Analysts Admit They Were Wrong To Doubt Data Center Stocks

• Shares of DuPont Fabros Technology, Inc. DFT and Centurylink Inc CTL have declined year-to-date, and over the past one month.
• Macquarie’s Kevin Smithen maintained on Overweight rating on both the companies.
• Smithen mentioned that their initial bearish thesis for data center stocks may have been flawed.

Analyst Kevin Smithen said that the key TMT and REIT investor database had evolved over the past 18 months. It was only recently that the multi-tenant colo model was expected to be erased completely by:

1. The Cloud
2. Declining footprint of physical servers
3. Rise of insourcing by tech giants like Google, Microsoft and Facebook

“Over the last year, while investors were focused on the thematic growth prospects of wireless telco, fiber and CDNs, and trying to rationalize declining lower multiples (since the 1H14 rally), data centers have gained noticeable mind-share,” Smithen wrote.

The analyst believes that there are three “key areas of improvement” that have resulted in improvement in the sentiment towards data centers –

Pricing: “We believe the inflection point for pricing in the wholesale colo space is behind us after bottoming in ‘12/13.”

Dividend yields: Average yield in the data center segment is 4.4 percent, with DFT and DLR offering yields of 6.4 percent and 5.3 percent, respectively. The analysts expect 10-year yield of less than 3 percent for the next few years.

Growth opportunities relative to telecom and infrastructure peers: The industry is in its initial stages and enjoys structural tech and outsourcing tailwinds. This should result in public operators generating a 10-15 percent revenue CAGR over the next five years.

“In addition to strong domestic organic demand, in our view there are ample opportunities to accelerate growth and valye creation with burgeoning int’l mkt’s like Singapore and active private mkt for data center assets in the US,” Smithen mentioned.

DuPont continues to be the top data enter in Macquarie’s coverage. The company’s stock appears attractive following the recent weakness, Smithen said, while mainlining the price target at $40. Citing Centurylink as a high-yielding telco, the analyst maintained a price target of $37.