Why Investors Should Consider Data Center REITs, According To Jefferies

Data center REITs benefit from the exponential growth of: cloud computing, wireless data, Internet of Things, big data, as well as a skyrocketing demand for streaming media.

Jefferies this week published a comprehensive 46-page research report, "Outlook Remains Strong as the DC REITs Consolidate the Industry," and announced that Jonathan Petersen is taking over four data center REITs under coverage.

Data center REITs provide the infrastructure and in many cases the connectivity, required by both government customers and enterprise customers to run legacy IT workloads, as well as private cloud and hybrid cloud applications.

Familiar Data Growth

The Jefferies report pointed out examples of CAGRs (compound annual growth rates) that most investors can relate to: YouTube hours of upload per minute at 68 percent and rising steeply; hours of Netflix video streamed per month up by 54 percent; and Facebook monthly mobile traffic growing at 34 percent.

Earnings Growth

According to Petersen, "In 2014, the top data center markets saw supply increase +21%, but market vacancy decline -160 bps, which suggests that demand outweighs supply."

Tale Of The Tape - Past Year

While CorSite Realty was mentioned in the report, it is not covered by Petersen.

• Digital Realty Trust, Inc. DLR $9.9 billion cap, 5 percent yield. Hold $71 PT (raised).
• DuPont Fabros Technology, Inc. DFT $2.4 billion cap, 5.6 percent yield. Hold $32 PT (lowered).
• CyrusOne Inc CONE $2 billion cap, 4.1 percent yield. Buy $37 PT (n/c).
• QTS Realty Trust Inc QTS $1.6 billion cap, 3.2 percent yield. Buy $45 PT (raised).

Notably, $15.4 billion cap Equinix Inc EQIX will now report as a REIT as of January 1, 2015, and is being covered by another Jefferies analyst. Equinix carries a Buy rating and recently announced an initial dividend yielding 2.5 percent. Shares have gained 28.25 percent during the past 12 months making them the second-best performer.

Equinix is the global leader in interconnection, and stands to benefit from the 37 percent projected CAGR in Asia/Pacific, as well as the 26 percent CAGR in North America.

While Equinix is the now the largest REIT by market cap, Digital Realty is still by far the largest REIT when it comes to square footage and 130-owned data centers. Digital will also benefit from having a global footprint, its recently announced Telx acquisition to boost interconnection revenues, as well as by having Equinix as a tenant in key locations.

Related Link: Now It's Official: A Look At Digital Realty's Strategic Telx Acquisition

Jefferies - Data Center REIT Trends

M&A Accelerating: As the industry has matured over the last decade, Jefferies sees "a natural progression" of industry consolidation by the publicly traded DC REITs. In addition, to DLR/Telx, recent announcements included EQIX acquiring TelecityGroup; CyrusOne acquiring Cervalis; and QTS acquiring Carpathia.

Petersen noted that these acquisitions are generally accretive, with the QTS and CONE acquisitions immediately accretive to earnings in the first year.

Connectivity Is Key: DuPont Fabros and Digital Realty have historically focused on larger, "wholesale" deals of 1 MW and larger, rather than smaller colocation customers. Digital Realty's recent moves are a clear signal it is evolving its strategy toward interconnection, and DuPont Fabros has a new CEO with a telecom background who is currently conducting a strategic review.

Branded Products: Jefferies believes that DC REITs are one of the few sub-sectors, "where brand recognition matters." Petersen pointed out, "CONE and QTS have proved, there are strong revenue synergies in having wholesale, colocation, and interconnection data centers, and DLR seems to be following their lead."

Jefferies - Top Picks

Petersen views CONE to be its top sector pick, along with Buy-rated QTS, projecting 12-month total returns of 27 and 17 percent, respectively.

These picks are expected to generate above average FAD (funds available for distribution) growth during the next three years according to Jefferies. Both currently trade at a discount to NAV (net asset value).