Equinix Inc. (EQIX): Connecting the World
The internet is fundamentally a network of networks. For example, this website that you are reading is stored on a server somewhere which is connected to a network that is likely different from the network you are using to read it. At some point, these different networks (Charter, Comcast, AT&T, etc) need to communicate and exchange information. They do this in a much more tangible fashion than you might realize – through physical wires connected between servers located within the same data center. These physical connections are called ‘interconnections’ and they are the foundation of our investment thesis in Equinix.
In the past, large telecom carriers controlled this interconnection activity, effectively forcing smaller carriers to house switching equipment on their premises to exchange traffic with the larger carriers. This was inefficient and the model eventually shifted to carrier-neutral internet exchange points – data centers owned and operated by third-party private companies.
Equinix is the largest of these such companies and is structured as a real estate investment trust (REIT). Unlike wholesale data center operators that provide large amounts of low-tiered commoditized capacity to customers (typically for storage), Equinix’s key service is offering these colocation and interconnection services in which customers pay for traffic exchanged with other customers in the same data center.
In this ‘connectivity’ market, the most important thing is scale – effectively how many customers do they have at each site. The more customers present, the more attractive that site is to other customers as this means there are more people they can interconnect with. Equinix is comfortably the market leader here and the power of their scale advantage continues to grow – in the last year alone they have added more interconnections than the next largest ten competitors combined.
This results in a very wide moat that structurally protects Equinix from competition: they have the most cross-connects and key cloud partners, so their data centers are the most attractive, thus increasing the density of the network still further. The physical location of each data center is also important and Equinix occupies a commanding position in this respect by covering key, scarce metropolitan areas that provide lower latency for latency-sensitive customers. Equinix currently has 211 data centers across 55 key metro areas in 26 countries (and growing).
Revenue streams for this business are very secure as customers face high switching costs since moving a server is risky and could disrupt a business due to outages. This results in long-term contracts, which also come with built-in 2%-5% price escalators and limited churn. The majority of Equinix’s cost structure is fixed, meaning they benefit from significant operating leverage as they add both capacity and interconnections to existing data centers, which results in attractive returns on new development sites, which Equinix is further magnified by Equinix’s five turns of leverage. Equinix is a great example of a business that is often missed by investors who are overly reliant on quantitative screens – 1) they will exclude REITs right off the bat and 2) they will exclude any highly leveraged business even though the underlying economics of Equinix supports significant leverage. Equinix carries what looks on the surface to be a lot of leverage – but it is not a substantially risky prospect given their revenue profile and contractual protection.
We believe that Equinix’s data center business is still in the early stages of a long growth runway driven forward by secular trends in global internet access, e-commerce, IoT (internet of things), high definition streaming video, and enterprises moving to the cloud. This tailwind, plus the inherent security that Equinix’s moat affords us in modeling gives us confidence that Equinix will be able to compound their cash earnings at 12-15% for the foreseeable future. And that is conservatively assuming no margin expansion for what is a high operating leverage business model.
At today’s market price (+20% in 2020), Equinix is not drastically cheap when looked at through a short-term lens. But as long-term investors, with high conviction in our projections, we are confident that the real intrinsic value here will provide us with double-digit total shareholder returns for many years to come.
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