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Equinix (EQIX) Stock | NASDAQ: EQIX

Data: The World’s Most Valuable Commodity

Equinix is a digital infrastructure company founded in Silicon Valley in 1998 by Jay Adelson and Al Avery, both former facilities managers at Digital Equipment Corporation, a computer hardware, software, and services company acquired by Compaq in 1998.

Equinix started as a vendor-neutral, multi-tenant data centre provider with the aim to enable secure connectivity and networks to share data traffic with each other and scale internet usage. The name “Equinix” stems from the words Equality, neutrality, and internet exchange.

Equinix operates as a Real Estate Investment Trust (“REIT”) - a REIT is a corporate structure that does not pay any federal tax in the US under the condition that over 90% of its taxable income is paid out to shareholders as dividends.

Growth

55

Valuation

63

Quality

70
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Where Are We Now

Updated on: 11/7/2021

Conviction Score

9

Equinix holds and operates the most important real estate of the 21st century. It is the largest data centre operator in the world with hundreds of such buildings worldwide. We like the company’s exposure to huge growth trends – cloud, telecommunications, financial services, social media networks, and IT providers all rely on Equinix’s data centres to provide these services to everyone.

  • We don’t know what the next “big” thing in technology will be, but we do know it will require data centre connectivity to make it happen. Equinix is the perfect place to look.

  • The business is growing around 10% per year. We would not be surprised to see this growth maintained (if not accelerate) for many years to come. At today’s share price, we think Equinix offers good value for the long-term investor.

Investment Thesis

  1. Equinix, Inc. (“Equinix”) is a global digital infrastructure company, operating data centres used by the world’s digital companies, including telecommunications networks, cloud and information technology (“IT”) providers, financial services, social media networks, and other large enterprises.

  2. Equinix focuses mainly on interconnections provided in its retail colocation ecosystem of data centres, where tenants can communicate and easily share critical data with each other to reach mutual business objectives.

  3. Equinix benefits from strong network effects and switching costs due to its large network of enterprises that use its data centres, and the “stickiness” of the interconnected relationships formed between tenants once they place equipment in Equinix data centres.

  4. The shift to the cloud (and hybrid cloud), edge computing, and skyrocketing data consumption act as tailwinds to Equinix data centres. We expect Equinix to lead these secular trends with its retail colocation model and large global footprint, factors that will prove to be extremely valuable to tenants.

  5. Equinix is expanding rapidly at the expense of healthy cash returns today. There is a major risk if technologies improve and reduce the need for physical data centre space or if digital adoption does not increase at the pace Equinix expects.

The Basics

Equinix’s service offerings are split into three segments: data centres, interconnection, and edge services. We believe it is imperative for investors to grasp what each of these services entail. With that, we have outlined our findings below.

Data Centres

Equinix’s main service offering is “colocation”, referring to the leasing of data centre rack space in flexible increments on a cabinet, cage, or suite in a data centre building that is shared with many different tenants.

Additionally, tenants seek space in Equinix’s data centres to process and store swaths of data, support network infrastructure to uphold web apps, databases, and virtual machines, and efficiently interconnect (see “Interconnection” section below for more details) with other companies within the same building to instantaneously transfer critical data related to shared business objectives.

Equinix Data CentersSource: Equinix Investor Relations

These services are typically delivered under fixed duration contracts (generally < 5 years) with annual pricing escalators between 2% and 5% and embedded renewal terms, providing Equinix with reliable monthly recurring revenues (“MRR”).

Equinix operates over 220 IBX (International Business Exchange) data centres across 26 countries and 63 markets that provide tenants with plenty of space, power, security, and reliability to aggregate and distribute their collected data and connect with the digital world. These spaces are vendor-neutral, that is, where organizations can privately store their data while sharing space with other tenants with potentially competing interests. This form of operations can be described as a “retail” colocation model in contrast to a wholesale structure, whereby tenants occupy substantial portions of space within a data centre. Relatively speaking, Equinix holds a massive share (~25%) in the global fragmented retail colocation space, having expanded internationally more rapidly and on a grander scale than competitors to solidify its large global footprint.

Equinix will also operate 32 xScale data centres upon completion through a joint venture with GIC, Singapore’s sovereign wealth fund. These data centres are being built to support the unique workloads and data-capacity requirements of hyperscale companies, including hyperscale cloud service providers such as Amazon, Microsoft, Google, Alibaba, IBM, and Oracle, who are already partnering with Equinix for IBX data centre uses.

These hyperscalers can continue to grow with Equinix while maintaining close physical and digital proximity to Equinix's large customer base of almost 10,000.

Global Retail Colocation Services Market Share

Source: Company Data, Evercore ISI Research, IDC

The joint venture structure allows Equinix to reserve capital for its traditional retail colocation model, which generates significantly higher returns (see “Capital Allocation” section below for more details) than wholesale structures, such as xScale. GIC and Equinix will own 80% and 20%, respectively, of the equity interest in these future joint ventures.

