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

Good afternoon, everyone. My name is Brendan Lynch, I cover communication infrastructure here at Barclays. I'm joined today by Equinix's Chief Accounting Officer, Simon Miller. Simon, welcome.

Thank you. Appreciate it.

Forward-looking statements?

Yes, absolutely. So we'll be making statements today [indiscernible] our SEC filings [indiscernible] risk factors affecting our business.

Great. Maybe as a place to start, Equinix is -- for years now been [ enabling companies ] is to execute on their digital transformation. Maybe you could just give us an update on where the average enterprise is in that process, maybe any changes in all the [ states ] of evolution?

Yes. Really good question. And as you can imagine, I'd say it varies across [ the board ]. You've got your - kind of the folks operating on the edge that lean in early. They're probably a good portion of the way through it. I'd like to consider Equinix one of those companies, we're going through our own ERP transformation right now, converting from Oracle on-premises to Oracle Cloud. ERPs are critical operational set of tools to operate the company. And what we've found when we go through that type of transformation is that there's a host of ancillary applications [ back ] that need to be considered as well because they don't tie in from an on-prem basis to a cloud basis very well, and you don't [indiscernible]. So a company like us, we're only about halfway through that. We've got at least another year along that transformation as for the ERP, and then we're going to start to get to work on some of these other ancillary applications with that. There's probably some other real quick early adopters, smaller companies that are going to be able to do it a lot quicker. But when you're talking about that broad swath of enterprises, it's probably at least a 5- to 8-year kind of transformation that's going to take place for companies over the next several years. The big companies like SAP, Oracle, Microsoft, they're all going exclusively cloud in the future. So if you're on-prem today, you're going to need to acquire some sort of cloud [ based ] architecture solutions in the future. I mean you're going to need to do at in a place like Equinix, quite obviously, where all of the other tools that support that transformation, all of those providers are there within Equinix as well as the carriers that provide [ access ] into those providers.

A lot of [ progress ], but still some room to run...

I still feel like it's very early. I mean for us, we had a few delays. There's just a lot of learning that goes into it. You're really moving from an architecture that has been the [indiscernible] better part of [ 50 ] years. Within that, a cloud solution is different is what I would say. You don't -- we don't customize anywhere near as much, but you have a lot more configuration capability. And I think going through the evolution, really looking at what do you do inside of your 4 walls and how do you have to do it differently, that was part of the process that I think we didn't fully appreciate going in, that took us a little bit of extra time as we [ moved through ] the development [ phase ].

Interesting that -- to hear that Equinix has to go through...

I know I actually wish Keith, our CFO, would talk about it a little bit more. We live it internally. But yes, we're drinking our own Kool-Aid internally for sure and utilizing our own resources that [indiscernible]...

Maybe in [ terms of ] the next wave of digital transformation, obviously, you guys getting enormous amount of attention. And a lot of companies are talking about how -- when they're asked about AI, they say, "Oh, we've been doing AI for years." And I think there's certainly some truth to that. Maybe you could talk a little bit about legacy AI applications, for lack of a better term, versus some of the AI demand that might be stemming from ChatGPT or [ OpenAI ] demand over the last 12 months.

Yes. And then -- and we have, like we've had AI inside of our 4 walls for several years now. It's -- they're more niche applications. When you think about that ChatGPT, that is a consumer-facing large, massive [indiscernible], but you've got various use cases for AI where it's real-time AI analytics doing something along the lines of [indiscernible] for an internal use application suite and enterprise that is very focused. That type of stuff has actually been around for the better part of 4 to 5 years and certainly increasing in [indiscernible]. By the way, that's the type of stuff that is perfect inside of an Equinix data center because you're trying to crunch a ton of data, like all of the [indiscernible] work historically, and [ process it all ] and give real-time answers. You're using a smaller data set that is very easy to provide compute right next to connectivity. That's the type of stuff that is getting launched and has been launched now. I think it's going to increase in size and volume as some of the bigger, let's say, tool and SaaS providers push AI [ involvement ] into the enterprise in a more, let's say, generalized fashion, to be able, not to necessarily replace but [ a necessary ] set of tools they have out there. That will be another layer of complexity. And then there's, of course, the consumer facing kind of a big transformation point in generative AI applications.

And are you seeing any of that generative AI, large language model demand yet or is that still probably a few years out?

