Tuesday, November 30, 2010

Data Center TCO is a Meaningless Number

By David Gross

Few metrics are as overused yet as useless as TCO.   Largely developed by sales and marketing to close deals, it has very little connection to financial reality, because it ignores the time value of money, offers little support of any kind for a buy vs. build decision, and typically pulls in a lot of costs that you are going to incur anyway. 

With data centers, TCO numbers can get comical, because this is an automated industry, where personnel costs are often a very small share of total outlays.   And while vendors love to talk about how they save power, which can also reduce operating costs, many of the products that save power require higher up front capital outlays, providing weak financial returns.   So then how are you supposed to measure data center costs?   How are you supposed to decide between more power consumption or more capital outlays?

As I wrote last week, data center expenditures should be set to minimize the NPV of cash outlays within operational constraints.   This is very different than randomly tagging your PDUs, CRACs, or servers with allocated overhead costs as TCO models typically do.  Moreover, many of the financial decisions that take place involving a data center don't involve money, but time.   If you're building your own facility, it's not really a decision to spend more or less, it's a decision to spend now.  If you're renting additional space, you're not just deciding on how much to spend, but when.    Moreover, TCO really doesn't apply, because you don't own anything, and if you force some sort of TCO calcuation, you need to place a discount rate on future rent payments, each of which occurs at a different point of time.

Specifically, here are some things the industry can do to bring TCO models closer to the financial reality:

1. Stop Summing Costs from Different Time Periods and then Comparing Them to One Another.  

This is a common tactic, to claim half of the "expenses" are capital costs.    Problem of course is that there is no such thing as a capital expense, there's depreciation of up front capital outlays.  

Moreover, don't say 50% of your "expenses" are capital outlays, say 60% of the present value of your cash outlays are capital expenditures at a 7% discount rate, but this rises to 70% at 12%, which is your corporate cost of capital.   If it costs more to borrow in the future, you'll need to look at renting more.   This is just one way in which financial data can be used to support important decisions, instead of just validating some vendor marketing department's claim about savings.  

2. Stop Making Pie Charts with Cost Categories

Just about every aspect of a data center operation can be rented or bought.   A key decision factor then isn't whether power is 15% of costs or 20%, but the fixed cost of turning a rented item into an owned one.   In the case of the facility, this is obviously going to be very high, in the case of a blade server, it will be low.   This ability-to-buy is far more important than assigning a percentage to facility rent or blade servers because you need both a building and servers regardless of what you decide financially.   What matters is if your cash outlays are higher than peers or competitors because you're leasing when you should be buying, or building when you should be renting.

3. Constantly Monitor the Tradeoffs You've Made

TCO often does a poor job of determining trade-offs that underlie decision making.   For example, if you buy a power hungry, 9 watts per Gbps Ethernet switch because it has a low port price, you need to monitor prices for power, prices for higher line rate ports, alternate protocols, alternate topologies, in addition to your corporate cost of capital..  The cost justification for such a tradeoff could change, and it won't show up in any static TCO spreadsheet.

Ultimately, as time passes, corporations will be spending more on renting, building out, and operating data centers.   Those that move beyond TCO models stand to gain significant financial benefits over those who try to force numbers into convenient categories that have little to do with financial reality.

Monday, November 29, 2010

Focus, not Cost "Synergies", Key to Mellanox-Voltaire Merger Success

By David Gross

InfiniBand IC supplier Mellanox announced today that it acquiring long-time customer, and fellow Israeli InfiniBand technology developer Voltaire.   The acquisition price of $8.75 a share represents a more than 35% premium over Friday's close of $6.43, and is net of $42 million of cash held by Voltaire.   Mellanox is financing the deal entirely out of its cash balance of $240 million.

Mellanox is down 4% on the news to $24 a share, while Voltaire is up 34% to $8.65, leaving very limited room for risk arbitrage on the deal.

While both companies have gotten into the Ethernet market over the last two years, the deal only makes sense in the context of InfiniBand, which as a niche technology, does not offer a chip supplier billions of ports over which to amortize development costs.   Mellanox already offers both ICs and adapter cards.   Moreover, and very importantly, InfiniBand switches are low cost, low memory, high performance boxes with stripped down operating systems and forwarding tables.   The intellectual property router and Ethernet switch makers put into system design and network O/S is less valuable here as a result.    The message acceleration software and management tools associated with InfiniBand devices require far less R&D than new ASICs or network operating systems for high-end, modular Ethernet switches.

What's likely to happen here is Wall Street will do its usual fretting over whether the proposed operating cost reductions will be achieved, which in this case are $10 million, whether the price is reasonable, and what customers will think.  Additionally, at least 30 hedge fund managers are likely to ask the same questions on the strategic impact of owning switches, InfiniBand vs. Ethernet, and will seek "more color" on how the integration is going.    But none of this will really matter.   The key to success here will be the extent to which the new company focuses on InfiniBand.    Outside of bridging products and maybe 40G NICs, there new company needs to stay out of the Ethernet market, which already has enough suppliers, and treat Fibre Channel-over-Ethernet as the toxic technology it already has proven to be for Brocade.

Friday, November 26, 2010

Cisco and Brocade - Great Technology vs. Proprietary Technology

By David Gross

Was just reading through an article over at Investopedia on Brocade, and it was so off-base, I thought I would give a counterpoint here.    The writer claimed that Brocade had great technology but poor ability to sell, that there was something wrong with posting non-GAAP earnings, that there was good reason to believe Brocade would take share, and that it would benefit from the market shift to Fibre Channel over Ethernet. 

All four of these claims are either wrong or based on random speculation.   But the strangest one is his point about great technology but poor ability to sell.   If Brocade was so bad at selling, it wouldn't have OEM deals with IBM, HP, Hitachi, Oracle, Dell, and others.   The company is fairly strong at sales.   And its technology might be "great", but on the Ethernet side, it has to deal with proprietary Cisco technologies like VTP, ISL, and CDP which have long held Foundry/Brocade's Ethernet revenue in the $100-$150 million range per quarter, while Cisco's has soared past $3.5 billion.   

As I've written here before, Wall Street simply doesn't seem to know about Cisco's proprietary routing and VLAN technologies, and has no idea how important they are to the business.   It's understandable considering that Cisco IR and its executives rarely talk about them, and instead focus investor presentations on flashy marketing themes about e-learning, conferencing, "human" networks, and so forth, and I can't fault them if so many Wall Streeters are going to center their analysis on investor relations spin.   Nonetheless, EIGRP, VTP, ISL, and other proprietary VLAN and routing protocols are to Cisco what Windows is to Microsoft.

While Cisco is setting up itself for mediocre returns by wasting capital on silly overdiversifications into conferencing and video, Brocade still hasn't been able to grow its Ethernet business as fast as Cisco has grown its Ethernet business, in spite of Cisco's being over 20 times larger.   Cisco posted a 25% y/y revenue increase for its switch business in its most recent quarter, while Brocade posted just a 9% increase, and has been selling its Ethernet products at gross margins 30 points lower than Cisco's.

Now, at the end of the Investopedia article the writer says that perhaps Wall Street thinks Brocade's SAN switches could become irrelevant.   But for the last three years, Brocade has acted like it thinks its SAN switches could become irrelevant, and has told a fancy tale about "convergence" and Fibre Channel-over-Ethernet that has made it seem like the company has no faith in the SAN market it dominates.   And for that, you can't blame Wall Street.

Wednesday, November 24, 2010

Cisco Buyback Program Grows while its Market Share Drops

By David Gross

One of the questions I'm answering a lot these days is whether F5 and Riverbed are overvalued.   But no one's wondering if the same is true for their "dominant" competitor Cisco.   In response to its limp stock performance, Cisco recently announced that it will increase the cap on its share buyback program $10 billion.

Share buybacks used to be seen as some sort of internal endorsement of the company.   But that was before technology companies started piling up cash without paying much in the way of dividends.   Now they're often used as gimmicks by cash rich companies to try to boost a stock that's treading water while smaller competitors are doing something far more important to their future stock price - taking market share.

