Equinix, Inc. (EQIX) Earnings Call Transcript & Summary

All right. Good afternoon, everyone. My name is Michael Elias, and I'm the data center and content delivery network analyst here at Cowen. For this meeting, we have Equinix. And from Equinix, we have Bill Long, who's the SVP of Core Product Management; and we have Chip Newcom, who is the Director of Investor Relations. This will be structured as a fireside chat, which will run around 40 minutes. I prepared a bunch of questions, but I'll do my best, I promise, to try and open it up to the audience for questions to the extent time permits. So with that, Bill, Chip, thank you so much for being here today. Really appreciate it.

Thanks. Glad to be here.

So we'd love to start off with a bit of an intro. For those who may be less familiar with you, Bill, can you give us a sense for your role at Equinix? And as part of that, how your role has evolved over your time with the firm?

Sure. So I've been at Equinix for about 9 years. The first 6 years of that, I was running product management for interconnection. For the past 3 years, I've been doing product management for the full portfolio, data center interconnection, everything we have globally. We're now transitioning into a business unit structure, and I'm going to be in charge of our business line for digital interconnection and networking.

And I will add as well, since we have to do the disclosure. Some of the things we may be saying today are forward-looking in nature, please see our SEC disclosures. So now that's done.

All right. So I was also going to ask you where you find yourself spending most of your time focused on these days. I mean it sounds like it's definitely on the interconnection side.

Yes. So I mean, interconnection, obviously, I spent the longest time there, and that's still kind of the tattoos I have. So lots of time on that. Spending a lot of time with our software development teams. I mean, I think that figuring out how to make interconnection is automated and simple and easy to use as possible is a pretty tall order, and we're -- I think, unique in the market that we have so much interconnection that it's a great place for us to continue to innovate and extract value.

I would agree. Transitional talk a little bit about demand. Equinix reported record growth and net bookings during the second quarter of 2022, which per management, sizably exceeded the prior peak that you had seen. As we think of the drivers of this bookings momentum in recent quarters, I mean, digital transformation initiatives, I think, have certainly been a key driver of this. Beyond this, are there any particular verticals or regions where you're seeing the most pronounced booking strength recently?

Yes. So I mean, I think, we talk to customers all the time. And when we look at the data, really, it's extremely broad-based. So it's -- if you -- from a vertical standpoint, it's everything from manufacturing and retail to health care and banking. So it's extremely broad-based. What seems to be a better indicator rather than vertical of someone ready for digital transformation and buying from us is really how progressive their CIO is and in their sort of hybrid multi-cloud architecture. So that's a good leading indicator for us. From a trend standpoint, we do see sort of technology trends starting in the Americas typically, then transition over to Europe and then get to APAC and that cycle typically takes about 18 to 24 months. So both from a vertical standpoint and a geography standpoint, it's good broad-based, really good broad-based growth. I will say that we have also matured our ability to find the right customers at the right time and the right persona in them. And so I think it's a combination both of good sort of secular tailwinds, as well as we're becoming better fishermen. And so I think that's helping to drive the bookings results as well.

And the thing that I've add as well is, as you look at sort of within our platform, part of what we benefit from is both from the service providers who are expanding largely to continue to fuel what the enterprises are looking to do, but then also from the enterprises themselves. So whether it is looking to continue to drive revenue through online sales growth, be it as a cloud service provider or a retail company that's selling shoes or something, we're the core way that they're monetizing a lot of that revenue growth online. Or if you're looking to sort of continue to get more efficient in what you're doing for your networking and your IT infrastructure, we're also a great place to be able to do that as well. So we can continue to win across multiple different types of economic cycles because there's different buying patterns that we'll see in good times and bad.

I just want to go back -- I appreciate that, I want to go back to what you said. And you talked about becoming like a better fisherman, right? And when I've spoken with Keith and Charles in the past, one of the things that they've highlighted is the focus on the right deals at the right price points. How is Equinix's thinking about what the right deal is and at the right price point evolved over the last few years?

In a lot of ways, it hasn't. I mean, I think, we're still very focused on the right customer, right price, right asset. And what that means is interconnection-rich retail infrastructure. And notice, I didn't say retail colo. And so one of the things that has changed is the form factor upon which that we actually monetize and activate that refining those customers. So what we've done with our digital services portfolio is we're reducing the barriers to entry for someone to be able to access our value prop. So you find the right customer who wants to have a -- wants to do a network optimization sort of use case. Historically, they would have to buy routers and firewalls, load balancers, you ship them, pay for them, ship them, install them. That was a relatively high barrier to entry, both from a CapEx technical expertise and time line standpoint. So what we're doing is we're now allowing that same core target customer to be able to access our value prop with our digital services where we predeploy with our Network Edge and our metal services. We're able to predeploy that infrastructure for them such that they can access it in real time. That is on sort of the reducing the barriers to entry. And I think we've also reduced the distraction of larger footprint deals with our xScale business. So we are still very much focused on those same interconnection-rich retail infrastructure, but we're using those tricks to get more efficient by both reducing the barriers and removing the distraction.

