QTS Realty – Dilution does not alter outlook

Analyzing QTS Realty Trust (NYSE: QTS) is challenging given the brief history. A small market capitalization company in the data center REIT space, QTS was listed on the New York Stock Exchange in October 2013. A potentially larger obstacle is to build a great future, which is not an issue for QTS’s management, despite bumps in the middle of the road.

Q1 15 Performance

In their Q1 2015 earnings report released Monday, April 27, QTS announced that the March issuance of an additional 5 million shares diluted FFO. The midpoint 2015 Alternate FFO guidance was reduced from $2.29 per share to $2.12 per share. The total fully diluted shares and limited partnership units outstanding increased from 37.5 million to 42.8 million.

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However, this event did not alter much the price target for 2015. Price-to-FFO has been approximately 17 which is in between year-end price-to-FFO for 2013 and 2014 and close to its peers’ median. The company’s dividend yield of 3.5 percent is also on par with their peers’ median.

Based on the above information, QTS has been an average performer in the data center REIT sector.

Summary

2013 2014 2015P
Dividends declared per common share, $ 0.24 1.16 1.28
Q1 Dividend, $ N/A 0.29 0.32
Listed on the NYSE 10/9/2013
Dividend payout ratio, in percent 74.5 62.2
Weighted average shares – diluted (CS&OP) 36,794,215 37,133,584 42,812,502
Dividend yield, in percent 3.9 3.4 3.4
FFO, $ ‘000s 45,964 70,958
FFO per share, $ 1.25 1.91
Alternate FFO (Operating), $ 000s 49,512 74,145 89,200
Alternate FFO per share (Operating), $ 1.35 2.00 2.12
AFFO, $ ‘000s 47,408 69,236
AFFO per share, $ 1.29 1.86
Debt to Implied Enterprise Value, in percent 27.6 33.4
Revenues – Q1, $ 000’s N/A 48,943 61,386
Revenues – Q1, in percent N/A N/A 25
Share Price on 31 December, $ 24.78 33.84 37.48
P/FFO on 31 December (Alternate) 18.4 16.9 17.7
 2015P=2015 Projections

Source: QTS Realty Financials and Q1 2015 Presentation


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.​

What Does Next Week’s Earnings Call Hold For DuPont Fabros?

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CoreSite Realty Corporation (NYSE: COR) and CyrusOne (NASDAQ: CONE) have been market darlings in the data center sector space. Due to the adverse impact of a tenant default as well as lackluster 2015 FFO projections, DuPont Fabros Technology (NYSE: DFT) has been punished by the investment community.

Year-to-date, both CoreSite and CyrusOne have been solid performers with gains of 23 and 17 percent respectively. The market opportunity seems so favorable that Carlyle Group decided on Monday, April 27, to monetize their investment in CoreSite by selling a portion of their holding. The shares decreased by 4 percent yesterday.

Conversely, DuPont Fabros is down 3 percent this year. Nevertheless, by addressing key questions during their next earnings call scheduled for May 7, DuPont Fabros’s outlook for the balance of 2015 could improve. Some of the questions are as follows:

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Has the situation with Net Data Centers been rectified?

Net Data Centers, one of DuPont Fabros’s top customers, filed a voluntary petition for relief under Chapter 11 Bankruptcy protection last February and ceased making rental payments. The question is whether Net Data Centers will either resume making payments or vacate the space enabling DuPont Fabros to generate revenue with a new tenant.

Will the average interest rate increase?

The company has indicated that interest expenses will increase due to the issuance of new debt for development. The outstanding concern is the extent to which the increase in interest expenses will limit 2015 FFO results.

Will the new CEO Christopher Eldredge shed light on growth prospects?

As noted in the previous earnings call, Mr. Eldridge has been tasked by the Board of Directors to create a strategic plan for the company. The question is whether the growth focus will change from their wholesale product to alternative offerings such as the recently launched mini-wholesale product.

With answers to the above questions, it is believed a more informed investment decision can be made.

Summary

 Metrics 2011 2012 2013 2014 2015P
Dividends declared per common share, $ 0.48 0.62 0.95 1.47 1.68
Q4 Dividend, $ 0.12 0.20 0.25 0.42
Dividend payout ratio, in percent 39.7 48.1 50.8 58.8 67.2
Dividend yield, in percent 2.0 2.6 3.8 4.4 4.7
FFO per share, $ 1.61 1.48 1.46 2.37 2.30
FFO per share (Q4 only), $ 0.37 0.38 0.46 0.58
Alternate FFO per share (Normalized), $ 1.48 1.96 2.39 2.37
AFFO per share, $ 1.21 1.29 1.87 2.50 2.50
Debt to total capitalization, in percent 23.9 23.3 27.0 25.1
Occupancy – Total, in percent 79 90 94 94
Share Price on 31 December, $ 24.22 24.16 24.71 33.24 36.07
P/FFO on 31 December 15.0 16.3 16.9 14.0 15.7
 2015P= 2015 Projections

