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

Look, good afternoon, and welcome, everyone, to the conference. My name is George Webb. I'm a software and IT services analyst at Morgan Stanley in Europe. Pleased for this session to be joined by Keith Taylor, Chief Financial Officer at Equinix. So welcome, Keith. Good to have you with us in London.

Thank you, George, and thanks, everybody, for participating in our conversation today.

Perfect. Well, let's kick off. Maybe just to give 1 or 2 minutes of brief background to Equinix as a business, your market position and what the value proposition is that you bring to customers?

Well, thanks, George. And again, some of you have been in our meetings today. So you will hear it again. But Equinix is the largest digital infrastructure company in the globe. We really like the position that we're in. We just came off a record quarter. We've had sort of 6, 7 record quarters in a row. So feel very good about where we're positioned ourselves. But for those that don't know us that well, we have 249 data centers across 71 markets in 32 countries. We're predominantly a recurring revenue model. Again, a lot of you know that. 95% of our revenues recur. And 90% of our quarterly growth comes from the installed base, customers who continue to grow horizontally with us and, in some cases, vertically as they procure more services. So we're the largest in our space. And what else can I tell you just quickly? Again, good capital. I think -- ourselves as good capital allocators. We've got 46 projects currently underway across 31 markets, 21 countries. We're very, very active in investing in the digital side of the equation, our digital services and then we have our data center services. But overall, the business continues to perform exceedingly well. We've got a very strong balance sheet, tremendous flexibility in our balance sheet. I think we've positioned ourselves well to weather the storm, if you will. So we have the liquidity. We generate liquidity. We have low leverage. We have capacity that's unused. And for all those reasons, I think we're in a very, very good spot to capture the opportunity that presents. And maybe I can just put a capstone on and say, as you think about all things digital, most of that should transfer, traverse or transport through Equinix. And again, we have 2,100 networks inside our environment, 3,000 cloud and IT services companies. We're effectively on- and off-ramp to the Internet, the cloud on-ramps, the hyperscaler on-ramps. We have roughly 40% of those in the markets that we operate in. So it feels like we've positioned ourselves really well for this next opportunity. And maybe I just -- I'll say one final comment. I still think we're early in this digital transformation that's taking place. And so that excites me and the opportunity that's still in front of Equinix.

It's interesting. I want to come back to that point in a minute. I guess the big debate at the moment for investors, and I'm sure you've heard it many times already, is what's the macro looking like as you go into 2023. It feels like it's going to be tougher, even if that is being led by the consumer, perhaps more southern enterprises. Have you seen any signs so far in your business about weaker macro feeding through? Any signs of sales cycles lengthening?

I think it's fair to say that obviously we all are either are experiencing or expect something to happen. The nice part about our business is we are -- we're critical infrastructure for a lot of companies. I think there are secular trends in our industry, and particularly our delivery mechanism that allows us to maybe withstand a lot of the challenges others are going to feel because all things digital are going to come to Equinix, and the world that we know today is increasingly going to become more digital. And for that reason, we just came off our best quarter ever in our history. And so maybe that's not a good indication, but we've had 6 prior quarters where we we're just -- we did much better than we anticipated. And I said on one of the calls, I said we had a really strong pipeline in Q3. I said our pipeline in Q4 is even stronger. So there's things that are going on in the space, I think, benefit us. And one of the other things I would say is I think there are secular trends, so we'll enjoy that. I think we're very diverse in our platform. Again, over many markets, or more for many countries, a diverse of over 10,000 customers that continue to grow and scale in their business. But I think our competitors are almost giving us permission to win more than our fair share because they're not investing in their future like we are. They're not investing in digital services, efficiency initiatives and other way to go to market. And so we're going to continue to invest. And so the 46 projects that we're building today, I can envision a scenario in 2023, where we'll be investing more than we did in 2022. And that gives you a sense of the opportunity that we see. So the pipeline remains strong, and the opportunity, I think, is substantial.

That's interesting. I think it's almost dangerous to say that this time can be different. So I'm interested in diving into that a bit deeper. I guess there's two schools of thought. One, as you've kind of laid out for us, cloud, digital transformation, very central to corporate road maps, even more so since the pandemic. Perhaps that can shield any demand slowdown as you go through 2023, would be interest in 2024 maybe. On the flip side, you are starting to see some SaaS companies, cloud companies talk about that demand softness. Where do you position yourself? What are your customers saying?