While Cisco still owns the switching and routing markets, their overdiversifications into other areas have caught up with them, and now they're doubling down on these bad investments by throwing more shareholder capital at a buyback program that will do nothing to stop John Chambers wild ride into conferencing, consumer devices, and a product that will make the Newton look like a success, the Cius.   After years of tremendous success naming products after numbers, Cisco somehow decided to go with something that sounds like it was ripped out of a High School Latin textbook.

It's kind of interesting how the stock has gone nowhere since John Chambers got bored selling switches and routers.  Over the last five years, Cisco has spent over $10 billion buying companies like Scientific-Atlanta, WebEx, Pure Digital, and others that have brought it closer to end users, and expanded its presence out of the guts of the network.   Over that same period, the stock has gone up 14%, or about 2% per year.   Juniper, meanwhile, which hasn't had the resources to buy all sorts of consumer device companies, has seen its stock rise a more respectable 42% over the same period.   Riverbed and F5 are up over 300%.   So how did Cisco become such an underperformer?

Any Idiot Could Run This Joint
Former Fidelity fund manager Peter Lynch once said that when evaluating companies, he likes to hear that "any idiot could run this joint, because someday, any idiot probably will".    Cisco found a person who could fit that description in 1995, but it did eventually catch up with them.

For all his attempts to overdiversify the company, John Chambers still has to contend with the fact that nearly 2/3rds of his product revenue comes from switches and routers.   While those products aren't exciting enough for Chambers or Cisco IR to talk about these days, they're still growing in spite of their size, with switch revenue up 25% year-over-year.   Moreover, these devices are built on routing technology Cisco built internally, and the switch business has grown out of two acquisitions, Crescendo and Kalpana, which were made before Chambers took over.   The third major switch acquisiiton, Grand Junction Networks, was made in 1995 soon after he became CEO.   The tens of billions of spent on new companies since then have done remarkably little to add to the top line, although they've done a lot to make Chambers speeches more interesting, because he wasn't about to go all over the world talking about enhancements to OSPF or spanning tree.

Before Cisco really lost its focus, it was a lot better about killing off products from bad acquisitions.   In 2001, it realized its $500 million buyout of Monterrey was a mistake, that it was not going to compete strongly in optical switches, and it killed the product line.    Yet its $6 billion acquisition of ArrowPoint has created a product line, the CS-series, which is getting crushed today by F5 and Citrix's Netscaler.    But it won't admit that it's strength is in layer 2-3, not layer 4-7, regardless of how bad a beating it takes.   Chambers used to say something about being 1 or 2 in a market like GE traditionally was, but now market position is losing out to market hype, and it's remarkable how much more is being written about the Cius, telepresence, and how little is being said about the proprietary VLAN and routing protocols which are the foundation of Cisco's $100 billion+ market cap.

Cisco can blame Federal spending levels, the economy, Chambers' receding hairline, or whatever it wants for its current struggles.   But there's one thing the company can do to fix things, one thing that will stop the share losses to smaller competitors, one thing that will allow it to dominate for decades - focus on routers and switches.   But this won't happen with the current CEO.

Instead buying back shares, the board should be bringing in new leadership.

Tuesday, November 23, 2010

Brocade Guides Down 3%, Stock Drops 5%

By David Gross

Brocade fell 5% in after hours trading Monday after guiding its revenue midpoint for next quarter down from $558 million, to $542 million.   The culprit behind the decline was the same as it was for Cisco - the government.   The company said it could see a drop in Federal Ethernet revenue of $20-$25 million due to delays in government contracts.   Now I remember when Foundry transformed its Reston, VA office from an AOL/Cable & Wireless/telecom focus, to a Federal focus in 2001 and 2002.  Almost seems like the tide is turning in the other direction now.   Nonetheless, Brocade still gets 23% of its revenue from the Federal government.   

Overall, revenue for its fiscal 4th quarter, which ended October 31st, was up 5% y/y to $550 million.   Ethernet revenue was up slightly to 26% of corporate revenue, compared to 25% a year ago.    The balance sheet remains unusually ugly for a network equipment manufacturer, with just over $330 million in cash and equivalents, but over $900 million in long-term debt, most of which came from financing the Foundry acquisition.    Nonetheless, the company is producing free cash, and its cash balance was up $40 million sequentially.   Moreover, gross margins were up 20% y/y to $325 million.

While I'm no fan of either Fibre Channel over Ethernet, or Brocade's all-things-to-everyone product strategy, this wasn't a bad quarter and there are plenty of other reasons to sell the stock besides a 3% drop in revenue guidance.

nlyte Software Raises $12 Million C Round

By David Gross

A month after Emerson announced its Trellis DCIM, or Data Center Infrastructure Management platfrom, nlyte Software, which makes capacity planning tools for data centers, recently announced it had raised a $12 million C round.    Whatever the valuation was, investors surely must have been encouraged by Emerson's $1.2 billion acquisition of Avocent last year.

While often mixed together with feel good PR about making data centers more green, DCIM tools are increasingly being used to bring some order and structure to the often chaotic process of building out data centers.   In nlyte's case, it holds a patent on a method of allocating servers into racks.   

While I don't like all the greenwashing that's going on with DCIM products, they do have the potential to improve the IRR on corporate investments in data center assets, both from their ability to track assets, as well as by enabling data centers managers to plan more efficiently.

Monday, November 22, 2010

Data Center Cash Outlays vs. Data Center Costs

By David Gross

An odd statement that I hear a lot is that "power is the biggest cost in a data center".   This idea has been repeated so frequently, it's become an assumption for some industry followers, especially in the press.   Now while power is a major cost, it's often not the largest, especially because data center tenants really need to distinguish costs from cash outlays to get the best returns on their investments in power and space.  

Part of the problem with some approaches to evaluating data center costs is that there's a bad tendency to force a number next to each category of expenses.   Assign one number to servers, another to storage, one to power, and so forth.  This distorts the true economic picture of a data center operation, because recurring personnel costs are extremely low, which means every data center owner or lessor has the choice of buying or renting just about every aspect of their data center operation.   But if you try to boil everything down to an amortized cost, the true economics of the operation get lost in that forced calculation.

Actual Operating Costs vs. Accounting Operating Costs
Power can be self-generated with wind, solar, or backup generators, but for the most part it gets paid for on a monthly basis - either by the amp or by the kWh.    If you look at a typical co-lo contract, it comes out to about 25-30% of total charges.  In terms of public companies, CoreSite reports that about 25% of its revenue comes from power.   

In addition to power, people, and rent (in the case of a colo/REIT customer), the other major operating cost is telecom circuits, which can become significant for a heavily cross-connected customer, a customer buying extended cross-connects, or one needing 100 Megabits or more out of the facility.   Equinix gets 20% of its revenue in North America from telecom services, and that doesn't include what its customers pay third party transit providers.   While telecom costs can be much lower than power expenses, they are also far more variable based on customer requirements.

But once you get past power, rent, and telecom services, there are all the servers, storage arrays, and network equipment boxes to buy.   In one scenario, I estimated the loaded capital cost per server for all of this equipment, plus software licenses, to be about $8,000, or around $25,000 per square foot.    Now the temptation here is to amortize this over 36 or 60 months and call it something-hundred per foot per month.   The problem with doing this is that you can lease the equipment, finance it through low cost debt or high cost equity, and you can cluster purchases in a handful of months - making a straight-line depreciation figure a financial accounting abstraction that has nothing to do with your economic reality.   The point is that these are fixed costs with a lot of  financing and purchase options, and throwing one number out there to cover them buries the economics of owning (or leasing) these assets.

What I recommend is not to force a number in per month, but to aggregate the cash outlays, and then NPV them at the corporate cost of capital, as well as other interest rates to determine the sensitivity to your discount rate.    This is the only way to get a true picture of the economic costs.    Additionally, leasehold improvements can be incorporated into this analysis as well.  Then the objective should be to minimize the NPV, not the amortized monthly cost, because no matter what you're paying for power, cross-connects, or bandwidth, your data center is an asset-heavy, not a people-heavy, operation.

