Equinix: In A Single Metric

Summary

• Equinix shares have recently reached their 52wk high, in spite of market turbulence. We believe EQIX is benefiting from secular trends, but also unique among data center providers.
• The purpose of this article is to highlight a single metric investors should focus on when analyzing Equinix. We believe interconnection revenue does represent EQIX's most solid performance signal.
• We resume our analysis of Equinix business model, competitive positioning and long-term prospects, while also emphasizing why it all comes down to its hard-to-duplicate, interconnection-rich environment.
• We believe EQIX is widening its moat and that its unique interconnection ecosystem is what separates Equinix from competition.

Equinix (NASDAQ:EQIX) shares have experienced a great run up in the last few years, and have recently reached their 52wk high at over $700.

Chart from Seeking Alpha, edited for clarity

We believe Equinix is benefiting from positive secular trends in the Internet infrastructure sector, but that the company has also unique characteristics that set it apart from other colocation (data center) providers.

The purpose of this article is to resume our analysis of Equinix's business model, competitive positioning and long-term prospects, with strong emphasis on providing investors with a single metric to focus on when analyzing the company's performance.

Having followed EQIX since inception and covered it, here on SA, since 2008, we have witnessed both the company's successful performance (17 years of consecutive quarterly revenue growth) and its management's ability to lead it to an indisputable, worldwide leadership.

IDC Worldwide Colocation and Interconnection Services 2019 - 2020 Vendor Assessment

Cloudscene H2, 2019 Data Center Ecosystem Leaderboard Rankings

Reducing a complex balance sheet and business model to a single metric may sound like a risky and criticizable effort.

However, we believe that interconnections represent for EQIX the key differentiator and the signal that may help investors understand the opportunity, both in terms of TAM and margin expansion, that still sits in front of the company.

Background

Equinix was founded in 1998 to help the Internet scale.

author picture from the 2018 Milan, Italy, Grand Opening

Neutrality has represented the essence of EQIX business model since inception, a strong differentiator from other Telecom data center providers, and the key factor that allowed the company to create a spectacular domino effect.

Interconnection has always been at the very heart of Equinix.

In this chart, we highlight six main steps that resume the company's history and are key to understanding its value proposition, today:

Author chart

This chart also aspires to give you a sense of Equinix's never-ending snowball effect - Tier 1 Networks may be limited in number, but nevertheless step 6 is not a finish line, but a start for new business - the company's magnet effect is now working with subsea cable companies:

Keith D. Taylor, Equinix CFO - Morgan Stanley Technology, Media & Telecom Conference

And subsea cable is another example of an opportunity that relies on our network foundation to basically locate subsea cable landing stations into data centers. And we're winning the substantial majority of them.

Transcripts courtesy of Sentieo

Equinix sits in the middle of a unique market opportunity:

Author chart

As Seeking Alpha contributor Hoya Capital Real Estate noticed, Interconnection represents the highest barrier to entry and carries the highest pricing/value in the data center world:

Welcome to the Hotel California - you can never leave

Christian Koch keeps an interesting quarterly Interconnection Update that resumes several data for public companies reporting metrics and revenues for their interconnection business.

This single chart, reporting Q4 2019 data, resumes very well Equinix leadership in this field:

Although it is sometimes difficult to compare data that are not always disclosed on a similar basis, we also tried to highlight how much interconnection represents as share of revenues for some of the largest data center providers:

Author chart, company's data.

QTS Realty (QTS) data from Q1 2020 conference call: "Today interconnection represents 8% of QTS' overall reoccurring revenue".

Equinix data would be much more impressive if we considered North American data alone - historically, Europe and Asia Pacific carry a lower percentage of interconnection revenues.

Here is an interesting comment from Equinix Q4 2019 conference call:

Interconnection revenues grew 14% year-over-year, driven by strong customer response to the Equinix Cloud Exchange Fabric, good traction in our new Internet exchange markets and solid interconnection adds.

The Americas and EMEA interconnection revenues are now 24% and 10% of recurring revenues, respectively, while APAC stepped up to 15%, a meaningful increase throughout the year.

We ... delivered our 12th consecutive quarter of adding more interconnections than the rest of the top 10 competitors combined.

[edited for clarity]

The simplest (and first implemented) form of interconnection was represented by a cross connect - a cable that runs from one cabinet to another.

A small, one time fixed cost for Equinix, leading to a high margin, monthly recurring revenue stream.

