I did a double take when I discovered Equinix
Let's start off with the good news. Given the crazy expectations of bandwidth growth in 2000, data centers were massively overbuilt, with many companies taking on crippling debt loads to build the expensive centers. Exodus at one point had a debt-to-equity ratio of 20-plus. It all ended badly, with many of the larger players exiting the business. Equinix took advantage of this, acquiring its initial batch of data centers at fire-sale prices in Silicon Valley, for example. However, acquiring those assets on the cheap didn't prevent the company from taking restructuring charges of nearly $17.6 million in 2004 and $33.8 million in 2005 because it had gotten out of unfavorable leases.
The bad news is that the supply of cheap data centers is now exhausted, and Equinix has to build new data centers for expansion from scratch, which is not cheap. The first phase of the company's new Chicago data center is being financed with debt (uh oh) to the tune of $165 million at an 8% interest rate. It's an aggressive move, to say the least, for a company that is still unprofitable and for which a substantial portion of its $49.5 million in year-to-date operating cash flow is made up of stock-options tax benefits.
What also concerns me is the fact that many of Equinix's best potential customers, like Google
Furthermore, Equinix isn't immune to one of the most challenging issues facing any company seeking to managing its infrastructure today -- power use. Equinix has negotiated limits on using power with some of its highest-demand customers. The effect is that it limits the existing data centers to using 75% to 80% of their capacity, which not only costs Equinix sales, but also tells the customer, "We can't serve you fully; build your own data center."
Yet investors seem to have forgotten the great flame-outs and have bid Equinix shares up 86% over the past year. The company's enterprise value is about $2.5 billion, or roughly 22 times 2006 EBITDA, which is the most generous valuation measure I can find because there is no E to go with the P/E. For investors, lessons are often repeated until they are learned, and this is one lesson that has not yet stuck. Investors might be wise to consider the increase in the company's share price an early Christmas present and move on before it turns into moldy fruitcake.
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Fool contributor Stephen Ellis does not own shares in any companies mentioned. You can view the stocks he owns and check out his 99th-percentile ranking in Motley Fool CAPS, the Fool's new stock-rating community. The Motley Fool has a disclosure policy.