We probably won't see that on the retail side of our business, but we're definitely getting a decent amount of inbound requests and discussions on the [ wholesale ] side of our business. So you're describing the large learning models, or language models are much, much more compute focused. They need a high amount of density in terms of power. Generally, the deployers of that, if you're thinking about a hyperscaler, which is probably where they would [ play ] mostly. They're looking for areas that -- they don't need to be super close to networks. So they're looking for locations where they have a ton of access to real estate expansion and power, because [ they build ] facilities that start at 200 megawatts, get as big as 500 megawatts, maybe as big as a gigawatt. They want access to the power. They want access to the power cheaply. They don't need to be around large city centers because it's a high compute environment. Where that stuff eventually gets pushed into the inference model is where I think you, pardon me, the opportunity for Equinix on the retail side of our business will start to expand. And we're starting to see a little bit of that. But again, it looks a little bit more like a niche homegrown AI model that people are [ serving ] for themselves.

Okay. I want to come back to xScale in a minute, but maybe just a few more on AI. You had some wins recently with [indiscernible], I think a few other AI start-ups as well. Can you just characterize the nature of that leasing, is it a large footprint in a single facility? Is it distributed throughout the U.S., throughout the world?

Yes, it's a couple of locations and really about leveraging our network node. It's that piece of delivering the inference out on the edge of the footprint as opposed to all of the [ core ] compute that we've done on the back end.

As you're building out into the AI realm, I think the positive could be that you're establishing a new ecosystem and kind of tapping into it as you did with the cloud for the past couple of years or so. Maybe on the negative side, it's an unproven business model. Talk about how you consider some of these risks and opportunities.

Yes, it's definitely unproven, but I would say it does [indiscernible] cloud 2.0 all over again. And back in the day, we -- there was a lot of questions around our business model, whether cloud was friend or foe. And at Equinix, we have just some of the best [ team of ] thinkers on the technology side. And we really sat down and developed a how do we become the home of the cloud and develop a series of products to work with hyperscalers to create cloud on and blend that with our network connectivity to offer a host of solutions to customers. AI feels like the same. It feels very similar. Once the inference engines get [indiscernible] on to the enterprise or to the data center, the way we're looking at it is it's just another stack in that suite of applications that I was talking about as a business leader that I need to implement and have supported. We're thinking a lot about it as it being just another stack that companies are going to need to have highly interconnected, talking to other sources of data in their architecture. If you think about -- so I have a bit of AI in my world. It's mostly -- I wouldn't call it fully generative, but those AI bots need to be proximate to where my business is, because it's grabbing data on [ some of the ] ERP, it's modifying it in some way and pushing it over here for use by either another human or another bot, right? In my case, that's very latency sensitive. And so I would expect, and the way that Equinix is looking at this is, is another technology stack that ties in really well with corporate digital transformation in general, especially when companies are using a host of cloud-based architectures, Infrastructure-as-a-Service or Software-as-a-Service.

Great. And as you're getting more of these AI-oriented workloads or your power density is increasing in general, talk about the metrics that you're presenting to investors now versus maybe what you will be in the future, to kind of capture how things are evolving?

Yes, sure. Right now, probably our most important nonfinancial metric is cabs billing. And actually, this last quarter, we had a lot of internal dialogue because we saw a flat cabs [indiscernible] that's a bit of a surprise to us, and we went back and started digging into it. And one of the things that we are seeing is, as we're churning out older deployments -- customer deployments in our data center, at call it, 4 kVA per cabinet, we're replacing that now with densities at 5 to 7 kVA per cabinet. I think a lot of that has to do with the underlying economics for the company, but also the things that they're deploying overall are more power intensive and need to interact more with networking year-over-year cloud providers over here -- providers over there. So I would expect to see that density, that metric increase. I would expect us as a company to go back and dig through that a little bit and try and figure out if there are other KPIs that we can use to enhance cabs billing. Right now, we feel like it's by far the best metric to look at the business, because it captures really not just specifically power that we charge for a cabinet, but it includes interconnection, which is a huge part of our business, managed services, and then any digital services that layer on, so that we can -- we can kind of project out what the yield potential is on a per cabinet basis to the investor base. But we're starting to realize that that's -- it's a little more complex. There's more to the story than that, and there's timing differences. So I would say there will be more to come on that. We're doing some internal [indiscernible], trying to figure out what suite of KPIs and metrics we could add to enhance that won't confuse or also [indiscernible].