Interconnection

Equinix’s interconnection services provide direct connections to businesses within and between data centres across the Equinix global ecosystem.

How Digital Ecosystems WorkSource: Equinix Interconnections Blog

Although companies around the world are shifting their information and data off-premise and onto the cloud, the digital transformation is far from complete.

Public cloud adoption is expected to accelerate in terms of use cases, pervasiveness, and size, which will likely result in a widely distributed, de-centralized, global base of IT infrastructure within a highly complex and interconnected digital ecosystem. Interconnection is no longer merely an option - it is necessary to grow and compete in our growing digital sphere.

Taking a few steps back, interconnection allows businesses to connect on a global scale to thousands of other tenants on the Equinix platform for networking, storage, computing, and application service requirements. Equinix Fabric facilitates this communication between tenants through their secure, on-demand, software-based interconnection capabilities. Equinix also offers three other powerful services related to interconnection for the digitally inclined organizations of the world:

  1. Cross Connects – physical cable links between Equinix tenants in the same IBX data centre that provide speedy connections and data exchange capabilities between businesses and service providers within the same building.

  2. Equinix Internet Exchange – intangible service enabling networks, content providers, and other businesses to exchange internet traffic with peers via service providers on the platform. For the end user, this reduces latency (i.e., data transfer delays) for end users when accessing content or apps.

  3. Equinix Connect – high-performance internet access solutions that organizations can leverage to directly access the internet and major content destinations quickly and on a large scale. These services are growing in importance as the global workforce becomes more distributed and mobile / remote devices grow in numbers and power.

Equinix makes money from interconnections services from billings on outbound connections from a customer. Just like colocation services, interconnection generates MRR.

Equinix is a clear market leader in the interconnection space, with over 65% market share among US data centre operators and enabling hundreds of thousands of interconnections, more than any major competitor.


Interconnection Services Market Share

Source: Company Data, Evercore ISI Research, IDC

Equinix Worldwide Interconnections (Q3 2021)

Source: Equinix Investor Relations

This is the result of Equinix’s relentless focus on building out interconnection capabilities while global digitalization was still relatively nascent. Now, as cloud adoption picks up and large digital ecosystems are forming, interconnection services are more important than ever to support global data traffic, sharing, and processing.

Graph of Interconnections in the industrySource: Equinix Investor Relations

Edge Services

Equinix provides edge services to as-a-service firms (i.e., SaaS, IaaS, PaaS, etc.) who operate centralized services, such as Microsoft OneDrive, Gmail, and Slack, and seek to place their network infrastructure on the “edge” (i.e., closer physical proximity to end users) to reduce latency, improve security and privacy, and increase overall bandwidth to create better user experiences in hopes of spurring growing demand for their services. Equinix bills customers for edge services based on instances and capacity utilized, again generating MRR.

Other Colocation Offerings

Equinix also offers support services for its colocation tenants to ensure their digital transformation efforts are conducted smoothly and efficiently at Equinix data centres. These services include installation, migration, and equipment procurement, as well as 24/7 on-site support for remote management, installation, and troubleshooting of tenant data centre equipment. These services are billed based on consumption and do not generate MRR – these are generally ad hoc services.

Equinix derives its recurring revenues from a few important and decade-defining verticals:

  • Enterprise

  • Cloud & IT

  • Network

  • CDM (Content and Digital Media)

Recurring Revenues by Vertical (Q3 2021)

Source: Equinix Investor Relations

Recurring Revenues (Q3 2021)

Source: Equinix Investor Relations

Total Revenues by Geography (Q3 2021)

Source: Equinix Investor Relations

Equinix does this on a global scale, with just over half of revenues derived outside of the Americas. Equinix focuses mainly on retail colocation services and is quickly expanding in the interconnection space. Colocation generates most of Equinix’s revenues, while interconnection and MIS & other (primarily managed services) make up around a quarter of revenues.

Equinix’s growth profile is robust – total revenue, adjusted EBITDA, and adjusted funds from operations ("AFFO") have grown at steady high double-digit rates in the recent past.

Equinix also scoops up much of these revenues on the bottom line by flexing its high adjusted EBITDA and AFFO margins.

Equinix Select Financials ($M) (Q3 2021)

Source: Equinix Investor Relations

Competitive Advantages

Equinix enjoys network effects as more customers choose Platform Equinix for their colocation and interconnection needs. Equinix’s data centres act as hubs within a larger digital ecosystem where tenants deploy distributed, interconnected IT infrastructures to deliver quality services to end users and communicate with other tenants within the ecosystem. It benefits organizations to colocate within the same data centres for performance and economic reasons.

