EUR 850.00 For Business Accounts Only

Morningstar | CyrusOne's 4Q Report Showcases Our Concerns, but the News Wasn't All Bad; Maintaining $50 FVE

CyrusOne concluded a good year with a weak fourth quarter, and the company issued 2019 expectations that management acknowledged as disappointing versus outsider expectations. Despite this, management expressed confidence that CyrusOne's opportunities and long-term growth trajectory are still bright. Underlying our no-moat rating on the firm is our belief that anyone with capital can build identical data centers and offer a comparable service. We believe the current weakness reflects that. However, the firm's inroads with cross connects and enterprise customers are promising, and continued traction on those fronts bode well for CyrusOne developing an advantage over time. After a sizable drop, the firm now trades at only a slight premium to our unchanged $50 fair value estimate.

Cyrus signed $20 million of annualized new leases in the quarter, its weakest quarter of the year (in which it booked $153 million) but similar to last year's fourth quarter. The dollar figure is not itself worrisome, as we expect bookings to be choppy, so we don't think investors should ever read too much into one quarter. Concerning to us was management's disclosure that cloud customers are behind the weakness. These customers have been slower to sign contracts, and financial funds, such as private equity firms, are building data centers. Management did not attribute cloud weakness to that competition, but it is consistent with our concern that Cyrus is not sufficiently differentiated.

The disappointing result with cloud providers, which are Cyrus' biggest revenue drivers, overshadowed strong results with enterprise customers. Enterprises were also likely a big contributor to another jump in cross connects--the company added 1,000 in the quarter and 4,000 in the year and is now up to 19,000. Success in these areas are big factors behind the network effect we see with some other data center companies.

Enterprise customers accounted for 80% of the quarter's bookings, and since enterprises typically take smaller spaces and pay higher prices, average price per booking was $250 per kilowatt, the second-highest level Cyrus has recorded as a public company. More impressively, it seems the firm is realizing better pricing from the enterprises, as monthly rent per square foot on the smallest leases (0-999 square feet) jumped almost 20% year over year. Enterprises seeing value with Cyrus is a good omen and will likely continue to drive cross connect volume growth. Cyrus now has twice as many cross connects per customer as it did three years ago, and management believes its interconnection revenue is growing faster than anyone else's in the U.S. (albeit off a relatively smaller base than many rivals). Interconnection revenue was up 17% year over year and 6% sequentially.

Overall, Cyrus grew revenue more than 20% in 2018, but because of acquisitions and the lack of organic growth disclosure, we don't find the number meaningful. The firm's adjusted EBITDA margin remained mostly flat for the year at 55%, but the firm's guidance implied it would drop a bit in 2019. Management attributes the decline in large part to getting data centers off the ground in Europe because many expenses arise prior to revenue fully ramping up. We project margins will bounce back in 2020, but from 2018 levels, we project only about 100 basis points of margin expansion over the next decade.