[Technical Difficulty] It's balancing...

Well, you don't want to rush to it, right? Really, we -- there was a bit of intrigue internally where -- like do we start disclosing that right as part of this earnings. Thankfully, folks like Katie Morgan and other people like that slowed down until we can test this and see the trends and make sure it's operating the way we think it is or should for now.

You mentioned xScale. You have your first xScale facility here in the U.S. now in Santa Clara. Maybe talk about what you see as the opportunity going forward to expand that here in the U.S.

Yes. Traditionally, our xScale strategy is focused on retail proximate facilities so that hyperscalers, in general, can leverage the connectivity that they already have in our data centers. Certainly, the last 12 months, I think the uptick in AI, although we had it on the road map, but I think it's just moved forward at a pace that with ChatGPT's launch and subsequent announcements is sort of quickening the pace a bit. So we'll continue to invest in that, call it, strategy 1 type of deployment because we think where there is some level of compute that needs to be close to our data center, with builds that are more [ built to ] [indiscernible], and the economics are a little bit better, will help our customers deploy there. But I think in the U.S., we do see us focus a little bit more on those AI-driven type of opportunities, which are bigger in scale. Our traditional xScale [ deployments ] are about 30 to 40 megawatts and require that they're close to our retail data center so that we can leverage connectivity. I think when you look at us expanding on the xScale side to take advantage of this AI opportunity, you're going to see us get further away in remote locations away from the kind of high-density network-connective data centers and closer to places with expansion opportunities on realistic [ power ].

A lot of dry powder out there in the infrastructure world looking to be deployed. What are you looking for in terms of a partner in the U.S. for the xScale applications?

Yes, I think somebody that shares that vision and has the right connections that can help grease the wheels if we want to get to [ business ]. But more importantly, somebody that's happy to let us lead the charge, because we're certainly a leader in this category. We've got the brand. We've got the customer connections. We build and operate and support data centers, we think, better than anyone in the world. So somebody that's happy to take that lead and partner with us. The size and scale of the investments that are going to be necessary are pretty big, to your point, Brendan, though there's money that is waiting to find a home. So not much of a shortage of people lining up to talk to. It's really going through that diligence process and finding that cultural fit, that operational fit. Sometimes purely financial investors, when you explain operational challenges, it's a bit tough. And so you want to partner with somebody that has at least an intuition around what it takes to operate in the business. Things rarely line up the way you put them on a piece of paper, the way that you model things. And so just working through that, finding a partner where the cultural fit, where the strategic intent and time horizons for exit and additional lending requirements will match up.

So it sounds like from your previous xScale JVs, they were more -- you had a financial partner on all those. It sounds like in the U.S., you might have more a partner that has some, at least, operating expertise.

I think we'll still lean more towards financial, but making sure we get that fit of somebody that understands the operational nature.

Sure. And in terms of the -- going into the business, building these hyperscale facilities. I'd argue that there's very strong demand right now, but there's arguably lower barriers to entry, which, compared to your interconnection hubs, which see relatively modest cabinet additions over the past few quarters, but I would argue much higher barriers to entry. How do you think about those risks and opportunities?

Yes. While I look at it and monitor it on the retail side, I don't really worry about it, quite honestly, because we have such a defensible market position, like you said, that the cost to [ just play ] -- you cannot build a data center with 1,800 carriers in it overnight. Attracting those carriers and then getting the people to come in, connect to those carriers and consume services, it takes 25 years. That -- it really does. And minimally, in a single market, it probably takes you at least 10 years. And so being able to sustain that type of ramp-up phase is very challenging for folks. While there is a lot of money on the sideline, people, I think, still want to utilize debt to get there. And I think the interest rate situation that we find ourselves in and probably will here for a bit of [ time more ] is a slight barrier to entry. I think the way we think about it is, look, we're the best builder and operator of data centers on the planet, we've got a very strong brand. Once we nail down with our customer where they want to go, how they want to go, how they want to get there, procure the lands, make sure that we've got the power allocated, we'll be ready to rock. I mean I think the thing that we have is that brand, the thing we have is our balance sheet to leverage in the meantime. [indiscernible] we still have a couple of turns of debt before we make the rating agencies uncomfortable. We've got a healthy revolver. So we have a ton of flexibility there. And I think our brand just gives us an immense lead in that category.

