I opened the Phoenix chapter of Bandwidth with the same six words. They earn a second tour here, because the data-center business ran the same play as the fiber business, on the same calendar, and sometimes with the same sellers.
In December 2004, Equinix filed a short Form 8-K with the Securities and Exchange Commission. Most 8-Ks are forgettable. This one recorded the end of an era in a single number.
The filing said that an Equinix subsidiary had leased "an existing data center located at 1735 Lundy Avenue, San Jose, California." The building held about 103,000 square feet. The lease ran "through 2020." Then came the line that mattered. Equinix had bought the data center infrastructure assets inside the building, for "approximately $900,000."The 8-K does not name AboveNet; Equinix's December 8, 2004 press release does. Equinix's 2004 10-K gives the price as $924,000. The "$80 million" quote that Bandwidth and Chapter IV attribute to the San Jose building matches the build cost Data Center Knowledge gave in June 2005 for a different Silicon Valley center. Both may be true.
Equinix's press release filled in the rest. The seller was AboveNet, the company that had come out of Metromedia Fiber's bankruptcy under Bill LaPerch. The building had room for roughly 2,000 cabinets. Equinix expected to spend about $5.0 million more to get it ready and to start placing customers there on March 1, 2005. At capacity, the company said, the center should bring in $25 million to $30 million a year.
Why would a seller take so little? As I wrote in Bandwidth, LaPerch sold multiple data-center assets in his first year as CEO, assets that, if held, could have been worth many hundreds of millions. He had a reason. He used the proceeds to push AboveNet's fiber into as many data centers as possible. LaPerch chose to own the roads into the buildings and let others own the buildings. As I wrote in Bandwidth, his ten-year execution of that strategy was extraordinarily successful. In 2012, my company, Zayo, bought AboveNet for about $2.2 billion.
Still, read those numbers again. Under $1 million for the guts of a finished data center, plus about $5 million of fix-up, against as much as $30 million a year of revenue. That was the trade on offer in the Phoenix years. Somebody else had paid to build the place. The new owner only had to fill it.
Equinix's next annual report turned the trade into a strategy. "In light of the availability of fully built-out data centers in select markets at costs significantly below the cost we would incur in building out new space," the company wrote, "we have altered our business strategy to acquire fully built-out data centers rather than build out our own." Stop building. Start shopping.
The fiber business was doing the same thing at the same time. In January 2002, as I quoted in Bandwidth, Forbes looked at the telecom wreckage and saw that "hard assets are selling for pennies on the dollar." I was one of the buyers who took that advice in fiber. In data centers, the buyers were a different cast, and this chapter is their story.
Equinix, a company trading for 30 cents a share in 2002, used a rescue from Singapore and a run of bargain buildings to become the place where the Internet's networks meet. A real-estate fund called GI Partners bought twenty-five technology buildings, many of them data centers, when nobody wanted them and turned most of them into Digital Realty. A young Las Vegas real-estate man named Rob Roy picked up a small building that Enron had wired for a bandwidth market that never came, and built Switch on top of it. Savvis, Terremark and Rackspace showed that the old Exodus business of running other people's servers could survive the Bust after all. And in 2008, a financial crisis bigger than the one that killed the hosting Gold Rush tested whether any of it would hold.
Equinix—Peter Van Camp and Steve Smith#
When we last left Equinix, Peter Van Camp had just taken it public at $12 a share, five months after the Nasdaq peaked, with a $1.2 billion building plan and nowhere near $1.2 billion in the bank.
The building plan did not survive the Bust. In early October 2002, Equinix stock closed at 30 cents. It was down 89.7 percent for the year. The company carried about $130 million of debt, and the bondholders owned a claim on a company whose shares traded like a lottery ticket.
From $12 to 30 cents in a little over two years. Exodus had made the same trip, and Exodus was in bankruptcy. Why didn't Equinix follow it?
The Singapore Rescue
The answer came from the far side of the Pacific. On October 2, 2002, Equinix signed a three-way combination with two other exchange companies. One was i-STT, the Internet-exchange arm of Singapore Technologies Telemedia. The other was Pihana Pacific, based in Honolulu.
Pihana was a Gold Rush company in miniature. It had raised $240 million in 2000 and built seven regional data centers, from Honolulu to Hong Kong and Sydney. By 2002, its Honolulu center was 40 to 50 percent occupied. Hong Kong and Sydney were about 30 percent full. Pihana had the buildings. It did not have the customers to pay for them.
