Alibaba Executive Chairman Jack Ma speaks at the 2015 CeBIT technology trade fair in Hanover Sean Gallup/Getty Images
Alibaba Executive Chairman Jack Ma speaks at the 2015 CeBIT technology trade fair in Hanover

DCK Investor Edge: China Looms Large as Data Center REITs Report Q3 Earnings

Cloud landlords parade China strategies while reporting solid leasing across the board

Data center REIT sector earnings for Q3 2017 appeared solid across the board. Earnings calls were all upbeat, and the outlook for next year remained universally positive for Digital Realty, Equinix, CyrusOne, CoreSite Realty, and QTS Realty. Notably, except for Northern Virginia, hyper-scale cloud leasing activity was not the main driver responsible for last quarter's strong results.

There were several reoccurring themes, including: expansion of existing customers driving leasing; increasing importance of building relationships with China's carrier-neutral data center providers, and its e-commerce and cloud giants; enterprise hybrid IT deployments; and the need to proactively build powered shells in top-tier US markets to compete for hyper-scale deployments.

China Casts a Giant Shadow

Prior to releasing earnings, CyrusOne announced a $100 million strategic investment in GDS Holdings, a premier carrier-neutral Chinese data center provider with strategic ties to Alibaba, Baidu, and Tencent.

This announcement came as a surprise to investors, as the companies had not revealed that they’d been in negotiations.

Meanwhile, as Digital Realty and Equinix reported earnings, it became apparent that the largest US data center REITs did not want to be left out when it came to discussing initiatives in China, or signing leases with Chinese hyper-scale cloud platforms.

Digital Realty made a point of emphasizing leases signed with six Chinese cloud and SaaS firms, including two of the top five names. It signed three deals with existing Chinese customers and three new logos. The largest deals, of 1MW, went to Ashburn, Santa Clara, and Chicago, with smaller deployments in Atlanta and Portland.

Notably, Digital now has a Mandarin-speaking salesperson in Hong Kong covering mainland China, who has existing relationships with Chinese internet companies.

Elsewhere across Asia Pacific, Digital also announced a 50/50 joint venture with Mitsubishi, which will give Digital customers access to the high-barrier to entry Tokyo data center market, and broke ground on a new 14MW data center in Sydney, Australia.

Equinix inked expansions in Q3 with Alibaba, Baidu, and Tencent, among others. Chinese hyper-scalers are placing content closer to the edge according to Equinix, expanding their footprint, access nodes, network nodes, and adding more compute around the world to enable e-commerce, digital media, and cloud.

The Equinix China strategy has been evolving for quite some time, with Equinix looking to work with joint-venture partner Datang Telecom Group to penetrate mainland China markets, beyond the current six data centers in Shanghai. According to CEO Steve Smith:

Most of the traffic we're still seeing coming into [People’s Republic of China] is inbound enterprise multinationals that need a safe pair of hands in China when they're setting up operations, and majority of our business still is multinational traffic coming in. That will change over time as we get deeper into the partnership with Datang and we start to take on some local companies.

Equinix already has a small business development team active in Beijing and in South Korea.

Must Be Present to Win

Commercial brokers specializing in data centers are fond of saying "supply creates demand." However, developers are not fond of carrying large speculative data centers on the balance sheet. Constructing large powered shells offers a way for data center landlords to deliver "just in time" data halls at low cost per MW, while deferring most of the CapEx spend closer to lease commencements.

CyrusOne has kept the pedal to the metal on powered-shell development. Its data center footprint has grown an eyepopping 50 percent in just one year, with 22 percent added during Q3 2017. As of Sept 30, 2017, CyrusOne data centers totaled 5,565,000 net rentable square feet (NRSF) with 532MW of available critical load capacity. 

According to the 10-Q filing, since December 31, 2016, CyrusOne's NRSF increased by 1,661,000, due primarily to expansions in San Antonio, Northern Virginia, New York, Raleigh-Durham, and Phoenix. CyrusOne also had 928,000 NRSF under development, as well as an aggregate of 1,404,000 NRSF of additional powered shell space under roof available for development.

During Q3, CyrusOne signed up 151,000 NRSF totaling 15MW of critical IT load. These bookings represented 20 percent of total revenues for the trailing twelve-month period. Despite this leasing cadence, CyrusOne's sales funnel has grown 65 percent larger year-over-year, according to management.

On the international frontier, in addition to the GDS China initiatives, CyrusOne intends to close on a Dublin, Ireland, transaction prior to the end of the year. The company is actively evaluating opportunities in Amsterdam, London, and Frankfurt as well.

Digital Realty beat consensus core FFO estimates by $0.03 per share and raised the FY 2017 outlook to $6.00-$6.10 per share, a nickel bump to the previous lower end of the range.

During Q3, Ashburn was an active market for Digital. The company signed a 4.5MW deal to fill the remaining space at its legacy Ashburn campus and a 1.5MW customer to anchor the first 6MW phase of the 36MW Building L being built on the new campus. Digital now has a wider range of hyper-scale offerings to offer customers in Northern Virginia, Chicago, and Silicon Valley, after the closing of the DuPont Fabros merger. The former DuPont ACC campus in Ashburn delivered super-wholesale leasing, with customer requirements of 15MW and 7MW reported for the quarter.

