Equinix's Earnings: An Unusual 'Meet And Lower' Instead Of 'Beat And Raise'

| About: Equinix, Inc. (EQIX)

Equinix (NASDAQ:EQIX) reported Q2 earnings last week on Wednesday, after market close.

The first headlines about its numbers were mostly negative (including here at Seeking Alpha), as resumed by this Reuters commentary:

Data center operator Equinix posted second-quarter revenue below analysts' expectations and slashed its full-year revenue outlook to account for a change in revenue recognition due to extension of contracts.

Net loss for the second quarter was $28.7 million, or a basic and diluted loss per share of $0.58, which also contributed to creating the impression of a very bad quarter.

It is little surprise that the stock took a hit after hours, losing as much as 11% at its bottom:

Equinix is currently trading at $175.88 down -8.2% in after-hours on 183,600 shares traded.

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Chart from Google Finance

A closer look at all numbers reported, however, shows a slightly different picture - Equinix may have hit a small road bump, but remains on its way to a great expected performance for the next few years. We see any stock weakness following Q2 results as a potential entry point if you have a long term approach to the colo sector.

Underneath the messy second quarter headlines

In our opinion, Citi Research's analyst Michael Rollins nailed it perfectly with his comments, which we have chosen as our headline.

Underneath messy headlines, Equinix reported results which were basically in line with management expectations as far as revenues, and probably even better than expected as far as adjusted EBITDA. The company took the opportunity to lower guidance to a point where it may be in a more comfortable position to beat its own forecast by year's end. A change in estimates for non-recurring revenue and an unexpected FX impact, as we will see in a minute, were mostly to be blamed for these negative news.

By the way, Citi upgraded Equinix to Buy to reflect an improved risk-reward scenario at the current price level (PT: $225).

Beat and lower the new motto on Wall Street?

We digress a bit, but we would like to quote Greenlight Capital recent Q2 2013 shareholder letter to put Equinix's behavior into a bigger picture:

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This quote may sound a bit like using a "misery loves company" argument to justify Equinix's negative news.

To avoid taking advantage of general market conditions as consolation to justify the company's poor numbers, we'll try to address why EQIX Q2 results and 2013 guidance did not look great at first sight, but may not be that negative if we examine all moving parts.

A closer look at what happened in Q2

Equinix reported revenues of $525.7 million. These numbers need to be adjusted for about $1 million due to FX impact (relative to guidance), and for about $5.8 Million reflecting a non-cash accounting change necessary to highlight an extended amortization period for non recurring installation revenues.

This is explained by the fact that the company's average contract moved from less than 2 years to 3 years or more in North America, which should lead to even more visibility into the company's long term business prospects. We see this as a positive (price increases are factored into these new contracts), as well as the decreased churn (2.4% in the last quarter).

When adjusted for the change in accounting estimate and FX rates, Equinix revenues were above the midpoint of management guidance at about $532.4 million, reflecting a Q/Q increase of 3.4%. Meeting guidance doesn't really sound too much of a stretch as the correct headline, after analyzing all data.

Adjusted EBITDA came even better than expected. Excluding FX and the accounting change (to reflect a number comparable to guidance), Equinix delivered $ 250.4 million in adjusted EBITDA, or more than expected.

As we mentioned, net loss attributable to Equinix was $28.7 million for Q2 2013. Absent a debt extinguishment charge of approximately $94 million, plus the write-off of the unamortized debt issuance costs related to the redemption of the company's $750 million 8.125% senior notes, Equinix would have shown a pro forma net income of $40.5 million, an increase of 13% over the prior quarter. Pro forma fully diluted earnings per share would have been $0.79.

Equinix's Q2 gross bookings were the company's third best result ever, but still came slightly short of expectations. This may probably represent the only area of concern for investors, as it might signal that sales are not ramping up as expected - or, said in a different way, that some verticals may experience some unexpected delays converting interest into orders, and that the new strategy to privilege smaller, interconnection rich deals may take a little longer to unfold.

New guidance not a real worry

The downward revision of guidance for 2013 reflects both FX weakness and the change in accounting estimates, as well as some concerns about a lengthening sales cycle in a specific vertical and some softness in Germany.

The revision is quite modest percentage wise, and - positively - doesn't suggest that the company expects any pressure on pricing or increased competition for its unique product offering.

Fundamentally, Equinix remains the absolute leader in network-neutral colocation services, and still expects to grow faster than the (fast growing) market for this kind of services. The company's disciplined approach to order picking should ensure even better results in the long term (as to the bottom line) than shown today.

Both Q3 and Q4 2013 growth rate are still expected to be stronger than those experienced over the first 2 quarters of the year, on a constant currency basis.

REIT conversion still expected in 2015

Equinix continues to move forward with its plans to convert to REIT status starting from 2015.

Although not many additional details were disclosed during the conference call, it should be noted that the company keeps incurring into several million cash costs related to the REIT program, that are impacting its current and future results.

As an example, Equinix's Q2 operating cash flow included REIT-related cash costs and taxes of roughly $57 million.

Here is how Keith Taylor, Equinix's CFO, commented on the REIT move:

We continue to make progress towards optimizing our global tax structure. And as part of this initiative, we've implemented a new organizational structure that centralized the management of our EMEA business activity into the Netherlands effective July 1 of this year. As a result of this, we expect our effective tax rate to be lower in subsequent periods as the new structure begins to take full effect. Assuming a successful conversion to a REIT and no material changes to the tax rules and regulations, we expect our effective long-term worldwide tax rate to ultimately decrease to a range of 10% to 15%, consistent with our expectation that approximately 50% of our revenues will be generated outside of the U.S.

The company has still some work to do to come out with a definitive definition of its AFFO. Using adjusted discretionary free cash flow as a close proxy, and excluding any REIT-related cash costs or taxes, the number for 2013 should range between $620 million and $640, or $ 12.75 per share, using the midpoint. We expect Equinix's AFFO equivalent to reach the $16 range in 2014, justifying a TP of $240 using a 15x multiple - this of course assuming that the company is successful in its REIT conversion.

Key developments

Hidden by the main headlines were also a couple of key developments which we would like to highlight as a closing remark.

Cross connects in the financial ecosystem grew 30% Y/Y, driven by Equinix's Chicago, London and New York campuses. The company now hosts over 120 exchanges and trading venues, up from 75 just last year. The domino effect of these customers is the beauty of Equinix's business model, and represents a very valuable asset.

In July, the company purchased its NY2 IBX, which is part of the Secaucus campus where Equinix hosts its New York metro financial services ecosystem. The acquisition is key to giving the company more control over a key component of the Secaucus campus and also provides space for future expansion.

Equinix now owns 18 of its 98 IBXs, mostly those that are key to network peering (like the Ashburn, DC metro IBX, the most interconnected hub on the U.S. East Coast) or strategic for their ecosystem participants.

Owned assets, located both in Europe and the USA, generate approximately 28% of Equinix's revenues.

Disclosure: I am long EQIX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.