Data Center Suppliers Go Hyperscale

News that global investment firm KKR (NYSE: KKR) is funding a new data center company in Europe highlights the growth of a complex market for hyperscale data center services.

According to its Website, the new company, Global Technical Realty (GLR), will focus on “providing build-to-suit data centers for hyperscalers and seeking suitable M&A opportunities, primarily in key European markets.”

Focus on hyperscale clouds will pit GTR against hundreds of data center suppliers in a space dominated by a handful of players — most notably Equinix (Nasdaq: EQIX) and Digital Realty Trust (NYSE: DLR).

The data center builders are clamoring to help extend the networks of the big cloud players, who are also creating their own networks — Alibaba (NYSE: BABA), Apple (Nasdaq: AAPL), Amazon (Nasdaq: AMZN), Facebook (Nasdaq: FB), Alphabet (Nasdaq: GOOGL), Microsoft (Nasdaq: MSFT), and IBM (NYSE: IBM).

All this activity has grown the hyperscale data center segment despite COVID-19. And experts expect the trend to continue at an estimated rate of over 25% CAGR, leading to a space worth $80 billion by 2022.

Still, to gain traction, newcomers such as GTR will need to excel in at least two areas: familiarity with complicated financing tools and a penchant for partnering.

Hyperscale Data Centers Demand Leverage

Digital Realty and Equinix succeed in part because they are real estate investment trusts (REITs) focused on data center resources. The income from their properties creates dividends for shareholders and investors, while fueling ongoing development of new facilities.

While Digital Realty and Equinix own much of the data center REIT market, other players include CyrusOne (Nasdaq: CONE), CoreSite (NYSE: COR), QTS Realty (NYSE QTS), and Switch (NYSE: SWCH). A range of smaller players, and ones with a regional focus, also aim for the hyperscale cloud customers.

All these suppliers need real estate to grow. In choosing sites, REITs such as Digital Realty and Equinix must weigh the most popular locations against factors such as tax rebates and credits and the terms of outside funding. The result is plenty of debt, based on a carefully structured system that optimizes lending rates and uses the most desirable instruments.

It’s a design that seems to work. In its latest financial announcement for the three-month period ending March 31, 2020, Digital Realty reported $823 million in revenue, up 5% sequentially and 1% year-over-year. The company’s total debt was $12.4 billion. And the vendor continues to aggressively add to its 213 data centers worldwide with construction underway in metropolitan areas in the U.S., Asia, Europe, and Canada.

Likewise, Equinix reported $1.4 billion in revenue this quarter, up 4% sequentially and 11% year-over-year, while carrying $11.8 billion in debt. It continues to add to its stable of 211 data centers in 26 countries.

Hyperscale Calls for M&A, Joint Ventures

The reference to M&A opportunities in GTR’s mission statement signals that, like many other data center companies, the startup will use acquisition as a tool to add data center resources as needed by hyperscalers.

In March, for example, Digital Realty paid $8.4 billion to acquire Interxion, which supplies data centers in Europe. In the same timeframe, Equinix paid $335 million to acquire Packet, which provisions servers on demand based on bare metal, white-box hardware.

Established players further streamline the process of building and equipping data centers through partnerships. At the end of 2019, Digital Realty announced a $1 billion joint venture with a Singapore-based REIT and capital company called Mapletree. The deal gives Mapletree an 80% stake in Digital Realty facilities in northern Virginia, a key U.S. hub for hyperscale networks.

Not to be outdone, in April, Equinix entered its own $1 billion-plus joint venture with GIC, a sovereign wealth fund based in Singapore, to build out hyperscale data centers in Japan. GIC will get an 80% stake in the centers.

Challenges Ahead for Hyperscale Data Centers

GTR seems ready to tackle its chosen niche. The new company is led by Franek Sodzawiczny, a veteran executive in this segment. He previously founded Zenium, a European firm specializing in hyperscale data centers, which was sold to CyrusOne for $442 million two years ago. This kind of executive background should help
GTR navigate the financial straits of the hyperscale data center market.

But challenges abound. As noted, cloud players are building their own networks -- AWS has been especially aggressive in this area -- adding to competition. Data center suppliers also face issues related to the pandemic — supply chain delays for equipment and a shortage of workers to help with construction and management.

In spite of this, demand for cloud facilities is growing, presenting opportunities for data center suppliers to profit -- if they have what it takes.