Large Interxion Shareholders Are Said to Be Unhappy With the Digital Realty Deal

Some of Interxion’s largest shareholders are reportedly upset with the takeover deal by Digital Realty Trust the European data center giant’s management has agreed to. Multiple bank analysts told DCK that the investors thought the agreed-upon $8.4 billion sale price was too low and would leave them short-changed.

But with reports of overpriced mergers and acquisitions becoming a drag on industry finances, and with Digital Realty CEO saying his company wouldn’t break even for two years after the deal’s close – with a stronger company emerging as a result – it’s unclear the allegedly aggrieved investors have a strong case.

Interxion shareholders would get a lesser share in the combined company than they would had the deal valued Interxion higher. But if the price is too low, how can the deal be unprofitable for Digital?

The merger, announced last week, would give Interxion shareholders 70 percent of a single Digital Realty (DLR) share for every share they held in the Hoofddorp, Netherlands-based firm. They would get the equivalent of $93 per share. As Interxion (INXN) prepared to announce the deal, some bankers familiar with the process issued public statements that reckoned it was worth somewhere between $100 and $120. Then, unnamed sources planted a rumor in a complaisant trade newspaper that wealthy investment funds were jostling to buy the company, and that its management had begun a formal bidding process. A faceoff between many suitors would surely bump up the price tag, the rumor suggested.

Related:Equinix CEO: Digital Realty’s Interxion Deal ‘Doesn’t Close the Gap’

But upon announcing the Digital Realty takeover last week, Interxion CEO David Ruberg said the rumor was false. “Contrary to what was in the press, we did not run a process," he told analysts on a conference call.

"For the last couple of years, we've been approached by a lot of people,” Ruberg said. But “we were focused on what we thought it would take to be successful. We were focused on what we thought a good partner would look like. The compensation was secondary.”

The revelation that there hadn’t been a bidding contest caused a stir among shareholders who believed Ruberg had guaranteed a low price by not inviting other suitors to bid against Digital, some bank analysts said.

$93 Per Share

The industry is mushrooming as the internet booms, goes their thinking. Data center companies are competing to acquire assets as the industry is going global. Meanwhile Interxion has some of the most highly-prized assets in the business, in some of the canniest locations. The US market has gone sluggish from over-supply – by companies like Digital Realty – and Europe promises high growth, as corporations there have caught on slowly to cloud computing and thereby only now are starting to push demand for data centers that deliver the cloud. Data center companies that have grown large in the US are now looking overseas for growth that’s been tapering back home. Interxion has been a valued target, and yet it’s selling for $93 per share.

Related:Tons of Data Center Businesses on the Market. Not All Will Sell

Global enterprises are meanwhile pressing global cloud providers to give them global computing systems on global contracts, said the analysts. Cloud platforms in turn are pushing their data center providers to go global. As the industry consolidates, firms compete to build and acquire data centers in Europe, and to get money at the best possible terms to fund it all. Infrastructure financiers and sovereign wealth funds are putting in large sums of money, and all eyes are on Europe. And yet Interxion doesn’t invite them all to see if they can outbid Digital Realty.

The deal is highly strategic for Digital, which explains why its management is willing to wait a couple years to break even. Known for renting data centers wholesale to single companies for limited purposes, the San Francisco-based real estate investment trust is now trying to be more like Interxion, a company that owns data centers centers that house the largest intersections of the internet – where all cloud providers and telecommunications firms rent space to get access to the global data highways.

The internet itself is about to grow unimaginably, as more and more computing power is delivered online, and companies like Digital aren't just trying to build assets like Interxion's – which is difficult at this stage in the game – they are trying to buy such assets. They are near-monopoly assets, as investment managers Chilton Capital said early this year. Interxion’s share price went up 60 percent in the year since. Anticipation ran high. Then it went for $93 per share.

Unhappy Shareholders

The talk of upset came from bank analysts who remarked upon the apparent contradictions of the deal.

Nate Crossett, an analyst with Berenberg Bank, said Interxion shareholders had told him the price was “way too low."

"They're not happy about it," he told DCK. "Interxion was trading at almost 90 bucks already, and they come out with this $93, and you're like, 'this isn't a premium – I could get this in one day on the market.’ Interxion shareholders don't want anything to do with it."

"You would think DLR would have to pay a lot more to get the highest quality assets in the data center space," Crossett said.

Most bank analysts were unwilling to speak about it on the record. One, who asked not to be named, said, "Interxion shareholders are frustrated with the way there was no process. Had they done a formal process, it could have led to a superior bid."

Erik Rasmussen, VP of equity research at Stifel, said in an email that he was surprised by the low price. Interxion was worth $113 per share, by his estimate.

The deal price was so low that a large infrastructure fund or private investor could gazump Digital, he said.

Colby Synesael, an analyst with Cowen and Company, wrote in a circular that the investment bank was surprised Interxion did not invite other bidders into a formal process. "We believe Interxion could have held out for a higher price, given its value in Europe," he wrote.

