The data center sector has undergone a dramatic upheaval over the past year. Three real estate investment trusts (REITs) focused on data centers have gotten acquired over the past few months. Now, Switch (SWCH), a data center company that was in the process of becoming a REIT, has changed directions and is exiting the public markets.
Here's a look at the latest deal and what it means for the data center sector.
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Taking the road well traveled
After some prodding by activist investor Elliott Investment Management, Switch decided to start the process of converting into a REIT late last year. However, three data center REITs have agreed to acquisitions over the past several months. Private-equity giant Blackstone acquired QTS Realty Trust for $10 billion, infrastructure REIT American Tower bought CoreSite Realty for $10.1 billion, and funds managed by KKR and Global Infrastructure Partners took CyrusOne private in a $15 billion deal.
This acquisition wave led Switch to launch a strategic review of its options earlier this year, including a potential sale. It reportedly received takeover interest from Brookfield Asset Management and DigitalBridge Group (DBRG -1.78%). It eventually agreed to a buyout deal with DigitalBridge and IFM Investors.
The partners will pay $34.25 per share for Switch, valuing the data center operator at $11 billion, including the assumption of debt. That implies a roughly 11% premium to Switch's closing price the day before the announcement when rumors started to swirl that it was near a deal with DigitalBridge. Meanwhile, it's 66% higher than the share price last August when Elliott Investment Management pressed it to consider switching to a REIT.
What's the draw of data centers?
Infrastructure investors have been gobbling up data center platforms because of the rapidly growing demand for space to store information. Streaming, cloud computing, the internet of things, 5G, artificial intelligence/machine learning, and other catalysts are creating an enormous amount of data, which companies need to store in data centers. That's providing opportunities for data center platforms to expand.
For example, Switch expects to construct 11 million additional square feet of data center capacity through 2030. That should enable the company to grow its earnings at a double-digit annual rate. This growth profile is very attractive to infrastructure investors, which is leading them to make moves to secure a toehold in this sector.
Dwindling options for public market investors
With Switch hitting the road to the private market, public market investors have seen their available options continue to dwindle. They could shrink further. Data center operator Cyxtera Technologies (CYXT), which went public last year in a special purpose acquisition company (SPAC) deal, is reportedly evaluating its strategic options, including a sale. Given all the private capital pouring into the sector, it shouldn't have trouble finding a buyer.
That would leave investors with two remaining options in data center REITs Equinix (EQIX -2.61%) and Digital Realty (DLR -2.76%). They're behemoths in the REIT sector, with market caps of around $60 billion and $40 billion, respectively. Given their large sizes, they're not likely to be acquisition targets.
Instead, both have been on the other side -- as consolidators in the sector. Equinix recently acquired four data centers in Chile for $735 million and MainOne for $320 million, expanding its operations into Africa. Meanwhile, Digital Realty acquired a majority stake in Teraco, valuing the African data center operator at $3.5 billion.
These deals enhanced their already strong growth prospects. Both data center REITs have several expansion projects underway around the world that should drive strong growth rates in the coming years.
Heading for the exit
Insatiable investor appetite for data infrastructure platforms is driving a wave of acquisitions in the space. Switch is cashing in on this demand by agreeing to a buyout deal at a healthy premium instead of staying on the road to become a REIT. While that leaves public market investors with dwindling options, they still have two attractive ones in Equinix and Digital Realty, which have lots of growth ahead.