Yes. So you reduced the barriers, as you said, for them to consume your interconnect value proposition. But at the same time, when you talk about the right customer, I imagine what you're looking at as an indicator is their propensity to consume interconnection.

That's exactly right. Yes. And so we have, call it, our star target, sort of AI algorithm that we run. And as we run that, it's getting smarter and smarter about what are the data attributes that we'll recommend, not just who to target and when to target them and with what persona.

And there really is a huge opportunity cost in terms of if you book the wrong kind of business, all you're doing is booking your future churn. So making sure that you have that right customer coming in with the right application, that really is ecosystem-dense, that is focused on really needing to be in an Equinix facility. That just keeps the flywheel going consistently because then you're not seeing that drip out of the bucket later on.

Yes. And I mean, I believe, we've seen over the last few quarters, we've seen the reduction in your churn. I would imagine, I mean, this is really the driver of it.

Yes.

Okay. So despite the booking strength that we've seen in the second quarter, what I thought was interesting is you highlighted that your pipeline entering the third quarter was stronger than your pipeline entering the second quarter. And that's despite the challenging macro backdrop. While we view this positively, I will say from the conversations I've had with investors, there is a concern out there that the increasingly challenging macro environment will lead to a decline in demand. What would you say to those investors who have that deal?

I think Chip did a great -- like when he just said that there's, why people buy from Equinix changes in different economic cycles? So when it's -- when we're -- when things are going well, people are wanting to use Equinix to enable their digital transformation. So it's very much how can I get in front of -- get my infrastructure in place to be ready to do the next great thing. When the economic cycle turns the other direction, they think about why am I operating this data center in my basement. My core competency is not operating a data center. So we see demand both in up cycles and down cycles, it's just for different reasons. And so in our -- we had a customer advisory board a couple -- I guess, a month or 2 ago now, and that narrative was starting to shift, where they have a whole list of great digital transformation projects that they want to go do with us. But then they're also saying, "Well, if the tide changes, I'm actually going to be looking at how can I close down some of my own captive enterprise data centers instead." So that reason is how you get 78 quarters of consecutive revenue growth. It's why people buy changes, but there's always a reason to buy.

Yes. So I want to transition a bit away from demand and talk about the pricing environment. When we met with Equinix earlier this year, I mean, management highlighted list price increases for data center space, which we believe have been in the range from 8% to 9%. I mean, is that a fair assumption when we think about colocation rent increases?

Broadly speaking, we are increasing our pricing when it comes to new deals. And part of it is we think about underwriting new projects, we're still targeting the same high 20s to low 30s on levered yields on our stabilized assets. So as we're seeing underlying costs going up to build new facilities, we're going to have to be thinking about adjusting our pricing accordingly. Now from that standpoint, though, we've got multiple different levers that we can think about. And we're always going to be commercial in terms of how we're talking to the customer. So certainly, we're going to have the option to raise list pricing and then how much do you hold the line relative to that when you're having a conversation with the customer? How do you think about stuff like interconnection that I know we can chat with Bill a lot about? And then how do you even think about stuff like contractual escalators? So the beauty of the business model is that we have lots of different levers that we can play with, with the customers, we think about price points. But broadly speaking, the pricing trend is going to be up and to the right over time.

Yes. I appreciate it when we think about pricing, it's a multi-barrier equation. But one of the things that I just want to make sure I understand is when we talk about those base price increases, is that uniform across the customer base or as you consider the relationships that you have with maybe some of the larger strategic customers in your ecosystem, are you not increasing the pricing for them? Just want to get a sense for how you think about that.

Well, I think in general, regardless, we price relative to the ecosystem value. So if there is a customer out there who's going to add a lot of value to the ecosystem to other people that are in our locations, we'll consider that in pricing, regardless of the inflationary environment. And so it's -- we very much use a lot of different levers to curate the ecosystem that matter and the locations that matter.

Yes, we have a whole organization at our commercial solutions organization within the sales team that looks at all of those various trade-offs, thinking about if this customer is already in 7 of our locations, they're looking to add an incremental eighth location. How should we think about that, not just in a value for the 1 location, but what's the broader total customer value that we're thinking about. So we're always taking into account those various different puts and takes.