The large number of interconnections Equinix created and the widespread ecosystem of 230+ data centres worldwide are attractive for large cloud companies and network providers when considering where to host their services. As many of these large enterprises ultimately choose Equinix data centres to host their networks and infrastructure, other companies are inclined to colocate and interconnect with these tenants and across multiple global locations.

Equinix Interconnection DiagramSource: Equinix Interconnections Blog

Equinix generates attractive returns on retail colocation facilities, spurring reinvestment into more data centres, creating more interconnections, and further deepening the powerful network effects Equinix holds.

Equinix is still in growth mode and every additional data centre is helping contribute to the bottom line rather than dilute it. Gross profit per average data centre operated is a great metric to track to see how strong Equinix's underlying economics truly are. New builds, expansions, and acquired data centres will not operate at full capacity off the bat. Therefore, Equinix's ability to keep gross profit per average data centre operated is extremely encouraging.

Equinix Diagram of CustomersSource: Equinix 2020 Annual Report

There are significant switching costs associated with data centre tenancy, especially Equinix’s data centres. Tenants are initially attracted to Equinix’s large global footprint, colocation with almost 10,000 customers including some of the world’s most important business (i.e., hyperscale cloud providers, ISPs, social media networks, etc.), and general economics of leasing data centre space rather than building their own spaces.

There are few upfront costs, capacity could be added quickly and with relative ease, greater access to space could be provided given Equinix’s massive scale and growing data centre portfolio, and no maintenance costs on the part of the tenant if they choose to lease through Equinix. Once the tenant joins Equinix for its global reach and colocation and interconnection benefits, it is difficult to cut ties with Equinix.

Contractual terms aside, a tenant that begins making interconnections with other crucial firms within Equinix data centres and sets up in critical markets around the globe, they would face large-scale business interruptions if they were to choose to uproot their servers and move elsewhere. Switching out of Equinix’s high-quality data centres is economically unattractive as well – while the average tenant pays between $1,550 and $2,450 MRR per cabinet, the average cost to move a cabinet is about $10,000. Even if a tenant were to get a steep $500/month discount at a competing data centre, it would take almost two years for this decision to pay off. For these reasons, churn rates remain consistently below 3%.

These network effects and switching costs place Equinix in a competitive position with pricing power. According to Evercore ISI research, Equinix can charge approximately 15% to 20% more than its competitors in most markets before considering interconnection benefits and additional services. If you recall, Equinix provides (1) Space (2) Power and (3) Interconnection, going beyond a simple real estate service that provides (1) and some of (2). Tenants take advantage of the highest quality data centre locations with the largest networks, and they are willing to pay a premium to be there.

This is showcased in Equinix’s ability to generate double the revenue per square foot than other data centre REITs in the United States.

Datacenters Revenue per Square Foot graphSource: Company Data, Evercore ISI Research

Data Usage Only Goes Up

Global digital transformation, rising mobile device penetration, 5G, augmented and virtual reality (i.e., AR and VR), internet of things (“IoT”) adoption, and growing data and content consumption are all poised to increase at rapid rates. 5G connections are expected to rise to 1.4 billion worldwide, up 100x from 2019, a mere four-year window. Almost 300 billion apps will be downloaded by 2023 and 1 trillion devices will be connected to the internet by 2030. This growth in devices, data consumption, and digital technologies will create 175 zettabytes (“ZB”) – 175 trillion gigabytes – by 2025, up from about 55 ZB in 2020 for a compounded annual growth rate of ~25%.

All this data must be stored, processed, and created somewhere and that location will be in data centres. Even the cloud, which sounds like a non-physical location, runs in data centres. Vast amounts of data consumption and billions of new connections will only increase the demand for data centres and create more interconnections as network, cloud and IT, and digital and media content providers among other enterprises communicate to keep the global digital ecosystem running. We believe Equinix is uniquely positioned to attract more tenants than any other data centre operator as it is the leading retail colocation and interconnections data centre REIT with the highest quality assets and insurmountable network effects of its global footprint.

Data Consumption Trajectories on a graphSource: Company Data, Evercore ISI Research, IDCGraphic of how technology is constantly expandingSource: Equinix Investor Relations

Cloud 3.0 and Edge Computing

The first wave of cloud adoptions saw organizations taking computing off-premises and instead opting for cloud services like AWS, Azure, and GCP for cost savings and business agility. Within this wave, each cloud provider differentiated themselves from others by specializing in certain fields (ex. AWS and ecommerce or GCP and web & app development). These value propositions from specialized cloud services drove a second wave of cloud adoption characterized by demand for multi-cloud environments whereby customers would sign up for two or more cloud services for different uses. Today, it appears we are entering a third wave of cloud adoption again catalyzed by the previous wave.

