Data centers are the physical backbone of digital life

Khanchit Khirisutchalual

By Christopher Gannatti, CFA

Individuals, businesses and even governments are changing their relationship with data.

Now, with a simple internet connection, services like Spotify (SPOT) provide access to almost entire discographies. The the idea of ​​trying to transport all its data no longer makes sense.

Data centers and smooth and efficient Internet connectivity are responsible for this change.

Cloud Providers vs Data Centers

Cloud computing has received enormous attention as a megatrend in its own right. In 2022, global sales are expected to exceed $495 billion, and could reach over $1 trillion by 2030. About 30% of enterprise workloads have moved to the cloud.1

When we think of the “cloud”, some of the biggest companies in the world come to mind. Amazon Web Services (AWS) from Amazon (AMZN) is the leader; combined with Microsoft (MSFT) and Google (GOOG)(GOOGL), the three companies account for 65% of the total share of global spending on cloud services.2

But when we say “the cloud”, what does it look like in the physical world? We can take it for granted that the software is still there on our smartphones, tablets and computers, but it all depends on a specific, purpose-built infrastructure.

Figure 1 is from Equinix’s (EQIX) Q2 2022 Investor Presentation. Equinix is ​​a leading provider of data center infrastructure, operating on six continents in 31 countries with 248 data centers.3 Here they take four of the big “hyperscalers” – companies that operate the cloud platforms that help meet a large portion of the world’s digital needs.

While we may be familiar with the names of hyperscalers – these tend to be some of the largest market cap companies in the world – we may not immediately know the name “Equinix”. Yet it’s very clear that Equinix is ​​at the heart of how today’s digital world works.

Figure 1: Equinix provides a physical foundation for cloud hyperscalers

Equinix Investor Presentation

Slice the cake of economic profits

Today, Equinix derives approximately 35% of its overall rent from the largest cloud providers. Would you like to sit on the other side of the negotiating table of the biggest companies in the world? When factoring in the impact of energy costs, large tech companies pay about half the rental rate of a small business or government tenant.5

Asking whether data center providers will ever replace the world’s largest companies in terms of their ability to extract economic value from the cloud ecosystem is probably the wrong question. Instead, it may make sense to think about the relationship between the current price and future forecast supply and demand balances. Data center infrastructure, writ large, is a commodity, assuming vendors can bring cloud companies essentially the same suite of capabilities.

The world’s increasing attention to climate and the environment makes it more difficult to build additional data centers, which consume a lot of water (cooling) and a lot of electricity. In the first six months of 2022, asking rents for data centers in major US locations increased by 5.9% compared to the same period in 2021. If this trend continues, it is possible that 2022 will be the first year of positive rent growth for data centers since 2017.6

Will hyperscalers go their own way?

The largest companies in the world, due to their vast resources, are able to think strategically over long periods of time. People outside Apple (AAPL), for example, might have realized only too late that the perceived connection to Intel’s chips (INTC) was not permanent and that Apple, with the commitment and appropriate investment, could design its own chips to make customer experience better. When companies generate tens of billions in cash flow on an annual basis, these resources combined with long-term thinking could melt away perceived limitations.

Hedge fund manager Jim Chanos is actually betting against data center infrastructure providers, like Equinix and Digital Realty Trust (DLR). These hyperscalers can and do build some of their own facilities — a Microsoft data center in Chicago is 700,000 square feet, the size of about 52 Olympic swimming Why wouldn’t they start the transition to building all their own facilities, eliminating the cost of data center infrastructure vendors?

Although nothing is ever “impossible”, when thinking of real estate that has such strategic value, location is important. If Equinix or Digital Realty Trust have their infrastructure in the most ideal places, connected to the most important networks with the right infrastructure, it is not possible to come in and build something new in the same place. If hyperscalers were starting from scratch today, they would probably be building a lot of them themselves. As these companies seek to use existing infrastructure where they can to serve their customers – assuming companies like Equinix and Digital Realty Trust own this real estate – they will likely continue to have a place in the ecosystem. The convenience of plugging into existing setups can replace the cost savings of doing it yourself.