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.​

Enthusiasm for CoreSite Realty cools down before Q1-15 release

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Even before the financial results for the first quarter of 2015 arrive this Thursday, the market has begun to lose its passion for CoreSite Realty Corporation (NYSE: COR). Its stocks became the worst performing on the equity REIT space the past week, with the price per share decreasing by 4.1 percent. Two analyst reports on April 16 downgraded the stock, and the CEO of CoreSite Realty on April 10 sold a small portion of its shares, resulting in a decline in the stock’s popularity among investors.

This decrease has not been enough for the valuation of the company to back down and converge to those of its peers. The most recent price-to-FFO multiple of 19.9 is still above the sector’s median of 17.1. Moreover, according to Fast Graphs, the price-to-FFO remains above its historical average. As far as dividends go, CoreSite Realty has been in the “middle of the pack,” exhibiting a 3.5-percent yield. The company has not provided a dividend distribution guidance for 2015.

WANT TO SEE CORESITE’S METRICS AGAINST ITS PEERS? DOWNLOAD FREE FILE.

There are several reasons for investors being excited with CoreSite Realty: It is a small-cap company in the expanding data center sector; it has posted double-digit expansion rates in revenues, FFO and dividend in the last quarter of 2014; and its FFO per share is expected to increase by 17 percent this year. It also has a comparatively conservative capital structure that provides room for more potential debt to fuel its expansion.

Takeaway: Despite its valuation, it is worthy of inclusion in the watch list.


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.​

U.S. REIT – The new CEO of DuPont Fabros has his hands full

Release: 22 March 2015 (Extra Edition)

Summary

  1. Following the February 5th announcement that the default of one of its largest customers would impair 2015 results, DuPont Fabros’s share price dropped 16 percent.
  2. The company has indicated that it is going to pay higher interest expenses due to new debt used for development, which will ultimately limit 2015 FFO results.
  3. New CEO Christopher Eldredge must show that under his stewardship the company can continue to prosper. He’s also in charge of putting together a strategic plan for the company and presenting it to the board and investors by the fall.
  4. These recent developments have really muddied the waters, and the company’s outlook is unclear.

Background

DuPont Fabros Technology’s new CEO Christopher Eldredge has had his hands full since he took over the position on February 17. After the February 5th announcement that the default of DuPont Fabros’s seventh-largest customer would impair the company’s 2015 results, share price dropped 16 percent over the following several days. Although some of this loss has already been recovered (as of 20 March 2015, the price is down only six percent since the announcement), Mr. Eldredge has a winding road ahead of him this year if he wants to show investors that he can put the company’s growth back on track.

Sniff Test

I initially selected DuPont Fabros for a deeper study because it has the highest dividend yield and the second-lowest price-to-FFO among the six data center US REITs – QTS Realty Trust (NYSE:QTS), CyrusOne (NASDAQ: CONE), Digital Realty (NYSE: DLR), DuPont Fabros Technology (NYSE: DFT), CoreSite (NYSE: COR), and Equinix (NASDAQ: EQIX).

Chart01

Note: Bubble size indicates market equity capitalization; share price as of 20 March 2015; dividend and FFO are last quarter available.

Also, the company’s high revenue per net leased square foot and a utilization rate held high at 94 percent caught my eye.

Chart02

Note: Bubble size indicates total net rentable area; revenue, occupancy and net rentable area as of 31 December 2014.

On the surface, DuPont Fabros looks like an attractive choice, worth a drill-down report. The company IPOed on 24 October 2007, so it has a respectable history.

Historical Analysis

DuPont Fabros’s dividend history goes back to 2008, when it was interrupted four quarters in a row before getting back on track in the fourth quarter of 2009. Concerns about liquidity led the company to preserve cash and limit cash distributions to only 10 percent of its 2009 AFFO. On December 31, 2008, debt was 83 percent of total market capitalization, 55 percent of which matured in 2009 and 2010.

Since then, the liquidity issue has faded and no additional dividend interruptions have occurred. In fact, dividends have displayed a compounded annual growth rate of 78 percent between 2009 and 2014.

Chart03

Funds from operations have consistently increased since 2009, except for a drop in 2012 from which the company was able to recover the following year. The compounded annual growth rate between 2009 and 2014 was 22 percent.

Chart04

Additionally, AFFO has not shown any issues between 2009 and 2014, growing swiftly at a CAGR of 26 percent.

Chart05

Annual revenue growth has gradually decreased from 22 percent in 2010 to 11 percent in 2014. CAGR between 2009 and 2014 was 16 percent. Interestingly, the company has been able to consistently add US$ 43-44 million in revenues year after year, but this pattern will be harder to maintain in 2015.

