Investor Relations: The Data Center REIT Technology Leadership Void and Establishing a Corporate Ide

Data Center Real Estate Investment Trusts (REITs) represent a compelling asset class. These companies sit at the nexus of the development of new technologies like artificial intelligence, machine learning, and self-driving cars, and the introduction of these technologies to mainstream society. For several years, data center REITs benefited from robust demand from hyper-scale cloud providers such as Amazon, Microsoft, Google, Facebook, Apple, Oracle, and Alibaba, among others. Technological advancement represents the lifeblood of data center REITs. We believe the data center REIT sector currently suffers from a lack of technological leadership, and we believe investor relations from a Wall Street perspective represents a primary tool toward developing a corporate identity, repairing management credibility, and ultimately filling the technology leadership void in Data Center REITs.

Data Center REITs face a technology leadership void. The technology leadership void began with:

1. The departure of CEO Tom Ray from CoreSite in the summer of 2016, followed by

2. The departure of CEO Chris Eldredge from DFT Data Centers in September 2017, and culminated in

3. The unexpected departure of CEO Steve Smith from Equinix in January 2018.

Each of these executives were respected for their ability to provide insights into technological evolution and how technology trends impacted the future for Data Center REITs.

To fill the technology leadership void, the Data Center REIT management team at a particular company must be focused on building a technology identity rather than building a REIT focused identity. While data centers are REITs, they adopt the investment structure to benefit from the tax advantages of being a REIT. Despite being a REIT, the primary way for a data center REIT to unlock value to shareholders revolves around technology. Ultimately, Data Center REITs work as investments because the breakneck pace of innovation in technology continues to drive significant demand for data center space and power. In our view, Data Center REITs are purely a commodity if a Data Center REIT is only a box with power for sale at some per kW per month rate. Data Center REIT managements and investor relations officers need to provide and focus on the context that makes these business attractive investments.

Why Does Technology Matter So Much?

1. Technology trends drive industry demand and therefore valuation. The golden metric of Data Center REITs is leasing activity and development.

2. Investors view the industry through the Equinix lens – a company driven by technology e.g. cross connects, rather than real estate.

3. REIT investors are not necessarily expert technologists.

Certainly, being a REIT attracts a significant REIT investor base. Furthermore, REIT investors likely enjoy talking to a REIT-style counterpart in investor relations or the C-Suite. Nevertheless, as a data center REIT Investor Relations Officer (IRO), my perception was that the way to unlock shareholder revolves around technology information flow around the drivers of data center demand. REIT investors are clearly competent in terms of modeling FFO and AFFO, therefore, these investors really seek the information and insights that can be provided regarding technology trends, since this may be outside their normal purview.

A significant problem I faced at DFT was that the investment community viewed the data center REIT group through the Equinix lens. The worldview when I started my tenure held that cross-connects were king, and anything that looked similar to Equinix was attractive. In this worldview, there were two distinct identities (1) Equinix driven by cross-connect, and (2) DFT driven by wholesale. The attractiveness and identities of the other data center REITs (CoreSite, CyrusOne, Digital Realty, and QTS) were a function of how closely business strategy mimicked that of Equinix.

A main accomplishment of our tenure at DFT revolved around educating the investor community that DFT represented the inverse of Equinix. A puzzle analogy will illustrate. If you operate a traditional retail colocation or cross connect business, your customer base most likely resembles a jigsaw puzzle. Customers are buying racks or cabinets and at times piece 753 and 342 might become available, but unfortunately are not contiguous. In wholesale, the customer set resembles more of a toddler puzzle with four pieces, as hyper-scale entities typically are purchasing an entire room of power versus a couple of cabinets or a couple of cross connects. Therefore, in wholesale, customer concentration and geographic concentration should be less of a concern if levered to the right customers e.g., hyper-scale cloud, et al.

Currently, the data center REIT industry faces two primary problems:

1. Lack of technology leadership, and

2. A lack of strong individual company identities built on technology.

In our view, CyrusOne and QTS are likely the best positioned to fill the leadership void and create strong individual company identities. Other contenders include Switch, as well as several private companies such as: Vantage, Raging Wire, OVH, Cyxtera, and EdgeConnex, among others. In our view, Equinix already represents an industry leader, despite the recent CEO departure, and the executive teams of both CoreSite and Digital Realty Trust are too REIT dominant to fill the technology leadership void.

Below, we provide our thoughts on how the IR programs at each data center REIT may help fill the leadership vacuum. We think implementing investor relations from a Wall Street perspective can help Cyrus One and QTS establish strong identities, and improve credibility, all while filling the technology leadership void in data center REITs.

