Global cloud giants have a difficult time projecting growth, and this can become a thorny problem for their data center partners.
CyrusOne, which leases data center space to cloud giants and other clients, is expanding to become the third US-based international data center REIT (along with Digital Realty and Equinix). This is a bold strategy but positioning a publicly traded REIT to take advantage of the twin tailwinds of cloud computing and enterprise digital transformation can be problematic – even if you continue signing huge deals.
REITS, or real estate investment trusts, must pay out at least 90 percent of taxable income as dividends to shareholders. Funds for new data center development can come in the form of cash from operations, equity, or debt. Meanwhile, shareholders expect publicly traded REITs to grow FFO (REIT earnings) per share which supports a rising dividend.
Publicly traded companies must balance long term strategy with delivering results for investors. Last year, CyrusOne delivered normalized FFO of $3.31 per share to shareholders. This Wednesday after the market closed, the company gave initial guidance for 2019 of $3.10 to $3.20 per share – much lower than the $3.51 per share analysts expected for the year – resulting in a steep drop in the price of CONE shares Thursday.
During the past 52 weeks, CyrusOne traded in a range of $43.49 to $69.01 per share. CONE shares that had been bid up substantially prior to earnings gave back a lot of that gain Thursday.
Size and Timing Matters
The cloud giants that drive much of CyrusOne’s growth have a difficult time forecasting their own business growth. The data center provider’s flexibility to expand capacity for these customers quickly in combination with being one of the lowest-cost providers has been a winning formula. But this proactive strategy is capital-intensive – not for the faint of heart.
The growing size and length of initial lease terms for hyperscale infrastructure cloud platforms, Software-as-a-Service, social media, content, and ecommerce customers is both a blessing and a curse. The leases can be anywhere between 6MW and 70MW, signed for 10 to 15 years. But when one of these customers will actually sign on the dotted line can be hard to predict.
Meanwhile, having the right product in the right place at the right time is essential. Sometimes these facilities are partially pre-leased. Sometimes they are fully leased build-to-suits designed from the outset to specifications of a specific tenant. Speculative builds can be a risky business.
Must be Present to Win
CyrusOne CEO Gary Wojtaszek told Data Center Knowledge Thursday that simply buying land in a major market and hoping to sign an anchor tenant isn't likely to be a successful strategy – especially for brand new players looking to strike it rich in the data center business.
There is no shortage of competition, he said, with $70 billion worth of private equity and infrastructure funds all trying to duplicate the business model from scratch. But buying land is the easy part, Wojtaszek noted. (Although there are some exceptions. It took the company several years to find a suitable site in Silicon Valley, but in November it finally announced its first land purchase in Santa Clara, and this week its second.)
"It takes intestinal fortitude" to build speculative powered shells in order to have data center halls available for hyperscale customers to lease, Wojtaszek said. This is particularly true for a publicly traded REIT that must report earnings each quarter and give annual guidance to Wall Street.
It is common knowledge in our industry that the initial phase of a large data center campus is rarely accretive to earnings (FFO) per share. But these enormous projects can pay huge dividends to investors over time.
It can take several years before utilization (and operating leverage) of a data center campus goes up enough to deliver returns for shareholders. These types of investments require a strategic vision and willingness to allocate capital today for substantial returns in the future.
During the past year CyrusOne has been strategically expanding into four European markets to build wholesale data centers. On the earnings call, management confirmed that $400 million of Capex will be spent on developing new campuses in 2019. Silicon Valley is its latest new market in the US. The company’s plan is to build the largest campus in Santa Clara (144MW). Last year, it also announced Atlanta for a new ground-up development project.
I am somewhat puzzled that so many Wall Street analysts thought CyrusOne would be able to invest in GDS Holdings (China) and ODATA (Brazil), purchase the Zenium platform in Europe and additional land, expand into new markets in the US and build massive powered shells in existing Tier I markets in Northern Virginia, Phoenix, and Texas – while growing FFO per share.
Wojtaszek is building a global platform to serve hyperscale customers and take advantage of the enterprise digital transformation over the coming decade. Investors that want to reap the benefits if this strategy may need to recalibrate their expectations for 2019.
Opinions expressed in the article above do not necessarily reflect the opinions of Data Center Knowledge and Informa.