Of the ten financial institutions listed as the largest Interxion shareholders, all of whom DCK contacted, none would comment. Managers for investment funds required to hold only European stocks – and who might be forced to sell their Interxion holdings at a "low price" before it realized its potential – would not address the unhappiness attributed to them. Neither did they refute it.

Interxion and Digital Realty also would not comment.

Happy Returns

Last week, when Digital Realty CEO William Stein told analysts the deal would lose money for its first two years, he didn't spell it out. But the numbers show what he meant. Interxion has consistently been about half as profitable as Digital Realty in the last decade – sometimes three or four times less profitable – even for all its prized assets.

Ruberg addressed the market talk indirectly in a written statement issued earlier this week, as Interxion released its quarterly earnings statement. The firm settled on a deal with Digital only after "many discussions over several years with potential strategic and financial acquirers," he said.

The deal valued INXN shares at about 70 percent the worth of DLR after considering the latter's $132 share price, Ruberg said. Interxion shares had been trading at $89 when the deal was struck. The doubly-profitable Digital Realty did $3 billion in sales last year. Interxion did about $700 million.

Digital would also be taking on $1.5 billion in debt, which Interxion amassed at relatively high rates while building its EU empire. Interxion couldn’t get investment capital at decent rates because it wasn't big enough, Ruberg said in August. Digital Realty would refinance Interxion's debt at a better rate. Berenberg’s Crossett said it would cut the EU firm's debt interest in half.

Yet all analysts who shared words or reports with DCK also repeated what Stein said on last week's conference call: the combined company would be so much stronger strategically that it would eventually become more profitable.

"We strongly believe the combination with Digital Realty will deliver significant long-term value for all our stakeholders," Ruberg said. "We are creating one of the largest data center operators in the world."

What's more, both Ruberg and Stein said on their call, customers had pushed into it. The same was true of other deals of varying sorts Digital had done in India, Japan, Brazil, and South Korea. Customers have encouraged it to build a global platform.

Sharks

Kevin Imboden, director of research at property consultancy Cushman & Wakefield, said Digital also faced the prospect of Equinix, a larger US-based data center company that has been investing heavily in Europe and elsewhere, taking those customers from it. Interxion felt this pressure as well.

"Interxion are getting to the level where there are a lot of sharks in the water. This provides a way out", he said. "If your competitor has got you in a corner, you have to do something about it. I don't think you can put a price on it."

Those sharks were evident in Cushman & Wakefield data analyzed by DCK. Interxion has been building data centers to capture demand in the four European cities that constitute the industry's biggest markets in the region: Frankfurt, London, Amsterdam, and Paris (the FLAPs). It will complete construction on data centers with 10,000 square meters of floor space this year – nearly as much as one-and-a-half football pitches. They will house 14MW of computer power.

But that’s less than 4 percent of all computer power being constructed in the FLAPs by the entire data center industry this year, and 2 percent of all floor space.

CyrusOne, a US rival to Digital that acquired its own European data center company in 2017, has been doing the greatest amount of FLAP construction – 10 times as much floorspace as Interxion and five times the power capacity. Interxion's construction is about 10th among the 15 data center companies doing most construction in the FLAPs. In all, they are building nearly 500,000 square meters of data center floorspace and more than 384MW of power, according to Cushman.

Other data meanwhile shows that Interxion's highly-prized internet data centers are facing intense competition. Companies such as Interxion and Equinix (which grew big by building connected data centers in the US) were once the predominant hosts of internet exchanges in the regions where they operate.

But recent tallies by those exchanges, which manage the communications traffic at the internet's major points of intersection, show that they have since distributed their traffic across many data centers owned by numerous operators.

DE-CIX, the internet exchange in Frankfurt where Interxion started out, was by last year distributed across 33 data centers operated by 13 companies. Interxion operated about half of them. Equinix ran about half the data centers that housed the Amsterdam Internet Exchange, while LINX, the London exchange, was dominated equally by Digital Realty, Equinix, and Telehouse.

Cushman & Wakefield data also illustrates internet intersections being established in other cities, away from the FLAPs, particularly as cloud platforms like Amazon, Google, and Facebook build enormous data centers of their own. Counting Dublin and other parts of Ireland alone in the reckoning of FLAP construction data, Interxion drops to about 15-20th among the biggest builders, accounting for about 1 percent of all construction.

Biggest of all is Atlantic Hub, a shell company fronting construction of a gigantic 300MW data center to catch one of a clutch of new transatlantic internet cables carrying traffic for those parts of the internet growing away from the FLAPs. Other big data center builders in Ireland this year – Amazon and Facebook – are among cloud firms laying their own subsea cables and building data centers in locations away from the FLAP intersections, such as Eemshaven (north of Amsterdam) and Sopelana (near Bilbao in Spain).

Interxion built a dominant position in one of the emerging hubs – Marseille, an internet intersection between Europe, Africa, and Asia. It built early positions in other major European cities a well: Vienna, Madrid, and Stockholm. But, said Imboden, Interxion might feel pressure to grow faster than it might by merely filling its network out in smaller cities around its own major hubs.