Equinix: A REIT With A Unique And Profitable Business

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About: Equinix, Inc. (REIT) (EQIX)
by: Kurt Pollet
Summary

Equinix is a REIT (real estate investment trust) that operates like a growth stock.

For most organizations, it's more economical to use Equinix's IBX than it is to build their own.

Equinix enjoys a recurring revenue stream. Most organizations that use Equinix's IBX don't have any viable alternatives.

The stock is expensive, but Equinix does have a loyal customer base which will ensure its future growth.

Introduction

Equinix, Inc. (EQIX) is an American multinational that specializes in internet connection and data centers. Equinix is a global leader in colocation data centers and has more than 200 data centers in 24 countries on five continents.

Equinix provides colocation data centers for businesses to rent space for servers and other computing hardware. The centres provide the building, power, and the internet connection while the businesses provide the servers.

Equinix calls its data centers International Business Exchanges (IBXs). An analogy to these IBXs is an international airport which has numerous different airlines operating from within them. An IBX allows many different businesses to each house their servers, and the internet connection is taken care off by Equinix.

Equinix is a REIT (real estate investment trust) as it provides the buildings which house their customers' servers. Equinix enjoys a recurring revenue stream much like regular REITs.

I think that Equinix's business model will ensure its growth well into the future - as it's cheaper for most organizations to use an Equinix IBX than it is to build their own.

The stock is quite expensive, but Equinix behaves like a growth stock rather than a conventional REIT. As a bonus, Equinix pays a dividend with a 2.3% yield.

Financials

Equinix has reported financial results for the fourth quarter of 2018 (data from Seeking Alpha and Yahoo).

The company's reported fourth quarter revenue was up 4.1% and its diluted earnings per share were up 67% from the fourth quarter of 2017.

On an annual basis, revenue for 2018 was up 16% and diluted earnings per share were up 52% over the 2017 fiscal year. The 2018 EBIT was $1.01 billion compared to full-year 2017 of $0.51 billion.

Equinix paid a dividend of $9.12 for the 2018 fiscal year which was up 14% from the dividend of $8.00 paid for the 2017 fiscal year. The current trailing yield is 2.08% and the forward yield is 2.32%. Equinix started paying a dividend in 2015 which increased on average by 11% per year.

The return on equity is currently 5.2%. Equinix has a history of low returns on equity with a typical range of 2% to 7% over the last decade.

The profit margin is currently 7.2%. This is at the higher end of its ten-year range. Excluding the earnings loss in 2014, the profit has been as low as 3%.

The asset ratio (total liabilities to total assets) is 64% which means that Equinix's total debt is 64% of the value of everything the company owns (note that the asset value is the book value and not the liquidated value of its assets). Over the last decade, Equinix's asset ratio has ranged from 61% to 70%.

The company's book value is currently around $89 and with a stock price of $439, Equinix is trading at 4.9x book value.

The analysts' consensus forecast is for revenue to increase by 106% in 2019 and increase by 9% in 2020. Earnings are forecast to increase by 39% in 2019 and increase by 21% in 2020. The 2020 PE ratio is 57x.

Revenue and Earnings

As an investor, I personally like to examine the company's revenue and earnings history. To make this task easier and more convenient, I like to visually present the data on a chart.

Equinix revenue and earnings history chart

Equinix data by ADVFN

The above chart visually shows Equinix's revenue and earnings historical trend along with the next two years of consensus forecasts.

Examining the chart shows that Equinix's revenue has steadily increased over the last decade with the forecast revenue continuing this trend heading into 2020. The earnings show a strong uptrend since 2016 heading into 2020, but prior to this, its earnings were volatile with no real growth from 2009 until 2016.

Equinix is a rather unique type of REIT - it's certainly not conventional. Equinix's business model is quite basic - they essentially rent out floor space within a building and provide a power supply and an internet connection to that floor space. The floor space is provided so those organizations can setup their servers and simply connect them to the power supply and internet. These 'server housing buildings' are referred to as International Business Exchanges.

Equinix's revenue is recurring. This means that it receives regular income from their IBXs for the duration of the contract. These contracts can be any length but one to three years is common. As most organizations that use Equinix's IBX don't have any other viable alternatives, they are forced into renewing their contracts once they expire. In effect, Equinix has a monopoly and this gives them pricing power. The recurring revenue accounts for 94% of Equinix's revenue. The remaining 6% is derived from installation services and setup fees.

A risk factor facing Equinix in the future arises from the growth of the public cloud giants - such as Amazon Web Services (NASDAQ:AMZN) and Microsoft Azure (NASDAQ:MSFT). These organizations currently house their cloud servers within Equinix's IBX; however, in the future, there's the possibility that these cloud giants build their own data centers in an attempt to reduce operating costs. For the smaller cloud organizations, it's generally more expensive to setup their own centers, but for the giants such as Amazon and Microsoft, this could be economically variable.

Losing the revenue stream from the cloud giants would reduce Equinix's revenue, but I don't think that it would adversely affect Equinix's growth. There are more than 6,300 organizations that use IBX, and for most of these building, using their own is just too expensive. This I believe will ensure Equinix's growth into the future.

Stock Valuation

Equinix's earnings have shown strong growth and the company has been consistently profitable since 2015. As Equinix has a history of growth, an appropriate method for valuing growth stocks is the PEG (PE divided by the earnings growth rate).

The growth rate from 2015 until 2020 is 19% per year which leads to a forward PEG of 3.0 with a 2020 PE multiple of 57x.

It's commonly accepted that a stock is fairly valued when its forward PEG is 1.0 which means that Equinix is overvalued with a stock price of $439. Its fair value would be around $150.

Equinix is certainly expensive with a forward PEG of 3.0 and a forward PE of 57x. Ordinarily, REITs are not considered to be growth stocks but income stocks. While Equinix is now paying a dividend, its forward yield is barely more than 2%. However, the low yield for a REIT is primarily due to its high stock price. Having said that, I still think that Equinix is a strong growth stock with a bright future and most good growth stocks are expensive.

Stock Price

As an active investor, I personally like to determine some likely price targets. This gives me a feel for how high the stock price could go in the short term and how soon it could get there.

Equinix ten year stock chart

Equinix chart by StockCharts.com

The stock chart reveals that Equinix's stock price has surged higher over the last decade. The stock peaked in late 2017 and pulled back with a small rally in 2018. The stock then pulled back again in late 2018 along with the stock market before rallying this year.

Should the stock keep rallying, in the short term, it could replicate the late 2016 to 2017 rally where the stock run up from $310 to $475. This $165 rally, when added to the $350 low of this year's rally, gives a target of $515. For this rally to continue, it would require the stock market to continue with its rally.

Over the longer term, the stock has the potential to continue higher and will probably do so as long as its forecast earnings are met. If future earnings show poor growth, then I would expect its stock price to trade down as it's quite expensive.

Conclusion

Equinix is a REIT with a difference. While the company enjoys a recurring revenue stream much like regular REITs, the company's business is in a high growth industry. Its business model is really simple, and to a lot of its customers, it's an essential service. While these customers can build their own data centers, it's usually far cheaper and easier to outsource this to Equinix.

I think that Equinix's business model will ensure its growth well into the future. While there are some concerns over the major cloud companies pulling the plug from Equinix's IBX, the company does have a customer base of over 6,300 organizations - so I think the adverse effect on future growth would minimal. As a bonus, Equinix pays a 2.3% dividend.

Disclosure: I am/we are 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.