Well, look, you don't have to go far. Go look at your news feeds and you'll see that there's a lot of companies who are doing different things to deal with the consequences that are in front of them. Some are cutting costs, some are seeing slowdown in the revenues, some are cutting costs because they're seeing a slowdown in the revenues. But I think it's a combination of all of those. But do remember, we are a critical infrastructure for the majority of those companies. And so those that are already inside our facilities is probably one of the last things they want to cut. Either we're a revenue engine for them or we're a cost savings initiative. And I would argue the opportunity set that sits out there, it wants to come to Equinix, particularly given that if you're running your own infrastructure, the world that we know is changing very dramatically. And again, power costs in Europe, in particular, are very, very substantial. And so if you're not a specialist in that space and my colleague, Philip, who is in the audience here, he was at the Customer Advisory Board meeting in Europe last month. And when we talk about the customers and what they're seeing, or the potential customers, to the extent that they're running their own data centers, they go, this is madness. We can operate to scale, efficiency and the costs are overwhelming. And so there's an even greater sort of maybe momentum that's coming from the enterprise given the difficulties that everybody is experiencing in this new world. And then you have the clouds who -- again, we'll talk -- I'm sure you're going to ask me a question there, the clouds, in and themselves have started to slow down, but we didn't -- we neither saw the steep incline of opportunity nor do I think we're going to experience the fact that they're slowing down. They're just -- they are slowing down. But we create that opportunity where we're sort of the aggregation point of all those up service nodes, aggregation nodes, network gateways and the like, that also comes in. And we're sort of that point, that ecosystem that allows everybody else to thrive. So I don't know if that's going to be an issue for us. I also think that there is an element of repatriation. As customers burst into the cloud, and they realize I'm going to live in the cloud when a better manifestation of their infrastructure should really be hybrid multi-cloud. So part in the cloud, part inside our environment, operating with a diverse set of different service providers, which are typically SaaS. And that's the delivery mechanism for a SaaS provider to sell to an enterprise inside an environment like us. And Equinix is a perfect example of that. We have 300 cloud and IT companies that we use to deliver our business and they operate inside our environment or we with them. And just gives you an example, enterprises have a diverse set of needs, both multi-cloud and hybrid. So living in the public, but also in the private world.

That's very clear. I want to touch on the energy price, basically in Europe, which is quite important more so than maybe perhaps in the other region. How has that impacted Equinix from a cost perspective this year? What are you expecting into next year? And then what can you do around hedging around using some of these national subsidy programs to try and to shield that impact?

Well, energy is our largest variable component inside our P&L. Again, it represents for 2022, roughly 12% to 13% of our revenues. Again, we're -- for round numbers, a $7.5 billion company, and so you can do the math on what 12% would be. As we look forward, costs have moved up dramatically. And so I'd first start off by saying that we have a very sophisticated and deep hedging strategy as it relates to many things, including currency, interest rates and the like. But as it relates to power, and it's less a hedging but more a forward commit. We're hedging forward exposure by committing to something. So it's not technically a true hedge. That said, we have regulated and unregulated markets. In regulated markets, we rise like everybody else, and the customers will ultimately pay that cost just like we do. As it relates to unregulated, we have a sophisticated hedging program, and we hedge out throughout the year. And by the time we get to this part of the year for the forward year, we should be predominantly fully hedged. And today, Equinix is greater than 97% hedged around the world. So it feels like a really good position. So we have that insight into what we're going to charge. So two things come out of that. We've been very clear, customers are going to have to pay for that. But we're going to charge it and not make any margin on it. And the way that we telegraph that in September or thereabout, we told the investors -- or pardon me, the customers that we're going to be increasing their bill. You don't have to look very far to see that your bills are going to be increasing. Then the next month, we told them a range. Then just last month in November, we told them exactly what we're going to charge them for that power. Again, we have a diverse set of markets in Europe. It also holds true, by the way, in Singapore and Japan, less so in the U.S. But we've told them what's going to happen. We've given a specific number and we're going to charge them for it. Naturally, you say, well, that's going to be a problem for the customer. And the answer is it is. I think it is a problem. It's a problem for everybody, particularly in the European theater that are paying a substantial amount of money for energy. Now the nice thing about being with Equinix is we're much more sophisticated than most, including the enterprise. And so we've got really good hedge positions. And those hedge positions suggest to us is that we're meaningfully below what they would actually pay elsewhere. So these are unlikely to turn to another to a competitor, one that's disruptive to churn, but two, you're going to churn to something that's more expensive. Two, it's -- they're not going to want to stay inside their own environment that much longer because it's very expensive. And they realize that we deliver a value that's different than they can. So our costs are below market. They're below what they could pay. So they're effectively below spot and forward. And so I think we've done a really good job of shielding them even though it's very difficult relative to what it could have been. If they're just a pass-through company, so just metered power again, unhedged, even though it's metered, they're going to take it on the chin. And in some cases, it could be 10x what they're paying last for '22. So that's a very scary scenario. So we -- so I think we're in a good spot. One, we've communicated very well. Two, we're better than the market. Three, we're going to continue to work with our customers to make sure that we are there for them in a way that how do you run it more efficiently, your infrastructure, to drive down your cost, I absolutely would expect that of them. The natural -- the second natural question is, are we going to see more churn? Yes, I'm sure there'll be customers who cannot live in this new world that we're all living in, and therefore, their businesses will fail. But that's part of our day-to-day issues. We deal with that every single day as companies come to us and -- whether their businesses are successful or not, including crypto, as a perfect example, not on the mining side, but more on the exchange side. So I hope that answered your question as again...