Digital has constructed a similar 36MW powered shell in the Dallas market and has a 6MW expansion underway in the supply-constrained Santa Clara market scheduled for delivery in the first quarter of 2018.

Digital Realty inked an impressive $66 million of lease renewals last quarter. However, management clarified that the renewals were not with a single large customer. This would imply that existing Facebook leases that are up for renewal in DuPont’s Ashburn facilities are still in negotiation.

CoreSite Realty has a history of inking large deals with strategic customers to seed the first phase of large developments. This helps to boost portfolio utilization, a key factor in CoreSite's ability to deliver impressive results year after year. The past quarter was no exception, with CoreSite's revenue, adjusted EBITDA and FFO growing by 22, 25, and 22 percent, respectively, year over year.

CoreSite is in pre-development for its SV-8 expansion in Santa Clara, and for LA3 in Los Angeles. Both projects are expected to commence in 2018, delivering capacity for 2019 and beyond. Including Reston, the three expansions represent 415,000 square feet of capacity in CoreSite's largest markets. CoreSite continues to look for "additional land and/or capacity" in Denver and Chicago.

CoreSite's campus expansion in Reston, Virginia, will deliver 3,000 square feet of capacity at VA1 in Q4 2017, as well as a 25,000-square foot first phase at VA3. CoreSite has started site work at VA3 for an 80,000-square foot data center building, which at full build-out will have capacity of 12MW, plus a 77,000-square foot centralized infrastructure building to serve the entire VA3 property. 

On the call, management emphasized that CoreSite represents the only network node in Reston, a low-latency alternative offering diverse fiber routes for companies located in Ashburn and Manassas, Virginia.  CFO Jeffrey Finnin also pointed out how the LA-2 chiller replacement project and efficiency upgrades, while technically $8-$10 million of maintenance CapEx, will deliver strong returns on the capital invested over time.

QTS Pivots to Greenfield

QTS Realty has also tossed its hat into the larger-scale data development ring, spearheaded by its first ground-up mega-data center project in Northern Virginia. However, QTS is not interested in competing head-to-head for the largest cloud deployments with the likes of Digital Realty, CyrusOne, CloudHQ, and Raging Wire.

"QTS’s philosophy around new development has not changed. We are designing our data centers to support multi-tenant capabilities, with flexibility around our 3C product mix, redundancy ranging from N to 2N+1, and densities to support customer needs from the lowest to highest compute requirements," QTS CFO Jeff Berson said in an interview with Data Center Knowledge. "This focus on design flexibility will continue to drive our success with new and existing customers, both Hyperscale as well as the broader enterprise user base."

Bill Stoller

In Phoenix and Hillsboro, Oregon, QTS intends to commence pre-development work required for entitlements but will hold off on committing capital for development until anchor tenants are signed to de-risk these projects. The first 4MW phase in Ashburn was de-risked by a 2.2MW pre-lease with a global health insurance firm.

If the early returns are any indication, QTS Realty's decision to acquire land in top markets to serve customers is already paying off for investors. QTS shares popped on that news, and investors continued to bid the shares up to new 52-week highs, after the outstanding leasing results reported for the three months ended September 30th, compared to prior quarters.

Notably, QTS will be hosting an Investor Day on November 13 in Fort Worth, Texas, to discuss where the company is headed in more granular detail.

Equinix Firing on All Cylinders

In addition to programmatic organic expansion, Equinix has been an M&A machine over the past decade, the combination resulting in a global footprint of 190 data centers across 48 markets, totaling over 19 million gross square feet.

Subsequent to September 30, Equinix expanded into Spain and Portugal by acquiring connectivity and cloud infrastructure solutions provider Itconic for $253 million, adding over 400 customers. Equinix also bought a second Istanbul data center facility for $93 million.

Equinix shares gapped up and have continued to trade near or at new 52-week highs. On the call, CFO Keith Taylor discussed raising AFFO per share guidance by 2 percent to $18.97 per share for FY 2017.

Bill Stoller

The Verizon Americas data center portfolio integration appears to be ahead of schedule. Taylor was guardedly optimistic regarding outperformance, reminding investors that Equinix itemized monthly billing has just begun. Notably, expansions have already kicked off at the Miami NAP of the Americas and in Denver to service customer growth.  

Equinix has some larger-scale leasing plans too. CEO Steve Smith shared earlier this year that the company was looking to participate in the "next wave" of hyper-scale deployments. However, during the earnings call, former COO Charles Meyer, who has taken the role of President of Strategy, Services, and Innovation, added some additional color, which generated buzz in the media. Equinix is buying land near existing campuses to accommodate strategic 2 MW to 5 MW deployments.

Investor Edge

The ability to deliver massive data halls of an acre or more in a matter of a few months in Tier 1 markets has become a prerequisite to service the largest hyper-scale customers. While supply is increasing in many US top tier markets, pre-leasing and net absorption rates serve to confirm demand remains strong from hyper-scalers and enterprise.

Increasing demand for global connectivity and the need for content distribution, compute, and storage at the "edge" of the network continues to fuel high-margin growth for the entire sector. Additionally, increasing activity from Chinese cloud, e-commerce, and content giants bodes well for the future, considering the GDP growth rate of the second largest economy in the world.

In a nutshell, data center REIT investors should continue to buy the dips to participate in the tailwinds from data growth, cloud computing, IoT, wireless, and streaming video, and the need for global cloud and network connectivity.

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