Financial Health of the Colocation Industry

I would like to preface this post with the statement that I am very much a novice when it comes to stock analysis and any form of insightful opinion into the valuation of a publicly held company. However, I think it is interesting, I'm learning, and it allows me to really dig into the inner workings of a company.

I decided to do a little analysis of the colocation industry and the specific stocks I was interested in

• Equinix
• Digital Realty Trust
• Savvis
• Terremark
• Dupont Fabros
• Rackspace
• Internap

I also like to track merger and acquisition trends and predict how the landscape will change in coming months. With acquisition activity picking up in 2010 I started by looking at the cash and cash equivalents for these companies. Combined they have $810.57 million. That is a little shy of the $842 million that Google's peak quarterly Capex was in 1Q 2008. Out of curiosity I also analyzed the cash equivalents of the big guys - looking at Intel, IBM, Cisco, HP, Dell, and EMC. Their combined cash of $50.01 billion is slightly more than the 2008 Gross Domestic Product for the country of Lithuania.

Key figures
The average price to earnings ratio for my colocation group is 24.1, with a few troublesome negative p/e's for Savvis (-60) and Terremark (-16). Another interesting one to look at was the debt-to-equity ratio. For the most part, the group stayed under 2.0, but Terremark's 6.18 and 3.61 for Savvis is an indicator of how they have been financing their growth. In the case of Terremark however, building such intense data centers like they do requires some serious capital outlay up front.

An interesting stock comparison number to look at is the revenue per employee. Digital Realty and Dupont Fabros aren't really in the same category as the rest in this group, and their revenue per employee figures reflected as much ($2.9 million and $2.6 million respectively). Otherwise Equinix and Internap were the highest with $745,000 and $597,500 respectively.

I ran across a few 'insights' from the industry on Equinix and Internap. The Motley Fool website included Equinix in their '5 Deathbed stocks?' article, talking about companies where revenues dry up, margins contract and profit evaporates. Apparently Equinix has an Altman Z-Score of 1.7. This score is used to predict the probability that a firm will go into bankruptcy within two years, utilizing multiple income and balance sheet values to measure the financial health of a company. I'm sure numbers don't lie, but I think I believe this one about as much as I believe in Jim Cramer's knowledge of the industry (in other words, I don't!). An article at Smartrend notes the uptrend for Internap by showing that they are currently above their 50 day moving average of $4.22 and above their 200 day average of $3.36.

Finally, I looked at Morningstar to review financial statistics on these companies. The morningstar 'grades' were interesting, as they analyzed growth, profitability and financial health of the company. Equinix received a B for both growth and financial health, but a F for profitability. Rackspace received the best grades with a C for growth and a B for both profitability and financial health.

If anyone is interested -- here is the Google spreadsheet where I tracked the data.

Overall I think the industry is doing well and set for a positive 2010. The toughest part may be just defining 'what' the industry really is. Many if not all of the financial sites I visited had not attempted to categorize the industry that these companies are in, or put them in odd categories with peers that really weren't industry equivalents at all. I think some of the smaller data center companies may be acquired and some interesting things will certainly happen in the related telecommunications sector.