Chart06

Price-to-FFO

Per the FAST Graphs chart below, the current price-to-FFO of 14.5 (black line) has been slightly under DuPont Fabros’s all-history average of 14.8 (blue line), indicating no significant share mispricing. The recent price rebound seemed to be an appropriate correction.

Chart07

2015 Guidance

This past February 5 during the Q4 2014 earnings call, DuPont Fabros senior management signaled that both Normalized FFO and AFFO per share for 2015 would not grow. In fact, 2015 result could even decline by $0.10 per share from the 2014 result.

Ticker Q4 2014 Release Date Share Price Change Since Release (as of 20 March 2015), in percent 2015 Guidance for FFO Growth, in percent
DFT 05-Feb-15 -6 -1
DLR 12-Feb-15 -2 -1
QTS 23-Feb-15 0 15
COR 12-Feb-15 12 17
CONE 18-Feb-15 16 13

Among other things, DuPont Fabros has conditioned a better performance of 2015 Normalized FFO to the financial performance of Net Data Centers, a top-seven customer that filed a voluntary petition for relief under chapter 11 on February 23, 2015. Responsible for approximately 3.5 percent of DuPont Fabros’s annualized base rent ($0.16 per share in revenues), Net Data Centers halted any 2015 base rent payments. As such, any revenue received from Net Data Centers will increase the 2015 Normalized FFO guidance.

As far as possible outcomes go, DuPont Fabros has not been able to determine whether Net Data Centers will resume payments or vacate the space. Additionally, DuPont Fabros management has not totally discarded the possibility of acquiring all or part of Net Data Centers. A colocation internet services company, Net Data Centers could potentially help DuPont Fabros broaden its scope of services.

Events like the one involving Net Data Centers remind investors that a high customer base concentration has been a vulnerable spot for DuPont Fabros. The failure of a single customer has greatly diminished its ability to continue growing in 2015.

The other challenge will be to lease a portion of Yahoo!’s space, which will expire on September 30, 2015. Fortunately, Yahoo! will vacate the space long before that so DuPont Fabros will have time to market it to new customers. If the company does not find anyone by September 30, 2015, normalized FFO will decline by $0.05 per share per quarter.

Lease Profile

One of the main concerns about DuPont Fabros is the low number of customers and high rate of concentration. The company has more than 100 lease expiration dates from only 38 customers, and the top four customers (Facebook, Microsoft, Yahoo!, and Rackspace) represent 60% of annualized base rent.

Also, although DuPont Fabros’s facilities are located in popular data center regions, 65 percent of its net leasable square footage is concentrated in Virginia, and the remainder is in California, Illinois, and New Jersey.

Nonetheless, lease expiration profile is not an imminent risk. The company has pretty much secured an average six years of triple net leases with full expense recovery. The only thing that caught my attention was that 40 percent of annualized base rent will expire within four years. However, this is not nearly as concerning as it is for DuPont Fabros’s peers – for CyrusOne, QTS Realty, and CoreSite, more than 40 percent of annualized base will expire by 2016.

Debt

Another concern is that DuPont Fabros has a good portion of floating debt (40 percent). The company has indicated that it is subject to higher interest expense due to new debt used for development, which will ultimately limit 2015 FFO results. This new debt could raise its total debt plus preferred to total market capitalization, which today is 33.6, the second-highest among DuPont Fabros’s peers. On the other hand, because it has a mid-range credit rating the company should pay reasonable rates in comparison with its peers.

Chart08

Ticker S&P Credit Rating
CONE B+
QTS B+
DFT BB-
EQIX BB
DLR BBB

Outlook

Recent developments have muddied the waters, and as a result DuPont Fabros’s outlook is unclear. The company has many short-term to-do’s. It must address the Net Data Center issue and, on a less critical level, find a replacement for Yahoo!’s partial move-out. Also, it must be able to grow debt for development without compromising FFO. Finally, despite his twenty years of experience in the wholesale data center space, Mr. Eldredge has yet to demonstrate that under his stewardship the company can continue to prosper. He won’t lack help from former CEO, co-founder, and newly-appointed board member Hossein Fateh.

The good news is that the company continues to move forward, expecting the delivery of 25.1 MW by the end of the year. This will increase IT load base by 10 percent. Further, Mr. Eldredge has been tasked with putting together a strategic plan for the company and presenting it to the board and investors by the fall. He will hopefully bring to light potential new paths for the growth of the company – new markets to prospect, ideas for marketing the recently-launched mini-wholesale product for possible retail customers, and additional add-on services.