While interconnection has since evolved to a much more complex concept, we believe that the original business model (high margin recurring revenue stream) still holds true.

Here is a quick look at how interconnection revenues have conquered a larger share of Equinix revenues in the last 10 years - and all this was happening within a fast growing company:

Author chart, company's data.

EQIX has been able to build a unique and unmatched collection of data centers characterized by a very high network density.

A "place to be" if you have interconnection needs - or, said in a different way, a place you cannot afford not to be in, and, like in the famous Hotel California lyric, a place you can never leave:

Hotel California is still in effect. Once customers check in they don't leave and as long as you provide them with a great quality product and a good level of service and commitment to them they just continue to be your customers for years and they grow.

CyrusOne's (CONE) CEO Discusses Q3 2013 Results - Earnings Call Transcript

An interconnection company selling ancillary services - power and space

If you embrace our vision, Equinix is basically an interconnection company that also sells some ancillary services, like space and power - although they represent EQIX largest revenue share.

Interconnection is the real signal investors should follow: and so far it speaks high margins, high growth, strong moat (barrier to entry), customers' stickiness and undiscussed market leadership.

A quick look at some selected Equinix locations on PeeringDB may be interesting to verify the density of peering (interconnection) happening under Equinix roof - you may try, as an example, Ashburn (D.C. metro), or any other location:

On twitter, 3:10 Value has compiled several interesting charts showing Equinix prevalence as the "place to interconnect" for major Internet players, based on PeeringDB data.

Here is one of the most recent ones:

3:10 Value's chart shows Digital Realty (DLR) both as a standalone company (with limited market share) and post Interxion acquisition.

May Equinix further leverage its interconnection leadership?

Christian Koch, in his March 9th foundations newsletter, noticed:

Back in January I shared a news story about Equinix expanding its ECX Fabric into a third-party data center in Belgium (LCL). While I do not think it is that much of a surprise, it is something to pay attention to.

Here is some commentary made by Equinix CEO, Charles Meyers, at the Citi Global Property Conference:

We continue to see exceptional deal volumes with very good mix of business in terms of hitting our sort of sweet spot in the market in small to midsized, highly interconnected deployments.

Over time, particularly as you think about evolving edge scenarios, how would we expand the reach of platform Equinix to accommodate workloads that have needs that are outside of ... our current footprint. I think there's a range of possible answers to that. And I think having a strong balance sheet and market leadership in times of uncertainty is always a great thing and would give us a lot of flexibility should we determine that there are assets that may be beneficial to us in those pursuits. But as I said in our Vegas conference recently with -- in the sort of fireside chat with Mike, I also think that we will look at other ways to extend the reach of platform Equinix into potentially -- into third-party facilities. And so I don't necessarily think we'll be constrained by the 4 walls of an "Equinix facility" over time. And we're testing those hypotheses and actively thinking about what that might look like going forward.

Transcript courtesy of Sentieo, edited for clarity, emphasis added

Here is a further comment from Christian Koch we strongly agree with:

This presents an interesting opportunity to multi-tenant data centers who struggle to build up similarly valuable ecosystems, and at the same time it grants leverage to Equinix to command and conquer specific markets of interest. As the road to $10 Billion for Equinix is currently being paved, just remember that this is not a zero-sum game.

As a side commentary, before completing the $335 million acquisition of Bare Metal provider Packet, Equinix tested a bare metal service in Japan, as shown by this data sheet.

Belgium may represent for ECX fabric a similar, localized test/experiment, before announcing a much larger strategic move.

Needless to say, the Packet acquisition was also targeting interconnection-oriented customers:

Justin Dustzadeh, Equinix - KeyCorp Emerging Technology Summit

So bare metal as a service is really a generalized compute that can serve a variety of use cases. And the combination of Equinix and Packet is really targeted towards interconnection-oriented use cases for the agility, flexibility and reliability needs of the digital business.

You can think of it as the ability for customers to provision physical infrastructure and the speed of software at the Edge and globally, leveraging Platform Equinix with all the other services that we can provide on top in terms of cloud on-ramp global interconnectivity with our ECX Fabric or Edge services and our private key solution that I talked about.

Transcript courtesy of Sentieo, emphasis added

Final considerations

Throughout the article, we've tried to highlight why Interconnection may be the most important single metric investors should look at when trying to analyze Equinix - a magnifying glass of its underneath performance, and a key differentiator to competition.

