According to a 13G recently filed with the SEC, SPO Advisory- an investment fund managed by John Scully– controls a total of nearly 2.8 million shares of Equinix Inc (NASDAQ:EQIX), a $9.1 billion market cap data center services company. In the fund’s 13F for the first quarter of 2013 (we track these quarterly filings as part of our work developing investment strategies; we have found, for example, that the most popular small cap stocks among hedge funds earn an average excess return of 18 percentage points per year) we saw that SPO did not own any shares of Equinix Inc (NASDAQ:EQIX). See Scully’s stock picks from the end of March.
Equinix Inc (NASDAQ:EQIX) stands out as a company which is dependent on high earnings growth, as the valuation has been bid up on optimism regarding data centers as a business. At its current market capitalization, it trades at over 60 times its trailing earnings and at 40 times expected earnings for 2014. Its last quarterly report, however, showed net income up only 4% compared to the first quarter of 2012 as 17% revenue growth was eaten away by higher costs and interest expenses. The company has been planning to convert to a real estate investment trust (therefore becoming more tax efficient and increasing shareholder value), but recently it has been revealed that the IRS is more closely evaluating its definition of “real estate” in response to a rash of conversion attempts from companies.
The stock had been a favorite among some other fund managers during the first quarter of 2013; our database had billionaire John Paulson’s Paulson & Co. reporting a position of 2.1 million shares (find Paulson’s favorite stocks). However, the factors we’ve discussed have also gained it a sizable bearish community: according to the most recent data, 20% of the float is held short. Shorts have helped push Equinix Inc (NASDAQ:EQIX) down 14% year to date against a rising market, and we’d certainly be concerned that even if performance picks up the company is looking at a pretty high bar unless it does receive REIT status.
Three data center companies which have already converted to real estate investment trusts are CoreSite Realty Corp (NYSE:COR), DuPont Fabros Technology, Inc. (NYSE:DFT), and Digital Realty Trust, Inc. (NYSE:DLR). Since real estate investment trusts’ favorable tax treatment is conditional on distributing a large share of taxable income to shareholders, these three stocks- as well as many other REITs- pay high dividend yields. CoreSite Realty Corp (NYSE:COR) pays a 3.4% yield at current prices, though at about $650 million it is the smallest of these peers by market capitalization (on average about 280,000 shares are traded per day, so at current prices of over $30 there is plenty of daily dollar volume) and the company only became publicly traded in 2010- making it a questionable substitute for blue-chip stocks paying similar yields.
DuPont Fabros Technology, Inc. (NYSE:DFT) and Digital Realty Trust, Inc. (NYSE:DLR) have somewhat longer histories of paying dividends as well as being larger by market cap, though DuPont Fabros did temporarily suspend its quarterly payments for one year in late 2008. That stock’s current yield is 4.3%, though it is a popular short target (30% of the float is held short) and it is down 18% in the last year as markets have been even more negative on it than on Equinix Inc (NASDAQ:EQIX)- the payout ratio is quite high, and investors may be worried about a potential dividend cut. Digital Realty Trust is in a similar situation. Recent quarterly dividend payments imply an annual yield of over 5% but short interest is high, the stock has been struggling recently, and the payout ratio is a cause for concern (although the company has a good record of increasing its dividend, including at the beginning of this year).
The dividend yields at these two companies are certainly high, and while income investors should be sure not to commit too much of their portfolio to REITs it might be worth looking into if their dividends are safer than shorts believe. As for Equinix, it seems quite dependent on winning REIT conversion and while that certainly could result in increased shareholder value we would avoid it for now given the potential for change in IRS policy.
Disclosure: I own no shares of any stocks mentioned in this article.
