyrusOne, and CoreSite. There are also Iron Mountain, the document management and storage REIT that has a sizable data center business; Switch, the only publicly traded American data center provider that isn’t registered as a REIT; and Cyxtera, which agreed to go public by merging with a SPAC earlier this year but has yet to finalize the merger and start trading.

The acquisition agreement between Blackstone and QTS is yet another M&A deal as the data center sector continues to consolidate. The two largest prior transactions in the sector were both done by Digital Realty: an $8.4 billion acquisition of the European provider Interxion in 2019 and a $4.95 billion acquisition of the American hyperscale developer DuPont Fabros in 2017.

But smaller deals have been coming steadily across the globe, as the industry matures and attracts more and more institutional investors.

QTS is the seventh largest data center provider in the Americas, with 3 percent market share in the region, according to Structure. Its 2020 revenue was about $540 million – a 12 percent increase from 2019. It operates 28 data centers in 14 markets, including the two facilities in the Netherlands.

The 60 percent of its revenue that doesn’t come from hyperscale leases comes from its retail colocation business. One of its big competitive advantages in the retail colo market is its software platform that provides customers with one of the most fully featured sets of tools for monitoring and managing their data center infrastructure.

A few years ago, QTS made a strategic decision to invest in developing a robust software platform, and the investment appears to be paying off. The Service Delivery Platform currently has more than 18,000 users, according to the company.

A fundamental QTS strength is in its portfolio of large data center campuses across several key US metros, where its customers can expand capacity, according to RBC’s note, which also pointed out that the company benefits from the low price it paid for land in places like Richmond and Dallas, Texas; and Chicago, translating to a low cost basis for the business.

More recently, QTS expanded to other hyperscale-heavy US markets in Northern Virginia, Phoenix, and Hillsboro, Oregon.

Another unique advantage the company has is its strong position as a data center provider to federal government agencies, Tan pointed out, which it gained through acquisition of Carpathia Hosting in 2015. Building on that deal, QTS has signed an outsize amount of government deals, which “a lot of the other operators are not as well-equipped … to do,” he said.