The deal solved everyone's problem at once. Equinix took over Pihana's and i-STT's exchange centers in Asia and the United States. ST Telemedia agreed to invest $30 million in Equinix, and Equinix would use most of it to retire its bonds at a deep discount. When the dust settled, ST Telemedia would own 28 percent of the combined company, Equinix's existing shareholders 33 percent, Pihana's holders 21 percent and the senior bondholders 18 percent.The October 2002 agreements authorized "up to $40 million aggregate principal amount of convertible secured notes" for STT Communications and other purchasers. The investment at closing was $30 million. Equinix also cut its credit facility by $8.5 million, to $91.5 million, and Pihana brought more than $26 million of cash into the combined company. The bond retirement left about $30 million of the 13 percent notes outstanding. "We feel we've solved that problem," Pihana's CEO, Rich Kalbrener, told the Honolulu Star-Bulletin.
Bandwidth readers will recognize the investor. ST Telemedia was the same Singapore company that paid $250 million for control of Global Crossing out of bankruptcy, as we saw in the last chapter. In the Phoenix years, the cash sat in Asia, and Asia was shopping.
The combination closed on December 31, 2002. Stockholders had approved it the day before in New York. More than $116 million of Equinix's 13 percent senior notes, about 85 percent of them, were retired. The same day, a 1-for-32 reverse stock split took effect so that Equinix could keep its Nasdaq listing. Lee Theng Kiat, ST Telemedia's CEO, became chairman. Van Camp stayed on as CEO. Phil Koen moved to Singapore to run the Asia-Pacific business.
Van Camp was a UUNET man. Before Equinix, he had been UUNET's president of Internet markets and the Americas. Bandwidth readers know how UUNET's story ended, inside WorldCom. Van Camp's new company had come close to its own ending. The Singapore money bought it time.
Van Camp's statement that day was a survivor's boast. "Equinix is the largest network-neutral Internet exchange services company internationally," he said. The deal, he added, would "result in a strengthened balance sheet that provides Equinix with a solid financial base."
A company that had needed a reverse split to stay listed was calling itself the largest in the world. Was he right? In a narrow sense, yes. Many of its competitors were in bankruptcy court.
Buy, Don't Build
Equinix came out of the rescue small. In 2003, it booked $117.9 million of revenue and lost $84.2 million.The 2003 loss figure ($8.76 per share) comes from the selected-data table in Equinix's 2003 10-K, not from a narrative statement. But its balance sheet could now carry it through the time it needed, and the market was about to hand it the cheapest raw material in the history of the business.
In December 2003, Equinix signed a deal to sublease Sprint's E|Solutions Internet Center in Santa Clara. The center held 160,000 square feet. Equinix took over the building on a lease and bought the data-center property and equipment inside it. The Sprint center "became our 14th IBX hub," the company wrote. A carrier had built it during the boom. A neutral exchange would fill it during the bust.
A year later came the AboveNet building on Lundy Avenue, for about $900,000. Six months after that, in June 2005, Equinix took a fourth Silicon Valley center on a long-term lease. Data Center Knowledge reported the history: "The new center was built-out in 2001 at an estimated cost of $80 million, or better than $650 per square foot." Equinix planned to spend $15 million upgrading it.Data Center Knowledge did not name the seller of the fourth Silicon Valley center. The lease began in October 2005 and covered 120,000 square feet.
Here is the mechanic that made those buildings worth more in Equinix's hands than in anyone else's. Equinix did not sell bandwidth, and it did not run its customers' servers. It rented space in buildings where many networks met, and it charged for the connections between them. Every new network in an IBX made the building more valuable to the next customer, and every new customer made it more valuable to the next network. A carrier like Sprint competed with every other carrier in its building. AboveNet sold fiber. Equinix had nothing to sell but the meeting.
That was the bet Jay Adelson and Al Avery had made in 1998. It took the Bust, and a fire sale of other people's buildings, to prove it.
The Seasoned Hand, Again
In October 2006, Equinix announced that Van Camp would hand over the CEO job. On March 19, 2007, it named his successor: Stephen M. Smith, a former Hewlett-Packard executive. Smith took over on April 2, 2007. Van Camp, chairman and CEO since 2000, became executive chairman. "I'm confident Steve will serve Equinix customers and shareholders well," Van Camp said.
