CyrusOne today held its inaugural Investor Day under its new leadership team of Bruce Duncan (President & CEO) and Katherine Motlagh (CFO), which covered a range of topics including the company’s geographic expansion plans in Europe and Asia-Pacific, operational headwinds such as declining renewal rates, and a new capital recycling program.
In particular, CyrusOne’s expectations for renewal rates to decline, on a cash basis, by 18% to 22% compared to current market rates, over the next 3 to 4 years, was noteworthy. Indeed, investors reacted with disappointment to these disclosures, amongst other headwinds, sending the stock down 6.4% for the session.
Geographic Expansion – CyrusOne Investor Day
Europe – CyrusOne
CyrusOne currently has a presence in the key European markets of Frankfurt, London, Amsterdam, Paris, and Dublin, which collectively are known as the FLAP-D markets. In particular, the company has an emphasis on Frankfurt and London, the two largest markets in Europe.
Development Projects – Near-Term
CyrusOne’s footprint will comprise 11 data centers with 192 megawatts of power capacity and 440k sqft upon completion of development projects that are currently underway. In turn, this capacity in Europe will represent nearly 20% of CyrusOne’s total portfolio.
The company’s approach to leasing this expansion capacity in Europe is to target its existing U.S.-based hyperscale customers.
Development Projects – Future
CyrusOne has developable capacity, in the form of powered shell and developable land, to significantly increase the size of its total footprint in Europe. Specifically, the company has the potential to develop 510k sqft of powered shell and 70 acres of land. In turn, this would result in 350+ megawatts of additional capacity.
Below is a decomposition of these future development projects by market and timing:
Asia-Pacific – CyrusOne
CyrusOne is also extending its expansion plans into the digital gateway markets of the Asia-Pacific region, alongside its hyperscale customers. Specifically, CyrusOne states that it intends to expand into the region within the next 3 to 5 years.
In terms of execution, CyrusOne plans to enter Asia-Pacific in a similar manner to how the company entered Europe, being through an initial platform acquisition. Indeed, CyrusOne agreed to acquire Europe-based Zenium Data Centers in December 2017 and has subsequently grown through a “land and expand” strategy. Importantly, the company acknowledges its core competency of developing capacity, as the way to generate appropriate returns on capital.
Operational Headwinds – CyrusOne Investor Day
As part of its Investor Day, CyrusOne highlighted three key areas where its business is facing challenges. Indeed, the company also provided steps which it plans to take in order to mitigate these challenges.
(1) Concentration with Large Hyperscale Customers
CyrusOne’s large hyperscale customers including Microsoft, Oracle, Amazon Web Services (AWS), Alibaba, Salesforce, and Google Cloud account for a disproportionate share of the company’s growth.
To mitigate this challenge, CyrusOne intends to grow its share with other hyperscale providers, to further diversify its portfolio. Specifically, CyrusOne’s Investor Day presentation highlights hyperscale logos including Apple, ByteDance (owner of TikTok), eBay, Facebook, Fujitsu, IBM Cloud, NTT Data, SAP, Tencent, Twitter, VMware, and Workday.
(2) Development Challenges
CyrusOne notes that land and power for data center development are becoming scarcer. Additionally, permitting challenges are arising and public sentiment towards data center development is turning more negative.
To mitigate this challenge, CyrusOne plans to leverage its local in-market experience to secure land, power, and permits. Additionally, the company is attempting to secure medium- and long-term capacity pipelines in markets where high demand exists.
(3) Pricing Compression (incl. Renewal Rates) and Churn
Pricing on data center leases has continued to decline in recent years, impacting renewal rates, churn, and development yields.
Drivers of this challenge both in the past and future include i) intense price competition in the Northern Virginia market, particularly from private operators, ii) Equinix’s entry and expansion of its hyperscale (xScale) initiative, and iii) QTS accelerating its expansion into hyperscale development with the financial backing of Blackstone.
Renewal Rates
Importantly, CyrusOne anticipates that rental rates on like-for-like leases will continue to decline from legacy pricing, to current market rates. Moreover, the company has quantified their estimate for relative changes in like-for-like renewal rates in 2021 through 2024:
- GAAP Basis: down mid-single-digits (i.e., down 4% to 6%)
- Cash Basis: down 18% to 22% compared to current market rates
Notably, the ~15% difference between GAAP Basis and Cash Basis renewal rates reflects the impact of customer ramps (i.e., prior to the customer occupying the facility) and escalations of 1% to 3% per year. Therefore, Dgtl Infra recognizes that the 18% to 22% decline in renewal rates, on a Cash Basis, is the most relevant metric.
Overall, CyrusOne’s estimates imply that as legacy leases come up for renewal, the effective rent that tenants are paying is above current market rates.
Finally, CyrusOne notes that declines in renewal rates in the coming years is not only a company-specific trend. Instead, it is a headwind that all data center operators will continue facing in the next 3 to 4 years.
Churn
CyrusOne’s outlook estimates churn of 4% to 6% of revenue annually. Specifically, churn derives from customer renewal rates (see above), footprint consolidations, customer exits, and different customer capacity implementations.
Development Yields
CyrusOne targets unlevered stabilized development NOI yields of 8% to 10%. Notably, in late 2020, the company reduced its development yield target to its current levels.
Overall, CyrusOne’s expectations for renewal rates, churn, and development yields implies that CyrusOne will likely be a price leader for new data center capacity.
Capital Recycling – CyrusOne Investor Day
CyrusOne plans to optimize its portfolio by re-directing capital from non-core assets, to investments with superior returns, through capital recycling. In so doing, the company will evaluate assets in existing markets and re-deploy capital from non-strategic assets to growth-driven locations across Europe and the United States.
In aggregate, CyrusOne plans to recycle/sell $1bn to $2bn in asset value, over the next 3 to 4 years. The company’s goal is to balance long-term value creation against near-term earnings dilution.
With the capital generated from these asset sales, CyrusOne intends to re-invest the funds into higher-yielding development projects.
