DCK Investor Edge -- This Monday, Switch once again reported a disappointing quarter, the third in a row for the Las Vegas-based data center provider that went public on NYSE last October.
All key metrics other than churn missed prior guidance and analyst estimates. A host of downgrades and lowered investment-bank 12-month price objectives for the stock followed.
The result was shares that had previously closed at $13.98 gapped down when the markets opened Tuesday at $10.50 per share.
At one point Tuesday, Switch shares traded as low as $10.00 prior to closing the day at $10.85 per share, down 22.4 percent on 18 times normal volume, the lowest closing since the company’s IPO.
The question for investors now becomes whether they should buy more SWCH shares and "average down" for the long-term, hold, or sell them?
Wall Street Loses Patience
At least three of the 12 Wall Street analysts covering Switch downgraded its stock and five cut their price targets, MarketWatch reported. Five had buy ratings and seven had hold ratings as of Tuesday afternoon.
Overall, based on what they told MarketWatch, the analysts appear to be losing patience with Switch management.
From the MarketWatch report:
BTIG analyst Edward Parker downgraded Switch to a neutral rating. Parker said the company needs to rebuild confidence in the wake of its new guidance, while cutting it some slack in that its addressing some of the “most complex areas of the market” with a different technology.
“However, Switch needs to deliver results consistently in order to regain the investor confidence it has lost over these past two quarters,” Parker said in a note.
J.P. Morgan analyst Richard Choe downgraded Switch to a neutral rating and cut his price target to $13 from $17. “The company’s updated guidance implies relatively flat revenue and margins,” Choe said. “We had expected revenue to ramp through the year and margins to improve, but growth appears to have been pushed out into 2019 or beyond. While we believe in the long-term strategic position of the company, we think the business is not ramping as fast as expected near-term.”
Switch competitors Equinix, QTS Realty, CyrusOne, Digital Realty, and CoreSite Realty are also focused on the enterprise vertical and delivering comprehensive hybrid cloud and colocation solutions.
The difference appears to be that the data center REITs named above are farther along in the process – and able to meet or exceed guidance and Wall Street expectations – while working on the longer lead-time hybrid cloud deployments in the sales funnel and deal pipeline.
In his lengthy prepared remarks on the earnings call Monday, Morton may have inadvertently hit on some investor concerns: "Switch's unique multi-user hyperscale Primes [data center campuses] are designed, constructed, and operated very differently from any other technology ecosystem in the world, creating what we believe to be an unrivaled technology infrastructure platform for our customers in fulfillment of our plans to provide stable, excellent returns for our shareholders for decades to come." That comment sums up the problem Switch has today.
Investors bought into a growth story presented in the October 2017 IPO Prospectus, as illustrated by the slide above. The decelerating growth story, EBITDA growth, and adjusted EBITDA margins are heading toward "stable returns."
But many analysts are now concerned that there will not be significant growth for the rest of this decade. Investors are not going to pay up today for potential returns in 2020.
Another structural issue for Class-A common shareholders to consider is the massive overhang of Switch, Ltd. Units (Class-B shares). The $150 million now set aside to purchase these units is not going to generate a penny of earnings per share or contribute to growth. Current full-year CapEx guidance at the mid-point is for an expenditure of $285 million, down from $403 million in 2017. If the $150 million were to be invested in success-based CapEx – perhaps accelerating development of The Keep Prime in Atlanta – fiscal 2018 CapEx would have been $435 million, a modest 8 percent increase year-over-year.
Meanwhile, Class-B shareholders are cashing in on long-term investments, while founder, CEO, and Chairman Rob Roy has total voting power due to his massive stake of Class-C shares. On August 14, a Form 4 was filed detailing Switch insider Gragson Scott Russell, a 10 percent owner, disposing on August 10 of 189,000 Class-A shares at $14.00 per share.
There doesn't appear to be a level playing field for ordinary shareholders. I would look forward to an opportunity to discuss this with Mr. Roy in Las Vegas, if he would be so inclined.
Opinions expressed in this column do not necessarily reflect the opinions of Data Center Knowledge and Informa.