Friday, November 19, 2010

SC10 and Optical Components for the Data Center

By Lisa Huff

It's a beautiful time of year in New Orleans for the top supercomputing companies to show their wares. While I wouldn’t consider SC10 exactly the place to sell optical components, there were a few new developments there. SCinet – the network that is always built at the top HPC conference – boasted 100G Ethernet as well as OTu4. Alcatel-Lucent, Ciena, Cisco, Force10 and Juniper, among others donated equipment to build this network. Module vendors Avago Technologies, Finisar and Reflex Photonics contributed QSFP and CFP 40G and 100G devices to the cause.

Meanwhile, the Ethernet alliance was showing two demonstrations in its booth – a converged network running FCoE and RoCE over 40GigE and 100GigE. Nineteen different vendors participated in this demo that was run by the University of New Hampshire Interoperability Lab. Both CFPs and QSFPs were used in this demo.

Some of you may wonder why I would attend SC10. I keep my eye on the HPC market because it usually indicates where the broader data center market will be in a few years. And, in fact, even medium-sized businesses’ data centers with higher computational needs are starting to resemble small HPC centers with their server clusters using top-of-rack switching.

Most of the top optical transceiver vendors and even some of the smaller ones see this market as an opportunity as well. While InfiniBand still uses a lot of copper interconnects, for 40G and 120G, this is changing. QSFP was the standout for 40G IB displays and CXP AOCs were shown for 120G as well. Avago Technologies was the first to announce a CXP module at the show.

Some believe that the CXP will be short-lived because there is progress being made on 4x25 technologies – Luxtera announced its 25G receivers to go with its 25G transmitter that it announced earlier this year. But it will still be a few years before all of the components for 25G will be ready for system’s developers to spec in. Tyco Electronics had a demonstration at their booth showing it is possible to run 28G over eight inches of a PCB, but this was still a prototype. And Xilinx has announced a chip for 28G electrical transceivers that can be used with this board design. But, none of these devices are even being tested by equipment manufacturers yet and the CXP has already been adopted by a few. So I think the CXP may have more life in it than some people may think.

Equinix Expands in San Jose

By David Gross

One of the most keys to success in the wholesale/co-lo market has been the ability to dominate certain geographies.  While Wall Street is still going on with its vague, misguided approaches to understanding demand, businesspeople who don't need to ask for "a little more color" get that they need to have high share within the metro areas in which they operate, regardless of how big their competitors are in other cities.   So for this reason, it was good to see Equinix announce its newest data center, not in Singapore, Sydney, or Slough, but San Jose.

While some companies overdiversify by offering too many services, Equinix has done so by entering too many markets, especially those where it has limited share.    To succeed in Los Angelese, it will have to invest a tremendous amount of cash in marketing, in order to reach media companies and content distributors already in CoreSite buildings.  Dallas will always be a tough market, because Equinix has no chance of catching up to the 2 million square feet owned by Digital Realty.   Northern Virginia, a former Equinix stronghold, should have another 1 million square feet of Equinix-owned space right now, but expansions elsewhere diverted capital to other markets, and created a nice opening for Digital Realty to come in and develop its Devin Shafron properties.

Equinix's newest facility in San Jose is its eighth.   Its first phase includes 1,098 cabinets, with a full build out of 2,600 and total space of 165,000 square feet.   In its press release announcing the opening of the facility, the company proudly pointed to its legacy serving Silicon Valley companies, and to the cross-connect opportunities across its regional footprint.    But both would be even greater if it wasn't stretching its capital budget to cover large markets already dominated by someone else.

Thursday, November 18, 2010

North Carolina Hype Getting Out of Hand

By David Gross

North Carolina recently added Indian IT Services provider Wipro to its growing list of private data center builders, and it's been off to the races for industry pundits, some of whom are hyping North Carolina as the next great location for the industry.   I've written a couple articles about North Carolina, and agree that it's doing a good job recruiting brand name companies, but any comparisons to Silicon Valley and Northern Virginia are ridiculous.

The public data center market continues to be driven by bandwidth, while the private market is driven by power and tax incentives.  Not surprisingly, they're heading into different locations as a result.   Moreover, these fundamental attributes aren't changing much.   No one is talking about building their own private data center in Santa Clara or Ashburn, and none of the public providers are heading to rural Oregon or the banks of Lake Ontario.

Investors need to get beyond the hype and conventional thinking that spreads quickly, and look instead at the factors that go into data center site decisions, which change far less frequently than many other aspects of the data center industry.

Wednesday, November 17, 2010

InfiniBand's Growth Slows in Supercomputing

By David Gross

The latest semi-annual Top500 survey is out this week, in conjunction with the SC10 show, and InfiniBand has posted fairly modest gains over the last six months, with implementations growing from 207 to 214 of the world's largest supercomputers. 

In the June survey, InfiniBand showed major gains from the November 2009 tally, growing from 181 to 207 system interconnects, and 151 interconnects from the June 2009 count.   Five years ago, InfiniBand was used in just 27 systems, and trailed not just Ethernet, but proprietary interconnect Myrinet.    Back then, over 40% of the world's top 500 supercomputers used proprietary or custom interconnects, while today just 11% do.   Ethernet has held steady over this period, dropping slightly from 250 to 228 of the top 500, and most of InfiniBand's gains have come up at the expense of Myrinet, Quadrics, and other proprietary interconnects.

While Ethernet still has a slight lead in number of systems, the average InfiniBand-connected supercomputer has approximately 70% more processors than the average Ethernet connected supercomputer.    With proprietary interconnects essentially wiped out, any future share gains for InfiniBand will now have to come at Ethernet's expense.

Tuesday, November 16, 2010

Lawsuit Filed Against Verizon's Upstate NY Data Center

By David Gross

Verizon recently won approval from the Town of Somerset to build a 1 million square foot data center on Lake Ontario, about 40 miles east of Niagara Falls.    But now the Buffalo News is reporting that the owner of the farm across from the proposed site is suing the town, claiming it didn't go through the appropriate environmental, planning, and zoning procedures.

There's already a 675 MW coal-fired plant next door to the proposed location, so the site is not completely pristine.  And living in the midst of Northern Virginia's many data centers, I think the farm's owner, Mary Rizzo, would benefit from seeing how these facilities often sit across the street from $1 million housing developments.   Hastings Drive in Ashburn, for example, is filled with cranes and construction vehicles as DuPont Fabros builds out its ACC5 project.   On one side of this data center are more data centers, two owned by DuPont Fabros, one by Digital Realty, and five owned by Equinix.   And on the other are expensive houses, separated by nothing more than a short construction fence and a narrow road.

I don't know how much legal merit the suit has, but if buyers of upscale DC-area homes can learn to live next to data centers, I'm sure upstate NY farmers can as well.

Monday, November 15, 2010

Top-of-Rack Switching - a Power Saver?

By David Gross

In just about any survey about energy efficiency, data center managers reply that it's their number one concern, a major priority, or give some other kind of indication that they are highly focused on saving energy.   Then they go out and buy power hungry, high density GigE line cards for their switches and routers.

Many technology surveys ignore the fact that buyers often say one thing and do another, but investors can't.   And when it comes to network equipment, the best ways to reduce watts per Gbps include buying an OC-768 line card, which costs over half a million dollars, or an InfiniBand switch, which typically requires a Clos topology, which is still uncommon outside of supercomputing.

As an example, Voltaire's 4036E offers 1.36 Tbps of InfiniBand switching with just 240 Watts, or just .18 Watts per Gbps.   Meanwhile, the 32-port GigE/1 port 10GigE uplink card for the Nexus 7000 consumes 385 Watts, or 9.17 Watts per Gbps, 50x more, and there are far more Nexus switches than Voltaire devices in most data centers.

There is often a trade-off between power consumption and features, because much of a high-speed router or switch's power is tied to TCAMs, packet processing, and the memory/forwarding requirements of large routing tables.   However, with few of these sophisticated features, Top-of-Rack switches offer tremendous bandwidth with limited power.  Force10's S4810 ToR switch, for example, requires just .44 Watts per Gigabit.   But its larger Exascale switch has a 10-port 10 GigE line card that needs over 3 Watts per Gig.    Configuration flexibility has a price.