I have a couple of follow-ups on that pricing side. A, if you think about prepandemic, in particular, what sort of levels of pricing you're taking per year? We're talking low mid-single digit? What did that look like in 2022? What does that look like next year? And then if you think about that ability for you to offer them lower cost than they could achieve on their own or with competitors, does this mean that if we think out the next 3, 4 years, actually, pricing will have to go up over time as those hedges roll if -- or as those forward commitment's role if pricing stays where it is? Is there going to be a staircase effect here?

Well, hedge typically -- as you hedge into a position and you take bites over a period of time to get whatever that number is, what it gives you is visibility and predictability. We just happen to do a good job at it, both on the currency side and on the power side. But over time, if there's a rebasing of value, then that is going to rebase and you will eventually get there in one form or another. And the inverse holds true if prices come down, you will eventually get there. And so yes, the answer is over the next 3 to 4 years if nothing changes, prices will continue to go up for our customers for sure. I'm going to tell you something else here, and I've now forgotten.

Anything on quantum from...

So as we look into 2023 from 2022, our -- I refer to them as stabilized assets, the price point we get through escalators and the like. There's sort of -- they've been growing every quarter on a year-over-year basis, stabilized 4% to 6%. We're at the high end of it right now largely because we're selling more services, we're getting better performance in the Americas, the price points are moving up and so that gives me great confidence. So that will happen. So as a business, I take you back to our June 2021 Analyst Day, we told the market that revenues would grow 7% to 9%. AFFO per share would grow 7% to 10%. Well, right now, our normalized constant currency growth on revenues is 10% to 11%. So volume has picked up for us, not price yet, volume. Simultaneous with that, we're selling more digital services. Currency is now at our back instead of interface. So we're going to see the benefit of currency as the U.S. dollar continues to weaken. 60% of our revenues reside outside of the U.S. Then you've got the power. We're going to charge for that. We're not going to make any money off it but we're going to charge for it, so it's going to show growth, but we're going to recover all of the EBITDA that would otherwise be lost if we didn't charge for it. And then the last piece is you've got inflationary increases. So you've got a combination of things that are going on. And so we know where inflation is. And it's fair to say that you're seeing us move up pricing, and range from anywhere from mid to low double digits.

And just on that...

Sorry, mid-single to low double.

Very clear. If we just think about the inflation piece, it feels like next year, particularly in some parts of the economy, whether that's labor, some of these areas are still going to remain pretty hot. How -- what are you seeing on inflation? Would you invest even if there was an incremental downturn from here? And what are you seeing on build costs for new data centers?

