You no doubt agree with me that M&A in the data centers industry will continue growing for the foreseeable future. In 2017 alone, 48 M&A deals with a total value of $20 billion went through.
This article is a data center report in which we are going to look at the trends in the data center industry. We will look at the changes in demand for add-on services, changes in edge markets, and why companies are interested in data center Real Estate Investments Trusts (REITs).
5 Trends to Watch for in 2018
1) Industry M&A is here for the long-term
The number of M&A deals in 2017 surpassed the total number of deals made in 2015 and 2016 combined. As companies in the data center market continue to expand in scale, expertise and service, the number of M&A deals are only going to increase.
2) Increasing Interest by Foreign Data Center Companies in US Market
A number of foreign data center businesses are venturing into the American market. Their objective is to offer their services to American customers.
3) Increased Demand for Add-On Services
With the continued growth of data center companies, businesses increasingly look for add-on services. Businesses also increasingly outsource data center expertise. Add-on services increase the popularity of hybrid data center models.
4) The growth of “Edge” Markets
Data center companies strive to be as close as possible to end users. The effect of this trend is that it increases growth in niche markets. Therefore, “edge” markets will play an increasingly important role in data center strategies.
5) Increasing Complexity, Uses, Facilities, and Solutions
Over the past couple of years, the technology and design in data centers has significantly become complicated. This trend will continue for the foreseeable future.
State of the Industry
As 2017 drew to a close, data centers worldwide had absorbed 583.5MW of power. The leaders in power usage were US and Canada, having absorbed 363.5MW. These were followed by Europe, Middle East and Africa (EMEA) at 135.0MW, and Asia Pacific (APAC) at 85.0MW.
Even with the dynamism of the data center industry, the power absorption remained relatively constant. In most of the major markets, cloud leasing is still a primary driving factor. Cloud operators alone drove 25% of leasing. Surprising, right?
JLL Data Center Solutions observed that “edge” markets started experiencing large increases in absorption during the latter half of 2017. The key players in the data center industry began expanding their geographic reach by venturing into Phoenix, Atlanta, LA and other “edge” cities.
That’s not all…
In general, the power absorption rate in 2017 started normalizing following the end of the leasing frenzy of 2016. Even with the decreasing absorption rate of data center services, there is still a lot of untapped potential in most of the key markets.
There was also an increase in the number of new data center construction projects in the last 12 months. The construction plans for data centers in 2017 outdid the number of plans made in a similar period in 2016.
JLL’s data center industry report shows that regions with the largest construction plans for data centers include Chicago (34MW), Northern Virginia (22MW) and Dallas (22MW).
2017 M&A Round-Up
In 2017, the following major M&A deals were made: Digital Realty acquired DuPont Fabros for $7.6B, Equinix’s acquired Verizon’s data center business for $3.3B, Equinix acquired Metronode for $800M and CyrusOne acquired Zenium for $442M.
According to Synergy Research Group, enterprises are concentrating on M&A to improve their IT capabilities and technologies. It should be noted that most companies did not complete M&A deals just for the sake of physically owning more data centers.
Digital Realty and Equinix were the major players in the 2017 M&A deals. Equinix acquired data center companies from all over the world. However, Digital Realty bought data center companies in Europe and North America alone.
I can’t emphasize this enough:
As data center companies acquire other data center companies, one outcome is a significant increase in network complexities. Consequently, this creates new growth opportunities in the industry.
Another outcome is an increase in the size and technical complexity of physical assets. According to JLL’s date center assessment report, data center operators are looking for more ways to increase their cost efficiency and optimize usage.
2018 and 2019 will see a significant increase in resource investments by both data center operators and occupiers in a bid to increase innovation. The areas that are earmarked for improvement include cooling systems, increased IT functionality and load adjustment.
The Year of Foreign Interest
2016 was called the “year of the cloud.” Why? Because cloud providers took a lot of capacity, which ended up affecting all the major and secondary markets in the US.
2017 was referred to as the “year of international exploration.” Data center companies and their operators expanded beyond American borders. They ventured into major markets like Amsterdam, London, and Sydney.
2018 will be called the “year of foreign interest.” In 2018, international data center companies will venture into the US market in an attempt to serve data center users and customers in the country.
Why does this matter?
