One week after datacenter services company
Equinix (
NASDAQ: EQIX ) disappointed the market with a lackluster set of results, it was datacenter REIT
Digital Realty Trust's (
NYSE: DLR )
turn to indicate that industry conditions are getting tougher. But is
this a short-term growth hiccup or a longer-term problem? And with
behemoths like
Google (
NASDAQ: GOOG ) and
Amazon's Web Services, or AWS, rolling out their own datacenters, are Equinix and Digital Realty headed for more difficulty?
Digital Realty reported
funds from operations, or FFO, of just $1.10 in the third quarter
compared to analyst consensus of $1.20. FFO is just a metric that REITs
use to equate to EPS. Although $0.07 of the "miss" is due to a rent
expense adjustment, its core FFO still only came in at $1.16.
Moreover, its guidance for 2014 was disappointing. Quoting from its conference call:
We are revising our 2013 FFO per share guidance to $4.60 to $4.62,
down from $4.73 to $4.82 previously, and revising guidance for 2013 core
FFO per share to $4.65 to $4.67, down from the prior range of $4.74 to
$4.83
This adjustment is a reduction of 3.5% or $0.17 of EPS at the
mid-point of guidance, but to be fair to Digital Realty, $0.07 is due to
the aforementioned rent adjustment and $0.03 is due to a joint venture
with
Prudential.
However, the worrying bit is the $0.06 that is due to "delayed lease
commitments." In other words, customers are not utilizing the datacenter
space—that they signed up for—as quickly as Digital Realty had
anticipated. This is a sign of a maturing industry, or at least, one in
which the customers have the upper hand with regard to pricing
negotiations. Moreover, in its earnings release, Digital Realty gave
preliminary guidance for 2014, and informed investors that rental rates
on renewal leases are expected to be roughly flat on a cash basis, along
with operating margins "approximately 25-75 basis points lower than the
historical run rate."
In other words, Digital Realty is finding it harder push through price increases. Another sign of a maturing industry.
Equinix deals with reality
These industry trends are confirmed when looking at Equinix's recent results. There is a more
detailed analysis of them linked here.
Equinix had lowered earnings guidance already this year, and its
third quarter results also contained some negative nuances. Its deal
sizes are getting smaller, while its sales cycles are lengthening.
However, Equinix's management argued that it was primarily a consequence
of delays caused by enterprises planning more complex hybrid cloud
deployments:
I don't believe they are really just driven per se by macroeconomic
uncertainty or a broader enterprise anxiety or anything like that...
...just driven by the fact that the decisions of CIOs to move to sort of
hybrid cloud infrastructures
Partially in response to these developments, Equinix strengthened its relationships with
Microsoft's (
NASDAQ: MSFT )
cloud platform, Azure/and also with AWS. The idea being that Equinix's
customers will find it easier to build out their hybrid clouds from
within its [Equinix] infrastructure. In fact, Equinix sees the
development of cloud services from the likes of Google, Amazon and
Microsoft as a net positive in the long-term.
The bottom line
Essentially, the evidence is
that the datacenter market is maturing and pricing power appears to be
moving away from the datacenter providers and toward the buyers.
Meanwhile, its incumbents are still investing in new capacity. Investors
in datacenter providers
InterXion,
Telecity and
DuPont Fabros should take note.
Whether the issue is going to be prove relatively short term (as is
implied by Equinix's arguments over the hybrid cloud deployment issue),
or if it's simply a function of oversupply, the near-term outcome is
likely to be similar. The industry is facing some pressures and cautious
investors should wait until there are signs of pricing power returning.