While many data center managers are still resisting ToR switches, there is roughly a 40% Watt per Gbps improvement just from upgrading from GigE to 10GigE.    And while there is a significant cost penalty at 10GigE going from short reach 850nm optics to longer reach 1310nm and 1550nm optics, there is no power penalty.    Here again, the least capital efficient networking options and the most power efficient.  

While the IRR on buying more expensive ports to save power is often negative, there are at least a couple options developing to reduce Watts/Gbps that don't require an entirely new topology, or a multi-million dollar router.

Akamai Leasing Another 16,000 Square Feet from CoreSite

By David Gross

While the Netflix-Akamai/Level 3 story is getting more air time now than "Panama" did in 1984, other events are still happening in the data center industry regarding CDNs, including news that Akamai has leased another 16,061 square feet from CoreSite, according to the data center provider's most recent SEC filing.  

In its quarterly newsletter, CoreSite mentioned that Akamai was now peering at 40 Gbps on the provider's Any2 IP exchange, a hint that more space could have been on the way. With the additional capacity, Akamai will be leasing over 29,000 square feet from CoreSite, making the CDN supplier CoreSite's 4th largest customer by annualized rent.   Facebook is still #1, and the I.R.S. is #2, with the tax collectors taking over 120,000 square feet of office space at the 55 South Market building in San Jose, where the successor to the MAE West exchange is located.

Either way, Akamai's growing presence is a major win for CoreSite against Equinix, which as I mentioned in the CoreSite earnings preview is struggling in LA against CoreSite's One Wilshire leasehold and 256,000 square foot 900 North Alameda building, which along with its New York City property, are making it a leading choice for media companies, including NBC Universal.    

Even though Akamai's annualized rent will now top $3 million at CoreSite, it will still trail the I.R.S in how much revenue it produces for the REIT.  And no matter how much rent the tax collectors pay to CoreSite, it's nowhere near as exciting as talking about Netflix and Level 3 as frequently as Z-100 played "Panama" in 1984.

Friday, November 12, 2010

CoreSite Earnings Preview

By David Gross

CoreSite has its first earnings call as a public company today, a few things to look out for:

  • Employee Productivity - While incorporated as a REIT, CoreSite did an un-REIT like $600k per employee in 2009, which is about what Equinix did, and about 75% lower than Digital Realty and DuPont Fabros.   Part of this is because of size, and also because the company needs more ops staffing to accommodate its Any2 exchanges, including hiring for an Ops Support Center.   At this point, investors cannot realistically apply REIT-like metrics such as NOI and cap rates to CoreSite like they can to DLR and DFT, because CoreSite has been structured like a REIT that's operating as an interconnection company.  
  • Media Clients and Los Angeles-  The company's customers include NBC Universal and Akamai, and in addition to its leasehold at One Wilshire, it has over a quarter million square feet at 900 North Alameda Street, making Los Angeles its largest market, with over 40% of its space.   CoreSite is giving Equinix major problems in LA, especially with Equinix building away from the downtown carrier hotels, and trying to get everyone to come out to its centers next to LAX.

  • Performance of the non-Data Center Assets - About a third of the company's portfolio is office and light industrial space.    Much of this comes from the over 200,000 square feet of office space in the MAE West building it owns at 55 South Market in San Jose, which is a 15 story property whose largest tenant is the I.R.S..

Updated North Carolina Map with Facebook

By David Gross

A few weeks ago, I posted a story with a map of the T5, Apple, Google, and American Express data centers in North Carolina.    I've just updated the map to reflect this week's news about Facebook's $450 million facility.

One odd take I've seen on the story is how "green" the center is.  If the economics of the decision work, there shouldn't be a need to greenwash it with some odd PR about clean power.   North Carolina is doing a great job attracting self-built data centers, but unlike upstate NY or the Pac Northwest, it has poor conditions for wind power, and no multi-Gigawatt hydro plants.   But so what?   Is everyone afraid of Greenpeace protesting at their site like they did in Prineville?

Where wind and hydro are available, they offer tremendous economic benefits, because of their low variable costs.  Coal's biggest problem isn't Greenpeace, but the rapidly rising capital cost of constructing coal-fired plants, which has surpassed $2,500 a kW.   The need for alternatives is an economic one, not just an environmental one.

View North Carolina Data Centers in a larger map

Wednesday, November 10, 2010

PCIe – An I/O Optical Interconnect Soon?

By Lisa Huff

The Peripheral Component Interconnect (PCI) is that bus in computers that connects everything back to the processor. It has been around for as long as I can remember having workstations. But in recent years, it has been morphing in response to the need to connect to the processor at higher data rates.

PCI Express (PCIe) GEN1 defined PCIe over cable implementations in 2007. Molex was instrumental in helping to define this and up until now, it has been a purely copper solution using its iPass™ connection system. This system has been used mainly for “inside-the-box” applications first at 2.5G (GEN1) and then at 5G (GEN2). The adoption rate for PCIe over cable has been slow. It is mainly used for high-end multi-chassis applications including I/O expansion, disk array subsystems, high speed video and audio editing equipment and medical imaging systems.

PCIe GEN3 is running at 8G and some physical layer component vendors are looking to use an optical solution instead of the current copper cable along with trying to move it into a true I/O technology for the data center connections – servers to switches and eventually storage. While component vendors are excited about these applications, mainstream OEMs do not seem interested in supporting it. I believe it is because they see it as a threat to their Ethernet equipment revenue.

CXP AOCs seem to be a perfect fit for this GEN3 version of PCIe, but neither equipment manufacturers nor component suppliers believe it will reach the price level needed for this low-cost system. It is expected that the optical interconnect should cost 10’s of dollars, not 100’s. However, CXP AOCs may be used for PCIe GEN3 prototype testing for proof of concept. But if the first demonstrations are any indication, this will not be the case. PCIe GEN3 over optical cable was recently shown by PLX Technology using just a one channel optical engine next to its GEN3 chip with standard LC jumpers. PLX and other vendors are looking towards using optical engines with standard MPO patch cords to extend this to 4x and 8x implementations.

Columbia University and McGill University also demonstrated PCIe GEN3, but with eight lanes over a WDM optical interconnect. This is obviously much more expensive than even the CXP AOCs and is not expected to get any traction in real networks.

Another factor against PCIe as an I/O is the end user. In a data center, there are typically three types of support personnel – networking (switches), storage/server managers and data center managers. While the server managers are familiar with PCIe from an “inside-the-box” perspective, I’m not sure they are ready to replace their Ethernet connections outside the box. And, the others may have heard of PCIe, but probably aren’t open to changing their Ethernet connections either. They can run 10-Gigabit on their Ethernet connections today so really don’t see a need to learn an entirely new type of interconnect in their data center. In fact, they are all leaning towards consolidation instead – getting to one network throughout their data center like FCoE. But, as I've stated in previous posts, this won’t happen until it is shown to be more cost effective than just using 10GigE to connect their LANs and SANs. The fact that PCIe I/O could be cheaper than Ethernet may not be enough because Ethernet is pretty cost-effective itself and has the luxury of being the installed base.

Correction from Monday's Story on Digital Realty and the Brick S-house

By David Gross

On Monday, I attributed to the initial comment about the "Brick S-house" at the IMN Forum on Data Center Investing to Digital Realty/GI Partners Managing Director Rick Magnuson.   While he used the term, it was in fact created by Jeff Moerdler of Mintz, Levin, Cohn, Ferris, Glovsky and Popeo during the pre-keynote banter, when I was still in the registration line, along with the people attending the Distressed Hotels event.   Now, some of this blog's readers who were already in the conference noticed that I credited Magnuson, and not Moerdler, for this term, and I wanted to publish a correction here, and let all of our readers know that neither I, nor Lisa, would ever want to incorrectly attribute any quote made at a conference about a "sh--house".  

