U.S. REIT – CyrusOne’s current share price is just about right

Release: 01 March 2015


Introduction

CyrusOne (NASDAQ:CONE) is one of the fastest growing companies in the data center REIT sector. However, that doesn’t make it an easy buy. Although the company is well positioned in a market where the fundamentals have been strong, CyrusOne is already trading at a reasonable value. Taking into consideration the company’s 2015 guidance, as well as its history and peers, the current share price is already the correct valuation.

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Company Description

Entering its third year as a public company, CyrusOne is a small cap company (market capitalization of US$1.1 billion) that develops, owns, and operates data center properties. It has 25 operating data centers in eleven distinct markets (nine cities in the U.S., as well as London and Singapore) that include power, cooling, and telecommunications systems, which enable interconnectivity between data centers and a range of telecommunication carriers. These data center facilities are critical to the continued operation of its customers’ information technology infrastructure.

CyrusOne generates recurring revenues by leasing colocation space, and nonrecurring revenues from the initial installation and set-up of customer equipment. It provides customers with data center services pursuant to leases, with a customary initial term of three to five years. At the end of the lease term, customers may sign a new lease or automatically renew pursuant to the terms of their lease. As of December 31, 2014, the weighted average initial lease term was 69 months, and the weighted average remaining lease term for the top 20 customers was 34 months.

Recognizing the growth potential of outsourcing in a market where only a portion of large U.S. enterprises use third-party data center colocation services, CyrusOne focuses on high-revenue clients – out of 669 customers, 144 are in the Fortune 1000. This strategy has led to revenue concentration within a small pool of customers: 40 customers account for 71 percent of leased space and 58 percent of annualized revenues.

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Source: CyrusOne Fourth Quarter 2014 Earnings Report

In 2014, CyrusOne’s growth was fueled by both new and existing clients, leading to an increase in leased colocation area of 20 percent, and to a corresponding increase in revenues by 20 percent, with the help of escalators, ancillary and services products, and interconnection.

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Source: CyrusOne Fourth Quarter 2014 Earnings Presentation

As of December 31, 2014, CyrusOne had 1.2 million colocation square feet. Colocation square feet (CSF) represents net rentable square feet (NRSF) leased or available for lease as colocation space, where customers locate their servers and other IT equipment. NRSF represents the total square footage of a building leased or available for lease based on engineers’ drawings and estimates, not including space held for development or used directly by CyrusOne. NRSF that is not CSF typically comprises office space and similar uses.

Market Landscape

During a webinar by 451 Research on February 18, enterprise data center expert Dan Harrington underlined that the number of data centers in North America has been declining due to the consolidation of enterprise data centers. In fact, he pointed out that the priority for data centers among enterprise in the short term has been asset utilization, consolidation, and retrofit (which allows more power into the rack and better cooling equipment).

However, although the overall market is in decline there are nonetheless pockets of growth. Cloud services, service providers, and multi-tenant data centers have been driving growth as companies look to outsource their IT to third-party providers.

In addition to being a third-party provider, CyrusOne is well positioned in the data center market for several reasons:

  • It is strategically located in popular locations in the U.S. that have grown significantly (Texas and Virginia) and in Europe (the UK).
  • A good portion of its top clients are heavy users – telecommunication services, information technology, and financial companies.

CyrusOne doesn’t expect material negative impact from energy companies. For its top 10 Oil & Gas customers, annualized rents represent only 0.006 percent of their operating expenses. On top of that, the proportion of business from energy customers is down to 28 from 37 percent two years ago (as of December 2014).

Source: Dan Harrington, Research Manager, Enterprise Datacenters, webinar The State of the Datacenter Market: Disruption and Opportunity for 2015 and Beyond

Revenue & FFO Outlook

Despite projecting 25 percent growth in colocation square footage in 2015, CyrusOne doesn’t estimate that revenue and funds from operations (FFO) will grow to the same degree. According to the company’s 2015 guidance, revenue should increase 12-16 percent and normalized FFO 10-16 percent. That’s certainly a slowdown in growth in comparison to the previous year.

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This disconnect between additional colocation area and revenue/FFO projected growth most likely results from one (or a combination) of three potential risks:

  1. The company cannot achieve its goal of adding 275-325 thousand CSF online in 2015, ending 2015 with approximately 1.5 million CSF. This is its most aggressive goal in recent quarters.
  2. The company cannot utilize the new area at the portfolio rate (88 percent), and consequently overall occupancy will fall.
  3. The company must lower its prices in order to quickly monetize the new areas. This possibility seems to be remote, however, because the average revenue per square foot has been flat over the past few years.

The chart below shows CyrusOne’s projected revenues for 2015 using the most conservative guidance numbers.

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Over the past four quarters, the median price-to-FFO has been around 14. Following the guidance of 11 to 16 percent growth in 2015, I estimate that Q4 2015 FFO will be between 0.53 and 0.56, which leads us to a target share price between 29.70 and 31.20 U.S. dollars. The current price is 29.72 U.S. dollars (February 27, 2015).

In addition, looking at CyrusOne’s peers (QTS, COR, DLR, DFT, and EQIX), the median price-to-FFO is approximately 15. Performing the same calculation, I estimate the target share price at between 31.80 and 33.60 U.S. dollars. This range is indeed above the current price, but too close for comfort.

Of course, relying on a company’s guidance can be tricky – companies tend to stand on the conservative side of the spectrum. Last year CyrusOne released guidance numbers for 2014 that it easily beat. If CyrusOne beats its guidance as it did last year, the share price range will move up to 30.91 to 34.60 dollars per share.

As such, I don’t see CyrusOne as a buy opportunity at this moment, for any of the scenarios mentioned above. I’ll move on in my analysis to another data center REIT.