I should say up front that Steve Smith is a friend of mine. He ran Equinix for about a decade, and years later he succeeded me as CEO of Zayo. I'll try to tell his story the way I'd tell anyone's, from the record.
Smith's résumé tells you what Equinix's board was looking for. He served eight years in the U.S. Army. He then spent sixteen years at EDS, where he rose to chief sales officer and president of EDS Asia-Pacific. After that came Lucent, as a vice president, and then HP Services, as a senior vice president.
EDS. Readers of Chapter I will remember it. In the 1960s and 1970s, EDS was one of the companies that ran other people's computers in the original glass house. Now an EDS-trained salesman was taking over the company that owned the rooms where the Internet's networks met. The founders had built Equinix as an engineering idea. Smith had spent his career selling and running services.
He moved fast. In June 2007, less than three months into the job, Equinix agreed to buy IXEurope for $482 million.The price was 125 pence, or about $2.50, per share. IXEurope had fourteen data centers with 380,000 square feet in London, Paris, Frankfurt, Munich, Düsseldorf, Zurich and Geneva. "The deal provides Equinix with a European presence to go with its network of facilities in the U.S. and Asia," Data Center Knowledge wrote. After the deal, Equinix's footprint topped 3 million square feet.
Five years earlier, the company had needed Singapore money to stay alive. Now it had exchanges on three continents.
The Juggernaut
Equinix still had a hole in North America. Its buildings sat in the biggest metros. The second-tier cities belonged to others, and the largest of those others was Switch and Data.
The two companies had talked once before, in 2006. Those talks ended, Equinix's merger proxy later explained, "because the expected value of Switch and Data following the initial public offering significantly exceeded the value that Equinix had indicated it would be willing to offer." Switch and Data went public in early 2007 instead.
Smith tried again in the spring of 2009, with the markets still raw from Lehman. On May 4, he, his CFO, Keith Taylor, and Mark Adams sat down with Switch and Data's chairman, William Luby, at Luby's office in New York. Smith asked about a combination. Luby's answer, as the proxy records it: "Switch and Data was not for sale."
Fifteen days later, Smith broke off. Equinix's management, the filing says, "was focused on other priorities." On July 8, he called to resume talks. A week later he floated "a 20-30% premium," mostly in stock, and asked for exclusivity. Luby refused.
Luby had a reason to hold out. Since January, a private, non-U.S. company that the proxy calls only the "International Party" had been talking with Switch and Data about a stock-for-stock merger of equals. Smith had competition.
So the price climbed. Equinix's letter of intent on August 28 offered $16.35 a share, a 20 percent premium. On September 21, it went to $18.50. Switch and Data countered the next day at $19.47 and asked for a forty-five-day go-shop instead of exclusivity. On September 24, Equinix settled at about $18.46 a share, a premium of about 30 percent. The next day, Luby signed twenty-one days of exclusivity and told the International Party that the talks were over.Every offer was 80 percent stock and 20 percent cash. The steps, per Switch and Data share: 0.19276 Equinix shares or $16.35 (August 28); 0.20170 or $18.50 (September 21); Switch and Data's counter of 0.21000 or $19.47 (September 22); an Equinix offer of 0.20351 or $18.80 on a date the proxy doesn't give; and 0.20422 or $18.46 (September 24). The implied values moved with Equinix's share price, which is why a higher exchange ratio on September 24 shows a slightly lower dollar figure. The premiums are the proxy's own.
Then came the twist. While the lawyers drafted, Equinix's stock kept rising. By October 19, it had reached $98.39. Because most of the price was paid in Equinix shares, the agreed exchange ratio now implied $20.09 a share, a 39.3 percent premium. Smith cut the ratio. "Equinix's board of directors was unwilling to pay such a premium," the proxy says. The new terms were 0.19409 Equinix shares or $19.06 in cash for each Switch and Data share. Luby pushed back on how the cash portion would move with Equinix's stock price, but he didn't walk. Two days later, the boards signed.
That kind of re-trade only works when the buyer's currency is strong and the seller has already sent its other suitor home. Equinix's board, the proxy adds, chose "not to approach the other participants in the industry." Smith had one target, and he got it.
On October 21, 2009, Equinix announced that it would buy Switch and Data for about $689 million in cash and stock. Switch and Data operated thirty-four sites in the United States and Canada, in cities such as Atlanta, Denver, Miami, Seattle and Toronto. Smith said the deal "further strengthens Equinix's position as the most comprehensive global data center services provider."
