Data Center Owners Expect More M&A, But Headwinds Could Push Down Values

The data center industry's corporate landscape is undergoing a major transition, and top executives expect the spree of merger and acquisition activity to continue this year. But emerging headwinds are beginning to slow an unprecedented investment boom and could depress data center valuations.

Over the last year, the number of data center-specific REITs has dwindled from five to just two — only Equinix and Digital Realty remain, with QTS and CyrusOne purchased by private equity firms and CoreSite’s acquisition by American Tower.

Several other digital infrastructure REITs own large data center portfolios, including American Tower, DigitalBridge and Iron Mountain, and they have spent aggressively to grow those portfolios over the last year.

Speaking on earnings calls over the past two weeks, industry leaders have suggested this surge in M&A is likely to continue in the months ahead. Large colocation REITs Equinix and Digital Realty both indicated that acquisitions and joint ventures would continue to be central to overseas expansion, while companies like DigitalBridge indicated they would continue to expand their domestic data center portfolios through M&A. 

“We continue to believe M&A is a very appropriate and powerful tool in the kit. We've been very successful at it, and we're going to continue to look at it as an opportunity to extend our reach, scale and our business in key markets,” Equinix CEO Charles Meyers said. “We're actively involved in those processes.”

Driving this continued consolidation, at least in part, experts say, is the importance of scale in addressing rising costs, supply chain issues and other headwinds facing the data center industry. When it comes to purchasing power with equipment manufacturers, the bigger the better. 

Issues acquiring equipment and rising prices are just two of the growing challenges industry insiders suggest will squeeze margins and perhaps lower deal valuations in the coming quarter. Increasing energy costs, likely to be exacerbated by the ongoing conflict in Ukraine, are a growing challenge. Industry leaders also point to labor shortages and rising interest rates, which present a particular challenge for REITs and squeeze the amount of private capital in the market. 

During DigitalBridge’s earnings call Thursday, its CEO predicted these factors would result in reduced valuations for data center assets in the coming year. While data center companies were selling for as much as 31 times their publicly traded value last year, DigitalBridge CEO Charles Ganzi says he expects that to drop into the mid-20s. 

“We see these transactions tightening up a bit,” he told analysts. “There are real headwinds out there.”

Below are some key takeaways from the Q4 earnings reports of major data center owners. 

Data center REITs report strong growth, but costs are rising

Equinix and Digital Realty, the two remaining data center-exclusive REITs and the colocation market leaders, both posted strong growth numbers in Q4 and for 2021 overall. Both companies also announced strong development pipelines for the coming year. But growing costs have some investors concerned.

Equinix reported $1.7B in revenue for the fourth quarter, up slightly from Q3 and a 10% increase over the previous year’s Q4. The company had its 19th consecutive year of growth in 2021 with $6.6B in overall revenue. On its Q4 earnings call, the company also announced 17 new development projects for the coming year, including four in North American markets: Los Angeles, Toronto, Calgary and the D.C. metro area. 

Digital Realty reported quarterly revenues of $1.1B, which were down from Q3 but an improvement over the last quarter of 2020. The company also grew year-over-year, with more the $500M in new business. The last year also saw Digital Realty engaged in significant U.S.-based land deals, most notably a $23M deal for 16 buildable acres in Northern Virginia. 

Despite the strong numbers from both data center REITs, investors have reacted negatively to the numbers. Both companies did come in below projections for key profitability indicators, exacerbating concerns among some analysts about rising costs for fuel and equipment due to supply chain constraints. The stock value of both companies has declined significantly since the beginning of 2022. 

Although the company is in the process of being taken private by KKR and Global Infrastructure Partners, CyrusOne did post a final earnings report last week, showing a small loss for Q4.  

Data centers are an increasingly important part of broader digital infrastructure portfolios

Digital infrastructure and telecom REITs whose holdings include everything from cell towers to switching stations and fiber hubs are increasingly prioritizing data centers as a crucial portfolio asset. 

There is perhaps no better example of these REITs’ hunger for data centers than American Tower’s acquisition of CoreSite during Q4. American Tower paid $10.1B for the data center operator, which was officially integrated into its now-parent company at the start of 2022. 

DigitalBridge is another integrated digital infrastructure REIT that has been explicit about centering data centers in its business model. The company already owns Vantage Data Centers, which focuses on hyperscale facilities, and DataBank, which owns smaller so-called edge data centers. Speaking on the company’s Q4 earnings calls, CEO Charles Ganzi listed the company’s data center assets as its top two priorities, pointing to the company’s purchase of four Houston-area data centers in January. And he said the company will continue to focus on buying data centers and hyperscale campuses in the months ahead. 

“We will continue to add hyperscale campuses to our balance sheet this year, whether it’s through Vantage or other acquisitions of hyperscale campuses,” he said.