Well, data centers -- I mean, the build costs are going up. You have elongated supply schedule. So -- but you build that into your supply, and we do a really good job of moderating build or capacity into the system. We're about 84% utilized. If you look at our more stabilized assets, they're about 87%, 88% utilized. Theoretically, somewhere between 90% and 95% feels about right. It will depend on building. That's where you get -- that's your maximum. Again, it's circumstantial because we measure capacity not only the physical footprint, but how the infrastructure gets consumed, or how it gets cooled or how it comes in from delivery, delivery from the grid. So it's not just -- this tabletop is the capacity. It's a Tetris. You're always working with different things to optimize it. So that's one thing. So I think the build cycles, they're a little bit elongated. Supply chain is a bit -- continues to be disrupted. I think we're in a good position with that. There'll be more projects, I believe, next year than there was this year. But that tells you that we're at -- we're near full utilization in a number of markets. And then we have a lot of markets to feed. And so with the opportunity, the other is not going to the markets because they can't, and us having capacity in these markets, I think is going to bode really well for us. And this is not about hyperscale. That hyperscale stuff sits in a JV. It's off balance sheet. And so we have a beautiful sort of solution to that where it doesn't contaminate our balance sheet. And so I think you're going to see us continue to build. 10% to 12% is the increase, probably on average on the data center. So that seems like roughly a reasonable number to -- that some things are going up substantially more than the 10% and other things are less. And then you've got the human capital side, both as it relates to the impact from the pandemic and also the geopolitical issue in Ukraine because a lot of labor was previously in some of these markets, including Frankfurt. And so you've got a shortage of labor. And in fact, the U.S. has a shortage of labor for a number of reasons, probably 8 million to 10 million people because of the pandemic, because of our immigration policies and because of COVID. COVID in the sense you had the pandemic, and what that did and it forced people into retirement, the pandemic because of death and then immigration policies, which was probably the biggest part of it. And it really had an implication on human capital. And therefore, our wage inflation is higher. So hopefully, that's given you sort of insights as to how we think, therefore, on our business, how prices need to move so that we get a recovery of that higher cost. Inflation, in some ways, I think benefits us to some degree. And then you've got escalators that are built into the contracts. And we've got new contracts renewing that will be uplifted in price. You have new contracts that are coming in that will be at a higher price. Our MRR per cabinet, which is our unit of measure, that's going to continue to increase, I believe. It's a U.S. dollar-denominated number, and therefore, you're going to get currency at your back as well. We disclose it both as reported and currency-neutral. And then you have new services you're adding on to it. So it's a combination of all of those things. I think you're going to see our volume continue to grow despite the market conditions. And you'll see our value per cabinet or per unit of measure grow, and then the profitability in the business or the cash that we generate will continue to scale. And again, that's 7% to 10%, which feels like a reasonable number to promote, which is consistent with our Analyst Day of last year.

Understood. And you touched a little bit on supply chains, they're getting a little bit better. I mean, when do you think those fully normalize? What are their pressure points still that are out there? And what have you done internally to reorient how you do some of those key component supply chains to make sure that when there's next time it rolls around to be even better position than you were this time?

Well, I think the -- George, the world was thinking -- I mean part of what we're all experiencing is the world is deglobalizing. You just see it even in the U.S. with the CHIPS Act. People are going to start building their own chips whether it's in Japan, whether it's in the U.S., whether it's parts of Europe. The U.S. is making a commitment to it. So deglobalization is there. The challenges we experienced are certainly what's going on in China. And prior to maybe the last few days, the real fear of continued lockdowns and the impact that had on supply chains to what's going on in Europe, and whether it's Russia or Ukraine or some of the surrounding countries. Access to raw materials has been very difficult. But as the world slows down and supply starts to increase, I think it's going to alleviate some of the challenges that we'd otherwise experience. And that feels good. So we invested over the last few years in a sort of, again, a procurement and strategic sourcing organization. And it feels good that we're getting ahead of it by not only the forward commitments that we're making, but what we're inventorying in the business, including those critical components that are there -- well, key components within a customer's architecture, whether it's a switch or a router or a server. And so we're getting ahead of that across our business platform, and then making commitments so that we know where we are in the production slot. And that was $300 million for us. And it feels like we got ahead of it, and it's not -- we're not going to suffer from it. So did that answer your question?

Yes, no. That's perfect. I mean if we move on to xScale, we've talked about the hyperscale JV structure you've got. Can you give us an update on where you are with that? And also what the benefits that you get from having it in that form of structure?

Well, the simple benefits is, again, we -- our stabilized assets generate 29% cash-on-cash return. That's before leverage. Now we put leverage at the corporate layer. We don't do it at the asset level. But it just gives you a sense of how much value gets created. Well, when you go into xScale, which is you're selling for hyperscalers, you're doing it -- previously think about high single to very low double-digit yields, and to think about putting that into a balance sheet when we know we've got about $10 billion of capacity to build. It would destroy our opportunity to invest in all the other things, retail and digital. And so by taking in a joint venture, we, being 20%, our partners being 80%, yet we're the general partner, and we get fees for it. We get all the strategic benefit of that asset because we run it, and operate, and build and do all that, but we don't contaminate our balance sheet for something that is yielding over cost of capital, or marginally over cost of capital. And then you've got this new world in which we live in with higher cost to build, higher cost of capital, higher cost to operate. And it's great that it sits out over there. And so what we have as last quarter, $2.5 billion of cash sitting on that balance sheet waiting to be deployed. We've already -- we're starting to prefund all of our needs for next year. And that tells you we've got a growing dividend, we have growing capital commitments. So relative to many, if not all of our peers, we are sitting so pretty on a relative basis. It feels really good, and that was the benefit of having that out there. Those that put it on their balance sheet, I'll use CyrusOne as an example. I don't know what -- when they were acquired for $15 billion, $16 billion, they're roughly 16x levered. We're 3.5x levered. So when you think about what their next decisions are, how do they monetize that asset in a way that doesn't -- that you can't take price out of the equation. And therefore, in a competitive environment, we can compete because we do all that we do, we self-build. And at the same time, we know that our competition is going to be moving price up because they have to. They have no choice. And so I just think it puts us in such a great position as a company. And I said earlier on in my comments, I believe we will spend more in '23 than we are in '22. And most of that is fully funded. And we keep $0.58 of every $1. So we use AFFO as a core metric, which is EBITDA after interest, taxes and recurring CapEx. So it's basically the cash that we keep in the business to fund our growth, that funds the dividend. That dividend, therefore, is 42% of that cash flow. Therefore, 58% goes back into the business. So we, relative to so many of those that are in the REIT space, the typical payout ratio is in the 75% to 80%, in some cases, even 90%, we don't have to do that. We keep $0.58. So we're in a much better position, and then we're going to continue to look for ways to finance in a very inexpensive way where we can. So let me...

