Chanos Targets Datacenters. Should They Worry?

How are the big datacenter service providers really doing?

On one hand, independent datacenter real estate investment trusts (REITs) are expanding aggressively despite economic trends, heralding ongoing explosive demand for faster and heftier cloud services despite woe in the financial markets. Datacenter providers such as CyrusOne, CoreSite, Digital Realty Trust (NYSE: DLR), Equinix (Nasdaq: EQIX), and QTS Realty Trust are servicing businesses, social media, and cloud hyperscalers with economies of scale via multi-tenant compute, network, and storage facilities.

On the other hand, those cloud hyperscalers – AWS, Microsoft (Nasdaq: MSFT), and Google Cloud -- could present unwanted competition that eats into the third-party datacenter market.

“The real problem for data centre [REITs] is technical obsolescence,” said Jim Chanos, founder and president of Kynikos Associates, an investment consultancy specializing in short selling stocks, in a recent interview with the Financial Times. “Their three biggest customers are becoming their biggest competitors.”

According to Chanos, cloud services are meeting demand formerly met by brick-and-mortar datacenter service providers. And when it comes to solid buildings, cloud providers are preferring their own facilities to those of third parties.

This triggered a debate on twitter from those in the know:

Not a dumb guy. And he means the 3rd party REITs, not Goog/Amzn etc https://t.co/eREpbRls2t

— Andrew Schmitt (@aschmitt) June 29, 2022

Big Plans on Both Sides

It is clear that the hyperscalers are focused on building their own datacenters. AWS, for instance, touts its own datacenters as superior to any others, and the company continues to build aggressively, even though it does tap the resources of companies like Equinix. Microsoft too boasts of hardware innovation in its global datacenters, which are proliferating worldwide. Google Cloud plans to invest over $9 billion this year in new datacenters in strategic locations, such as Dallas, Texas.

But the datacenter REITs aren’t slowing down either. Equinix continues to expand its own hyperscale datacenters under its xScale brand. To date, Equinix claims to have sunk over $8 billion into 36 xScale facilities worldwide. According to Equinix, the goal isn’t to displace hyperscaler datacenters but to support a select group of hyperscalers with green energy and interconnection to multiple large enterprise customers in key locations worldwide.

“We're not sort of trying to chase every bit of hyperscale that's out there,” said Equinix CEO Charles Meyers on the company’s March 2022 earnings call. “We're focused on a relatively small number of sort of global hyperscalers that we think are critical to how the overall cloud macro plays out and are focused on them.”

It seems CEO Meyers is reaching beyond the definition of hyperscaler as a public cloud provider to encompass large enterprises looking for independent facilities to reach ecosystem partners and provide multicloud connectivity at key Internet points of presence.

Datacenters Not Slowing Down

In that case, is it really true that the cloud hyperscalers will elbow the leading third-party datacenter service REITs aside? A glance at the growth and strategy of both the hyperscalers and the datacenter REITs says no. Indeed, there are several signs that the REIT market is not shrinking.

For example, consolidation among companies in the third-party datacenter space reveals the value placed on them. Over the past 18 months, four large players – CyrusOne, CoreSite, QTS, and Switch, have been acquired in deals worth over $35 billion.

The leading datacenter firms are also investing heavily in their own acquisitions. In September 2021, Equinix spent $170.5 million to buy GPX India, a provider of two datacenters in Mumbai. In April 2022, Equinix completed the $320 million acquisition of MainOne Cable Company Ltd., which comprised four data centers, a subsea cable, and a terrestrial fiber network, all supporting communication in West Africa. And the vendor is waiting to close a deal with Chilean telco Entel for approximately $734.7 million for four datacenters in Chile and one in Peru.

Digital Realty announced in January plans to buy Teraco, an African interconnection and datacenter service provider, for $3.5 billion. When it closes this year, the deal will bring Digital Realty seven datacenter facilities and seven subsea cables circling the African continent.

Multicloud, Added Value Are Key

There are several takeaways from all this. First, M&A in the datacenter provider space indicates that there may be fewer companies in the sector, but those companies are growing. They are investing in new markets. And they see value in offering neutral, third-party points of network connectivity to customers seeking multicloud support and interconnection at key points worldwide. This means that as multicloud strategies gain momentum, so will independent datacenter REITs.

This contrasts with the strategy of the hyperscalers to attract enterprise customers to their specific services, even as they claim to support multicloud environments. The cloud players are surely growing fast, but there is a gradually widening space for multicloud support.

The REITs are also looking to add value in terms of private 5G support and cloud automation -- both areas that also promise robust growth.

Bottom line? Equinix, Digital Realty, and other datacenter REITs will continue to expand services to enterprise customers looking to tap top urban markets at Internet hubs around the world. These companies will continue to grow with the trend toward multicloud and hybrid cloud expansion. Shorting them is a shortsighted bet (pun intended).