Tuesday, June 29, 2010

Data Centers Continue to Grow in a Weak Economy

by David Gross

Few industries have withstood the recession as well as data centers. Lease rates are still rising, capacity is being filled up, and new centers are opening every week. The industry's great recession was not in 2008 or 2009, but in 2002, when it was decimated by dot com overbuilding, and some facilities were turned back into warehouses.

Riding the industry's recessionary expansion, Digital Realty (DLR) grew to $191 million in revenue last quarter, a 28% year-over-year increase. The data center REIT is now larger than many of its retail and office counterparts, and is over half the size of office stalwart Boston Properties (BXP). During its first quarter, co-location provider Equinix (EQIX) grew at a comparable 24% year-over-year rate, coming very close to a $1 billion annual run rate before closing its merger with former rival Switch and Data.

The double digit growth for an industry that suffered during the last recession raises the question of whether this expansion can continue, or if the current economy is too weak to sustain further top line growth. Nonetheless, there are a number of factors supporting the industry right now, including:

Dependence on financial trading volumes, not underlying asset values. Pushing trades, quotes, and market data across data center networks, the financial services sector accounts for about a quarter of the industry's revenue. And traffic volumes in the recession have had a weak correlation to underlying security prices. As long as the number of algorithmic trades, derivative price quotes, and electronic executions continue to rise, traders are likely to demand more data center space.

Growth in consumer transactions. Amazon.com (AMZN), an Equinix customer, is still growing its top line over 20% per year. In addition to e-commerce companies, content providers like Hulu and Sony, and many gaming networks, are all running their traffic over data center networks. An indicator to watch here is page views for these consumer sites, as well as the trend of top 10 sites developing their own centers, as Facebook and Google (GOOG) are doing right now.

Major price discrepancies in long-reach and short-reach data links. Not quite as obvious as some of the consumer indicators are the persistently high price differences between short-reach and long-reach data connections. For example, a 10 kilometer, 10 gigabit link can require more than 10 times the capital outlay of a 10 meter link due to large cost differences in the optical modules and line cards needed to provision the connections. Therefore, it makes far more sense for content providers to interconnect with one another, or with their telecom carrier at a neutral data center, rather than construct a dedicated private line to reach the nearest telecom central office.

In addition to these factors, data centers have not been impacted much by the lack of job growth. Online video page views don't sag because of a weak unemployment report, and the cloud computing and Software-as-a-Service (SaaS) providers locating servers in data centers are automating many of their customers' job functions themselves. Leading SaaS provider salesforce.com (CRM), another Equinix customer, is growing at a 20% year-over-year pace comparable to Amazon.

The credit crisis, high unemployment, and limp economy of the last two years have done little to slow the growth of public data centers. If anything, limited credit has stopped the industry from overbuilding like it did eight years ago.

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