I mean it's interesting you speak because it felt in the whole conversation -- so it feels like you emerged from tough and challenging market conditions in a -- what sounds like a stronger competitive position versus peers. And therefore, net-net, obviously, there's this challenge, maybe some increase in churn, et cetera. But longer term, this is something that could actually turn out to be net positive for the business. Is that fair?

I think absolutely net positive. Certainly, the days -- the heydays that we experienced, most of us will never experience that again, where capital is virtually free. I hope we don't experience again because it does -- it doesn't separate the good from the bad. It really doesn't. And I think we've always been good capital allocators, and you couldn't differentiate our cash flow dollar from somebody else's. And some would say, well, that's a good. I don't think it's good because I think there's a lot of sloppiness out there. So I think it's been good to us. But the challenges that we've been experiencing, people wanted more growth and say, we're not -- we live for the long term. We want to create long-term shareholder value. By making these short-term knee-jerk decisions over a quarter or a year, it'll come back and hurt you. It's coming back to hurt them now. And then you've got currency, which was in our faces, now at our back. And the dollar has been so strong over all these years, and 60% of our revenues coming from markets that are growing faster than that of the U.S. that has really put pressure on the business. And the last thing I would just say, look, we're getting very, very -- because of these times, no surprise, we're getting very, very focused on how to drive more efficiency into the business, how to manage our costs differently. And we're going to be doing a lot of things and -- that makes sense for the business despite our strength. And it feels right. So let's stop there.

I mean just on the interest rate environment, that's, I guess, a different dynamic as well. How comfortable would you feel with those different pressures coming through, either hurdle rates of investment or through the P&L directly?

The nice part is we've all -- we've self-identified 20% to 30% hurdle rate. So we're already well above whatever the cost is. And yes, so the costs have gone up a bit and so maybe eats a little bit into that. But our capital structure is very, very sound. We have the lowest rate of borrow in our industry at roughly 1.94%, 1.95% with the longest tenure in our industry yet, an average of 9 years. So we have a long time before we have to start paying back debt. Now our maturity retires, that's the average. We've got a 30-year paper, and we got paper that will come -- some due in 2024, but it's like $500 million. So I don't worry about our capital structure. One, we've got a really sound structure. Our rating agencies have upgraded us even during this time of difficulty, and one -- even give us more leverage another turn of leverage. So it feels like we have a good relationship. They like our structure. So I will look to the cash from the business will be the primary funding source. Then we're going to put some more debt on the business because we can. We're 3.5x levered today. Then we'll use our ATM where appropriate. That debt, I've said it quite publicly if all going well our next transaction will be in Japan. Cost of capital there is 2% to 2.5% for us. We have some Japan needs. And the reason I don't worry about that capital ever maturing because it's going to be permanent capital for us. I will permanently place that capital in Japan given the scale and size of our Japanese business, both present and in the future. And so I'll just refinance it despite the yen being pretty weak to the U.S. dollar today. So really, I think our capital structure is going to be an advantage for us for the foreseeable future.

Perfect. Well, we're heading up against time. I want to ask one final question. You've had, I'm sure loads of group meetings, investor meetings. What are some areas you think investors focus too much, or something that's generally underappreciated about the Equinix story?

Well, I think the one thing that probably -- frustrate is not the right word, but the one thing that I don't think is appreciated is how different we are than everybody else. Yes, we have competition. But the way that we've set ourselves up, both from history and present is highly differentiated. And that's why I'm saying in this new world, I think you're going to appreciate the difference between a good capital allocator and a poor capital allocator. And so understanding that our assets are different, and we have a different customer opportunity than many of those that are out there.

Great. Well, look, that's the end of the session. So appreciate everyone for being here.

Thank you all very much.

Thanks for being with us.