Fitch: Equinix's 'BB' Rating Unaffected by Asset Divestitures

NEW YORK--(BUSINESS WIRE)-- Fitch Ratings believes the ratings for Equinix, Inc. (Equinix) including the company's 'BB' Long-Term Issuer Default Rating (IDR) and Stable Rating Outlook, are unaffected by the announced agreement to divest eight data center assets as a condition of obtaining clearance from the European Commission to obtain regulatory approval for the acquisition Telecity Group plc (Telecity), which closed in January 2016.

On May 16, 2016, Equinix announced it reached an agreement with Digital Realty Trust, Inc. (Digital Realty) whereby Equinix will sell eight data centers (seven Telecity and one Equinix) spanning 213,000 net sellable square feet for $874 million, or about 12.5x EBITDA (based on Equinix's publicly disclosed EBITDA figure of $70 million for the divested assets). The transaction is subject to regulatory approval and is expected to close in the third quarter of 2016 (3Q2016). Related to the transaction, Digital Realty granted Equinix an option to acquire an internet gateway in Paris for $215 million. The Paris transaction, assuming the option is exercised, is expected to close in the second half of 2016, and is subject to its own regulatory approval process and confirmatory diligence by Equinix.

The sale of additional retail facilities to the world's largest wholesale data center provider is likely to further speculation that wholesale providers will compete more aggressively in the retail space, considering Digital Realty's acquisition of Telx Inc. (Telx) in October 2015. Fitch does not view rising competitive intensity from wholesale providers as a significant risk for Equinix for the following reasons: (i) Fitch believes Digital Realty's two recent acquisitions are primarily motivated by interconnectivity and network density, as opposed to pivoting its business model to focus on smaller deal sizes; (ii) different go-to-market approaches - Digital Realty continues to focus on network and cloud customers versus Equinix's strategy of targeting enterprise customers; (iii) wholesale providers acquiring retail facilities can dilute margins or funds from operations (FFO) metrics. Digital Realty's two recent acquisitions are unique with regard to synergies from owning several Telx facilities prior to that acquisition and the opportunity to acquire the Equinix/Telecity facilities at a multiple significantly lower than what Equinix paid for the assets due to the forced nature of the sale; and (iv) adding a successful retail business is not as simple as partitioning a facility into smaller sized cages; significant operational know-how with regard to managing this customer base is required. This is evidenced by Digital Realty's difficulty in successfully building out its retail business prior to the acquisition of Telx.

Fitch expects the impact on leverage from the sale to be minimal as Equinix was already accounting for seven of the eight assets as discontinued operations. Pro forma for the divestiture, Fitch estimates total pro forma adjusted leverage (total adjusted debt to operating EBITDAR and including a full year of Telecity and Bit-isle EBITDA) as of March 31, 2016 of 5.1x, versus Fitch's negative rating sensitivity of 5.0x. Fitch expects Equinix to reduce leverage below the rating sensitivity level by the end of 2016.

Fitch assumes Equinix will use the majority of the sale proceeds to help fund its expansion activity (debt documents require the company reinvest in the business or repay secured debt), which Fitch expects to comprise over 80% of an expected $900 million to $1 billion of total capital expenditures for fiscal 2016. Fitch forecasts capital intensity in the low to mid 20% range over the rating horizon, and negative free cash flow (FCF) due to required REIT dividend distributions.

KEY RATING DRIVERS

Rating strengths include:

--Scale, network density and reputation as a world-class premium colocation provider;

--Increasing interconnection revenue mix is a positive driver for growth, profitability and retention;

--Stable business model highlighted by over 90% recurring revenue and churn consistently in the 2.0%-2.5% range;

--Low customer concentration - its largest and top 10 customers account for 3.0% and 16.6% of total revenue, respectively.

Rating concerns include:

--Capital intensity from the high cost of building new capacity; Fitch expects capital intensity in the low to mid 20% range over the rating horizon;

--Required REIT dividends constrain FCF and limit ability to delever outside of EBITDA growth;

--High operating leverage based on fixed costs from labor, power and rent, accounting for roughly 70% of total cash expenses;

--Low unencumbered asset coverage due mainly to leasing the majority of its square footage.