The brand and the ecosystem, I think, are totally -- very...

It's a little bit different on the AI side. If you become the place where AI gets done on the learning side and have a solid track record on inference, even though they might be small deployments, it feels like Equinix will be the place where AI gets done in the future.

In terms of the demand that you've been seeing -- you alluded to it earlier, cabinet [ bookings ] have been relatively modest year-to-date. I think they're only up about 0.5% after growing some 25% over the past couple of years. I've heard Charles Meyers described 2023 as the year of optimization. Where are we in that process? Do you think that could continue into 2024?

That's a great question. I'll tell you that is probably the single biggest questions we've been asking ourselves internally as we're going through our [ planning ] season right now. And I'll say, I think our bet is that things will maybe clear up a little bit compared to '23, but there will still probably be a bit of volatility. I think Q1 for us will be a really [ interesting ] quarter, seeing how we perform against our pipeline will be really interesting to me. I'm an accountant, so I always kind of think in terms of planning cycles in the business and just knowing that most enterprises out there are nailing down their budgets right now. Once those budgets get pushed down to the functional leaders at the company, they will have their authority to go spend starting in Q1 of next year. And you'll get a really good sense of how those enterprises are planning internally when you see the [indiscernible]. I would say we're looking at things a bit cautiously [indiscernible] more what's going to happen [ in the ] really interesting, I think, shift towards AI. It may slow down a little bit, but I still believe enterprises are in full pursuit of digital transformation. It just might be a little bit lumpy around that.

Is it generally macro uncertainty that the [ caution ]...

Yes, I think so. People dealing with inflationary challenges out there. In our space specifically, we had to absorb a really big inflationary hit last year on power. We don't expect anything close to that magnitude this year, which is definitely going to be helpful for us. [ It was ] a bit of a challenge to talk to people when you're pushing out several hundred million in power price increases to your installed base but, hey, can we sell a new implementation as well. I think that that will clear up a little bit here in 2024. But there's still long lead times for customers out there, supply chains, inflation globally is still pretty high, especially outside of the U.S. And there's a host of companies [indiscernible] they announced actions that they were going to take to cut costs within 2023 are probably going to -- some of that's going to extend into '24 [indiscernible] action taking in support of those cuts.

On the power front, maybe you can give us an update on where you are in terms of hedging going into 2024, and also how you will be handling the power increases that you have passed on already in an environment where energy costs are generally coming down?

Yes. We'll give an update on how we're heading into '24, so I'd just refer you back to Q3 on what we said there. But generally, where we can be hedged, we're fully hedged. We think that [indiscernible], that's a benefit to our customers. And last year, when we rolled out a ton of purchase -- excuse me, power increases to their bill, we had to walk them through that, how we actually saved them money by being hedging -- hedged coming into the year. The way that we do it is we kind of look out a couple of years and we put about 4 years of layering in there so there we've always -- we're really just cost balancing the overall portfolio. Sometimes [indiscernible] doesn't definitely in a time of increasing prices. So we're going into next year at least feeling like the volatility around that is better. In some markets where you're expecting to see power increases in terms of prices, in others it's probably going to be [indiscernible]. I think appropriately, we've been pretty consistent, both with the investor base and definitely with our customers, that we'll push that back down to them if we're seeing [ material increases in pricing ] and they're contractual in nature for us or at least we feel like they're going to be we'll be able to sustain them for a period of time. So some volatility, but a little bit less. And where we [ can be hedged ], we'll be hedged or close to fully hedged there. That's for sure, Brendan.

When we look at your pricing year-to-date, it's up about 9%. Maybe just aggregate what component of that is power related versus just pushing power increases -- excuse me, price increases on to the customer base and any difficulty you might see doing that going forward given some of the budget constraints and some of that macro hesitancy that you're seeing contributing to the relatively modest cabinet [indiscernible] this year-to-date.

Yes. gosh, I have to get back to you on the specific [ breakout ]. I mean it's a good portion of it. [ Katie ], do you know offhand, [ by any chance ]?

[indiscernible] and of that, roughly about [ 42, 43 ] was the underlying pricing adjustment, excluding the power price...