Can CyrusOne (CONE) Fill the Leadership Void?

We believe CyrusOne represents the best positioned company among the publicly traded Data Center REITs to fill the technology leadership void in Data Center REITs. Management is the most agile in the industry given their ability to both reignite growth via acquisitions and shift the business from predominant retail colocation to significant wholesale on the fly, something QTS has not been able to achieve. While the company suffers from a credibility problem (investor either think it is the greatest or a complete fraud), we think the strong executive team combined with investor relations from a Wall Street perspective can entrench the company in a leadership position.

Primary problem: Credibility and Lack of Consistency

CyrusOne represents the Data Center REIT best positioned to fill the technology leadership void while creating a technology dominant corporate identity. The company deserves credit for much of the innovative work it utilizes to build data centers in a quick and cost-effective manner. The problem lies in a lack of a consistent message, which causes confusion among investors. Furthermore, the company benefits from the most technology dominant executive team, as well as the most charismatic. Unfortunately, the combination of inconsistent financial presentation, lack of identity, and charismatic executives, does not typically translate in maximum shareholder value.

Why Is CyrusOne Best Positioned to Fill the Void?

As stated above, CyrusOne benefits from the most technology dominant executive among the publicly traded Data Center REITs outside of Equinix. The company has exhibited an ability to scale up through acquisition, as well as an ability to re-accelerate revenue growth through acquisition. While Equinix and Digital Realty Trust represent the largest Data Center REITs, we believe CyrusOne will likely be able to scale up to their size via acquisition over time.

How Do You Fix the CyrusOne Credibility and Consistency Problem?

While CyrusOne is best positioned to fill the leadership void, we believe the company would benefit immensely from investor relations from a Wall Street perspective. The company’s strength lies in its confident presentation of its story; however, lack of consistent message means the company struggles with clarity, which leads to sub-optimal investor engagement. We believe CyrusOne can resolve its credibility issue while further establishing a technology dominant corporate identity via an investor relations program from a Wall Street perspective.

Executive Strength. The single greatest asset of CyrusOne is the company’s executive team. Management deserves credit for creating innovative ways to build data centers quickly and cost effectively, for re-accelerating growth via acquisitions, and for confidently presenting the company to investors. The executive team benefits from significant technology experience, which we believe should be showcased via the earnings call to establish a dominant technology identity. We believe CyrusOne would benefit from positioning its CEO as a leading tech thinker who is on top of the latest technology trends.

Formulaic Earnings Call. The company would benefit from a more formulaic earnings call that focuses on telling the CyrusOne story. An earnings call that sticks to the primary KPIs and accomplishments that further highlight the long-term story provides immense value. Essentially, the earnings script should talk about the same topics in the same order each quarter, updated for the most recent quarter performance. Using the earnings deck to drive the earnings script causes management to talk about too much and can shift focus away from telling the long-term story.

Streamlined Presentation. A key issue for CyrusOne revolves around a lack of consistency in presentation. For example, the company has a penchant for providing spot metrics e.g., the cost to build per MW in terms of Amazon. When CyrusOne talks about its cost to build being below $5 million per MW, they are attempting to show parity with Amazon AWS. The problem is that no other industry participant discusses this metric, and all it does is call into question the long-term viability of the industry. The company would benefit from identifying the most important metrics it wishes to discuss to highlight the long-term viability of the business and discuss those specifically.

Separate Earnings Deck from Call Script. CyrusOne would benefit from separating the earnings call script from the earnings deck. In our view, a company needs to treat the earnings script, earnings deck, and investor deck as distinct products. When attempting to pull double duty from any of these products, the company runs the risk of obscuring the long-term investment thesis, which drives sub-optimal investor engagement. In the case of CyrusOne, pulling double duty creates a lack of clarity between the short-term and long-term context of the company’s performance. The earnings deck should be treated as a pictorial supplement to the earnings script.

Create Stand-Alone Investor Deck. CyrusOne utilizes its earnings deck as its primary investor deck. A stand-alone investor deck will allow the company to establish its identity while presenting the company over the long-term view. An Earnings Deck, by definition takes a short-term look at the company, as it focuses on the performance in the most recent quarter. Both current and new investors are not making an investment solely on the performance of the current quarter. Investors need to understand the context to how your business evolves over time, hence the importance of the long-term view.

Earnings Supplement. The company would benefit from disclosing the names of customers listed in the Customer Diversification Section of the earnings supplement. While CyrusOne identifies their top customers in the earnings deck, the company provides no way to tie back the logos to actual rankings listed in the supplement. The lack of connection between the supplement and earnings presentation represents a prime example of lack of consistency in financial messaging. Tying these two products together would drive greater clarity, as well as unlock shareholder value.