According to the IDC’s January 2018 and Q1 2019 Cloud and AI adoption surveys, over 80% of IT decision-makers indicated they had moved workloads from the public cloud back to an enterprise environment. The top reasons are related to downfalls we would expect from subscribing to multiple large, public, centralized cloud environments – sub-optimal security, performance, cost, and control. Enterprises are essentially looking for ways to avoid data breaches, have greater control over data assets, and reduce unpredictable costs, redundant services, and costs arising from ease of consuming services on the public cloud.

It may seem cloud customers are moving all workloads off the cloud, but not quite. In the third wave characterized by the “hybrid cloud”, it is the secular trend of public cloud adoption that results in more distributed IT architectures, driving this hybrid cloud approach. Hybrid cloud refers to a mixed computing approach, leveraging a combination of on-premises infrastructure, private cloud, and the public cloud. Not everything belongs on the public cloud, therefore, private cloud services complement existing public cloud services for the cloud-inclined enterprise.

Equinix will be the ultimate beneficiary of this trend as its colocation model and vast number of cloud on-ramps (i.e., private, direct connections to the cloud) provides a one-stop shop for enterprises looking to host a private cloud and directly connect to public clouds within the same building. Equinix provides almost 200 such cloud on-ramps, more than double the amount the next closest competitor, Digital Realty, hosts.

How the Cloud is expandingSource: DP Facilities
Equinix Cloud On Ramps compared to othersSource: Equinix Analyst Day 2021 Presentation

Lastly, the hybrid cloud approach will allow edge computing to work at its full potential. The number of devices and “things” that will be connected to networks and consuming data are growing exponentially. Edge computing is more easily understood once the concept of “edge” is understood – this is where the digital and physical worlds meet. Simply put, your devices and “things” will work better and faster if the source of the data you are looking to consume is closer to you.

Public clouds will be too far away to provide exceptional service with low latency, so businesses are seeking to place their infrastructure as close to the “edge” as possible. This is where Equinix fits right in – its growing portfolio of global data centre assets is only poised to grow, providing closer and closer access to end consumers of data.

Capital Allocation

Return on Invested Capital (“ROIC”) over the past several years was in the mid single digits, a low return profile considering the quality of Equinix’s assets. We believe this reflects Equinix’s long-term mentality. ROIC has been pinned down by Equinix’s massive growth capital expenditures.

Over time, we expect these capital expenditures to drop off significantly as growth opportunities dry up in a decade or two or more, raising free cash flow margins and ROIC. We also believe this showcases Equinix’s long runway given the amount of investment opportunities available. This behaviour should be encouraging for long-term investors – stabilized IBX profitability generates about 27% annual cash gross margins on gross capital investments.

Equinix sports a weighted average cost of borrowing and equity capital (defined simply as AFFO / Total Revenue) at well under 5% while 90% of its debt has fixed interest rate terms. Equinix finances its operations at near-zero rates while returns are substantially high given its operating leverage and resulting modestly rising margins.

Equinix Cash Dividend Source: Equinix Investor Relations

Risks

  • ROICs are low and could prove destructive if data centres are not adopted at the speed or utilization rate expected by management. It is crucial that all investments made by Equinix are made prudently and with the expectation of eager uptake by customers in the future in this capital-intensive business.

  • On a similar note, Equinix is highly leveraged (it holds lots of debt relative to its EBITDA). This is to be expected and normal, though, for a real estate company that also has access to cheap financing. However, Equinix's leverage ratio (net debt / EBITDA) has been steadily rising for some time. The figures below exclude leases for comparison purposes to account for the semi-recent lease accounting changes.

  • Equinix operates on a global scale, giving rise to currency risks. Although we do not expect substantive volatility in foreign currencies versus the US dollar, financials could be adversely impacted if the US dollar strengthens against local currencies.

  • Equinix finances a substantial portion of its capital investments with equity. Equinix has issued several billion shares in recent history and repurchased nil. Equity investors could be significantly diluted if accretive investments do not outweigh the pace of equity issuance.

  • Technological enhancements that reduce latency and / or the need for data centre real estate would likely pressure demand for Equinix’s services and adversely impact financials. Tenants would downsize in this scenario and increase vacancy in Equinix's vast ecosystem of data centres.

Bottom Line

Equinix operates as the world’s largest single data centre owner, leasing or sub-leasing space to thousands of global enterprises. The company is in full-on investment mode – about 40% of revenues are eaten up by capital expenditures, showcasing the conviction and long-term mindset of Equinix management to expand globally and take advantage of high-return data centre assets.

Equinix also faces several tailwinds that should propel it forward and support its investments. Data consumption is set to explode, interconnections (where Equinix is the clear leader) are increasingly sought after by businesses, and Equinix appears to be the best play on the global shift to the hybrid cloud model and edge computing. Equinix’s global scale, network of large enterprises, interconnection capabilities, and retail colocation model is set to be a winner in this age of digitalization.

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