In all seriousness, it was a great event, with a lot of good detail on site selection issues, financing, pricing, and competition.   I highly recommend hedge fund and mutual fund PMs take a look at the 2011 event if it continues with these themes.

Tuesday, November 9, 2010

Netflix Story is No Reason to Sell Akamai

By David Gross

Akamai is down nearly 5% today after CDN expert Dan Rayburn published a story in Seeking Alpha saying that Netflix is leaving Akamai, and handing over its business to Level 3 and Limelight.   While he says he cannot precisely nail down how much revenue is associated with this, he estimates it's $10-$15 million.     So Wall Street is knocking the company down 5% for losing what amounts to 1% of annual revenue.   Yet another emotionally charged expectations multiple, although the 5 here (5%/1%) is lower than the double digits we've seen with Riverbed and Equinix.

The flip side is that not only is Limelight soaring, but Level 3 is out of the delisting zone, back over a dollar, which is an important development considering it got warning from NASDAQ last week due to its stock spending too much time trading under a buck, which means it would need to reverse split or hold above a dollar to avoid being booted down to the OTC market.

Level 3 is up 14% on this news, which like Akamai, would get about a 1% shift in revenue based on Rayburn's estimates, which means its getting an expectations multiple of 14, almost as high as Equinix's record 17 when it dropped 35% after guiding down 2%.  What makes this even sillier is that Akamai's cost structure hasn't changed a bit, and it still spends half as much per dollar of revenue on bandwidth as Limelight, and generates more revenue from CDNs than Level 3 does from managed hosting, colocation, Ethernet, wavelengths, IP/VPNs, wireless backhaul services, managed WAN Optimization, SIP Trunking, Wholesale VoIP, PRIs, and CDNs combined.

Part of the reason there is such an overreaction from the manic buyers and panic sellers on Wall Street is that the customer is Netflix, which is heavily followed, and whose executives can't go to the bathroom without some analyst pondering the greater meeting.   If a less exciting Akamai customer, like the Food and Drug Administration, or the National Center for Missing and Exploited Children, was going over to Level 3 or Limelight, I seriously doubt we'd see this response, even if the revenue opportunity was the same.

Independent Phone Companies - Hosting Providers of the Future?

By David Gross

During last week's earnings announcements, Cincinnati Bell CFO Gary Wojtaszek stated that:

"The results from our recently acquired CyrusOne operations demonstrate great progress towards our goal of being the preferred provider of global data center colocation services to Fortune 1000 companies"

He made this statement the same day that Windstream announced its $310 million acquisition of Hosted Solutions, which had the same previous owner as CyrusOne, ABRY Partners.    But what's happening?  Have formerly conservative independent LECs suddenly become leading edge colo providers?

Independent telcos like Cincinnati Bell, Windstream, SureWest, and the 1,100 phone companies serving rural communities, are known for selling mature, established services like DSL, voice, and business T-1s.   But being boring no longer produces the cash flow it once did, and now telco executives are talking less like owners of 100 year old telephone exchanges, and more like providers who interconnect at Equinix exchanges.   But is this just PR gloss, or can they really succeed?

To date, many colo and hosting providers have succeeded by avoiding telecom services, while many telecom providers, notably Cogent and AboveNet, have focused on providing telecom services to data centers, not by selling the space inside of them.   The "end-to-end" provider has not fared well.   Level 3, in particular, received a delisting warning from NASDAQ last week, and has long struggled to compete against the multiple providers it faces across a variety of markets.   AT&T and Verizon Business have had some success in hosting, but much of their focus in the business market has been on high bandwidth and shared network services such as Transparent LANs and IP/VPNs.   However, independent telcos like Windstream and Cincinnati Bell have far fewer of these large corporate customers.

In the late 90s, Cincinnati Bell made an attempt at becoming a more exciting business provider when it acquired Texas-based IXC Communications and temporarily changed its name to Broadwing Communications.  When it re-branded back to Cincinnati Bell, the company mentioned the great tradition behind the name.   Now it is banking its future on another rapidly-growing Texas company, although this one is not in the midst of a crazy fiber optic building spree like IXC was.

Privately-held hosting and colo providers like i/o Data Centers and SoftLayer have had no trouble raising capital, and shortly before its acquisition, CyrusOne raised $150 million on its own.   While I can't say how much CyrusOne wanted to be acquired, ABRY Partners, not unlike GI Partners, clearly needed a "liquidity event" to maximize its IRR on its hosting investments, and in this case, getting 8x prior year revenue was far more than they would have gotten from an IPO, especially with CoreSite trading around 2x annualized revenue. 

While Cincinnati Bell unquestionably overpaid, I think it did the right thing operationally by keeping the Cyrus One brand, and not re-creating another "Broadwing" or oddly-branded provider.  But outside of CenturyLink/Qwest, which will stretch the definition of an "independent" phone company because of Qwest's RBOC operations, there are few other independents who can afford to spend $500 million on a hosting provider.

Monday, November 8, 2010

Rackspace Hits Expectations, Down 2% After Hours

By David Gross

Rackspace met sell-side expectations with an EPS of 9 cents, and revenue beat by 1% at $199.7 million.   Normally, I don't like getting into this EPS-by-a-penny chase, but Wall Street can't help but have emotional responses to news in this industry.   Even though Rackspace hit public estimates, it fell slightly short of a Morgan Stanley estimate of 10 cents that was published this afternoon in Investor's Business Daily.   The stock fell 5% after hours after the earnings report hit the wire, but has come back a bit and is now down 2%.  

Cloud continues to be less than 20% of revenue, but over 80% of the hype, but was up sequentially from 12.4% of revenue to 13.4%.   More important to profitability, the company's SG&A/Revenue ratio continued its decline, dropping 44 points sequentially to 36.94%, and down 2.15 percentage points year-over-year.   This boring, but financially significant detail, is the main reason why earnings growth has been 55% over the last 12 months while revenue growth has been 23%.   But with the company saying "cloud" as if they get a multiple off of how many times they can they the word, don't expect a lot of news about techniques to control SG&A costs.

IMN Forum on Data Center Investing - "The Brick S-house"

By David Gross

The actual name is "The Forum on Financing, Investing, and Real Estate Development for Data Centers", but that's too long for a blog title.  Either way, it's taking place today in Los Angeles, and there have been a lot of interesting discussions about supply, demand, financing, etc.  GI Partners/DLR Managing Director Rick Magnuson started things off with a  keynote where he referred to the "Brick S-house", a term which has been repeated at least seven times in ensuing discussions, at least according to the unofficial count I'm keeping in my program.

I'll be speaking later on the analyst/PM panel.   I'm also sitting behind the Millers from Data Center Knowledge, and they should have more info on the event later.

Rackspace Earnings Preview

By David Gross

Rackspace reports after the close today, here are a couple things to look out for:

  • An Expectations Multiple off of Guidance, Actual Revenue, or Actual Earnings.
The stock is near its 52-week high, and is likely to trade down at a multiple of any guidance or revenue disappointment.   So if revenue comes in 1% lower than the expected $197 million, don't be surprised if the stock drops 5-10% after hours and on Tuesday.   This has been happening with most data center stocks after they report, with exaggerated price swings down or up based on slight disappointments, or marginally better-than-expected results.   From Equinix to DuPont Fabros to Terremark to F5 Networks to Riverbed,  few earnings calls have taken place this quarter without being followed by an unjustified emotional response from the stock market.   I'm sure some smart trader is taking advantage of this.

  • The Growth Rate in Managed Services Revenue
The year-ago quarter saw the highest sequential increase in managed services revenue the company has had over the last year, providing a high comparison for this quarter's y/y calculation.   Year-over-year top line growth last quarter for managed services was 18%,  and for all the talk about Cloud, this company is not worth 60x annualized earnings if its growth depends on a service where it's running behind Amazon's EC2, and where it does not have the same cost advantages in leasing and personnel costs that it has in managed services.  Managed services competitors have lower asset utilization, higher rent costs, and more costly personnel, largely because they're also offering unmanaged colocation,  which adds significantly to space requirements, and because they're hiring in DC, New Jersey, and Silicon Valley, while Rackspace is staffing up in low cost markets like San Antonio and Blacksburg, VA.

