Although the humble data center is not an exciting aspect of information technology, it's essential to its functionality. After all, it's where organizations store the servers and related equipment that power their networks, websites, and apps.
As a result, publicly traded data-center operators such as Digital Realty Trust (DLR 1.07%), CoreSite Realty (COR), and Equinix (EQIX 0.05%) have been very popular among investors lately. Could Nevada-based Switch be the next star in this firmament when it hits the market following its IPO later this week?
Prime real estate
Switch operates three large data centers, which it calls "Primes." Two of these are located in its home state, and one in Michigan.
That's because the company likes to plant its flag in "areas within the United States with limited or no natural disaster risks, favorable business and tax climates, close proximity to major cities, robust telecommunications networks, and significant customer demand," it wrote in its IPO prospectus.
Switch serves just over 800 clients, a list that includes such big names as eBay (EBAY 1.68%), Verizon Communications, and JPMorgan Chase. eBay is its most important tenant, contributing nearly 10% of total annual rental revenue.
Switch's structure as a traditional corporation sets it apart from its publicly traded competitors, which are all real estate investment trusts (REITs).
Switch's future strategy is, essentially, growth by expansion. The company said it intends to keep building out its Primes while chasing new clients. The company also aims to expand into new regions of the country that fit its geographic strategy.
That, combined with still-hot organic growth, should continue to keep the consistently profitable Switch in the black.
In the first six months of this year, revenue grew by 17% on a year-over-year basis to just over $181 million. Net profit was basically flat, as increasing headcount and capital expenditures have affected the bottom line lately. Still, it landed at over $35 million for the period. That's a nearly 20% margin.
That figure is very competitive with the data-center REITs on the market and more or less matches that of Digital Realty Trust, which in my view is the best stock in the segment just now.
This Fool's take
It nearly goes without saying these days that demand for data-center services will only continue to rise. We live in a rapidly digitizing and device-laden world; servicing that world properly will necessitate ever more space in data centers.
It's little wonder that stocks in the data-center space have seen their prices rise significantly -- many investors want a piece of that growth. Digital Realty Trust stock is up by more than 20% so far this year, and it's a laggard. Equinix has improved by 25%, CyrusOne is up 32%, and CoreSite Realty has gained 41%.
There's no question in my mind that Switch will ride this wave. I have two major concerns, though.
First, after the IPO, more than two-thirds of the company's voting rights will effectively be in the hands of its founder and CEO, Rob Roy. I'm not comfortable when minority shareholders essentially have no say or influence on their investment's operations.
Second, Switch will be the one data-center stock currently on the market that isn't a REIT, meaning it's a big question mark when -- or even if -- it'll pay a dividend. REITs, on the other hand, are required to; they must distribute at least 90% of their net profit as dividends to maintain their REIT status. Switch is vague on its dividend policy, saying its board "may elect" to hand one out.
Meanwhile, the data-center REITs reliably distribute them every quarter. Digital Realty Trust currently yields 3.1%, with CoreSite Realty hovers just above 3%, CyrusOne pays out at 2.8%, and Equinix clocks in at 1.8%.
Like many income investors, I prefer a company that pays a dividend. This is particularly applicable here, as in my view Switch isn't a vastly superior operator compared with its REIT rivals. That, plus the governance issue, would make me more inclined to buy shares in one of those companies than Switch.
There will be 31.25 million shares of Switch on sale for $14 to $16 apiece in the IPO. Beginning on Friday, Oct. 6, they will be listed on the New York Stock Exchange under the ticker symbol SWCH. The underwriting syndicate is headed by Goldman Sachs, JPMorgan Chase unit J.P. Morgan, Bank of Montreal's BMO Capital Markets, and Wells Fargo Securities.