Retail colocation allows for multiple data center tenants to co-locate their equipment in the same facility and take advantage of additional services within those facilities such as managed IT. The key issue we discuss below is that the data center industry as a whole is growing rapidly, however, certain types of data centers have been growing slower, not growing at all, and/or experiencing high levels of churn.

Retail colocation, as a sub-segment, is currently shrinking and, in the future, will continue to shrink. Therefore, certain data center REITs and stocks that are over-exposed to retail colocation, is something to scrutinize, in the public markets.

Overall, the best examples to observe these retail colocation trends, are through the U.S. publicly-traded data center stocks or soon-to-be public data center companies. Specifically, examples of publicly-traded data center companies that have a significant retail colocation component to their business include: Equinix, CoreSite, Iron Mountain, and Cyxtera.

Retail Colocation is Shrinking

Below we provide two examples of why retail colocation is currently shrinking, namely: i) customer churn and ii) migration to the cloud.

(1) Customer Churn – Resulting from Older Data Center Facilities

Industry-wide, many retail colocation facilities are now 15 to 20+ years old. Therefore, these facilities do not meet the network architecture requirements of customers today. Additionally, these retail colocation facilities do not have modern power, back-up power, or cooling systems.

When these retail colocation facilities are benchmarked against Data Center Certification standards such as those from the Uptime Institute, they perform poorly. Indeed, these older facilities are graded as Tier-1 or Tier-2 data centers (i.e., poor grades) when they aspire to be a Tier-3 data center, or higher.

Data Center Tier Classification System

Because certain retail colocation facilities have become old and outdated, their customers are choosing to leave these facilities to go find other, newer, multi-tenant data center providers. When retail colocation facilities lose customers, this presents itself in their customer churn metrics. Indeed, the public data center companies report churn metrics on a quarterly basis, with higher churn implying that more customers are leaving.

CoreSite – Customer Churn – Quarterly

CoreSite had customer churn in Q4 2020 of 5.4%, which is double its typical quarterly average of 2% to 3%. Indeed, this figure is also materially higher than at any time over the past three years (shown below).

CoreSite Retail Colocation Churn

This increase in churn was a result of a few customers moving-out of CoreSite’s facilities. Most notably, Uber which vacated 5 megawatts of capacity in one of CoreSite’s Silicon Valley data centers. Specifically, SV7 – Santa Clara.

Iron Mountain – Customer Churn – Quarterly

Iron Mountain had customer churn in Q4 2020 of 3.9%, which is well above the sub-1.5% average for prior quarters.

Iron Mountain Retail Data Center Churn

This was a result of customers moving-out of one of Iron Mountain’s Northern Virginia facilities (i.e., VA-1). Indeed, Iron Mountain has also had significant churn in the past, with a churn spike in Q1 2019, at 5.1%. At the time, the company referenced churn being related to move-outs in its Phoenix data centers.

Equinix – Customer Churn – Quarterly

Equinix’s churn in both Q3 2020 and Q4 2020 has been above 2.5%. This compares to the company’s guidance of 2.0% to 2.5% per quarter. Additionally, the company has historically kept churn below 2.5%, on a quarterly basis.

Equinix Retail Data Center Churn

Equinix notes that the recent churn uptick was from “unforecasted churn”. Importantly, given that Equinix is a superior data center operator of retail colocation facilities, the magnitude of its churn uptick recently, has been less than its peers.

Retail Colocation Facility Churn All

Cyxtera Technologies – Customer Churn – Quarterly

Cyxtera Technologies will soon be another public data center operator that focuses on retail colocation. Specifically, in late February 2021, Starboard Value Acquisition Corp. (NASDAQ: SVAC) a publicly-traded special purpose acquisition company (SPAC) announced it will be combining with Cyxtera Technologies in a $3.4bn deal. The deal will close in mid-2021.

Thus far, Cyxtera only discloses a metric called “core churn” (see below), which is a highly-engineered metric. Indeed, Cyxtera makes a small footnote #2 at the bottom of its disclosures which reads: “Core churn defined as churn excluding CTL as a customer”.

Cyxtera Technologies Quarterly Churn
Click here for a larger version of this image.

Notably, “CTL” refers to CenturyLink, which is now called Lumen Technologies. However, more importantly, Lumen or CenturyLink is Cyxtera’s largest customer at 13% of revenues.

Cyxtera Technologies Customer Concentration CenturyLink Lumen Technologies

Therefore, Cyxtera excludes their largest customer, which has experienced churn, from their churn metrics, with this highly-engineered “core churn” metric.

Overall, Cyxtera should provide more appropriate disclosure, which if they do so, will show their un-engineered churn is well above the sub-1% figure, which they claim through the “core churn” metric.

(2) Migration to Cloud Data Centers

The second point of rationale as to why retail colocation is shrinking is that the customers of these retail colocation facilities are migrating to the cloud. Importantly, the cloud service providers primarily locate in wholesale or hyperscale data centers, not retail data centers.

With growing acceptance of cloud-based technologies, retail colocation is losing customers that decide to fully leverage cloud infrastructure offerings instead of managing their own. Indeed, customers are choosing to migrate their data to a cloud service provider, often referred to as “hyperscale” cloud providers.

In aggregate, data center customers are not disappearing. Instead, these hyperscale cloud providers are winning customers from retail colocation. Specifically, these hyperscale cloud providers include Amazon Web Services (AWS), Microsoft Azure, and Google Cloud.

From an analytic point-of-view, cloud infrastructure service revenues of the largest cloud service providers, in aggregate, totaled $130bn, for full-year 2020. Indeed, this an increase from $100bn of revenue in 2019, which represents a staggering growth rate of 30% year-over-year.

Recent Storylines – Retail Colocation Data Centers are Shrinking

Leading data center operators are not standing idle with the changing dynamics in retail colocation. Indeed, major data center operators are pivoting their business in small and large ways, in order to strategically re-position themselves.

Digital Realty Sells 11 Data Centers to Ascendas Reit for $672m

Firstly, shrewd operators like Digital Realty have been taking-part in M&A to sell-off some of their older retail colocation facilities. Indeed, the company has been able to offload these assets to less experienced data canter investors. Read more about this development here.

Equinix xScale Joint Venture Grows in Europe, Asia-Pacific

Secondly, traditionally retail-focused data center operators, like Equinix, have been moving into the hyperscale data center business. In-part, the company is pursuing this strategy to cover-up for some of the loss in its retail colocation business. Read more about this development here.

Cyxtera Technologies Acquired by Starboard Value Acquisition for $3.4bn

Finally, more of these data center companies, that are over-exposed to retail colocation, are being taken public. In doing so, these companies are passing-off their ownership to less sophisticated investors.

Particularly, this private-to-public phenomenon is occurring through special purpose acquisition companies (SPACs), which have become increasingly prevalent. Read more about this development here.

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