Ultimately, the numbers speak volumes, and I still see a reasonably priced stock with sub-par short-term growth prospects in revenue, FFO, AFFO and quarterly dividend. Mr. Eldredge will have to get these waters clear first.

Note from the author: All tables and graphs (except for FAST Graphs) have been processed and put together by the author using sources believed to be reliable.

Source: DFT website and FAST Graphs.


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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.​

U.S. REIT – Digital Realty Disappoints

Release: 15 March 2015


  1. Despite impressive historical growth, Digital Realty’s revenue and funds from operations (FFO) growth rates have slowed significantly over the past three years.
  2. In 2014, Digital promoted positive initiatives to increase return over invested capital.
  3. However, net rentable square footage increase was weaker, and development space was proportionately lower.
  4. Inorganic growth could be a real game-changer and alter Digital’s trajectory towards mediocre performance in an industry full of growth opportunities.

Chart00

Despite a 15 percent FFO and 14 percent dividend compounded annual growth rate over the past ten years, Digital Realty (NYSE: DLR) has disappointed lately. Digital is one of the largest REITs in a fragmented industry with growing opportunities such as multi-tenant data centers, so I’d been hoping to see stronger performance. This is not in line with their target markets (mobile, social media, cloud, big data, and so on).

Chart01Source: Q4 2014 Earnings Conference Call Presentation

In public appearances Digital has been trying to live off its glorious past (which demonstrates management commitment to growth), but unfortunately the underlying truth is that the revenue, FFO, and dividend growth rates have slowed significantly over the past three years, and there hasn’t been any indication this will turn around in 2015. chart02

chart03

On one hand, in 2014 Digital promoted a number of positive housekeeping initiatives to increase return over invested capital. The company reduced finished inventory, initiated a program to strengthen the quality of its capital by selling non-core assets, reduced total debt and preferred stock to enterprise value from 47 to 39 percent, and incrementally boosted its portfolio occupancy from 92.6 to 93.2 percent. Kudos to senior management for these great efficiency-boost results (although they would be more suitable in a mature industry).

On the other hand, Digital’s latest size numbers simply haven’t been compelling. 2014 marked the company’s lowest expansion rate in net rentable square footage over the past ten years.

chart04

Further, development space is at its lowest in a decade in proportion to total net rentable square footage.

chart05

Note: ’13 and ‘14 use the most conservative published numbers.

In addition, Digital’s leverage has been higher than its data center REIT peers’ – despite the company enjoying one of the lowest interest rates in the industry due its BBB investment grade rating. For Q4, Digital’s average debt rate was 3.99 percent, as opposed to QTS – Quality Realty’s 4.74 percent, DFT – Dupont Fabros’s 4.1 percent, and EQIX – Equinix’s 4.93 percent. COR – CoreSite is the only competitor that enjoys a lower rate, at 2.5 percent.

chart06

chart07

Moreover, Digital’s dividend has stalled. Annualized Q1 2015 dividend grew only 2.4 percent compared with 2014 annualized dividend.

chart08

Last but not least, 2015 guidance has been disappointing. Digital’s management believes that both FFO and Core FFO (which has been tracked by the company since 2012) will stay at current levels, despite pronounced growth rates in previous years.

chart09

Although size might be a reason for underperformance compared with Digital’s smaller peers, Equinix – which also targets enterprise – has been enjoying better revenue growth rates.

chart10

Source: MarketWatch

Overall, Digital Realty isn’t a bad company. Quite the opposite, in fact. It enjoys healthy margins (Adjusted EBITDA has been flat at around 60 percent), and has been distributing most of its adjusted FFO. Dividend yield is currently at 5.3 percent, price-to-FFO has been around 13 (lower than its peers), and annualized rents have been growing. That should explain why some analysts are still bullish about Digital. See chart below.

chart11

Source: Benzinga, March 13, 2015

Digital’s management seems to be committed to finding a path to rapid growth. They’ve been trying new products and attracting small to mid-size clientele. Also, they decided to begin a strategic evaluation. The only downside is that it might take a while for Digital to figure out which direction to pursue next.

If organic growth is slowing down, inorganic growth can be a real game-changer and alter Digital’s trajectory towards mediocre performance. Chief Executive Officer and Chief Financial Officer William Stein hasn’t discarded the possibility of opportunistic acquisitions in 2015. However, I personally have made up my mind, and will wait for the next ride – this one won’t lead me to the express lane.


Did you enjoy our newsletter? Subscribe and receive for free our biweekly newsletter in your inbox. We won’t sell your email address to third parties. It’s our privacy policy!

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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.​

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.

chart05

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.

chart01

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.

chart02

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.

chart04

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.

chart03

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.

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.

Chart01

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.

­­

Chart02

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).

Chart03

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

Chart04

Chart05

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

Chart06

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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)

Chart08

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

Chart09

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.​