Has the surge in share price taken QTS Realty Trust to the clouds?

U.S. REIT – Has the surge in share price taken QTS Realty Trust (NYSE: QTS) to the clouds?

Brazil REIT – Anhanguera Educacional (BVMF: FAED11B) – Changes to the Student Financing Fund (FIES) should affect tenant.


Release: 15 February 2015


REITs

U.S. – Has the surge in share price taken QTS Realty Trust (NYSE: QTS) to the clouds?

Although QTS Realty Trust (NYSE:QTS) is one the fastest growing companies in the sexy sector of data-center REITs, the recent share-price rally has pushed its valuation to higher levels in comparison to its peers. Since the IPO in October of 2013 investors have driven the stock to a 73 percent appreciation. At least for the moment, I feel that the risks surrounding purchasing this stock outweigh any potential future returns.

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To justify the current valuation, the senior management will have to make an extra effort to put into practice the company’s ambitious expansion plan to double net leasable area and monetize it in a very competitive industry. I don’t see them outgrowing the market pace without losing margins or maintaining lower levels of occupancy.

Despite being bullish on data-center REITs due to the sector’s strong fundamentals, I’ll keep looking elsewhere before considering QTS again. The company will release its fourth quarter results soon, but I don’t expect that this picture will change much in the short term.

Performance

  • On the one hand, QTS’s growth rates have been phenomenal. During the Stifel Technology, Internet & Media Conference, the company’s CEO Chad Williams showcased two-digit grown for revenues and adjusted EBITDA, and three-digit grown for operating FFO.

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Source: Extracted from QTS presentation on February 9, 2015 at the Stifel Technology, Internet & Media Conference.

  • In addition, QTS demonstrates higher growth rates than its peers, at the same level as the growth experienced by CyrusOne (CONE).

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  • On the other hand, QTS has been more leveraged than its peers.

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  • And, most importantly, QTS’s Price-to-FFO has been higher and dividend yield lower than its peers.

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*Extracted from the most recent financial for each company as of the date below. For price-to-FFO and dividend yield, share prices as of 13 February of 2015. QTS, CONE, COR, and DFT are small-cap stocks.

QTS, CONE, EQIX – 9/30/2014

COR, DLR – 12/31/2014

Investment Thesis

Over the past three or four years, the need for storing data has increased exponentially. Just think about how many servers are used by some of the Internet’s most popular companies, such as Google, Amazon, or Facebook. Last year, an average of more than 300 million pictures were uploaded to Facebook on a daily basis. Their warehouse’s incoming daily data rate was about 600 terabytes, and their maximum total capacity was 300 petabytes (1 petabyte is equivalent to about 1,000 terabytes). Would you expect these numbers to go up or down in the coming years, and how quickly?

This February, Cisco released mobile data traffic statistics for 2014, as well as projections and growth trends for the next five years. The numbers are daunting: 1) Global mobile data traffic grew 69 percent in 2014, 2) Last year’s mobile data traffic alone was nearly 30 times the size of the entire global Internet in 2000, and 3) Global mobile data traffic is expected to increase nearly tenfold between 2014 and 2019, at a compound annual growth rate (CAGR) of 57 percent (Source: Cisco Visual Networking Index Global Mobile Data Traffic Forecast Update)

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As data production accelerates, organizations of all sizes increasingly seek sophisticated and reliable information and content management, security, storage infrastructure, and archiving solutions. Not only Internet companies and mobile carriers lean on big data, but also financial institutions (credit cards, for example), enterprises, health care institutions, and governments. This leads to a growing demand for external data-center space and the services associated with it.

Company Description

QTS Realty Trust is a national provider of data-center solutions, operating twelve data centers across several states. They own, build, lease, and operate space that houses the network and computer equipment of multiple customers, and provide access to a range of communications carriers.

Overall, QTS provides three types of service: custom data centers (C1), colocation (C2), and cloud and managed services (C3). C1 and C2 account for the majority of the company’s revenues.

QTS currently has 920,000 square feet in space, and this number is expected to rise to 2.1 million square feet over time.

QTS’s largest data center in Atlanta, Georgia

Customer Base Diversification

QTS has a number of multi-tenant data centers that house companies of all sizes representing an array of industries, each with unique and varied business models and needs. The current base of 850 customers is not concentrated, ranging from Fortune 1000 companies to small and medium businesses. These customers have been engaged in multi-year contracts.