Strong, positive secular trends, a high quality business model leading to strong margins and a powerful cash generation, large barriers to entry and a worldwide leadership have been the driving forces leading to a stock price that looks "priced for perfection", until you realize that the company has a potential $10 Billion market in front of it, and is on solid footing to achieve it.

Analyst’s 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.

Comments

[Pure Profit]

Great to have you back covering Equinix Paolo. Do you think Equinix can continue long streak of growing both revenue and EBITDA when they report on Weds? I think it is something like 70 consecutive quarters now, which may be a record. You are right, interconnection is the special sauce. Hotel California indeed. Mike

[Paolo Gorgo]

I do expect EQIX to continue to improve its track record of 17 years of consecutive quarterly revenue growth.
It's been a very interesting 20+ years trip for the company, with ups and downs - and I'm sure there will be more to write about.
Be safe.

[Legend of the Growth Investor]

Paolo, fantastic article. Easily one of the best I've read in equity research for years. Some thoughts on valuation: I would argue this is cheap against its closest comparables. DLR trades at a higher forward price to sales for 2020 and 2021 with much less of a stranglehold on interconnect. I'd say this is the cloud equivalent of the Visa / Mastercard interchange network effect. The virtuous cycle is more data centers, more interconnect, more client capital tied up in each data center.

[Paolo Gorgo]

@Legend of the Growth Investor - thanks, appreciated.

I agree with your Visa/Mastercard analogy - it should have been part of the article, also to support the "high multiple" criticism that is often related to EQIX valuation. At least, it got its way in the comment section, thanks.

I've been a DLR shareholder in the past - great company. I just believe Equinix business model, with its retail and interconnection focus, is better.

DLR is a great partner to Equinix, sometimes a competitor (especially after its Interxion acquisition), but I'd stick with Equinix as the best company in the colocation market that, in my opinion, can also offer, over the long term, a better return for investors.

[Nate_Z]

Great article. I have Eqix in my IRA. Do you follow the tower reits as well ? Looking at AMT and SBAC

[Paolo Gorgo]

Thanks. Not really following tower REITs, I'm sorry. I wouldn't be adding much in terms of diligence to what you probably already know.

[monkey_luffy]

Really insightful article. What are your thoughts on valuation though? This is a really expensive stock compared to its peers. What would be a fair value in your opinion? Thanks

[Paolo Gorgo]

@monkey_luffy
Thanks for your kind comment.
As to the comparison with peers, the purpose of this article was to highlight that it may be an apples to oranges sort of discussion: Equinix is slightly different from other data center providers, kind of playing in a different league, because of its interconnection rich environment. Higher multiples may be justified just because of this.
Hard to give a fair value to its shares: as I wrote, some stocks that have peculiar characteristics "always look expensive" (think Visa, or other tech companies). It's about what I resumed as "positive secular trends, a high quality business model leading to strong margins and a powerful cash generation, large barriers to entry and a worldwide leadership". A de facto semi-monopoly on interconnection.
In addition, while EQIX is a capital intensive company (a bet on a new data center is in the $100 million range), if you think about the "value" that customers put into its cabinets, it is also leveraging other people's capital. The value sitting inside an EQIX data center is a sum that exceeds (by far) what the company alone invested.
The "Hotel California" business model: customers won't leave, but most likely will ask for more interconnection, space, new locations.
Some color on this from Equinix CFO, Keith Taylor:
>We're trying to be that company that's not a $600 a share company. We're $1,000 a share company. There were $10 billion in revenue [TAM]. That we're creating long-term sustainable value. If we listen to everybody over the years, we would have levered up our business too much. And we would have -- we would've priced our customers out of the business. And our view is its long-term sustainable value creation for the shareholder. And yes, we can give you more margin. And I don't mean you. I mean that, sort of -- but we're very mindful and Charles is good about the discipline investing in the future because we have this opportunity. Yet, at the same time, giving something back to the shareholder. And what we did was made sure that you've got great AFFO per share growth at 9% to 11%. And that doesn't even include the refinancing. So we're doing -- we're investing in the future. We're growing the business in a disciplined way. And we think we're setting ourselves up well with that long-term historically significant company that we want to be part of. And at the same time, create immense value for our shareholders. But we don't live in the short term, we live in the long term, sort of medium to longer-term, because we think that's where investors want us to be, certainly our largest investors.<
Morgan Stanley Technology, Media & Telecom Conference
San Francisco Mar 3, 2020 (transcripts by Sentieo)