I did a double take when I discovered Equinix (Nasdaq: EQIX ) recently -- I could have sworn it was a misprint, and the now-bankrupt Exodus had by some miracle been resurrected. Equinix, after all, rents out data-center space and network bandwidth, similar to what Exodus did. Alas, upon further investigation, I confirmed that Exodus, the former data hosting center highflier that filed for bankruptcy after the great bubble, was still dead and buried. However, Equinix shares some disturbing similarities, and given its rapidly weakening balance sheet and sky-high valuation, I think shareholders might be in for a lump of coal in their stockings.
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 (Nasdaq: GOOG ) , Yahoo! (Nasdaq: YHOO ) , and Microsoft (Nasdaq: MSFT ) , are building their own data centers to handle their infrastructure needs. While both Google and Yahoo! use Equinix to some extent, IBM (Nasdaq: IBM ) was actually the company's largest customer, with about $25 million in 2005 revenues.
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.
For more about the companies mentioned, see:
There's a whole world of naughty and nice out there!Take a lookat the rest of the bunch.
Yahoo! is a Stock Advisor selection and Microsoft is an Inside Value recommendation. Both of these newsletters are beating the market, so take a free trial to see why.
Fool contributor Stephen Ellis does not own shares in any companies mentioned. You canview the stocks he owns and check out his99th-percentile ranking in Motley FoolCAPS, the Fool's new stock-rating community. The Motley Fool has adisclosure policy.