C1 customers are typically large enterprises with significant IT expertise and specific IT requirements. These include financial institutions, “Big Four” accounting firms, and the world’s largest global Internet companies.

C2 customers represent of a wide range of organizations, including major healthcare, telecommunications and software, and web-based companies.

C3 customers consist of both large organizations and small businesses seeking to reduce their capital expenditures and outsource their IT infrastructure on a flexible basis. They include a global financial processing company, a U.S. government agency, and an educational-software provider.

Source: 2013 Annual Report

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Source: 2013 year end QTS presentation in Germany on March 10-12, 2014

Competitive Landscape

Gartner, a specialist in high technology, published research in October of 2014 laying out the market trends for the online data industry. A number of events are expected to impact the market over the coming three years:

  • Infrastructure efficiency is a big driver in this industry. The customer base is currently looking to do more with less, but a considerable portion of the facilities is aging and needs restructuring. This is leading to an increasing demand for modern data center equipment and networking components, as well as for advanced power and cooling solutions.
  • A mismatch between IT customer expectations and vendors opens up an opportunity for alternative vendors. Traditional vendors have not been able to entirely keep up with customer expectations, and so new vendors able to provide state-of-the-art infrastructure allied with complete solutions could potentially gain the upper hand.
  • Nationalism will play an important role. Following Edward Snowden’s disclosure of classified information in 2013 (one of the most significant leaks of secret affairs since the 70s), international markets are increasingly considering domestically-developed and open-source technologies, and looking for local labor.
  • Traditional in-house data centers have been limited. Organizations are aware that outsourcing can both lower infrastructure costs and be more secure from an IT perspective. In-house data centers have therefore been shrinking, making room for external data-center operators.
  • There’s an increasing perception that “hardware” is disposable. Data-center margins will drop and storage companies will suffer erosion of revenues. The only way to differentiate yourself is to create solutions that complement storage.

One way or another, all these trends place QTS in a favorable position.

Example of Efficiency: Virtualization of Servers

One way to add server capacity to data centers without adding hardware is to utilize a software technology called virtualization. Since servers often operate at low capacity, virtualization allows the creation of multiple virtual servers using the same machine. Virtualization software sits on top of the server’s operating system, rationing resources into several virtual servers at once. This boosts capacity and keeps costs contained. Players spearheading this technology include VMware of Palo Alto and Citrix Systems of Fort Lauderdale.

Source: Plunket Research Online


Brazil’s Anhanguera Educacional (BVMF: FAED11B) – Changes to the Student Financing Fund (FIES) should affect tenant

Investment Thesis

As real income rises and the search for a better lifestyle intensifies, young Brazilians have been increasingly looking to for-profit institutions of higher education in order to achieve their professional ambitions. However, this movement toward education is still a relatively recent phenomenon, and therefore it has excellent potential for higher returns because the market hasn’t yet been completely tapped.

Higher education in Brazil is a huge market. According to UNESCO, Brazil is the world’s fifth-largest market, and 73 percent of students have been enrolled in private colleges, universities, or vocational schools. In 2013, out of the approximately 7.3 million students enrolled in higher-education institutions, 5.4 million attended private schools. Just to put the size of this industry into perspective, the U.S. has 21 million students enrolled in higher-education institutions.

Chart10 Source: Brazil’s Ministry of Education

Already large, the Brazilian higher-education sector is still growing. In 2013, the number of enrolled students in private institutions grew by 4.5 percent, as opposed to only 1.9 percent in public institutions. Also, the sector has low penetration compared to other countries – only 19 percent of Brazilians between ages 18 and 24 go to college, while this rate is 41 percent in the U.S., 29 percent in Chile, and 64 percent (at least begin college) in Argentina. There’s still a lot of wiggle room to grow and catch up with comparable economies.

What makes higher education compelling is that pursuing a college degree is certainly worth it in Brazil. Contrary to the popular debate in the U.S., Brazilians are not skeptical about the returns of higher education. You are likely to reap meaningful rewards by taking loans and investing time to get a diploma. There’s a wide wage gap between those who hold an advanced degree and those who stopped at high school, which many see as an opportunity to make an income leap. Also, with its historic low employment rates, Brazil’s economy has been starving for more skilled workers.

Chart11 Source: Brazil’s Ministry of Education

Over the past decade, the perceived importance of education has become deeply rooted in Brazilian society. As the educational sector evolves and offers more alternatives, families have not only demanded greater access to school for their children but also become significantly more concerned with the quality of education provided. This is creating a trickle-down effect that will influence higher education for years to come.

