Analysts See Sustained Demand for Data Center Deals

Consolidations in the data center sector generated over $12.3 billion in deal values globally in 2011, said consultancy BroadGroup, citing the U.S. as the most active market for deals. It noted billion-dollar-value deals like CenturyLink’s acquisition of Savvis and Verizon’s purchase of Terremark. But 45 percent of all consolidations were below $100 million and almost half of all transactions were in the $100 million to $700 million bracket and almost half used debt financing tools. JPMorgan Chase had the highest number of deal arrangements in the sector, followed by RBC Capital Markets and Barclays Capital, while Morgan Stanley and Seaport Capital were in joint fourth position, the firm said.

Telcos are expected to play a major role consolidating the data center sector, said analysts from Tier 1 Research. The trend by telecom carriers to add data center and cloud players to their mix of services through transactions has been consistent, said Brian Washburn with Current Analysis. Even consolidation among telecom providers has data center implications, he said, citing Windstream’s purchase of PAETEC and the Level 3/Global Crossing deal.

A month later, Time Warner Cable, the nation’s second-largest cable company, acquired Navisite, another business hosting service, for $230 million. In both deals, the acquirers agreed to pay over 30 percent more than the 30-day average prices of the two stocks. And it is not just older communications companies fishing for cloud computing acquisitions. Data storage players have also attracted the more traditional technology companies like HP, EMC and Dell, analysts noted. The transactions allow the companies to find new revenue growth as their traditional business segments slow due to increasingly saturated consumer markets, analysts said.

Demand for smaller data center assets is strong, said Rob Stevenson, a managing director at Macquarie Capital and head of its Real Estate Investment Trust (REIT) equity research. But demand for larger companies that operate large numbers of data centers is scarcer, he said. “It’s a bifurcated market,” he said. “There is plenty of appetite for individual assets,” he said. Private equity investors and other short-term investors are interested in buying and building up data centers and then selling them to larger operators for a good return, he said. But the recent “binge” on mid-sized and larger data center operators by phone and cable companies last year, and a rally in the publicly traded data center operators’ stock price, has probably reduced the demand for data center deals among larger companies, Stevenson said. “The market and appetite for public M&A is probably not real high right now given where some of these assets are expected to be valued."

Because many data center operators are run as REITs, and therefore avoid corporate income taxes, their stocks typically trade at a higher earnings multiple, said Jonathan Schildkraut, an analyst with Evercore Partners. That means that potential acquirers from outside the sector eyeing data center acquisitions may have to pay cash, rather than their own shares, to buy them, he said.

Financing is available for larger deals, but lenders are less willing to finance smaller transactions, Stevenson said. As a result, the smaller end of the sector has attracted a lot of private equity capital, he said. “They want a high return and they don’t want to wait very long,” he said. Some investors are financing the construction of new data centers and hoping to sell them later, he said. “It’s not a massive wave of over-construction like the single-family housing market, but there is still development going on because there is significant demand for data center space,” he said. “Private equity and other forms of expensive capital are filling the void left behind because traditional banks aren’t lending on this."

There are “a multitude of potential buyers” of Cincinnati Bell’s data center unit, including data center peers like Digital Realty and telcos like AT&T, said Benchmark analyst Clayton Moran. “Given a strong M&A trend, a sale is certainly possible,” he said. The analyst noted strong growth in the data center space, as reported by Verizon, CenturyLink and Rackspace, and “a powerful consolidation phase” including the sale of Terremark to Verizon and Savvis to CenturyLink.