The deal closed in the spring of 2010, one week after the Justice Department finished its antitrust review. By then, the value had slipped to $683.4 million: about $134.0 million in cash and about 5.5 million Equinix shares.Each Switch and Data share received either 0.19409 Equinix shares or $19.06 in cash, prorated to 80 percent stock and 20 percent cash; the proxy confirms these terms. The $683.4 million excludes assumed employee equity awards. Equinix's 8-K dates the closing to April 30, 2010; its completion release is dated May 3, 2010. Data Center Knowledge wrote that the deal closed "about a year" after its announcement; it closed about six months later. In January 2010, the same publication rounded the price to "$700 million." How big was Switch and Data next to Equinix? One research firm, Nortia, estimated that Switch and Data had about 8,920 cabinets billing and 5,080 more available, against about 23,600 billing cabinets at Equinix in the United States. In other words, Equinix was adding more than a third to its U.S. base in a single deal. Equinix went from six North American metros to twenty-two. The combined company had eighty-seven IBX and partner centers in thirty-five metros and more than 6 million square feet. Data Center Knowledge called the result "a colocation juggernaut spanning three continents."
Let's do the arithmetic. In October 2002, Equinix's stock traded at 30 cents and its bondholders were trading their claims for 18 percent of the company. Seven and a half years later, it handed over about $549 million worth of its own shares to buy a competitor with thirty-four sites.
The phoenix had a name, and the name was Equinix.
Digital Realty—GI Partners, Richard Magnuson and Mike Foust#
"Back then data center investing was an oxymoron," Richard Magnuson said in a 2010 keynote.
He was talking about 2002. Data centers were sitting empty or selling for very little. The industry was in a slump, and the space was oversupplied. The hosting companies that had built the buildings were in bankruptcy, and the carriers that had built the rest were trying to stay out of it.
Magnuson saw what the operators couldn't. The buildings were fine. The buildings were always fine.
The Fund
GI Partners, in the words of its later IPO prospectus, "was formed in February 2001 after a competitive six-month selection process." The selector was CalPERS, the California state pension fund, which made a $500 million equity commitment. Magnuson founded the firm to focus on data centers.The prospectus does not say who chose GI; the "selection process" was CalPERS's, which made the $500 million commitment. GI Partners later said CalPERS hired it after a request-for-proposal process in 2000. Data Center Knowledge's 2012 retrospective says Magnuson founded GI in 2001 to focus on data centers. The timing looked terrible. The Nasdaq had already crashed, and the hosting bankruptcies were just beginning.
That was the point. From 2002 to 2004, GI bought twenty-five technology buildings, many of them data centers, with $280 million of equity.The Digital Realty prospectus calls them "technology-related real estate properties," and several were not data centers: the Maxtor Manufacturing Facility, the ASM Lithography Facility and Ardenwood Corporate Park, for example. Its 2004 10-K says Digital Realty "acquired 24 technology-related real estate properties" between January 2002 and December 2004. The twenty-five figure and the $280 million of equity are GI's own, as reported by Data Center Knowledge. The first was the Univision Tower in Dallas, in January 2002. The Digital Realty prospectus explained the logic in one sentence: "the cost of acquisition is usually substantially lower than the cost to construct a new facility."
One purchase tells the whole story. In Santa Clara, at 2045 and 2055 Lafayette Street, stood two 150,000-square-foot buildings finished in 2000. "The property was built specifically for Exodus," the prospectus said. Digital Realty estimated that Exodus had put about $150 million into the electrical systems alone. In May 2004, GI bought both buildings for $60.0 million, fully leased to Savvis, the company that by then owned Exodus's remains. That was forty cents on the dollar for the wiring alone, with the buildings thrown in.
The tenants had their own troubles. Since GI's first purchase, the prospectus disclosed, fourteen tenants leasing about 474,000 square feet had gone through bankruptcy. Eight of them, with about 370,000 square feet, never missed a rent payment and kept their leases. When a company goes bankrupt, it stops paying for a lot of things. It keeps paying for the room where its servers live.
Here is how GI's model differed from Equinix's. Equinix was an operator. It ran the exchange, sold the cross-connects and staffed the building around the clock. GI was a landlord. It owned the building, the power and the cooling, and it leased the space to tenants who ran their own operations inside. The tenant signed a long lease. The landlord collected rent. When the tenants were big, creditworthy companies, the rent looked a lot like a bond.
