I love it when rain keeps falling on a company whose future is
News that the InternalRevenue Service was scrutinizing this
company's application to become areal estate investment trust
(REIT) sent theshares down 5.5% in one day last month. Regardless
of whether the company is allowed to change its corporate status,
the fact that it's applied to do so means upward of $420 million
in additionaltaxes over the next four years.
This company's shares also took a beating on April's
first-quarterearnings report, plummeting 12% when revenue and
profits missed loftyanalyst expectations. Even though revenue
increased 17% over the previousyear and the company'sgross margin
was an outstanding 50%,analysts expected 7 cents more in earnings
per share. Investors punished thestock , and short-sellers are
swarming, with almost 17% of theshares outstanding borrowed and
But all this just gives investors a chance to pick up a growth
story that might soon be announcing a 10%special dividend . This
company is in one of the hottest sectors of the tech world, and
it's made a commitment to returningmoney to shareholders.
The Growth Industry That Doesn't Have To Pick Sides
The tech world is notoriously competitive, and investors usually
have to pick the winner of the next software or hardware
Witness the battle over mobile supremacy between
Apple (Nasdaq: AAPL)
. Growth in the sector doesn't necessarilymean that bothwill
profit as they fight over prices, software and rounded
Investors in Internet search giant
Baidu (Nasdaq: BIDU)
understand this all too well. Rival
Qihoo 360 (
has stolen Baidu's spotlight and helped drive a 40% loss in BIDU
over the past two years. Almost 400 million new Internet users in
China since 2006 could not keep the country's largest search
engine from losing the battle between PCs and mobile devices.
The growth in data center needs means that providers are not
forced to compete in a no-holds-barred deathmatch. The number of
Internet users worldwide doubled between 2006 and 2011, from 1.04
billion in 2006 to more than 2 billion users, and that still
leaves 5 billion people to be connected. The number of
smartphones in use around the world is expected to jump 400% to 2
billion by 2015.
With growth happening everywhere,investment for new centers
and equipment is expected to exceed $35 billion this year. These
are not services that can be outsourced to one or two locations
around the globe -- they must be built close to clients. When
your clients are every Internet and data user on the planet, then
you're going to need more data centers.
In this industry, it's a race toput up enough locations to
serve exploding demand.
Equinix (Nasdaq: EQIX)
is an $8.7 billion provider of data center services to protect
and connect the information assets of enterprises and network
providers across the globe. The company serves more than 4,000
companies with managed IT infrastructure and co-location
services, as well as connecting companies directly to their
customers with its own interconnection platform.
In September 2012, Equinix's board approved the conversion to
a REIT, with January 2015 as the target conversion date.
Converting to a REIT could save Equinix between $55 million and
$130 million a year on taxes.
News broke that theIRS was scrutinizing the company's
eligibility for REIT status last month, and EQIX was hit hard.
It's now down 20% from its $230 peak this year.
At odds with the IRS is the treatment of interconnection fees
Equinix receives for services like power and telecom networking.
The fees brought in $272 million in 2012, or about 14% of total
revenue. Other data center REITs like
CoreSite Realty (
do not account for these fees as tax-exempt, so to qualify for
REIT status, the company may need to change itsaccounting and pay
taxes on the portion of revenue. Three other data center
companies -- CoreSite,
Digital Realty Trust (
DuPont Fabros Technology (
-- are already operating as REITs, so there is a powerful
precedent for Equinix's approval.
Thedownside to filing for REIT status is that the company will
need to pay between $340 million and $420 million indepreciation
recapture taxes for reclassifying its assets asreal estate . The
amount is payable over four years and already modeled into the
Revenue in 2012 came from a broad variety of services,
including networking (26%), cloud and IT services (24%),
financial services (21%), content and digital media (20%), and
enterprise (9%). Revenue has grown by an annualized 28% since
2008 while costs have grown at a slower 24% pace, meaning that
margins are improving with highersales . Gross margins are
expected to be an outstanding 68% for 2013, about the industry
Ownership in the stock is at 115% of shares outstanding
because of extremely strong institutional holders and the 16.8%
of shares shorted. Some big hitters own Equinix, including Coatue
Management (8.9%), Goldman Sachs (4.9%), Lone PineCapital (4.6%)
and Paulson & Co. (4.2%). The fact that more shares are owned
than issued means that any strength in the stock could quickly
lead to ashort squeeze as short-sellers are required to cover
their borrowed shares. This could happen on any favorable notice
by the IRS.
Make A Quick 10% Return And Keep The Shares For
On top of its regular distribution once it's been granted REIT
status, Equinix expects toissue a special distribution of $700
million to $1.1 billion in undistributedaccumulated earnings and
profits. Theannual report lays out the plan to do this in a
combination of 20%cash and 80% stock after a favorable ruling
from the IRS, with the distribution to be mostly completed before
2015. Splitting the difference on the $700 million to $1.1
billion, a special distribution of $900 million would amount to
$18.75 a share, or just over 10% of the current share price.
An analysis of the company'scash flow backs up the argument
for a healthy dividend.
This amounts to a dividend of $10.91 per share and ayield of
6% on current price. Although most companies do not pay out all
distributable cash, a distributed cash flow-to-dividend ratio of
1.5 is common and would yield a $7.25 dividend for a 4% yield.
This yield should easily be sustainable and still leaves plenty
of cash for capital expenditures and growth.
Analysts at Wells Fargo agree. They estimate that the company
is worth much more, giving it an "outperform"rating and a
valuation range of between $277 and $293 per share.
Risks to Consider:
Even with the 20% drop in the shares, the stock is trading at
an expensive 61 times trailing earnings and could fall further if
the IRS declines togrant it REIT status.
Action to Take -->
Other data center companies have been allowed to convert, and it
should only be a matter of time before Equinix receives good
news. The stock has some strongupside catalysts and could be a
good addition to your REIT portfolio.