It is also true that the clientele will probably evolve. Just as hyperscalers might think of ways to extract more economic value and remove the line item paid to technology infrastructure providers, other companies are seeing big spend paid to companies like Microsoft, Amazon, Google Cloud , etc. It is possible that the wide range of companies undergoing their specific “cloud migrations” will explore direct relationships with infrastructure providers in the future.

People have been debating this idea for almost as long as hyperscalers have been in the cloud computing business, and so far data center infrastructure providers, like Equinix and Digital Realty Trust, are still around.

Conclusion: Digital transformations need physical infrastructure

We spend a lot of time looking at different megatrends, like cloud computing, artificial intelligence, 5G, internet of things… the list goes on.

Figure 2 shows that data transmission standards – what we call 2G, 3G, 4G, 5G – generally have a lifespan of around 20 years.8 The move to 5G tells us that more and more data is going to be generated and processed, and we will need data center infrastructure to support it.

Figure 2: Evolutions of connectivity standards in the United States

US connectivity standards market share

If investors are considering a different way of exposing themselves to megatrends – their underlying infrastructure rather than the more direct players – the concept of “new economy” real estate may offer something unique that could have a of risk and return different from that of growth. – oriented technological actions. Learn more about our specific strategy: the WisdomTree New Economy Real Estate Fund (WTRE).

1 Source: “Cloud computing giants compete to protect big profits” Economist08/29/22.

2 Source: Aaron Tilley, “Cloud Business Outlook Cools as Customers Tighten Spending,” the wall street journal08/25/22.

3 Source: Equinix Investor Presentation, Q2 2022.

4 Source: Carol Ryan, “Data Centers Are Unpopular. So much the better for their stocks,” the wall street journal08/30/22.

5 Source: Ryan, 8/30/22.

6 Source: Ryan, 8/30/22.

seven Source: Anna Gross, “Will the Cloud Kill the Data Center?” Jim Chanos thinks so,” FinancialTimes08/29/22.

8 Source: “Introduction to the tower industry and the American tower”, American Toweras of 12/31/21.

As of September 9, 2022, WTRE held 4.70% and 5.03% of its weighting in Equinix and Digital Realty Trust, respectively. Click on here for a full list of fund holdings.

Important risks related to this article

There are risks associated with investing, including possible loss of capital. Investing abroad involves special risks, such as the risk of loss due to currency fluctuations or political or economic uncertainty. Investments in real estate involve additional special risks, such as credit risk, interest rate fluctuations and the effect of varying economic conditions. A Sub-Fund focusing on a single country and/or sector and/or emphasizing investments in smaller companies may experience greater price volatility. The Fund invests in securities included in or representative of its index, regardless of their investment merit, and the Fund does not attempt to outperform its index or take defensive positions in declining markets. Please read the Fund’s prospectus for specific details regarding the Fund’s risk profile.

Christopher Gannatti, CFA, Global Head of Research

Christopher Gannatti started at WisdomTree as a Research Analyst in December 2010, working directly with Jeremy Schwartz, CFA®, Director of Research. In January 2014, he was promoted to Associate Director of Research where he was responsible for leading various groups of analysts and strategists within WisdomTree’s broader research team. In February 2018, Christopher was promoted to Head of Research for Europe, where he will be based in WisdomTree’s London office and will be responsible for all of WisdomTree’s research efforts in the European market, as well as supporting the UCIT platform on a global scale. Christopher came to WisdomTree from Lord Abbett, where he worked for four and a half years as a regional consultant. He received his MBA in Quantitative Finance, Accounting and Economics from NYU’s Stern School of Business in 2010, and he received his BS in Economics from Colgate University in 2006. Christopher holds a Chartered Financial Analyst designation.

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Editor’s note: The summary bullet points for this article were chosen by the Seeking Alpha editors.

Ramon J. Espinoza