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Amanda

Data Centre Analysis Part II - Equinix Case Study

Updated: Nov 3

Equinix, Inc. is a global leader in data centre and interconnection services. It operates a vast network of data centres across major markets worldwide, providing a platform for businesses to connect and exchange data.


Today, I will demonstrate how I build a DCF model and conduct an analysis to determine whether I should invest in this company. I have attached the complete model at the end of this article.


The first step is to clarify which methods I want to use to calculate the terminal value that will be incorporated into the DCF model. In this analysis, I will use both the "Exit Multiple" method and the "Perpetuity Growth Model." To do this, I need to establish assumptions for the risk-free rate, cost of equity, and cost of debt to derive the WACC.


In the "Exit Multiple" method, we multiply the terminal EBITDA by the terminal multiple to obtain the terminal value. In the "Perpetuity Growth Model," we discount the 12-month forward unlevered free cash flow based on the difference between the risk-free rate and the implied growth rate (please refer to the calculations in the Excel file).

I use the 10-year U.S. Treasury Bond yield as the risk-free rate and the effective interest rate on senior notes as the cost of debt, as this better reflects the company’s credit profile.


I assume a terminal exit multiple of 27 based on historical data and an implied growth rate of 4%. While a long-term U.S. GDP growth rate of around 3% serves as a reasonable base, the higher growth expectations for data centres—especially in emerging Asia-Pacific markets—may warrant a slightly elevated rate for Equinix. Demand for data centres is anticipated to increase due to the growing needs for cloud computing, AI, and data storage. Market estimates suggest an industry CAGR ranging from 5% to 10% in certain regions, although this rate is expected to moderate over time. For a conservative approach, one might consider a long-term growth rate of approximately 3.5% to 4.5%, which is slightly above the U.S. GDP but takes industry dynamics into account.


Next, we move to the free cash flow projection. We begin with revenue and then forecast operating expenses, taxes, depreciation and amortization, capital expenditures, and net working capital to calculate unlevered free cash flow.


I anticipate that Equinix's revenue and capital expenditures (CapEx) will grow rapidly over the next 3 to 5 years, as they plan to expand their business in the EMEA and Asia-Pacific regions, then the expansion will slow down to a lower than average level.


To determine the company's value, I discounted the unlevered free cash flow using the weighted average cost of capital (WACC). The sum of the discounted cash flows, along with the discounted terminal enterprise value, gives us the total enterprise value. After adjusting for debt, preferred equity, non-controlling interest, and cash, we arrive at the implied equity value. Dividing the total equity value by the total shares outstanding results in the implied share price.


The exit multiple method suggests that the true share price should be $813, indicating that Equinix might be considered slightly overvalued if it fails to meet its growth targets. Conversely, the perpetuity growth model, which assumes steady growth, implies a true value of $945, suggesting that the stock may be slightly undervalued relative to its long-term profitability potential.


It’s important to note that DCF analysis is not entirely reliable; it is highly sensitive to the assumptions made regarding future cash flows, growth rates, and discount rates. Small changes in these inputs can lead to significant differences in valuation outcomes. Additionally, accurately predicting future cash flows can be challenging, particularly for companies in volatile industries or those undergoing substantial changes.


To gain a clearer picture of the company, I conducted a simple comparable analysis. Since most data centre companies are private or have been privately acquired, it can be difficult to assess the financial performance of many competitors. Therefore, I compared Equinix only with Digital Realty (DLR) and Iron Mountain (IRM), both of which are publicly traded and focus on the data centre sector.

Equinix and IRM have favourable EBITDA growth over 10% in the context of the data centre industry, suggesting they are expanding its footprint or increasing revenue per facility very fast, indicating healthy demand for its services.


AFFO, which adjusts for recurring maintenance CapEx, shows the cash available for distribution to shareholders. An AFFO growth rate exceeding EBITDA growth implies that Equinix is not only growing operationally but also managing its capital expenditures and expenses effectively. This can translate to a sustainable dividend growth outlook, a critical factor for investors in REITs.


IRM has the highest EBITDA growth but lowest AFFO growth. The discrepancy could be caused by high CapEx, increased non-operating expenses, or high debt costs.


Equinix has the highest EV/EBITDA but the lowest P/E ratio, presenting a complex picture. The high EV/EBITDA ratio indicates that investors are optimistic about Equinix’s operational growth and cash flow generation potential. However, the low P/E ratio suggests that the market is less convinced about the company's ability to convert that operational performance into net earnings. This discrepancy can signal potential concerns regarding the sustainability of profits or future earnings volatility.


Both the DCF and comparable analyses present a mixed picture. In my opinion, I wouldn’t invest in this stock right now, but I would keep a close eye on it. As soon as the price falls below approximately $813, I will start buying.


Although these analyses cannot provide an accurate transaction signal, they can help us understand the company's fundamentals and determine a favourable price range for buying or selling.






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