Can QTS Fill the Leadership Void?

We believe QTS deserves a lot of credit for trying to improve their positioning given the take out of DFT Data Centers, and recent activist attack from Land and Buildings. Unfortunately, some of QTS’ problems are of their own making, given the perception of poor messaging around the investor day in late 2017, poor messaging around 4Q17 results (abrupt change from analyst day), as well as poor messaging around recent churn events. Investor relations from a Wall Street perspective would help immensely, as the company has the right executive bench strength (CFO and IR are both ex-Wall Street) to fill the Data Center REIT leadership void and would help QTS establish a true corporate identity.

Primary Problems: Investor credibility and poor execution.

QTS suffers from an investor credibility problem stemming from poor consistency of message around their analyst day in November 2017, and subsequent business model changes unveiled during 4Q17 earnings in February 2018. Furthermore, we think the company’s messaging around recent churn events further exacerbates the problem. Lastly, QTS’ business model of re-positioning assets means the company needs to relentlessly educate the investment community on why their contrarian model works well.

How to Fix the Problem?

QTS needs to convince investors that it can take share in hyper-scale cloud leasing. Secondly, the company needs to anchor investor expectations to is forecast of $3.50 in OFFO in 2020. Ultimately, QTS’s future success will be a function of how well it executes on hyper-scale leasing opportunities and how well it anchors investor expectations to $3.50 in OFFO in 2020.

How Can Investor Relations from a Wall Street Perspective Achieve this End?

Utilize Executive Strength. First, QTS should do everything it can to leverage the Wall Street background of its CFO and Investor Relations executives. QTS should utilize its earnings calls to put its executive team as technology leaders that can meet the needs of hyper-scale customers.

Formulaic Earnings Call to Establish Identity. QTS needs to do two things to be successful (1) anchor investor sentiment to the viability of $3.50 in OFFO in 2020, and (2) close true hyper-scale cloud leasing. The earnings call should be set up in such a way to achieve these two ends. The prepared remarks need to be balanced between talking about the company’s achievements and holding the company out as a thought leader in technology. If the company can simplify its investor messaging to communicate strong OFFO performance, increasing margins, and hyper-scale execution, then QTS will be a huge success.

Stand Alone Investor Deck. One of QTS biggest problems revolved around the lack of a distinct set of earnings slides and investor slides. In February, the company made strides in creating its first stand-alone investor deck, which should help immensely. While the presentation represents a great start, we believe the deck remains over complicated and buries the most important information.

Separate the Earnings Deck and Conference Call Script. One of the worst practices we can think of is using an earnings slide deck that doubles as the investor deck to drive the prepared remarks on the earnings call. In our view, following this methodology obscures the message and results in management’s prepared remarks drifting off topic rather than sticking to what is most important. QTS needs to do all it can to establish and illustrate an identity as a technology thought leader in data centers. The primary way to do so revolves around using management’s prepared remarks on the earnings conference call.

Earnings Supplement. QTS benefits from one of the best and most transparent earnings supplements in Communications Infrastructure. The company would be well-served to identify some of its top customers by name rather than industry. All QTS needs to do is show that some of the top customers are key technology players, and then build out that list over time. Identifying customers will go a long way to unlocking shareholder value.

Hyper-scale Leasing Execution. QTS continues to position themselves as an attractive wholesale player. The company began the shift with the introduction of hyper-block leasing several quarters ago. Recently, the company benefited from a couple of hyper-scale leases that range from power shell to significant wholesale. QTS needs to establish a track record of winning significant wholesale leases.

Anchoring Investor Expectations. QTS deserves significant praise for anchoring investor expectations to $3.50 in OFFO in 2020 in several of their investor presentations. Providing investors a pathway to future earnings expectations allows them to apply a simple multiple to value the company. In this case, $3.50 in OFFO by 2020 on a depressed 15x multiple yields an approximately $53 stock.

Quick Thoughts on Switch (SWCH) and Private Data Center Companies

The primary problem at Switch revolves around credibility, as the company remains a relatively new public company, given its IPO in late 2017. Switch already reported its first quarterly results as a public company in 3Q17. The problem is that they provided no earnings supplement. Providing an earnings supplement is required in Data Center REIT land to be taken seriously, as all the companies provide an earnings supplement.

There are several private Data Center companies that could easily position themselves in way that creates a strong corporate identity around technology and allows them to fill the Data Center REIT technology leadership void. Some of these private companies are Vantage, Cyxtera, EdgeConnex, OVH, RagingWire, among several others.