Equinix had a bad day Tues, with stock price dropping by about a 25% in one day and not recovering since. This dramatic price drop also affected the stock value of many prominent public data center companies or data center centric companies. The Equinix price drop was created from a revenue warning from Equinix and a lawsuit filing questioning churn and revenue forecasts. The market is clearly jittery about any uncertainty in the revenue filings and forward expectations of margin and revenue for what has been a very robust company and market segment. These questions have hurt all companies in this segment. My analysis, and this is purely my analysis and opinion as an industry person, not a recommendation or investment professional report.
Equinix has always reported churn to be very low and that it’s customers have a certain stickiness due to its collection of network providers at each site and the group of core customers attracted to be in Equinix for peering with each other. And while I have been saying for years that fiber is ubiquitous, adding insignificant dollars to large data center projects to bring fiber to even remote sites, as a past large customer of Equinix, I can attest to the value of these peering relationships and network options. However, while there is great value in these network connections, they can be accomplished with little equipment, a rack or two. Meanwhile, the rest of the customer’s servers are located in a lower cost wholesale or internal data center (I’m referring to large users). And as networking technologies and equipment improve and shrinks in size to accomplish the same number of connections, “network” customers of Equinix need fewer racks for these networking connections. A past 2-4 rack requirement is now 1-2 racks, so churn is not loss of customer but a decrease in the number of racks. Meanwhile, that customer may add more cross-connects to peer with more Equinix customers in the same data center, further entrenching the “network” community that is there to peer with each other. And each of these cross connects is fairly low monthly recurring revenue (MRR) yet pure margin, so Equinix maintains high margin even if total MRR declines slightly over time. Overall, a good business model that retains high margins even if revenue falls slightly.
The challenge for Equinix is to grow MRR as customer equipment shrinks, since Equinix sells mostly space in a power driven world. Also wholesale providers are selling to customers with 20+ racks instead of what was the minimum buy in at about 100 racks. So the wholesale and other data center providers are closing in on the smaller rack customers that are core to Equinix while Equinix has not moved up in size to competitively serve the larger rack customers, those with over 25+ racks, as the wholesale providers serve those customers at significantly lower costs. As large rack customers of Equinix migrate to wholesale providers, they keep up to a few racks to maintain networking connections with high margin but Equinix looses market share and larger revenue customers, essentially driving Equinix to their core business and core high margin customers with a few racks and lots of cross connects, exactly what they want purging the large customers with dozens of racks at a lower MRR per rack. So while rack churn sets in customer stickiness remains. Summary point: Network is ubiquitous; most don’t need 20+ carrier connections; those that do keep a networking rack or two for peering and networking connectivity and maybe caching servers; rest of racks move to lower cost centers
Separately, cloud providers continue to move in to Equinix, an excellent growing customer segment for Equinix. But I predict that as these providers get large in the number of racks, where it becomes lower cost to relocate to a wholesale or other lower cost provider, they will. I used to work for Exodus Communications who started the co-location market and I also ran a data center co-location company several years ago, and as a past large customer of Equinix, DRT, DFT and many others, and also ran data center operations for one very large Internet play and once very large software provider, so I am familiar with the challenges of moving racks from one location to another. This challenge adds to the stickiness of customers and limits churn. But as customers grow and add new servers, customers can add new servers in new locations via cloud and with the help of virtualization and quickly have them virtually replace servers else where, making transitioning from one data center to another a much easier task, whereby primary servers can change from one data center location to another, and then be physically taken offline, making data center transitions much easier than before. This is especially true as more and more folks do not rely on the one data center basket for all servers, and instead, of multiple, geographically diverse data centers that load balance and fail over to each other in real time.
A couple of final points. I like Equinix; I believe they have an excellent product and a very high margin business. While being very focused to retain margins they have missed what I believe are revenue growth opportunities in booming Asia and with larger rack customers albeit at lower margin. Also, the intense focus on networking hubs has forced them to have data centers in high power cost markets, which directly and significantly affects COGS while corporate data centers have been moving out of metro areas to rural areas for cost benefits. This brings better fiber to those areas and “known-ness” to those areas as we see with data center bunching, for better of for worse in places like Central Washington, Utah, Reno, North Carolina, etc. Equinix is limited by their focus on network and high margin to metro areas, again further limited revenue growth and having a higher impact from high power costs and market share loss to those moving to lower power cost centers. This will help them retain margins while likely loosing market share, so I see Equinix’s value in high margin with less revenue growth—a result that should be valued but we’ll see what transpires over time, as many investors have often been more focused on revenue growth. Let’s hope all data center stocks are not devalued and that revenue forecasts are accurate as possible to maintain the proper value of these data center companies.
Also, be sure to register for the SVLG Data Center Efficiency Summit on October 14th in San Jose, as registrations are expected to be sold out soon.