Okay. About 1/3 of that is related to power. And the good news about how our contracts work is that we generally -- we have price escalators built in but they're not automatic. Historically, we've been very strategic about [ keeping those down ]. Where we're seeing real inflationary costs, we'll continue to maximize whatever leverage we have against the agreement to push that down to our customers. We will probably be a little bit more strategic depending on the reaction there because we have that flexibility. At the end of the day, like 90% of every dollar that we book in the quarter comes from an existing customer. We just have to be cautious about doing that. But we have a ton of flexibility within our contracts to do it. [ It's ] anywhere from 3% to 5%. And these days, when we're locking in new agreements, we're putting -- we're maximizing that language as much as possible, and we're stepping people up to the, what I would call, new post-inflationary rates, list prices that have been increased anywhere from like 8% to maybe 12% depending on the market. So we're going to -- new deals are getting uplifted when we go through renewals, when we go through our annual PIs, we'll be very subjective. But we're going to be very sensitive to what we're seeing out there with the customer base. And again, I feel like this year will be an easier time to have that conversation because last year, you're hitting them with a contractual PI at the same time you're doing this big power PI. And so that just felt like a double punch. This year will feel [ like a single punch ]...

Yes, I can imagine last year was a difficult [ conversation ] though, you went through some pretty assertive price increase.

But I give our team full marks because we started [indiscernible] towards the middle of the previous year and having conversations with customers. We sent them 3 notifications telling them here's the date that we're going to get back to you with the range of your price increase, here's the date that we're going to come back to you with definite increase, trying to hit it at the time where they -- they would be able to influence whatever budgetary decisions they were making back [indiscernible] at the company.

Maybe one accounting question. You can walk us through the variety of maintenance CapEx costs that you have, which ones do you consider operating expenses versus recurring CapEx? And I suppose the genesis of the question is that PP&E has grown at about 11% CAGR over the past 6 years, while recurring CapEx is [ only up about ] 5%. So I suppose there's an element of you have some newer facilities that are probably just operating more efficiently. But maybe there's a consideration that there's some catch up in maintenance CapEx coming up.

Yes. No, we've got some facilities that are well over 20 years old. This is actually something that's been on our mind for a few years now. Generally, when we go in and do a big maintenance project, we put a lot of pressure on our design and construction teams to release capacity. Where we are able to release capacity and live up to this standard of how we define AFFO in our earnings release, if we create capacity for incremental revenue, not just [ maintain ] revenue, we push that into expansion CapEx. And that takes the shape of replacing CRAC units so that you can provide more air flow to the white space and therefore distribute more power, so you can take cabs off of engineering [indiscernible]. So I may be [ able ] -- after release of -- after 1 maintenance project, release 300 cabs in data center. Well, that's 300 cabs of incremental revenue. And I'm actually going to get a return on it. So we'll put that into expansion. Where we don't have that opportunity, it's just traditional recurring CapEx. And we've got a, as you mentioned, we've got some big ones coming up, putting a ton of pressure on the team to just rethink how we might engage in replacing some of the bigger parts of that infrastructure, definitely around air movers, CRAC units, in some cases power distribution. The good news is we've got one of the best design and construction team in the business, and they're coming up with a very creative ways to not only give us a surety that a critical data center is going to stay up and live and relevant and meet our customers' demands, but actually improve, on the efficiency side, drive down PUE and give us additional capacity to sell, which is for us, that's affinity and what we're always trying to achieve.

Tall order, but...

It's a big one. But honestly, I mean, it's a great question because we've been looking at this for a couple of years now. This is not something that -- like we've been sort of seeing this coming for a while, started having a couple of just high-level conversations with the team like 3 years ago. But when it came to putting the actual plans on paper and putting execution and a few [ arms ] around it, it happens, right? If you talk about it enough and really explain to people why it's so important and show the value that you can create and why if you're IBX operator, your project has a higher likelihood of getting approved -- but I'm just being -- playing -- then everybody gets on board with it. We get some amazing solutions out of it. Stuff -- quite honestly, we're putting stuff right now that I just never -- I really didn't dream 2 years ago when we were kind of looking at this probably 5-year to 7-year period of, I'd call it -- we call it a refresh, but maintenance is probably a good word for it.

Great. Well, I look forward to seeing some of these developments in 2024. Thank you, Simon.

Absolutely. Thank you, Brendan. Appreciate it.