Data Center Spending Stocks

nvestors can glean a lot of useful information from earnings reports and the associated commentary. Naturally, it’s unreasonable to expect the average private investor to spend all hours God sends researching and looking for anecdotal evidence but that’s where the Motley Fool can come in and help. In this regard, I want to highlight one sector of tech that is doing very well at the moment.



Data Centers Demand

Despite the current weakness in the global economy and a number of tech companies lowering their guidance, data center investment shows no signs of abating. The fundamental drivers of it are secular in origin. With every other business seeking to expand cloud based service offerings, the strain on data center provision will only increase.

Furthermore, smart phone and tablet penetration is increasing the number of hours spent online while content is becoming ever more media rich. Another –often overlooked-driver of data center demand is the financial services sector. Their fixation with using technology to gamble against each other with products (whose risk they don’t really understand) is only increasing. If they want to do it then so be it, don't give them your money but invest in areas where they will spend theirs.

Data Centers

The most obvious place to start would be the data center providers like Equinix (NASDAQ: EQIX), Digital Realty Trust, Interxion or Telecity. In contrast to much of the tech sector, these stocks have soared. All of them have been ramping up capital expenditure plans in a bid to capture future growth. They are attractive businesses because their customers are sticky and much of the growth in demand is coming from them. This gives them good visibility over future revenues.

The question is when will industry capacity exceed demand? I always think the key to this question is gross margins, so let’s look at Equinix.

There is no apparent decline so it appears that the capacity ramp up is justified for now and this is the key to ongoing growth. I think investors should stay with the capex plays while the data centers are spending.

Data Center Capex Benefiting Suppliers

Increased spending on data center infrastructure is good news for the equipment suppliers. Indeed it has been noticeable that two of the biggest tech names out there have seen their strongest prospects come within data center spending. Intel recently gave a trading system and basically said its whole business was weaker with the exception of data center spending. Moreover, Cisco Systems (NASDAQ: CSCO) has reported stellar growth in data center revenues.

This isn’t a coincidence. Data center spending is strong. Unfortunately, Intel and Cisco are not the best way to invest in the sector and I think investors need to look at more focused companies.



Stocks With Data Center Exposure

Finisar (NASDAQ: FNSR) recently gave results and whilst there was continued weakness in its telecom sales, its Datacom division (primarily sells to data centers) has been operating well. Telecom made up 36.7% of revenues in Finisar’s last quarter and you can’t ignore this in your investment decision, but it’s possible we have seen the worst here and management is talking about it picking up in the next quarter. As for Datacom, don’t be fooled by its decline in the last quarter. There were two fewer shipping days and the result was also a snapback from strong growth in the previous quarter. It's worth a look.

Another angle on data centers would be to look at companies that have exposure to data center needs and the industry trends that are creating the underlying demand. An example of this would be security. Cisco and Juniper service this market but if you are looking for a specialist play in the area I think Check Point Software (NASDAQ: CHKP) is worth looking at. It specializes in the type of high-end sophisticated security solutions that large corporations and data center providers need.

Another interesting entrant into the data center security marketplace is F5 Networks. In addition its core market of application delivery controllers is heavily exposed to the increased demand to accurately control the quality of applications sent over the internet. In this regard, I also like Riverbed Technology (NASDAQ: RVBD). It is the market leader in wide area network optimization. In other words if you need bandwidth heavy data sent quickly over the internet, then Riverbed is your port of call.