Right. So just we can bring it back to the comment that you made about no change in essentially your return targets. So as we think about the pricing increases, I mean, that's positive for your revenue growth. But you've also talked about how you've seen broader inflationary pressures, which are affecting wages, as well as operating costs. As we think about the net impact of that on margins, are the price increases simply intended to offset those inflationary pressures on the cost side? Or is there opportunity for you to drive margins or even returns even higher via the price increases as you look to get more value from the ecosystem?

Yes. So I'll...

You start, and then I can go.

For sure. So we, obviously, are going to be -- I think if you look at our results last quarter, we are showing the ability to win our costs increase, we can raise the prices. Now we do -- we are still very much committed to the sort of EBITDA percentage targets that we communicated at Analyst Day. It does create a more interesting dynamic with the power pricing increases because you're just passing through more of the cost, which obviously, from an AFFO per share standpoint, it's neutral. But it does create a bit of a headwind...

On the margin percent.

On the margin percentage. Now some of the things we're doing, we are -- we announced a [ cross-connect ] price increase that helps offset some of that. So it's -- on an AFFO per share standpoint, it's neutral, but it does create a bit of a headwind. I don't know if there's...

Yes. And look, long term, we know that there is inherent operating leverage within the business. It's just there are things like European power price increases that we know are going to have to be passed on to customers when we get to 2023. That will muddle the equation. So from our perspective, what we really want to be focused on in the end, our guiding light is AFFO per share growth. And we know that to drive AFFO per share growth, we do need to continue to try to run the ship a lot more efficiently over time, but with stuff like power pass-through. You might get incremental revenue out of it, but at 0% margin, as Bill was saying. So that muddles the equation a little bit. But sort of ex that, do we think there is ability to drive operating leverage in the business? Absolutely.

Yes. So even if you -- yes, we took the power out of the equation, yes, you would expect to see that, you'd expect to see the margins trend up. Power will create some, as you said, will kind of muddle it a little bit. But as we think about the returns that you're thinking about, I mean, no change in your returns, so that would, to me, would suggest that even if you're seeing an increase in your, let's say, build costs or so on, you're increasing your prices in a way that's commensurate to offset the higher costs?

Yes, that's a fair way to think about it.

Okay. All right. So then one other topic of conversation we've talked about today here at the conference has been inflation. That's top of mind for a lot of people, including the average person. So as we think about the inflation in the context of your escalators, I have historically thought of Equinix escalators being fixed in the 3% to 5% range. Management recently talked about resetting escalators to levels that are more appropriate to reflect the current environment. My question for you would be, would you consider shifting to more of a CPI-based escalator globally? Or do you think increasing your fixed escalators will be the approach that you'll take?

So we already do a little bit of both, right? So we do have CPI-based escalators in a lot of our contracts, and it varies depending on the customers. So that can be a negotiation point, whether someone wants fixed price escalators or something that's CPI-based. What you'll see us do over time is we'll see how the current inflationary environment evolves. If inflation stays relatively high, then 3% to 5% doesn't feel appropriate anymore. If we see through aggressive actions by the Fed, more of a normalized rate of inflation back towards their 2% target, then 3% to 5% still feels roughly accurate. I think part of what we'll have to see though as we're renegotiating contracts and having those conversations with customers is sort of where we're seeing inflation trend overall. And then that will sort of inform us on what we're going to do.

We do have the contractual ability to do it.

Yes.

So just to be clear, you have the contractual ability in contract to increase the escalator in the middle of the contract?

Not increase the escalator, we have CPI.

Okay, okay. Got it. It's that. Okay.

But then as we sort of renegotiate, we can adjust what we're going to do.

Got you. Okay. All right. Yes, that makes sense. So that's one thing I'll say is that I was having a conversation with someone at Equinix, I got the sense that the -- you guys will -- the way that you would approach it, one of your peers is talking about doing much more CPI-based escalators globally, floor of 2%, cap of 6%, I got the sense that the approach that you guys would take is just increase the percentage or increase the actual fixed escalator in your contract. That would be the way that you think about that. Did I get that wrong?

Certainly, we can do it. It's just it's a question of what are you going to negotiate in terms of commercial terms, whether it's going to be a fixed price increase or CPI plus some element on top of that. That's, again, as we go through the commercial conversations of renewing contracts, that will be something we'll continue to work through.

Okay. So when you consider the like-for-like deals that the company is renewing, I mean, how would you characterize the cash renewal spreads that the company has been able to drive recently? I don't think that's something that you guys...

Yes, we don't typically talk about it. But I do think -- I mean the -- and correct me if I get this stat wrong, but for every pricing action we take with the customer where it goes down $1, there's a pricing action with another customer that's up $3.20. So the net pricing action when we're up for renewal is headed in the right direction.