That is a real-estate business, and Wall Street knows how to value real estate. GI would take it public as one.
The IPO
On October 28, 2004, Digital Realty Trust priced its initial public offering: 20 million shares at $12.00, or $240 million.The underwriters also had a 3,000,000-share overallotment option, of which 1,421,300 shares closed on November 30, 2004, adding about $15.9 million. The 2004 10-K puts the net proceeds from both sales at about $230.8 million, after $18.0 million of underwriting discounts and commissions and $8.3 million of other expenses. The deal closed on November 3, and the stock listed on the New York Stock Exchange under the ticker "DLR." The company was organized as a real estate investment trust, a structure that let it pass its rental income through to shareholders.
The portfolio held twenty-two properties in the United States and one in London, about 5.6 million net rentable square feet. At June 30, 2004, 87.1 percent of it was leased, on leases averaging 12.6 years. The largest tenant, at 12.6 percent of rent, was Savvis. Qwest was second. Magnuson became executive chairman. Michael F. Foust, a GI managing director, became CEO.
The IPO also put a price on GI's contrarian nerve. For the properties it contributed, GI received operating-partnership units worth $383.2 million at the offering price. The historical net tangible book value of what it contributed was about $114.6 million.
Twelve dollars a share. That was Equinix's IPO price four years earlier. Equinix had gone public on a forecast. Digital Realty went public on signed leases.
The Contrarian's Scorecard
GI had also bought from the Bust's survivors. In September 2004, it paid $36.5 million for a 179,489-square-foot building in downtown San Jose that had been redeveloped in 1998 for AboveNet's data center. Digital Realty estimated that AboveNet had invested "over $30 million" in improvements, and AboveNet stayed on as the main tenant. Three months later, the same seller let Equinix have the inside of a different San Jose building, on Lundy Avenue, for under $1 million.The two San Jose buildings were different facilities: the 179,489-square-foot downtown building that GI bought in September 2004, with AboveNet as the main tenant through November 2019, and the 103,000-square-foot center at 1735 Lundy Avenue whose lease and equipment Equinix took over in December 2004.
GI kept investing around the edges of the business too. Over the decade, it backed Savvis, The Planet, EV1 Servers, Telx, SoftLayer and ViaWest. GI Partners turned up on a lot of the survivors' cap tables.
In September 2009, GI sold its last data-center holding, a former Exodus center in Frankfurt. The buyer was Equinix, and the price was $28 million. Remember that Exodus had once been worth more than $20 billion. Its buildings were still changing hands, one at a time, among the companies that had figured out what they were worth.
By GI's own figures, the fund turned its $280 million of equity into more than $1 billion of proceeds, a 3.7x multiple and a 60 percent gross internal rate of return. Twenty-one of its twenty-five buildings became the nucleus of Digital Realty, which by then had a Market Value of about $6 billion.
"That's why we, as contrarians, did very well," Magnuson said. He stepped down as Digital Realty's chairman in 2012, with the oxymoron long since turned into an asset class.
Should we take a fund's word for its own returns? Not entirely. Funds report their own numbers in the best light, and these numbers are GI's own. But the public market set the $6 billion Market Value. Even with a haircut, it was one of the great trades of the decade.
I made a version of the same bet in fiber, as I described in Bandwidth.
Switch—Rob Roy#
"Legend has it that the company managed to acquire what was once meant to be Enron's broadband trading hub for a song," Ashlee Vance wrote in The Register in 2008.
Legend is the right word. The Switch story starts with Enron, and the Enron part has grown in the telling. So let's take the legend apart and see what the sources actually say.
The Enron Building
Bandwidth readers know Enron Broadband Services. My former MFS colleague Scott Yeager became one of its leaders. Enron promised a market where bandwidth would trade like natural gas or electricity. A witness at the 2005 trial of its executives said the software behind that market was called "the secret sauce or pixie dust." The market never arrived. Enron did not survive the attempt.
To trade bandwidth, Enron needed places where many carriers' networks met. One of them was in Las Vegas.