In addition, due to the continued support of the federal government for private higher education, it is now easier for middle and lower-middle income students to attend college. The government has launched programs that finance monthly tuition fees, such as the Programa Universidade para Todos (PROUNI) and Fundo de Financiamento ao Estudante do Ensino Superior (FIES).

Overall, the fundamentals for investing in higher education are strong, and growing enrollment is driven by a number of factors: 1) the prospect of career advancement, 2) the significant increase in individual income for those who hold an advanced degree, 3) the substantial unmet and growing demand for skilled workers, and 4) the increasing availability of educational alternatives for the middle and lower-middle income population.

Fund Description

Anhanguera Educacional’s primary revenue source is the lease proceeds from its three properties in the state of São Paulo – Taboão da Serra, Leme, and Valinhos. The Taboão campus has offered both undergraduate and graduate courses since 2005, while the Leme campus offers additional in-person courses and also houses the installations for the distance-learning department. The Valinhos location contains the company’s administrative offices.

Anhanguera Educacional – Taboão Campus

 

Fund raising has taken place in two tranches. The first tranche, which happened in November of 2009, was earmarked for purchasing the Taboão unit at R$37.4 million. Later, a second tranche in October of 2010 financed the purchase of the Leme and Valinhos units at R$4.9 and 9.3 million (respectively).

Initially, monthly leases were fixed at 1.0 percent of the real estate value, and through negotiations over the past five years this has remained the same. The table below, extracted from the fund administrator’s December report, provides more details about the leases.

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Source: BTG Pactual

Tenant Profile

Announced in April of 2013 and completed in June of 2014 following the approval of Brazil’s antitrust agency, the merger between Anhanguera and Kroton formed the world’s largest private education institution in market capitalization, with one million students. Anhanguera has now merged into Kroton, whose shareholders in aggregate kept the majority of the new company. The second-largest private educational company is New Oriental, a Beijing-based company listed on the New York Stock Exchange, with 2.5 million students.

Student Financing Fund

The search for better wages and employment opportunities by young workers explains why the Student Financing Fund (FIES) has become an absolute success. Since the redesign of FIES in 2010, the number of student loans has spiked from 76,170 in 2010 to 1,029,107 in 2013. Nonetheless, a tighter 2015 federal budget has prompted the government to propose changes that might limit further growth.

FIES is a Ministry of Education program to finance the higher education of students enrolled in private institutions. Although it has existed since 1999, the 2010 redesign expanded the program to better reach lower and lower-middle income segments, which historically had no access to higher education. The National Fund for Education Development took control of the program’s operations and implemented several meaningful changes. Perhaps most significantly, interest rates fell from 6.5 to 3.4 percent a year, students can apply for funding at any time of year, and the repayment grace period after finishing school has increased from six to eighteen months.

According to Anhanguera’s 2014 Q2 report, FIES has been the primary tool for improving the company’s accounts receivable and will continue to be the focus of collection and retention efforts. Over 44 percent of the students enrolled in Anhanguera’s campuses at the end of June 2014 were part of the program.

FIES Enrollments at AnhangueraChart12

Source: Anhanguera Educational’s Q2 2014 Report

Potential Threat

Late last year the Ministry of Education established new rules for FIES that will potentially reduce the number of contracts and limit the growth of private-sector enrollment. Students can now benefit from the loan only if they reach a minimum score on the national standardized exam for high school graduates. Also, not all students who enjoy a federal scholarship will continue having access to FIES. It remains uncertain how these new rules will affect educational institutions.

So far, Anhanguera Educacional share price (FAED11B) has remained stable and dividends have grown, yielding 11.8 percent.

Chart13 Source: Infomoney

Paid Monthly Dividends R$Chart18

Source: BTG Pactual


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Written by Heli Brecailo

Disclaimer This newsletter is not engaged in rendering tax, accounting, or other professional advice through this publication. No statement in this issue is to be construed as a recommendation to buy or sell any security or other investment. Please do your own due diligence before making any investment decision. Some information presented in this publication has been obtained from third-party sources considered to be reliable. Sources are not required to make representations as to the accuracy of the information, however, and consequently the publisher cannot guarantee accuracy. Disclosure The author has no positions in any shares mentioned, and no plans to initiate any positions within the next 72 hours.​