In today's Oxen Group recap, we will be looking at Equinix (NASDAQ:EQIX) in our daily deeper look. We want to update our EQIX 12-month price target as the year-ends and 2014 is starting to take shape. The Oxen Group covers Equinix year round, and we want to update our current pricing to reflect recent occurrences. In our Company News section, we will take a look at Blackberry (NASDAQ:BBRY) as the company had significant volume today. Additionally, as always, we will do our typical market overview, important news breakdown, and give our perspective on what's moving the market.
The market was weaker on Tuesday on the back of three Fed officials saying that December taper was a real possibility on Monday. These were the last speeches before the FOMC meeting next week, and many are still unsure as to what the Fed will do. That question has left the market somewhat helpless. Without much other news today, the market drifted a bit lower for most of the day. On the data side, we got news that there were 3.93M job openings in October, rising from 3.88M in September. Wholesale inventories rocketed to 1.4% in October from 0.3%. The inventor/sales ratio, though, stayed at 1.18, but rises in inventory are never a good sign if they last awhile.
Today, we are taking a look at Equinix. Coming into today, we had a Hold-rating with $217 price target on this name. The company is an attractive growth name that is slightly overvalued. We want to update that thesis today and see what is in store for EQIX in 2014.
After our update, we have found that shares are now Buy-rated with a $225 price tag.
Equinix operates within the colocation industry as a data center service company that protects and connects companies to customers/partners/third parties. The company offers it clients Platform Equinix, which offers global data centers, interconnection between 900+ networks, and work within the Equinix Internet Business Exchange (IBX).
The company's main services are colocation, network connectivity, cloud storage, and reliability. The cloud business is a crowded one, however, and there are a lot of data center companies that are offering a lot of what EQIX does with a different name and slight changes.
Here are some general industry statistics important for Equinix:
- The IDC believes that cloud network spending will increase 25% in 2014 and account for 89% of all IT spending growth.
- The cloud could produce $100B in sales in 2014 as more data centers come online, as well as an increase in cloud infrastructure services.
- According to some studies, 69% of businesses that have separate budgets for cloud computing believe that they will increase that budget.
- Emerging markets are expected to account for $740B of IT spending in 2014
- Online retail will continue to grow with another 10% jump in 2014 and potentially $250B in sales, making up 8% of the entire industry.
Here were recent comments from company CEO Stephen Smith about the industry:
Positive secular trends are driving significant demand in the broader data center market. As capital has flowed into this sector, the market has further segmented and we are seeing customers continue to embrace more sophisticated infrastructure strategies, such as multitier architectures and hybrid cloud.
For Equinix, the company has two main catalysts - growth of cloud-hybrid offerings as well as conversion into a REIT. The company is working to take advantage of the REIT. As the company has noted in their latest quarterly call, cloud traffic will grow 35% CAGR through 2017 when 2/3 of global data center traffic will be based in the cloud. As a more classic data center company, these statistics threaten EQIX's future for sure. So, the company is undergoing two major transformations of their business.
Let's take a look at the REIT status first. The company, since it owns and installs its data centers with products (servers), considers itself a real estate location and can therefore come under the tax shield of the REIT-status. Here were company comments on the REIT:
Peter Van Camp, Executive Chairman of Equinix, said, "We are committed to creating long-term shareholder value. The REIT structure supports this objective and positions us to achieve profitable, strategic growth domestically and internationally. We believe the conversion process, and the REIT structure itself, will have virtually no impact on the delivery of services to our customers or the performance of our global platform of high performance data centers."
"As a REIT, we will be able to provide our shareholders with regular distributions from earnings. While operating as a REIT, we will continue to fully execute on our global growth strategy of expanding in markets where demand and financial return warrant. We are executing with discipline and focus, and remain on target to generate over $3.0 billion in annual revenue by 2015 and positive adjusted free cash flow in 2013, excluding REIT conversion costs and tax liabilities," said Steve Smith, CEO of Equinix. "We have already seen several of our peers in the data center industry operate under a REIT structure, and we believe that this tax-efficient structure will enhance shareholder value and enable us to be even more competitive."
What exactly could the REIT status do for Equinix? The REIT tax shield is estimated to save EQIX around $312M in taxes in 2015 and 2016 and would have a very low tax rate. The company would then return about 90% of its income to shareholders through lofty dividends. The advantages of the REIT-status will be fleshed out further in the pricing/valuation section. Overall, though, this move would allow EQIX to save a lot of money as they have 100s of sprawling data centers that have become much more of investments in real estate.
The issue, though, is on the other end that Equinix in many ways is a more old-school data center provider. The company is a more basic data center storage company, but they realize pushing into the cloud is going to be essential for their future. Yet, the drawback of moving into a hybrid cloud is that it means less large deals. With hybrid clouds, the combination of servers and software for IT and standard colocation both springing up, it has created a decision for most companies. The company is benefiting from the cloud because it is an integral part of the cloud and additionally colocation. The issue is that the length of deals now takes longer as the hybrid cloud is more complex. With the trends towards a multi-tiered architecture to IT and data storage, the company is following the trend:
This quarter, cloud and IT services again delivered record bookings and continues to be our highest growth vertical as many cloud players leverage Platform Equinix to deploy their service. With over 1,200 cloud and IT services customers, Equinix is the best location for enterprises to access leading Software-as-a-Service, Infrastructure-as-a-Service and cloud enablers to leverage the cloud. Hybrid cloud deployments are a major growth opportunity for Equinix, as enterprises seek to take advantage of bursting into the cloud while retaining control over critical data and application.