The best period source is a November 2004 report by Ky Plaskon of Nevada Public Radio. According to KNPR, Rob Roy bought a former Enron building about "two years" earlier, at a private Enron sale, for $930,000. Roy was about thirty-three.Switch's October 2017 prospectus gives Roy's age as forty-eight as of September 1, 2017, which makes him about thirty-three in late 2002. KNPR reported his age as twenty-nine in 2004, and The Register gave it as thirty-eight in May 2008. The prospectus is the authoritative source. Enron Broadband Services said it had marketed its properties to 300 IT companies. Its managers said only Roy saw value in this one. Enron's attorneys put it plainly: "It wasn't just an auction. It was a private auction to just Rob Roy."
Roy did not have the money. The closing was delayed while he found financing. A partner called GK Acquisitions came in about two months later. In June 2004, Arden Street Technology Partners bought in for $1.6 million. Then, in October 2004, Tom Thomas of the Las Vegas developer Thomas & Mack bought the building for $3 million and leased it back to Roy. Switch Communications ran the business inside. The building sat on east Sahara Avenue, past U.S. 95.
"Rob Roy is quite lucky because he was prepared when the opportunity came," a Switch spokesman, Mike Ballard, told KNPR.
Data Center Knowledge added detail in 2008. Switch had "acquired a former Enron broadband services facility out of bankruptcy" in December 2002. Enron had planned a commodity bandwidth exchange there and had arranged exceptional connectivity to the site. But the building was small, about 12,000 square feet. And according to court records, the buyer was not Switch or Roy. It was a company called "Colo Gateways."Data Center Knowledge, citing court records. KNPR dates the purchase to "two years" before November 2004; Data Center Knowledge says December 2002. A 2000 Nevada Business article, which I've seen only as a search excerpt, names Roy as chief executive of a Las Vegas colocation start-up called Colocation Gateways.
By 2008, the story had grown. The Register reported that Switch had acquired what was planned as Enron's broadband trading hub, with access to more than twenty carrier backbones in one place. "We were the only ones that bid on it," Roy told Vance. In the same article, Vance flagged a dispute: one of his contacts said the Enron network had gone to a different buyer, Wilhagan Ventures, later WVFiber.
And when Switch finally went public in 2017, its prospectus didn't mention Enron at all. The word appears nowhere in it. The company told its origin story differently: "Mr. Roy first began developing data center facilities in 2000, merging several predecessor companies into Switch, Ltd. after its formation." He had been its CEO and chairman "since 2003." In his letter to investors, Roy put it in one line: "I knew data would run the planet."
So here is what we can say. In late 2002, a thirty-something Las Vegas real-estate man bought a small former Enron Broadband building, wired to many carriers, for about $930,000 at a private bankruptcy sale. He needed partners to close, and he sold the building two years later and leased it back. Was it "Enron's broadband trading hub"? That depends on how big a fish you want the story to be. The 12,000 square feet were real. The carriers were real. The hub grew with each retelling.
The Kid from Wisconsin
Roy grew up in Wisconsin. He helped his paralyzed father earn a degree in computer science. He went from commercial real estate in Las Vegas into colocation. His brother, Mike Borden, became Switch's president.
A real-estate man buying a building cheap makes a real-estate story. What Roy did next made a technology story. He used the carrier connections Enron had paid for as the seed for something much larger.
In 2008, Switch was building the SuperNAP. Data Center Knowledge put it at about 400,000 square feet and $350 million, with room for 7,000 cabinets at full build-out.The Register put the SuperNAP at 407,000 square feet and 1,500 watts per square foot. It was designed to support more than 1,500 watts per square foot with air cooling, backed by a 250-megavolt-ampere substation and 146 megavolt-amperes of generators. Vance wrote that it would use more energy than three mega-casinos. In Las Vegas, that is saying something.
By September 2010, Switch said the SuperNAP had grown to 740,000 square feet, with more than 100 megawatts committed and up to 17.2 kilowatts per cabinet.
Nevada noticed. In 2015, the Las Vegas Review-Journal reported that the state's tax abatements for data centers traced back to a 2004 program designed to win Switch.I have seen this Review-Journal article ("Legislators told data center tax help will benefit Nevada big," 2015) only as a headline and summary; the paper's site blocked automated reading. It concerned SB 170, which offered twenty-year partial abatements for investments of $250 million or more. By the time of the IPO, Las Vegas produced 99.4 percent of Switch's revenue, and Roy and an affiliate would control about 67.7 percent of the vote.
From a $930,000 building to a $350 million one in about six years. And as we'll see in Chapter VII, the Switch story was just getting started.