  • Continued Reductions in SG&A Costs as a Share of Revenue
Over the last five quarters, Rackspace's SG&A costs have dropped from 39.9% of revenue to 37.4% of revenue, which has been essential to increasing net margins as gross margins have held steady.    SG&A ratios have dropped because employee productivity has risen from $229,600 of annualized revenue per "Racker", to $249,600 over the same period. 

While y/y top line growth last quarter was in the low 20s, the company's current valuation of 74x annualized earnings is just above its 60% y/y growth in bottom line profitability.   Continued reductions in its SG&A/Revenue ratio are essential to maintaining such a high valuation.    Still, watch out for a sharp reaction on Tuesday if top line guidance surprises in any way.

Limelight Earnings Disappoint

By David Gross

Limelight reported revenue of $49 million, an increase of over 50% y/y including revenue from its Delve Networks acquisition.   However, the company dropped the guidance midpoint for next quarter from $53.2 million to $52.5 million, or about 1.4%, and the stock fell nearly 7%, for an expectations multiple of 5.

While Wall Street overreacted to the news, this company is not that far from having some liquidity issues.   It has $71 million in the bank, with no l-t debt besides a small amount of capital leases.     However, it is burning about $10 million a quarter, and will need to break-even on an actual, not adjusted EBITDA, basis in order to keep funding its capital plan without borrowing.   Moreover, its bandwidth costs remain over 30% of revenue, while rival Akamai's are just 16%.    This is a serious cost disadvantage that the company has done little to address, and will be even more challenged to tackle if it has to cut capex to conserve cash.

While there has been some improvement in margins with growth, SG&As + R&D still add up to over 50% of revenue, compared to the low 40s for Akamai.   This is a big problem when Gross Margins are still in the 40s, while Akamai's in the high 60s.   While it's great to hear about all the exciting growth initiatives from mobile to enterprise storage, the company has a lot of boring expense reduction it still needs to complete in order to chip away at Akamai's cost advantage.

Sunday, November 7, 2010

F5 to Present This Week at Wells Fargo and Piper Jaffray Conferences

By David Gross

F5 is presenting at Tuesday's Wells Fargo Conference, and Wednesday's Piper Jaffray Conference.   The webcasts from the events will be available at the F5 IR website.

Additionally, the company announced it will be holding an analyst & investor day next Tuesday, the 16th, in New York.   Registration and more information on that event is also available on the F5 IR website.

Friday, November 5, 2010

Digital Realty Corrects Information from Earnings Call

By David Gross

Digital Realty filed an 8-K today to correct information it gave in the Q&A during this week's earnings call.   In the filing, the company stated that:

"On November 4, 2010, during the Company’s regularly scheduled earnings conference call, management incorrectly stated in response to an inquiry from an analyst that EBITDA growth in the fourth quarter of 2010 would generate $65 million of additional debt capacity under the company’s internal debt guidelines discussed earlier in the conference call. Because this incorrect figure could cause investor confusion, the Company wishes to clarify that the correct amount of additional debt capacity the Company expects from fourth quarter EBITDA growth under its internal guidelines is $260 million at the midpoint of the Company’s expected EBITDA performance range."

InfiniBand, not 100 Gigabit Ethernet, to Dominate Market for CXP AOCs

By Lisa Huff

For those of you that believe that 100 Gigabit Ethernet is just around the corner, I have a bridge I want to sell you.  We haven’t even seen the height of 10 Gigabit Ethernet adoption yet, and there are some equipment companies saying they will sell 100’s-of-thousands of CXP 100GBASE-SR10 ports in 2011. Are you kidding? What is the application and where is the need?

First, 10GigE has taken more than eight years to get to a million ports – we believe it could take 40G and 100G even longer. Second, even for clustering applications, which could potentially drive demand faster, 100GigE port-adoption won’t be that quick. Ethernet architecture is different than InfiniBand's – the density of an InfiniBand director-type switch provides over a two terabits per second, whereas the newly released 40GigE ones are mostly around 250 Gbps  (due to both slower data rate and fewer ports). InfiniBand is also typically implemented with a CLOS architecture where you have equal bandwidth everywhere, while Ethernet is more often used in an aggregated network, so it ends up having a lot fewer higher-speed ports than lower speed ones. This is further supported by clustering applications that use ToR switches that are currently Gigabit connections to the servers with 10G uplinks to the network core. These will be upgraded to 10G downlinks and 40G uplinks first, but this won’t happen quickly.

While several router manufacturers claim to have the need for 100’s of thousands of 100GBASE-SR CXP ports in 2011, I have found no evidence of this. Who are their customers? In fact, even those companies that could use 100G ports today, i.e. Google, Facebook , IXCs, etc., would need six months to a year to evaluate router products before they would deploy them. Since these devices do not yet exist, the reality is that the market will really not begin to materialize until at least 2012. Right now, the majority of router connections are either Gigabit Ethernet or OC-48 (2.5G) or below, with OC-192 (10G) or 10GigE being implemented on an as-needed basis. Until routers transition through 10G, then probably 40G, 100G installations will be few and far between.

But, there is a market for CXP AOCs today – InfiniBand. This is becoming a volume market now and will continue to be the best opportunity for CXP AOCs (Active Optical Cables) for at least the next few years and probably over the lifetime of the CXP products. In fact, we expect the volume of InfiniBand CXP AOCs to be at about six million by 2015. By comparison, the total volume of Ethernet CXP AOCs is expected to be less than 100-thousand. While 100GigE clustering applications will initially use CXP AOCs, customers in these markets prefer to use pluggable modules mainly because they are used to structured cabling solutions, and like their flexibility and ease of use, so AOCs will quickly give way to pluggable modules as they are developed. 100GigE CXP ports may eventually eclipse InfiniBand once it permeates most data center distribution and core networks, but this will take longer than many equipment vendors expect.

Thursday, November 4, 2010

DuPont Fabros Revenue Up 16%- UPDATED

By David Gross

DuPont Fabros reported quarterly revenue yesterday of $60.3 million, up 16% y/y, with FFO per share rising from 29 cents to 37 cents.

Property operating costs rose just 2% in spite of the revenue gain, allowing net income to grow from $5.5 million to $15.3 million.   Additionally, the company's NOI, or Net Operating Income, margin is now 63%, close to the 65-70% range that is typical for other apartment, office, and data center REITs.   A year ago, it was just 52%.  

DFT's ACC6 Building Under Construction Nov 2010
Leasing activity at its primary Ashburn, VA campus continues to be much stronger than at its expansion site in Piscataway, NJ, with ACC5 Phase 2 now 75% leased, while NJ1 is just 22% leased.  Both buildings were placed into service this week.   The company's Ashburn tenant roster includes brand name websites like Yahoo, Rackspace, Facebook, and Match.com, while the financial services sector which dominates Northern New Jersey is new for the firm, and is already crowding into facilities owned by Equinix and Digital Realty in Weehawken, Secaucus, and Piscataway.

The stock is down 4% today, possibly because the company reduced its annual FFO guidance midpoint slightly, from $1.35 to $1.32, due to a one-time write off of unamortized interest charges on its ACC4 loan, which it paid off early.

The earnings release came out last night, but the call is today, dial-in information is available here.

Top 5 Mistakes Investors Make with Data Center Stocks

By David Gross

The downs and ups we've seen over the last month in data center stocks have given a good indication of how investors can be forced into manic buying and panic selling in this industry.    But in order to avoid mediocre returns from buying and selling with the herd, investors need to stop doing the following:

5. Worrying About Shrinking Servers Reducing Demand

Wall Street seems hung up on this, while few in the industry are.   And for good reason.  One is that data centers are filled with switches and routers that are not getting any smaller.  Many common boxes, from the Cisco 6509 to the 7000-series routers to F5's load balancers, are the same size now as they were five years ago.  And while servers are unquestionably getting smaller, they are not doing so at a pace that will destory demand for colocation.   Rackspace, for example, has .36 servers per square foot now.   Two years ago, it had .29.    Additionally, there is far more data center space being leased now than there was ten years ago when commercial blade servers didn't exist, and corporate data centers were filled with monstrous Sun E10000s.

