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Switch: Switching Off The Momentum; More Downside Ahead


  • Switch reported Q4 results that were below expectations and continued on the revenue deceleration trend seen since Q1.
  • 2021 revenue and adjusted EBITDA guidance were both meaningfully below expectations.
  • This is a capital intensive business and with net leverage currently at 3.4x and rising, the company may need to raise some debt to remain competitive.
  • Valuation is currently over 15x forward EBITDA, which seems a bit higher for a 6% EBITDA growth company with utilization trending down and leverage trending up.

Switch (SWCH), a co-location company that rents out server rack space to other enterprises, reported a disappointing Q4 in addition to providing 2021 guidance well below expectations. The stock enjoyed a nice 70%+ run after their March 2020 lows as the buzz words of "cloud" and "digital transformation" resonated in the market. However, the company simply provides the servers and real estate capacity to handle companies transition to the cloud and do not directly help companies move their applications to the cloud.

Q4 revenue grew 6% compared to the year ago period, though missed consensus expectations for ~9% growth. While EPS beat by $0.01 during the quarter, there are more concerns around future growth. 2021 revenue guidance missed consensus by ~$25 million, or ~5%. In addition, the company is forecasting adjusted EBITDA growth of only 4-8%.

Not surprisingly, the stock has taken a big hit since reporting earnings, trading well below their recent high of ~$19. However, I believe the pullback was overdue considering the company has consistently seen their revenue growth decelerate since Q1.

2021 revenue guidance was well below expectations and adjusted EBITDA growth of 6% is not very impressive. On top of that, the company is expecting another year of capital expenditures running higher than adjusted EBITDA. When combined with their $50 million of annual dividend payments, I would not be surprised to see the company raise additional debt, on top of the $1+ billion debt level and ~3.4x net leverage.

With valuation currently above 15x forward EBITDA, I believe investors would continue to be better off on the sidelines and waiting for a better entry point. The company has potential long-term growth considering the number of enterprises moving to the cloud, but this is a capital intensive business which has been under some pressure as of recently.

This article was written by

Individual investor with hands-on experience in the equity markets. Largely focusing on Tech companies or major mispricings in the market.

Analyst’s 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.

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Comments (10)

Slade_01 profile picture
In retrospect, not too great a call. Bearish, and it went up over 100%.
Great earnings posted today. Looks like a team of you have been posting short garbage here for months but this stock is resilient and doesn’t fall. It must frustrate you. Keep eating the crumbs fed by your overlords 😂😂😂
This writeup was published within 48 hours of the 52 week low. Up roughly 25% since then.
Slade_01 profile picture
@getrichslow It just kept going up, what a terrible call!
And more than a double up these days! The Author nailed a bottom pretty well:)
“While some of their applications will remain with Switch, there are many enterprises around the world who are not only looking to move to a cloud model, but likely deploying a hybrid-cloud model. With the low power workloads better suited for the public cloud, the company could be faced with lower demand from companies looking to completely outsource their applications to a private cloud.”

This statement demonstrates a clear lack of understanding of how Switch and other Colocation providers fit into the overall hybrid cloud ecosystem. Switch’s data centers provide the space, power, cooling, and telecommunications infrastructure that enable enterprise customers to deploy their own “private clouds” using hardware from vendors such as Dell, VMware, Nutanix, Cisco, etc. Colocation data centers like Switch are increasingly the preferred way for enterprises to establish a “hybrid cloud” footprint as they offer low cost, secure connections between the enterprise’s “private cloud” and a third party public cloud like AWS, Azure, or GCP. Switch also provides data center space to the public cloud players themselves, making enterprise hybrid cloud workloads even more seamless, secure, and resilient given the physical proximity between the enterprise user and the public cloud compute nodes. To sum it up - if you are bullish on hybrid cloud, you should be bullish on Switch.

To your point on capex - yes, the data center colocation business is capital intensive. It’s key inputs are concrete, steel, electrical circuits, and fiber optic cable. This industry is a far cry from software and thus should not be analyzed or valued as such. In comparison with its peer group (EQIX, DLR, CONE, COR, QTS) Switch has the lowest net debt to EBITDA ratio, a below average capital intensity ratio (CapEx / Revenue), and industry leading returns on capital.

Valuation - when valued through the lens of a high growth software framework, sure, 15x EBITDA may seem expensive for a company growing revenue low double digits (11.5% 5yr CAGR, all organic). But compared with its peer group Switch trades well below the peer average valuation of over 20x EBITDA. This is despite having the highest organic growth and by far the highest per share growth since it’s IPO, as it has not once needed to issue dilutive equity to fund its growth or dividend payout.

Full disclosure - I am VP of Investor Relations at Switch. I would appreciate the opportunity to speak with you (the author of this article) to establish a dialogue about the company and colocation industry at large. Prior to Switch I was a sell-side analyst for several years covering data center and cell tower REITs, and believe I could help improve your knowledge of the sector. I have no issue with you publishing negative opinions on the company, but it will benefit both of us if your research is free of factual inaccuracies and a more informed industry viewpoint. Please message me back or look me up on the Switch IR website if you would like to connect. Thanks
@GCBanalyst I stopped reading after this -

However, the company simply provides the servers and real estate capacity to handle companies transition to the cloud and do not directly help companies move their applications to the cloud.
@jhojho Switch does not provide servers or any other form of hardware for our enterprise customers. As I mentioned in my response, Switch provides the space, power, cooling, and network connectivity infrastructure for the customer to deploy its own hardware. Our revenue is based on the physical footprint, power capacity, and connectivity that a customer requires to operate its workloads. This is an important distinction, because the data center infrastructure Switch builds is a long lived asset on our balance sheet with a decades long useful life. Hardware, such as servers, is a 2-3 year asset that needs to be replenished frequently, which results in a high degree of ongoing "maintenance capex". The actual data center infrastructure has very little ongoing capital requirement once the building is fully completed. This allows Switch to use the free cash generated by each mature data center to provide growth capital for funding construction on new data centers, creating a portfolio that is constantly harvesting cash from seasoned, high return assets into new assets that will eventually fill and flow cash, so on an so forth.
@GCBanalyst Thank you for your enlightening comments!
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