Managed Hosting Survives—Savvis, Terremark and Rackspace#
Equinix rented the meeting room. Digital Realty rented the building. Both models dodged the hard part of the old Exodus business, which was running the customers' computers for them.
Exodus had died trying. Did that mean the idea was dead?
Savvis
When we last left Exodus's data centers, Cable & Wireless had bought twenty-eight of them out of bankruptcy for $560 million in cash.The figures are from the Exodus (EXDS) bankruptcy disclosure statement of April 2002: Cable & Wireless's subsidiary bought interests in twenty-eight Internet data centers and "paid $560 million in cash upon closing," on February 1, 2002. "No other parties, however, bid on the assets." Press reports at the time, cited in Chapter IV, described the sale as Exodus's best thirty centers for about $570 million. Exodus had operated forty-four centers in June 2001. Nobody else had bid. The new owner did no better than the old one. In December 2003, Cable & Wireless USA, the unit that held the old Exodus business, filed for Chapter 11.
The Gores Group agreed that month to pay $125 million for the assets. Then came an auction under Section 363 of the Bankruptcy Code, with seven bidders. The winner was Savvis, a St. Louis company run by its chairman and CEO, Rob McCormick. In January 2004, the court approved Savvis's bid: $155 million in cash, plus about $12.5 million of assumed liabilities, for most of the assets of Cable & Wireless USA.
The trade press could not resist. "How the mighty have fallen," InternetNews wrote. "The acquirer gets acquired."
Follow the price down. In February 2000, Exodus had a Market Value of more than $20 billion. In February 2002, twenty-eight of its data centers sold for $560 million. In January 2004, fifteen of those data centers, with more than 5,000 customers including Starbucks and Reebok, went for $155 million.
Savvis paid for the deal with help from its private-equity backers, Welsh Carson and Constellation Ventures, and with a classic Phoenix-era trick. It sold its rights to several of the data centers (five, in later press accounts; four plus an office, in Savvis's own 10-K) to Du Pont Fabros Interests for $52 million and leased them back for fifteen years.Light Reading reported the Du Pont Fabros sale-leaseback as part of the plan, along with about $170 million of subordinated notes from Welsh Carson and Constellation Ventures. Savvis announced on March 8, 2004, that it had closed the purchase. Keep that name in mind. It comes back later in this chapter, and it doesn't come back happy.
Savvis expected the combined company to reach about $700 million of annualized revenue by the end of 2004. The Exodus customers, it turned out, had never left the buildings. They had only changed landlords, twice. And as we saw, Savvis had become the largest tenant of the new real-estate company buying those landlords' buildings, Digital Realty.
Terremark
When we last left Manny Medina, he was building a giant network access point in downtown Miami and telling reporters that his "concern regarding the potential use is zero."
The NAP of the Americas opened in interim space on December 30, 2000. The permanent NAP became operational on June 29, 2001. It occupied 120,000 net usable square feet inside a 750,000-square-foot building called the Technology Center of the Americas.Chapter III, from 2000 press reports, described the Miami building as 700,000 square feet; Terremark's 10-K for fiscal 2001 says 750,000. I've used the 10-K. The 10-K also said completion of the NAP was expected in the third quarter of 2001. The consortium members included AT&T, Global Crossing, Level 3, Cable & Wireless and Sprint.
Look at that member list with what we know now. Global Crossing, the anchor tenant, was bankrupt within months. Cable & Wireless was on its way to losing Exodus. Level 3 barely avoided bankruptcy. Terremark's own auditors weren't sure about Terremark. For the fiscal year ended March 31, 2001, it lost $104.0 million, and the auditors wrote that "substantial doubt exists about our ability to continue as a going concern."
Terremark continued as a going concern anyway, and it did so by owning more, not less. In December 2004, it bought the NAP of the Americas building it had been leasing, with a $49 million mortgage and $30 million of notes. In 2007, it bought thirty acres in Culpeper County, Virginia, for what it called the NAP of the Capital Region, and paid $85.0 million for a hosting company called Data Return.These facts come from the capital history in Terremark's Schedule 14D-9 of February 2011. Terremark had gone public in April 2000 by a reverse merger with AmTec, and in June 2009 it sold $420 million of 12 percent secured notes. In May 2009, VMware bought four million Terremark shares at $5.00 each. By 2008, Terremark had become valuable enough that someone wanted to buy it.