4. Looking at Supply/Demand Conditions too Broadly

Speaking with institutional investors, I get asked a lot about general supply/demand trends.    The problem is that this is the same question everyone else asks, and does not lead to any conclusion that will give you an edge.  Moreover, there is no general market for data center space.    There are certain industry, price, and cross-connect requirements in Northern New Jersey, which differ dramatically from the buying industries, price, and cross-connect issues in Dallas, which differ dramatically from conditions in Los Angeles.   But none of this gets considered with very high-level ideas about "where demand is going".

3. Fearing that Colocation is About to Become a Commodity

Many investors are afraid that colocation is about to become a commodity.   But they have nothing to worry about, because it already is a commodity.   As are semiconductors, CDNs, Ethernet Exchanges, and just about any other telecom service or computer hardware product.   Whether or not colo is a commodity is irrelevant, what matters is whether a certain provider has high market share and therefore can maintain margins, just as Intel has done in chips and Akamai in CDNs, even though prices in both cases have been falling through the floor.

Market share in colo and wholesale data center space is only relevant on a region-by-region basis, making it even more important to stop looking at supply/demand at too broad a level.    Equinix, for example, is remarkably strong in the DC area, but has much lower share in Los Angeles.  Pricing and desirability as a cross-connect location will reflect this.   Moreover, an extremely well-capitalized startup with half a billion dollars is only going to be able to focus on one or two markets at best, reducing the ability of some garage company to come in and take significant share away from an established supplier.

2. Overreacting to Changes in Revenue Guidance

I track an expectations multiple of guidance changes to stock price swings, and it has been simply ridiculous since Equinix's October 5th warning.   On October 6th, the company's stock lost 35% of its value off a 2% guidance drop, while on October 27th, it popped 7% on a .4% increase in guidance, for an expectations multiple of 17.   This week, Terremark jumped up 13% on Tuesday after lifting guidance 1% on Monday.  Similar swings have occurred with data center technology suppliers such as Mellanox, Riverbed, and F5.

I'm sure some traders have figured out how to make money from the manic buying and panic selling, but fundamental investors who respond so sharply are setting themselves up for weak returns by getting in and out at exactly the wrong times.

1. Overemphasizing the Importance of the Macroeconomy

This industry was in a depression in 2002, when the rest of the economy was in a mild recession, and it grew in 2008 and 2009, when the rest of the economy was in a deep recession.   Data center revenue growth has shown a remarkably weak link to GDP growth, because it's tied to growth in web usage, Internet traffic, and financial market data and trading volumes, which have all grown when real GDP hasn't.

Wednesday, November 3, 2010

Terremark's Guidance Goes Up 1%, Its Stock Rises 13%

By David Gross

Wall Street continued its manic buying and panic selling of data center stocks yesterday, with Terremark rising 13% to just over $11 a share after it lifted FY2011 revenue guidance 1%, from $346 million to a range of $350-$353 million.   This gave the stock an expectations multiple of 13, or 10 if you want to round from the midpoint, not much lower than the wild 17 Equinix got when it guided down 2% and dropped 35%, and guided up .4% and rose 7%.    It's also higher than the expectations multiple of 4 that Riverbed got when it guided up 5%, and rose 20%.

Corporate revenue was up 21% y/y to $163 million, and similar to the growth rates we've seen with Equinix and Rackspace.   And remember all the Wall Street panicking over the colocation market after Equinix's infamous October 5th announcement?  Terremark's colocation revenue was up 32% y/y to $70 million.

The Federal Government accounted for 21% of the company's revenue, and Terremark made a very smart move bringing its government customers way out to Culpeper, rather than trying to compete against DLR, Equinix, and DFT in Ashburn, which is 60 miles closer to DC, but also closer to terrorist targets.   Ashburn is about 30 miles from Washington, and as a Virginia resident, I can tell you the only thing within 30 miles of Culpeper, besides cows and hills, is James Madison's estate at Montpelier, which often gets overlooked with Monticello another 25 miles down the road.   So while Terremark might call its Culpeper data center campus the "NAP of the Capital Region", it would be a bad idea to tell a local in Culpeper County that he's a suburban Washingtonian.

While Terremark also leases space in Santa Clara and internationally, the NAP of the Capital Region and NAP of Americas in Miami represent over 80% of its space, including 100,000 square feet it has yet to develop in Culpeper, which is far larger than the extra 20,000 feet in Santa Clara it said it would lease during the earnings call.  This geographic focus is paying off in its asset utilization, with the company generating $652 of annualized revenue with just $476 million of Property, Plant, and Equipment on its books, or a ratio of 1.37, far higher than the <1 ratios put up by Digital Realty and Equinix, and nearly as high as the 1.6 put up by Rackspace, which doesn't spend a dime on building construction.    This is balanced out though by hits on the income statement for sales and support costs, however Terremark's net margins improved over the year from -16% to -11%. 

While I refer to EBITDA occassionally here, I did too many financial plans for CLECs and ISPs ten years ago to take the metric too seriously, and similarly have a problem using it to measure so many of these capital intensive data center providers.   Depreciation might not be a cash expense, but it gives an indication of how efficiently a company uses its fixed assets, and how well its times its capex relative to revenue, so I can't report on "adjusted EBITDA" with a straight face.   So while Terremark is EBITDA positive, that would be meaningless if it wasn't improving net margins.

Investors looking at this company who don't want to buy and sell with the herd should probably take a little attention off the top line, and instead consider how Terremark has been able to grow with a fairly tight geographic focus.  Dominating Culpeper and downtown Miami is proving to be a better strategy than having a small piece of Northern New Jersey or Chicago.

Neutral Tandem Announces Interconnection to Ethernet Exchange It Already Owns

By David Gross

I know this is supposed to be the week of the Ethernet Exchange press release, but Neutral Tandem announced this morning that it is interconnecting its network with another network it already owns.  

Neutral Tandem paid $95 million to acquire global IP transit provider Tinet in September, expanding the number of places where its "Ethernet Exchange-enabled".    Basically, it seemed to be saying "we're not necessarily setting up Exchange ports in Bucharest or Bratislava, but if you call up and ask for one in those cities, we'll give it to you".   Today, it said that the two networks are interconnected, meaning that if you hook into Neutral Tandem at 60 Hudson Street or 111 8th Avenue, you can now reach Ethernet customers in Bratislava through its Ethernet Exchange.  

While you might question the need for GigE ports in former Communist bloc countries, I would remind you that this rapidly growing Carrier Ethernet business is heading for an oligopoly among CENX, Equinix, and the Neutral Tandem/Telx we're-working-together-on-this-thing arrangement.   Additionally, we've gone one hour and twenty-eight minutes without an Ethernet Exchange press release, so another one should be on the wire shortly.

Tuesday, November 2, 2010

BOB Joins Neutral Tandem Ethernet Exchange, COLT Joins CENX

By David Gross

In the last post, I mentioned that it should be a good week for Ethernet Exchange press releases with the LightReading Ethernet Expo event taking place now in New York, and I have a couple more to add.

First, Neutral Tandem announced BOB, or Business Only Broadband, as the first fixed wireless customer to come into its Ethernet Exchange.    BOB provides service in Chicago and New York.

Separately, CENX announced that Colt, a European telecom provider, had connected to its Ethernet Exchange in London.   CENX, Equinix, and Neutral Tandem (which is partnering with Telx for Ethernet Exchange services) are all rushing to announce customers as this service enters its second year.    And the competition is among companies who know each other well - CENX co-founder Ron Gavillet was also the co-founder of Neutral Tandem.

CENX Reaches 15 Million Ethernet Service Locations, Adds AboveNet as Partner

By David Gross

With LightReading's Ethernet Expo taking place today and tomorrow, I expected Carrier Ethernet Exchange news to burn the press wire this week, and CENX and AboveNet have not disappointed.   CENX announced that it has reached 15 million ESLs, or Ethernet Service Locations, on its network.    In order to reach such a high number, they are likely counting computers located in buildings where their member carriers provide Ethernet service.   They announced that they had reached 10 million in June.

