Since the Iron Mountain (IRM) disclosure on June 7th that the IRS is reviewing its real estate status for REIT conversion, Equinix (EQIX) has come under pressure, with the stock down $20, which I believe is largely related to confusion over this catalyst. This article will attempt to lay out the facts and show why I believe the stock is being overly discounted for this fringe issue.
First, the situation:
· EQIX filed an 8-K on 6/7 indicating that the IRS' working group is reviewing what is considered "real estate" for REIT conversion purposes.
· Before EQIX can convert to a REIT, which management intends to do on January 1, 2015, the working group study has to be completed. This 1.5 years is certainly plenty of time for the working group to issue its private letter ruling (PLR) which would then allow the conversion.
· IRM's stock fell steeply because its planned conversion was on January 1, 2014, a full year ahead of EQIX; thus a delay at this point on the PLR is likely to actually materially affect its plans, whereas for EQIX, they have enough time to meet their prior deadlines. The IRS's language that it is "tentatively averse" to providing the PLR for that company was further pressure.
· In EQIX's 8-K, the company laid out a few examples where other data centers currently operate as REITs, providing further precedent for its move. (Look no further than CyrusOne, a retail co-location data center that had a smooth PLR in 2011)
Now, why am I confident that this will not be a speed bump for EQIX?
It's simple. EQIX's ACTUAL assets are power, electrical, and cooling systems that it OWNS and INSTALLS in its own data centers. These are essentially real estate infrastructure, plain and simple. Whereas IRM had RACKING STRUCTURES, which some think are similar to EQIX's CABINETS, the difference is that EQIX's cabinets are a very small portion of its asset base, compared to the vast majority which is real, tangible real estate infrastructure.
So, how much is in the stock for the REIT?
Based on a sum of the parts, I have seen numbers widely quoted that the REIT tax shield is roughly worth $50 a share for EQIX. (see e.g. some sell side research like Deutsche Bank, JP Morgan's estimates, as well as what I believe the buy side "whisper number" to be). A look at its peer Telecity's (TLCTF.PK) trading multiple of 12x 2014E EBITDA, would imply (keeping this valuation at parity) a stock value for EQIX at $190, even HIGHER than current valuation (at the time of publication).
So, the market is essentially giving EQIX ZERO credit already for the REIT conversion … i.e. there is no upside in the stock at all at current levels for the potentially material tax shield that will start to reflect street # in 2H/13.
What else is in the Short Thesis on EQIX?
Besides the IRM disclosure, EQIX has come under pressure more broadly since May 21st, which also coincides with improving Treasury yields (which pressures yield-focused REITs, EQIX peer trading group). On a technical basis, the stock appears oversold and has traded poorly in the last few weeks after hitting through a few support levels.
Key Upcoming Catalysts
EQIX should start to materially outperform as investors gain comfort that the REIT conversion is still on track, and when EQIX issues its initial 2014 guidance alongside its 3Q earnings results, which should support a $3b revenue target in 2015. Some bears believe EQIX will have to guide down for '13, which I believe is misguided given management's track record of execution, conservative guidance, and good history of setting #s that can be beaten.
Based on these catalysts and a re-rating as we head into the back half of 2013 and expectations focus squarely on 2014 achievability, I believe the next near term stop for EQIX is likely at the $230-$240 level, representing ~30% upside.