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Morningstar | Underwhelming 3Q Results Don't Change Our View of CyrusOne; Maintaining $50 FVE

CyrusOne's third-quarter results missed consensus estimates on the top and bottom lines and likewise fell a bit short of our expectations. However, Cyrus is still generally tracking our full-year forecast, and we don't see anything in the quarter to alter our longer-term views. We are maintaining our $50 fair value estimate. Despite the recent pullback that has brought the stock close to our fair value estimate, we continue to favor the other data center names we cover, which also sold off recently and are now all trading below our fair value estimates. Unlike those peers, we believe CyrusOne's offering is more commoditized and has no long-term competitive advantage, hence our no-moat rating and lack of enthusiasm.

Leasing revenue was up 14% in the quarter, similar to last quarter but a significant deceleration from the 20%-35% growth of recent years. The firm's depressed adjusted EBITDA margin--at 53.5%, it was lower than it has been at any time since 2016--was primarily attributable to higher metered power consumption. Though metered power costs are passed directly to tenants and accounted for as metered power revenue, it is zero-margin revenue, so a higher level weighs on margins. Our expense assumptions already account for metered power use, which we expect to rise at the same rate as leasing revenue (averaging mid-teens growth throughout the next decade), so we are leaving our margin assumptions unchanged.

Underlying booking metrics were also modest, but data center bookings are historically choppy on a quarterly basis, so we don't read too much into it. In the quarter, the company signed $2.2 million worth of monthly recurring revenue for 114,000 colocation square feet and 15 megawatts of power. Though the signings are substantially lower than the last two quarters, they leave the firm with a $90 million annualized revenue backlog and on pace to meet our full-year revenue expectation, which implies about 20% growth in leasing revenue versus 2017.

CyrusOne continues to expand rapidly and broaden its footprint. It closed its Zenium acquisition in the quarter, which gives it a substantial presence in Frankfurt and London. Subsequent to quarter-end, it entered into strategic partnerships to develop data centers in the Netherlands and Brazil, both new geographies for it. We expect the firm to continue expanding to new geographies especially in Europe in the near term, and we think it has interest in a bigger presence on virtually all continents eventually. In our view, CyrusOne is striking while the market is hot, but we have concerns that the company may ultimately end up with overcapacity for undifferentiated data centers, which would eventually weigh on pricing power and returns.