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Morningstar | European Expansion Could Make CyrusOne More Valuable to Customers and Be a Needed Differentiator

CyrusOne is primarily a wholesale data center provider that pursues hyperscale tenants. About three fourths of its rental revenue comes from its largest leases--those for over 10,000 square feet--and cloud providers account for about one third of total sales. While the firm has seen major growth in interconnection revenue recently, as more enterprises are colocating and connecting with their cloud providers, it does not operate any major Internet exchanges, and many properties are in second-tier cities, so we think little differentiates its offering.Cyrus believes cloud companies favor outsourcing data centers because they can earn higher returns on capital in their core businesses and data center companies have a building-cost advantage. Cyrus is quickly growing its portfolio to exploit the opportunity. It has three times as much undeveloped land as developed, and it is now expanding outside the U.S. In 2017, it announced an operating partnership with GDS (to gain exposure to the Chinese market) and the acquisition of Zenium (which netted two data centers each in Frankfurt and London). It intends to continue adding in Europe in the near term before focusing more on Asia. Our concern about CyrusOne's business is that we think it requires the current environment to persist. We believe that is possible--it is our bull-case scenario--but we think the most likely course will be for the outsized growth of recent years to calm and for data centers like Cyrus' to become more commoditized. Given the switching costs inherent in the industry and what is effectively Cyrus' first-mover advantage in procuring its existing tenants, we think Cyrus will continue to grow and retain its customers. However, we fear that Cyrus' strategy to accumulate land and continue building could ultimately prove too aggressive, and it may not be able to fill all its future space on comparable terms, especially given cloud providers' bargaining power (they have the size and financial ability to keep data centers in-house, and they provide the attraction for Cyrus' other tenants). CyrusOne is currently investing massive amounts, and we are not confident it will ultimately realize a worthy payoff.