With its 1.3 billion people, China is a key player in the data center industry. In its data center audit report, Technavio predicts that in the next 4 years, China’s data center sector is poised to grow by 13%.
Chinese companies like Alibaba, Baidu, GDS, and Tencent will create more competition with American giants like Microsoft, Google, and AWS.
There are also other rapidly expanding players from Australia, Japan, and the UK that are diversifying on product and price offerings of their American competitors.
So as to get ahead of the international curve, US companies are partnering to consolidate their markets. For example, CyrusOne + GDS, Apple + GCBD, Equinix + Metronode, and Amazon + Beijing Sinnet Technology are great examples.
Data Center REITs in Review
With an increase in the uses and need for data centers across the globe, data centers have grown exponentially and become more dynamic.
Data center-focused Real Estate Investment Trusts (REITs) have become major players in the industry. REITs have facilitated the physical growth of the industry. In fact, the growth is so huge that the stock price of data center specific REITs grew 1.4% in 2015, 22.8% in 2016 and 25.2% in 2017.
Why Data Center Operators and Developers Became REITs
The main reason behind data center operators and developers becoming REITs was to get access to very low cost capital. Data centers are very capital-intensive and this is the highest entry barrier.
REITs are required by law to distribute at least 90% of their taxable incomes to shareholders as dividends. This gives REITs the ability to deduct dividends paid out to shareholders from their taxable income.
For long-term leases, data center REITs have stable rent for long-term leases, adding to the benefits associated with operating as a REIT instead of a standalone developer.
That’s not all…
Companies also prefer working with data center REITs because of two reasons:
First, most of the success REITs enjoy comes from their scale of operation, expandability, and geographic reach, which individual developers cannot match.
Second, companies working with a REITs can adapt their operations quickly. This allows them to receive a very redundant product within a short time and at a low cost.
Why is this important?
In their data center market report, Cisco predicts that the demand for content, data creation, and internet traffic will grow by 20% over the next four years. This will fuel exceptional growth for networks, servers and data center facilities.
Even as we discuss REITs, it is important to remember that there are numerous small players, each holding 2% or less of the market. This adds up to 46% of the global market share, which is larger than REITs market share of 35%.
In the one year ending in 2017, the global leasable area offered by REITs has changed dramatically. Just to illustrate, CyrusOne grew 46.4%, CoreSite grew 0.1%, Digital Realty grew 20.2%, QTS grew 8.1% and Equinix grew 70.4%.
The gross leasable area offered by REITs was 51.5 million square feet in 2017, which was a 26% increase compared to 2016. Equinix’s 70.4% growth in 2017 was due to its acquisition of Verizon’s data center infrastructure.
What’s the real story?
The stock growth in data centers was highest in 2015 and 2016 when it significantly outperformed the stock market. Growth slowed down significantly in 2017. Interestingly, stocks of data center REITs grew 68% over the past 3 years, nearly tripling the growth of S&P 500.
The merger between Digital Realty and DuPont Fabros in 2017 created one of the largest data center REITs in the world. Even with Digital Realty’s 27.7 m.s.f footprint, that is thrice that of Equinix’s 9.2 m.s.f, it only generates 1.9% more funds from operations.
That’s not all…
Data center REITs have had a painful past few months. For example, JLL’s data center risk assessment report shows QTS’s stock dropped for 5 months in a row, and in one day in February 2018, dropped 22.7%.
Even as growth in the data center industry remains steady, their stock prices will remain discounted based on the total value of assets held. The five largest data center REITs have a net asset value of $68 billion discounted at 2.1%, making them the industry’s underdog.
In conclusion, data center REITs have used four main strategies to grow.
First, they have capitalized on buying land in preparation for future growth. These companies are purchasing land around the planet with the goal of expanding, and further establishing themselves in markets where they already have a presence.
Second, REITs have set their sights overseas, where they purchase assets, strategically acquire and lease large amounts of capacity.
Third, data center REITs are focusing on hyper-scale. This is true for the five biggest data center REITs. CyrusOne leads in the hyper-scale race, and other REITs have made massive strategic moves to remain in the game. An example is Digital Realty’s acquisition of DuPont Fabros.
Finally, growth is the main acquisition vehicle by which REITs grow. Equinix is a great example, with $1.05 billion in pending international purchases. In second place is CyrusOne and Digital Realty, both having leveraged acquisitions and international partnerships.