Surfing The Data Tsunami With REITs

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Includes: CONE, COR, DLR, EQIX, IRM, LMRK, QTS
by: Dave S. Gilreath
Summary

5G will turn the current wave of wireless data into a tsunami, increasing commercial demands for storage capacity.

Predicting winners among wireless service providers over the next few years is extremely difficult; likely winners among support service providers are clearer.

The criticality of edge computing positions big data center REITs to profit from the tsunami, though some small challengers have potential.

Healthy dividends are likely to pay investors for the ride.

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While 5G undergoes development and testing in dozens of countries, investors are wondering which service providers will deliver superior returns when the high-speed wireless technology goes into widespread use over the next few years. Yet there's more clarity in choosing winners among suppliers of critical services these providers will need to offer consumers the fifth generation of wireless service.

The global obsession with faster downloads of streaming video to handheld devices on 4G means 5G will be in great popular demand because of its far greater speed. Service providers will do whatever they must to garner lucrative subscriber revenue from this need for speed.

More speed will mean a lot more wireless traffic, data storage and processing, as consumers download streaming video from smart-home gadgets like doorbell cams, the never-ending well of YouTube (which receives 100 hours of uploads every minute) and social media sites. New virtual reality sites and hardware, which "put" them on the sidelines of sport teams during games, show that there's no end to consumer motivations to create, share and access data. Atop this will come a vastly increased volume of data from industrial sources.

The new technology will add abundantly to already rapidly increasing data, amounting to what's known as the coming data tsunami. Adding to this wave will be the continued data growth of the existing internet of things (IoT), the network for various internet-enabled machines-- factory equipment (sensor data anticipating problems with equipment), household appliances, as when your fridge ordering food from a supermarket server and other sources. (Many data volume projections include IoT data from autonomous cars, but I believe widespread use of these vehicles may take decades longer than this industry likes to predict.)

IoT is a term often used interchangeably with M2M (machine-to-machine data communication), but there are some differences. Perhaps the most fundamental of these is that while M2M allows machines to communicate, IoT takes M2M traffic, integrates web applications and connects it to a cloud. (Cisco (NASDAQ:CSCO) estimates that by 2021, a majority of all data center servers will be cloud based.)

Growth projections for internet-enabled items are nothing short of mind-boggling. Gartner, the global consulting firm, estimates that such items will total more than 20 billion by 2020 (not counting computers, tables or cell phones), and annual spending on them and related services will total $1 trillion.

This will mean beaucoup data, especially after 5G becomes fully commercialized and widely deployed. By 2025, the International Data Center projects, global data creation from all sources will have grown to 163 zettabytes (a zettabyte is about 1 trillion gigabytes) - about 10 times the level in 2017.

All this data will have to be stored somewhere, and that means data centers, which are controlled by owners of something that's decidedly low-tech: real estate. This means REITs that own and develop these highly specialized properties (perhaps the least sexy way to invest in the data tsunami). Specialty REITs in this space not only provide good dividend income, but also stand to reap a harvest from the data tsunami while providing defense with a tendency to be resilient amid trade wars.

Several data center REITs are potentially well positioned to ride the tsunami-among them, Equinix (EQIX) and Digital Realty Trust (DLR).

In the 5G era, effective wireless communication will hinge, more than ever, on proximity. The tech buzz phrase concerning this priority is edge computing-protocols for storing data as close as possible to beginning and end points to improve response times and conserve bandwidth. Thus, having more data centers than the competition becomes a big advantage.

Equinix and Digital Realty are the number one and two market leaders, respectively, among domestic companies regarding colocation sites-essentially, carrier hotels where different carriers rent equipment, bandwidth and physical space with uninterruptible power supplies, air-cooled chillers and physical security.

Equinix, with a market cap of about $44 billion, has 202 centers worldwide and more than 8,500 customers. Over the last 10 years, Equinix has posted a total return of about 18.6% per year. Return for this year as of July was a whopping 39.1%. Its dividend yield the last week of July was 2.01%.

Digital Realty Digital Realty (market cap, $25 billion) is second only to Equinix in international holdings, which comprise about 20% of that enterprise, compared with 50% for Equinix. Digital Realty owns and operates 215 data center properties in 14 countries. The company is poised for inexpensive capacity growth because many of its properties have still-undeveloped land, points out Brad Thomas, a widely known REIT analyst. Digital recently acquired Ascenty, a data center provider in Brazil, and has posted impressive returns since going public in 2004. Its dividend yield as of late July was about 3.83%. YTD return as of July: 10%.

Smaller data center REITs, all with market caps in the low single-digit billions, include:

  • CyrusOne (CONE). With about 45 data centers worldwide, CyrusOne lists 190 Fortune 1,000 companies as customers. Recently, it has developed the European market, and its revenue has increased more than two-fold over the past three years. CyrusOne has shown significant growth potential this year, delivering strong first quarter earnings with solid top- and bottom-line growth. Dividend yield: 3.24%. YTD return: 7%.
  • QTS Realty Trust (QTS). QTS has 26 centers in 13 markets. Last spring, it expanded in Europe, acquiring two data centers in the Netherlands. The company plans to double its capacity at exiting sites in the coming months. Dividend yield: 3.99%. 2019 return: 21.6%.
  • CoreSite Realty (COR) has 22 data centers in eight domestic markets. Though small, it has a prestigious customer roster that includes Cisco Systems, IBM (NYSE:IBM) and AT&T (NYSE:T). Dividend yield: 4.55%. YTD return: 31.3%.

Another small competitor is Iron Mountain (IRM), an $8.7-billion-market-cap REIT that has historically focused on the low-tech endeavor of paper records management, storage and scanning but in recent years has invested $3 billion in data center properties. To develop these, it can draw on the value of its $2.5 in industrial real estate. So while paper isn't the future, it's role in the past has given Iron Mountain resources for the digital age. Its dividend yield is one of the best in this REIT category, at 8.13%.

Among non-REIT players in this space is Landmark Infrastructure (LMRK), a master limited partnership with a market cap of about $430 million. Along with data centers, Landmark is into sites for cellular towers, another lucrative REIT area, along with billboards and wind turbines. But recently the company has been concentrating on infrastructure development. Landmark has been getting buzz lately from FlexGrid, its neutral carrier colocation offering, designed for 4G/5G, IoT, private light-network and other wireless traffic. On the downside for some investors, because Landmark is an MLP, it issues K-1s-a form that typically arrives after most people have filed their tax returns, potentially meaning an amended return or an extension. And when MLPs are held in tax-deferred vehicles, partnership income from them might, in the aggregate, incur unrelated-business tax. Yet Landmark's dividend yield as of late July was a monster 8.53%.

While focusing on the larger companies, Equinox and Digital Realty, is probably the best way to leverage edge computing as 5G cranks up, the smaller players might be viewed as longer-term plays - given the coming data inundation and the prospects it poses for industry growth.

While focusing on data center REITs is by no means a panacea for 5G investing, data center concerns are generally well positioned to command revenue from service providers. This might be a boring way to invest in tech, but it makes sense. Though the types of data centers needed may change, real estate will forever be just that - real estate, the bailiwick of REITs.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.