KEY ASSUMPTIONS

--Average pro forma annual revenue growth in the high single digits over the rating horizon;

--Overall cabinet utilization between 78%-80% per year;

--Stable overall MRR per cabinet;

--EBITDA margin expands to reflect benefits of increased scale;

--Tax rate of 10%-15% per year, reflecting taxes paid from taxable REIT subsidiaries;

--Expansion capital expenditures of $50,000 per cabinet install; recurring capex of 4%-4.5% of revenue per year; capital intensity (capex/revenue) approaches the low 20% range over the rating horizon;

--Dividend payout ratio OF 45% of AFFO;

--FCF negative over the rating horizon.

RATING SENSITIVITIES

Future developments that may, individually or collectively, lead to a negative rating action include:

--Debt-financed acquisitions that increase leverage above Fitch's rating sensitivity or dilute margins; financial impact will be considered in context of strategic rationale;

--Fitch's expectation of leverage (rent adjusted) sustaining above 5.0x;

--Indications of heightened liquidity risk as debt maturities approach.

Future developments that may, individually or collectively, lead to a positive rating action include:

--Fitch's expectation of leverage (rent adjusted) sustaining below 4.0x;

--Unencumbered asset coverage of about 2.0x;

--Consistent positive FCF generation, but still allowing for sufficient capital investment to maintain market leadership and premium offering.

LIQUIDITY

Fitch believes negative FCF over the rating horizon limits internal sources of liquidity. The company had $1,457 million available under its $1 billion revolver ($43 million LOCs and $0 drawn) as of March 31, 2016. Fitch estimates about $1.5 billion in cash and cash equivalents pro forma for sale proceeds from the divestiture ($1.3 billion assuming exercise of the option to acquire the Paris internet gateway), but expects the company to reduce this to a more normalized level over the next two years.

While other REITs can often leverage unencumbered assets to address liquidity needs, Equinix's data centers are mostly leased (owned assets represent 33% of gross square footage and 34% of recurring revenue), limiting sources of contingent liquidity. However, its owned facilities are mainly in top global markets, implying a lower capitalization rate in a sale or financing scenario. Fitch estimates unencumbered asset coverage of below 1.5x, which is weak relative to the 'BB' rating category. Fitch believes Equinix's strong business and operating profile characteristics described above provide key offsets to this risk.

As of March 31, 2016, total unadjusted debt was $7.2 billion and consisted of:

-- $1,500 million revolving credit facility (unfunded) due 2019;

--$459 million term loan A due 2019;

--$681 million term Loan B due 2023;

--$50 million mortgage and other loans payable;

--$1,600 million capital lease and other financing obligations;

--$422 million bridge term loan;

-- $500 million 4.875% senior notes due 2020;

-- $750 million 5.375% senior notes due 2022;

-- $1,000 million 5.375% senior notes due 2023;

-- $500 million 5.750% senior notes due 2025;

-- $1,100 million 5.875% senior notes due 2026;

--$29 million Brazil financings;

-- $150 million 4.750% convertible notes due 2016.

Additional information is available on www.fitchratings.com

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

View source version on businesswire.com: http://www.businesswire.com/news/home/20160516006524/en/

Fitch Ratings
Primary Analyst
Matt Hankin, CFA
Director
+1-646-582-4985
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Steven Marks
Managing Director
+1-212-908-9161
or
Media Relations:
Alyssa Castelli, +1 212-908-0540
[email protected]

Source: Fitch Ratings

---

Serious News for Serious Traders! Try StreetInsider.com Premium Free!

---

You May Also Be Interested In

• IHT converts $3M debt to equity to meet NYSE American listing rules
• 【Real Time • Tide Watching | "China Plays a Constructive Role in the SCO's Development" - Interview with SCO Secretary-General Nurlan Yermekbayev】
• Form-8.3 APTITUDE SOFTWARE GROUP PLC - 28 08 2026 - (CGAML)