Equinix Inc. (EQIX:US), operator of data centers for companies such as AT&T Inc. (T:US) and Amazon.com Inc. (AMZN:US), is the latest technology business to consider changing its corporate status to cut hundreds of millions of tax dollars.
Demand for Equinix’s services is booming as more companies and consumers turn to the company to manage their Web traffic, mobile apps and online video. As Equinix’s data centers -- essentially computer-age warehouses -- continue to sprawl, the property required to house them has convinced Chief Executive Officer Stephen Smith that the time may be ripe to redefine the business as a real estate investment trust, a designation set aside for companies that invest heavily in real estate.
“Tax efficiency is the most important attribute of being a REIT, so that’s certainly a positive,” said Clayton Moran, an analyst at Delray Beach, Florida-based Benchmark Co., who recommends buying the shares. “REITs are valued at a premium given that they’re highly recurring dividend plays.”
REITs typically are subject to lower taxes and pay higher dividends than other companies, so the conversion would help Smith return more money to shareholders, he said in an interview. More technology-related companies that make money from owning and operating facilities are making the switch to REITs. Recent examples are storage services provider Iron Mountain Inc. and American Tower Corp. (AMT:US), which leases wireless communications tower space.
Equinix’s stock has beaten every large U.S. technology company in the past year as demand for its services drove a four-fold rise in revenue (EQIX:US) since 2007.
Even though Equinix belongs to tech indexes run by Standard & Poor’s (S4INFT) Financial Services LLC, Russell Investments and NASDAQ OMX Group Inc., it gets more than three-quarters of sales from renting out server space in more than 100 facilities worldwide, meeting criteria required to become a REIT. If it converts, the company would pay most of its income to shareholders in the form of a dividend, while also joining a favored asset class -- the Bloomberg REIT Index has topped the S&P 500 Index in nine of the past 12 years.
Equinix, based in Redwood City, California, has surged 60 percent in the last 12 months, the second-biggest gain among the 116 members of the Russell 1000 Technology Index (RGUSTL) after SolarWinds Inc. (SWI:US) and about six percentage points better than Apple Inc. (AAPL:US) The stock fell 3.2 percent to $162.48 yesterday in Nasdaq Stock Market trading.
Even with its recent gain, Equinix trades at a discount to REITs, according to data compiled by Bloomberg. For 2013, Equinix has an estimated enterprise value to Ebitda (earnings before interest, taxes, depreciation and amortization) ratio of 10 (EQIX:US), compared with 17 for the Bloomberg REIT index, a group that includes owners of malls, storage facilities, apartment complexes and medical buildings.
Data center operators Digital Realty Trust Inc. (DLR:US) and DuPont Fabros Technology Inc. (DFT:US), which are not in the index, have ratios of 15 and 13, respectively. American Tower has jumped 17 percent since converting into a REIT on Dec. 31. Iron Mountain is up 11 percent since approving a plan to become a REIT on June 6.
“The path has been laid for additional companies to elect to operate as a REIT,” said Mark Decker, the head of real estate investment and corporate banking at BMO Capital Markets in Chicago.
The conversion would eliminate Equinix’s corporate tax and the company would send about 90 percent of income to investors, who would be taxed on the dividend received. Colby Synesael, an analyst at Cowen & Co., estimates the change would save the company $312 million in taxes between 2015 and 2016, the first two full years that a plan would be in place.
Equinix provides data center space to more than 4,300 companies, including AT&T, Microsoft Corp. (MSFT:US) and Amazon, which rents space in some areas to deliver its Web hosting service.
Kevin Landis owns $3.3 million in Equinix shares and counts it as the 10th-biggest holding in his Firsthand Technology Opportunities Fund. He’s betting on the company’s ability to win sales from the world’s largest businesses as the need for space and connectivity increases.
“As an investor, I love arms merchants,” said Landis, whose firm is based in San Jose, California. “As servers get banished from the enterprise, can you even imagine a scenario in which data centers don’t get more and more important?”
Landis said he didn’t have any special insight into the REIT question, though he expects to get additional details tomorrow, when Equinix reports (EQIX:US) second-quarter results. The company is expected to say that sales (EQIX:US) in the period climbed 18 percent to $467.2 million from $394.9 million a year earlier, according to the average estimate of analysts’ forecasts compiled by Bloomberg.
That follows revenue growth (EQIX:US) in 2011 of 32 percent to $1.61 billion from $1.22 billion in the previous year. Equinix is forecasting sales of $3 billion by 2015.
“We don’t want to do anything that would damage our growth profile,” Smith said in an interview. “That’s the biggest debate with the board.”
Smith told investors in February that Equinix had hired advisers to help explore a conversion, and during last quarter’s earnings call in April he added that the company will incur a $2 million expense this year for the analysis.
Another issue the company must confront is that its international (EQIX:US) business accounts for 36 percent of revenue and is spread across 12 other countries from Brazil to Singapore. The company has said eventually more than half of sales will be outside the U.S. Each country has a different tax code, so to convert globally would be an expensive, time-consuming endeavor.
While Equinix could just convert its U.S. operations and continue to pay corporate taxes abroad, that approach would probably change how the company is valued, because it wouldn’t be a “pure-play” REIT, said Cowen’s Synesael, who rates the shares “outperform.”
“The majority of growth most likely is going to come in international markets going forward in terms of where they build,” Synesael said. “That may impact the multiple.”
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