Additionally, AboveNet announced that it is launching its Ethernet eXchange Hub for carriers that want to reach customers through its network, and that it will be co-located at both CENX and Equinix Carrier Ethernet locations in major markets, such as New York, Chicago, London, Washington, and San Francisco.   The company already offers standard Ethernet Exchange services in these large markets, but the Ethernet eXchange Hub will allow carriers to offer AboveNet services to their customers, not just to interconnect with the provider, which they can do now.   This new service will be available next quarter.

San Francisco/Silicon Valley Meetings November 9th and 10th

By David Gross

Following the IMN Conference next Monday, I will be in San Francisco November 9th and 10th.  Please send an e-mail to mail-at-datacenterstocks.com if you are interested in setting up a meeting. 

Force10 Announces 40 Gigabit Ethernet Top-of-Rack Switch and Line Card

By David Gross

Extreme and BLADE Networks announced the launch of their 40 GigE ToR switches a few weeks ago, and now you can add Force10 to the list of vendors selling the devices.    The company announced a new Top-of-Rack switch today, the S4810, which features 4 40 GigE uplinks, and will be available for sale by year-end.   But Force10 didn't stop with the ToR switch news, it also announced a 40 GigE line card for its Exascale core switch.

IBM currently re-sells Force10's S60 ToR device, but the company did not say if the S4810 would be included in the IBM resale program.   It did say that it would offer lower power consumption than BLADE's RackSwitch, which was an important statement, because it means that unlike ToR switches with Voltaire, Juniper, and other company's logos on them, the S4810 is NOT an OEM of the BLADE RackSwitch.

Unlike Extreme and BLADE, Force10 did not publicly announce pricing for its 40G ports, but the other vendors are charging around $1,000 per port on their ToR switches.   But these are for short-reach links.   Longer reach 40GBASE-LR4 ports will be much more expensive when they come to market, and 40 Gigabit OC-768 ports on routers cost half a million dollars, or 500x a 40GBASE-CR4 switch port.   Meanwhile, 40 Gigabit QDR InfiniBand ports now sell for under $300, with similar short-reach QSFP links as the Ethernet boxes.  Ultimately, with values between $250 and $500,000, you can't really say there is such a thing as a price for a 40 Gigabit port, but rather a price based on transceiver type, port density, and most importantly, link length.

Voltaire Revenue Up 25% to $18.1 Million, But Says "Ethernet" More than "InfiniBand"

By David Gross

Voltaire reported quarterly revenue yesterday of $18.1 million, up from $14.5 in the year ago quarter.   The company also said annual revenue would come in near the top end of its previously issued guidance of $67-70  million.

The company is a leader in InfiniBand switch systems, but like its supplier Mellanox, is very eager to show that it's hedging its bets with Ethernet.   Reading through the call transcript on Seeking Alpha, I counted seven mentions of "Ethernet" excluding the Q&A, and just three mentions of "InfiniBand", the technology Voltaire's long been associated with.

InfiniBand continues to gain share in supercomputing, and is used as the interconnect in 207 of the top 500 supercomputers, up from 121 two years ago, according to Top500.org.   Yet Voltaire, Mellanox, and the InfiniBand Trade Association they're both affiliated with are terrified of being considered "niche" vendors, so they've released Ethernet products, in addition to developing InfiniBand-over-Ethernet, a.k.a. RDMA over Converged Ethernet, in spite of InfiniBand's strength.

Nonetheless, Voltaire's Ethernet strategy is fairly focused, and like the Juniper EX2500, its top-of-rack 6024 switch appears to be an OEM of the Blade RackSwitch G8124.   But while the talk/actual-percent-of-revenue ratio is way out of line with cloud services, Ethernet's strength with PR people is far more impressive, especially considering that it's older than many of them are.

Monday, November 1, 2010

Terremark Revenue Up 22%, Lifts Guidance 1%

By David Gross

Terremark reported quarterly revenue today of $85 million, up 22% year-over-year, and lifted annual top line guidance from $346 million to a range of $350 million - $353 million.   Cross-Connects were up 10% year-over-year to 9,650, and as seen elsewhere in the industry, cloud revenue continues to account for less than 10% of Terremark's sales, but over half of the hype surrounding the company.   Cloud revenue came in at $7.5 million, or 8% of total, up from 6.5% sequentially.

We'll have more on this soon.

Data Center Stocks Up 11% Since Equinix's October 5th Warning

By David Gross

Data center stocks sunk early in the month on the Equinix news, but then spent the rest of October recovering, almost back to where they were when the quarter started.   Our DataCenterStocks.com Services Index closed the month at 98.48, up more than 10% from an October 6th intraday value of 88.95, when it was stung by the Equinix warning that had investors panicking.

While Equinix itself moved up nearly 20% from October 6th to finish the month at over $84 a share, Savvis continued the strong run it had in the 3rd Quarter, gaining nearly 14% for the month of October.   At $24 a share, it is up over 80% since July 1st. 

Small cap providers Limelight and Navisite were both up around 15% in October, while AboveNet rose over 9%.  CoreSite, which is going toe-to-toe with Equinix in Los Angeles for media and content providers, lost 9% in its first full month as a public company, although it was up 3% in the last four trading days of October. Everyone else besides Equinix was up or down less than 5% for the month.   The aggregate market cap of the stocks in our index was $29.399 billion, up from $26.553 billion on October 6th after Equinix's infamous warning call.

DataCenterStocks.com Services Index

Company Ticker Mkt Cap Oct 29 Close Oct 1 Open Monthly Chg
Equinix EQIX $3,840,501,600 84.24 102.35 -17.69%
Digital Realty DLR $5,214,429,000 59.73 61.70 -3.19%
DuPont Fabros DFT $1,486,673,000 25.10 25.15 -0.20%
Rackspace RAX $3,119,251,200 24.96 25.98 -3.93%
Savvis SVVS $1,326,312,400 24.01 21.08 13.90%
Level 3 LVLT $1,610,200,000 0.97 0.94 3.52%
Akamai AKAM $9,383,788,700 51.67 50.18 2.97%
Navisite NAVI $144,314,400 3.83 3.34 14.67%
Terremark TMRK $656,442,900 9.99 10.34 -3.38%
Limelight LLNW $667,864,400 6.79 5.89 15.28%
AboveNet ABVT $1,431,921,300 56.89 52.09 9.21%
CoreSite COR $257,676,600 15.06 16.39 -8.11%
Internap INAP $259,550,000 5.00 4.90 2.04%

Index Value October 1
Index Value October 6
Index Value October 31

Data Center Stocks News From Around The Web - Mellanox, QTS, NetLogic

By David Gross
  • Oracle has taken a 10% stake  in Mellanox, and given a strong endorsement of InfiniBand with CEO Larry Ellison saying ""InfiniBand is by far the fastest and most efficient switch fabric for running enterprise data centers".
  • Privately-held QTS, (aka Quality Technology Solutions) has closed on a $125 million secured credit line, which appears to have been used to re-finance $60 million higher interest debt, as well as provide additional borrowing capacity for the future.   The line is backed by the company's Atlanta data center.
  • TCAM, excuse me, knowledge-based processor vendor NetLogic reported 3Q revenue of $100 million, a 5.3% sequential increase.   The company's 10 GigE PHYs were recently selected by HP-subsidiary H3C for its S12500 Ethernet switches, which are designed for high-end data center applications.

Reminder: IMN Forum on Financing and Investing in Data Centers

By David Gross

The IMN Forum on Financing, Investing, and Real Estate Development in Data Centers is next Monday and Tuesday in Los Angeles.   Speakers include executives from Telx, Digital Realty, i/o Data Centers, Terremark, as well as private equity firms, data center power engineers, telecommunications providers, and buyers of public data center space.   I will be speaking on the analyst/portfolio manager roundtable.

More detail on the agenda is available at the IMN's website.