The company has noted that a lot of cloud companies are using them to leverage data storage. In the latest quarter, the company had 1200 cloud company customers. Additionally, the company made a great move in partnering with Microsoft's (NASDAQ:MSFT) Azure. Customers can now connect directly into Azure with a private connection provided by EQIX. The company, further, will build 10 new cloud hubs in 2014 to continue to develop its hybrid offerings.
How much growth can the company expect to see?
The company is already seeing 25% of its revenue coming from cloud and IT services, and they want to be the largest cloud infrastructure provider. So, as Salesforce (NYSE:CRM) and F5 Networks (NASDAQ:FFIV) grow, EQIX can grow right along with them. Here was the company's CFO responding to exactly what this infrastructure will look like and where EQIX fits into it:
Yes, well certainly as it relates to cloud based companies is really all of the above, it's not only the SaaS providers, is the pass providers and the IS providers; and certainly recognizing infrastructure, and platform providers are going to be highly important. And one of the things that we've been very clear on as we look forward there is a subset of 10, potentially 20 of those platform companies that will be of such significant scale around the globe that we need to win their critical infrastructure because they will then sell their services to the enterprise. Now then a subset of that or not a subset -- increment to that is the SaaS providers and it will be -- whether it's an Oracle or Workday or Taleo, I guess the service now a Box.net or a Dropbox. These are companies who will continue to sell their services to others.
And I am very intrigued by what I think that potential opportunity is. Again, it's not only about what we have today, its how they'll continue to scale and globalize within the Equinix framework. So I think that we continue to -- we could experience a significant growth spread through and continue to expand globally, but I also think as they sell to the enterprise that's the accelerant that we're really looking for as a business.
Revenue - The company expects to be making $3B by 2015 with about $2.4B in 2014. A 10-12% growth rate still looks solid for this company as they do have a lot of potential in the cloud moving forward. In our model, we will use a 2017 revenue projection of $3.6B.
Operating margin - What will end up happening is that margins will likely move down some as the hybrid structures will not be worth as much. The sales will take more work to get, and the crowded space creates competition. We would expect a drop back to around 18-20% in margins.
Taxes - This is the key spot where the company will see some changes. The company operates with a 28-30% tax rate right now, but when they transfer to a REIT, taxes will become much less around 5% or less.
Capital Expenditure - These will stay high at 25-30% of revenue because of the nature of the high expenditure business that EQIX operates within. It costs them a lot to buy servers, buildings, and continue to expand to incorporate networks to stay ahead of the curve.
With this updated model, we came up with a price target of $225. While we have decreased some overall estimates, we have also seen the discount rate drop with lower beta and better cash. Additionally, we are more confident in the REIT structure passing. Without the REIT structure, though, shares are worth around $115 in our model, so the decision there is crucial.
On the company news side, we will be focusing on BlackBerry today. After the company traded almost twice its typical volume and popped nearly 4%, we were wondering what was up. The company has its FY2014 Q3 earnings call scheduled for next Friday AM. There is likely to be quite a bit of volatility into this report, and we want to breakdown what to watch in this report.
This report will come after the company failed to get the financing necessary for a $9 per share buyout. Instead, the company locked in $1B in financing for convertible debt. The company's latest rebound efforts were through the BlackBerry Z10 model that was expected to bring about a bounce back. Instead, the company had to take a $1B write-down on the units. The Z50, though, will be very interesting with a 5.2inch 1080 x 1920 resolution display as well as Qualcomm (NASDAQ:QCOM) Snapdragon 800. Yet, the company is vastly behind Apple (NASDAQ:AAPL), Samsung, and now even Microsoft with its push into phones.
This report is likely not going to be good, and we all know that. Losses will likely be quite large for the company, but it's the first call with new CEO John Chen. We will be very curious to see what he is planning to do to turnaround this fledgling company. Overall, there is not much to be excited about going into the report, so downside from here seems somewhat small (outside of bankruptcy). The company is trading at only 0.3x sales and 0.3x book.
What might John Chen say to spark excitement or the reverse?
Chen has iterated that the company is no longer for sale, and that the company is looking to enterprise over consumer products moving forward. The company will have four target areas: hardware, enterprise, cross-platform messaging, and software. The company could definitely go places with messaging if they advance their technology and make it more widely available. The company also was once the enterprise leader, and they hope to get back to that place.
This conference call and report will be mostly a conversation about how this will go moving forward. Frankly, we are very excited about the call, as it could be a very important moment for the company. If the plans are decent even, we could see some new cash flow coming into the name. This stock is priced about as cheap as you can get without being bankrupt, so it's not a bad time to take a flyer.
The market got flushed a bit on Tuesday, and things do not get much more exciting on Wednesday. The only data will be crude inventories and the Treasury Budget. Neither of those have much authentic market impact, nor we will likely drift and speculate on taper for most of the day. Overseas, we don't get much action as well with German CPI and Japanese Machine Orders about it. So, we should expect another very light day. The Dow Jones (NYSEARCA:DIA) dropped over 50 points on Tuesday while the S&P (NYSEARCA:SPY) dropped 5.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: I have no business relationship with any company whose stock is mentioned in this article. The Oxen Group is a team of analysts. This article was written by David Ristau, one of our writers. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.