Earnings Point To Healthy Fundamentals, Demand - Todd C. Weller - Stifel, Nicolaus And Co., Inc.
September 19, 2011 - The Wall Street Transcript has just published Data Hosting Centers & Data Storage Report offering a timely review of the Computers sector. This Special Report contains expert industry commentary through in-depth interviews with public company CEOs, Equity Analysts and Money Managers. Please find an excerpt below.
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Todd C. Weller, CFA, joined the Stifel, Nicolaus & Co., Inc., research team in connection with Stifel's acquisition of Legg Mason's capital markets group in December 2005. He covers the software and Internet infrastructure sector with a current focus on data centers, managed cloud hosting and security. Before joining Legg Mason in August 1998, he was an Associate Analyst at Prudential Securities covering companies in the Internet and electronic commerce sector. From June 1996 to August 1997, Mr. Weller was a Research Assistant at BT Alex. Brown, Inc. He was ranked first for earnings accuracy and third for stock picking in the software industry and second for stock picking in the health care technology industry by the Financial Times/StarMine in 2009, when he also was ranked third for stock picking in Internet and computer services by The Wall Street Journal. In 2008, he was ranked second for earnings accuracy in the software industry by the Financial Times/StarMine. Mr. Weller has a B.A. in economics with certificates in finance and management science from the University of Maryland, Baltimore County, and an MBA from the University of Maryland, College Park.
TWST: What trends are on the horizon for this space?
Mr. Weller: Yes. There are new entrants in the data center market. You have privately held Vantage Data Centers that is backed by Silver Lake Partners. They are having success out in the Silicon Valley market focusing on more power-efficient designs, which they believe can lead to lower operating costs for companies. So that's one approach. There's another high-profile private company, i/o Data Centers, that's best known for its presence in Phoenix, but also recently expanded into the New Jersey market. They're focusing on a container approach.
Those are definitely some of the key trends. I think as far as other trends, certainly the customer demand profile tends to change. We're seeing cloud computing companies emerging as bigger sources of demand for data center providers. I think as you look over the next few years, health care should become more interesting as the move to electronic medical records continues. Then you have the federal government consolidating data centers, and a lot of those are smaller owned data centers, but you have seen the federal government look to lease capacity from third-party data center providers. And the federal government is also certainly pushing toward more cloud computing adoption. So those are some of the big things.
On the data center side, if you think about the cost to build a data center, 10% of the cost is the land and the building shell, and then 90% is the power and cooling infrastructure. When you think about that, we're not talking about servers and things like that that are changing rapidly. We're talking about Caterpillar (CAT) generators, batteries, chillers, uninterruptible power supplies. Those are technologies where you don't see rapid levels of change.
TWST: What are your top picks right now and why?
Mr. Weller: We're pretty long the sector. Equinix is our top pick overall. We felt, and still feel, that valuation is very attractive. If you look at the multiples or valuation on an enterprise value to EBITDA basis - and that's the way we look at it, and I say it that way because from a REIT perspective, the typical valuation metric that REIT analysts will focus on is price to FFO or AFFO or net asset value, but we look at EV/EBITDA - Equinix at approximately seven times forward EBITDA is, we think, pretty attractive. Again, we felt like the last three quarters have all been around restoring confidence that the issues Equinix experienced were company specific as opposed to it being some big negative inflection point for Equinix and for the data center market. I think mission accomplished so far.
Unfortunately, the last few weeks have been devastating to Equinix's share prices, as well as any other stock on my screen because they reported very solid results as I mentioned, and you saw the stock up to $105, and now we're sitting here in the low $80s. We still think that's a good story. We think that the estimates are conservative for the back half, and there's room for upside there. We're also positive on Rackspace, and that's a different segment, managed hosting, but they also compete in the cloud market. Cloud is an evolution of hosting, and Rackspace is the most attractive growth story on the tech side of that sector, with growth accelerating to 30%. That stock's pulled back as well. They do have a fair amount of their business exposed to the small- and mid-size business segment, so there are cyclical things to consider with respect to that segment.
Long story short - and no pun intended there - we're pretty long on our recommendations, but that is reflective of the different segments of the market combined with scarcity in that there are not that many plays in each of those segments. For the tech, media, telecom or generalist crowds, you have Equinix and Rackspace, which are two very different players.
One I haven't mentioned, which we don't currently cover, which is certainly an interesting story, is InterXion (INXN). They went public back toward the end of January, and they are very similar as far as business model to Equinix, except they are totally focused on European markets. They are one of the leading providers of European carrier-neutral colocation services. They don't compete in the U.S. or Asia at this point, but they are listed here on the NYSE.
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