Yes. And that's a stat Keith gave on the earnings call. So on a net basis, the way that we think about it really is those net pricing actions, which admittedly, there's always going to be some movement around and saw 2 things depending on where our customer is at renewal relative to where market price is. But the overall trend, if we're seeing positive net pricing actions, means that any potential price decreases that we're seeing are being more than offset over the long haul because of those price increases.

Got it. Okay. So last thing on this pricing topic is, I mean, you've talked about increasing the pricing for the base space. We've talked about increasing pricing for interconnection. Also, power pushing through more on the power side, also smart hands costs are going up. So could you give us a sense for how you think about towing the line between those price increases? I understand it's amid the inflationary environment and upsetting the customer or hurting the customer relationship.

I think we think about it carefully. And I think there's obviously -- you want to make sure that the value we're providing is commensurate with the price that we're charging. So this commercial services team, commercial solutions team that we talked about is a big focus of exactly that. So we have the team that does that kind of pricing, but we're also looking at our product portfolio for things that we can do to activate more demand at the right price point. So for instance, if a customer is using a cross-connect today and they're carrying -- that cross-connect is carrying 1 gig of traffic or 400 gigs of traffic, they're paying the same price. So what we've done with fabric is we've allowed a bandwidth based here where if someone is using -- only wants to use a little bit of bandwidth, they can use fabric instead, and they can scale that down to $75 for a connection instead of $250. And so that helps us unlock more sort of elasticity of demand at the lower end, while also allowing us to have higher cross-connect pricing because there's that out. You can say, well, if you don't like paying cross-connect price, move it over to fabric for your low bandwidth connections and you can get to the lower price point. So we're -- I think it's holistic we have the -- we think about the value to the ecosystem, the value they're getting from being at Equinix, but also introducing products that better align sort of use with payment.

All right. So let's transition and talk a bit about interconnection. So in the second quarter, I thought it was interesting that Equinix began disclosing total interconnection by region, inclusive of virtual interconnections as we've seen the adoption of those virtual cross-connects increase over the recent years. Could you help -- and I mean, you just touched on it a bit, but I would love if you could unpack for us the difference in terms of pricing and margins between a physical cross-connect versus a virtual one. I believe, just based on what you said, the virtual cross-connects has a usage component, but I would really appreciate your view.

Yes, so a cross-connect, I just think it was a piece of fiber that you pay, there's an install nonrecurring fee and then a monthly recurring fee for that piece of fiber. On fabric, you pay a relatively low port fee to connect, so between $100 and $200 for that base port. I'd say that's a 10-gig port is going to be your $200. And then you have connections on top of that, and you're going to pay for each connection depending on how big, how fast that speed is. So you buy a 10-gig port, then you might buy a 1 gig virtual circuit on top of that. So fabric has those 2 components: a, the port; and then the virtual circuit. When you net all of that out, if you take all of the fabric revenue and divide by the number of connections that are on it, it is marginally higher ARPU than a cross-connect. But it also has marginally higher cost because there's an actual network there that does it. So when you net it all out, it's slightly higher revenue, but largely at neutral, neutral margins. So we're largely agnostic on whether you're using a cross-connect or a virtual surrogate to connect. That is different than other fabrics that are out there on the market. We were able to operate our fabric at interconnection economics versus network provider economics. And when I say that, what I mean is, on fabric, 85% of our connections are happening within a single data center campus. So we're not having to pay to lay fiber, to lease that fiber, to light it, to carry it between data centers because it's all terminating within a single data center campus, the majority of the time. So that allows -- you look at other fabrics that are on the market today, 90% of the time, their connections are between different data centers and, therefore, those connections incur the network cost. So their economics look more like a network service provider versus interconnection.

Okay. Pardon for asking this, but I'm just curious. Is there a point -- can you quantify the point where it becomes more economical to use a physical cross-connect versus a virtual one, i.e., in terms of like how much traffic you're sending over it? Does that...

Yes. I mean, in general, the rule of thumb is that if you're doing more than like -- and by -- right now, if you're doing more than in by 10 gig, so if you're doing multiple 10 gigs, you're going to be -- you're going to want to pull that over to a cross-connect and use a 100-gig interface for that. That line is changing because as the technology gets better, we're sort of managing our price on fabric as well to change that to over point. So I would expect the next couple of years, it will be economic to use fabric for 100-gig connections as well. It will just be as the technology progresses, the price points will grow into that. But by then, cross-connects will be at 400 gig. So it's kind of fabric is the one generation behind the sort of highest or the highest speed.

Yes. I mean, we saw this a few years ago that 10 to 100 gig migration. It seems like the next step along the evolution would be, what? 400 gig?