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Morningstar | Capacity Constraints Provide Near-Term Headwinds, but We Still Like CoreSite's Measured Strategy

CoreSite operates carrier hotels and prioritizes interconnection, which we think makes the firm's business much more attractive than nearly all competitors over the long term. Most data center providers emphasize providing space for tenants and are riding the current wave that the cloud has sparked--cloud providers' use of third-party data centers has been exploding, and cloud customers often become tenants on the same campuses to maximize the performance of their hybrid cloud solutions. While CoreSite has benefitted from that trend, it is not aggressively expanding its footprint to simply accommodate cloud providers and the tenants that would then follow, which we think is smart, as we find that to be a less competitively advantaged business. Rather, it focuses on having highly connected buildings where networks exchange the traffic that underlies the Internet. CoreSite counts over 450 network providers as customers, and we believe that all companies that need Internet connections--none more than the major cloud providers—will always have a need for those difficult-to-develop buildings.CoreSite operates exclusively in eight U.S. cities and generates over 70% of its annualized rent from just Silicon Valley, Los Angeles, and Northern Virginia, three of the most critical cities in the world powering the Internet. While it has not foreclosed the possibility of expanding internationally or to other additional markets, its priority is to add depth to current markets rather than look for new ones. We think that strategy results in far less speculative land acquisition and never-ending periods of extreme capital spending intensity. Like its peers, CoreSite is tied to the cloud providers, which make up nearly 30% of annualized rent and lease in large size. However, we think CoreSite is less exposed to the cloud providers' power because of its uniquely connected properties. Whereas we believe cloud providers could eventually seamlessly relocate most of their data centers or build their own new ones, we don't think they could readily replicate CoreSite's highly connected properties and will therefore always require a presence there.