The first approach came from an unnamed private-equity fund in October 2007. In April 2008, with the stock at about $6.00, the fund sent a letter implying $9.00 to $10.00 a share. Credit Suisse ran a market check and contacted twenty-one parties. Twelve signed confidentiality agreements, and six bid, between $6.62 and $9.00 a share. The private-equity fund couldn't finance a buyout. A strategic buyer offered $8.75, mostly in its own stock.
On August 8, 2008, five weeks before Lehman failed, the special committee ended the process. The bids were below what it thought Terremark was worth, the financing was in doubt, and the sale was distracting management.Terremark's Schedule 14D-9 dates the decision to August 8, 2008. Data Center Knowledge, reporting in November 2008, tied the end of the process to the September credit freeze. The filing shows the decision came first. The six bids valued Terremark at 6.8 to 8.8 times 2009 EBITDA. Two more private-equity funds bid $10.25 and $10.50 a share in early 2010, and the board turned both down on February 3, 2010. "The (potential) transaction was incredibly disruptive," Medina told Data Center Knowledge. The stock hit $7.50 on September 19 and was at $4.69 by early November, even though quarterly revenue had grown 31 percent, to $59.6 million.
Medina got his sale two and a half years later, and it started on a conference stage. In late summer 2009, he met Kerry Bailey of Verizon Business on a VMworld panel. That December, Verizon's strategy chief, John Diercksen, visited Miami and said Verizon would want "to participate at some equity level." The equity idea faded. The relationship didn't. In May 2010, Verizon became a customer, licensing 25,000 square feet in Miami and Culpeper. In October 2010, Diercksen offered a 35 to 40 percent premium to the $9.90 share price, about $13.37 to $13.86 a share. Medina said his board wanted the "high teens."
On December 13, 2010, Diercksen came back with $19.00. He called it "all-in." Verizon, the 14D-9 says, "would not participate in any competitive bidding or auction process," and it wanted exclusivity. It got it. In January 2011, Verizon agreed to pay $19.00 a share in cash for Terremark, about $1.4 billion of equity value.Verizon's press release described $19.00 as a 35 percent premium. The 14D-9 calls it an "approximately 46% premium" to Terremark's $13.00 share price on December 13, 2010, the day Diercksen made the offer. Verizon also struck Terremark's proposed forty-day go-shop; Terremark got a two-tier break fee instead. Terremark ran thirteen data centers. Verizon already ran more than 220 of its own. Verizon wanted Terremark for what its press release called its "Cloud Strategy." The deal closed on April 11, 2011.
From a $6.62 low bid in 2008 to $19.00 "all-in" in 2010. The credit crisis had cost Terremark a sale and handed it a better one.
Rackspace
Rackspace was the patient one. Its operations began in 1998 as a limited partnership, and it incorporated on March 7, 2000. The same month, it filed to go public. Then the Nasdaq crashed, and Rackspace withdrew the filing.
It took eight years to try again. Rackspace spent them running servers for small and midsize companies and selling the one thing the Gold Rush hosting companies had forgotten to sell: service. The prospectus called it "our commitment to serving our customers, known as Fanatical Support®."
On August 7, 2008, Rackspace priced its IPO at $12.50 a share, near the low end of its $12-to-$16 range. It sold 15 million shares, about $187.5 million worth, and listed on the New York Stock Exchange as "RAX."The offering included 12.7 million shares from the company and 2.3 million from selling holders, and could raise up to $215.6 million with the overallotment. Like Google four years earlier, it used a Dutch auction to set the price. The timing was close to the edge. Lehman Brothers would fail the next month. Rackspace ran eight data centers in the United States and the United Kingdom and had more than 31,000 customers.
Here is the number that separated it from the class of 2000. In 2007, Rackspace booked $362.0 million of revenue and earned $17.8 million. It made money. Exodus, the year before its IPO, had booked $12.4 million of revenue and lost $25.3 million.
The glass house was back again, and this time it turned a profit.
The Telcos Come Calling
Verizon's deal for Terremark set a price for everyone else. Savvis's proxy tells it as a chain reaction. On January 23, 2011, Barclays brought Savvis's CEO, Jim Ousley, together with CenturyLink's Glen Post. Four days later, Verizon announced Terremark. "In the days following this announcement," the proxy says, "Savvis experienced significant appreciation in its stock price." On February 1, Time Warner Cable announced a deal for NaviSite, another hoster, and Savvis's shares rose again.
CenturyLink opened at $38.00 a share. Post told Ousley that "valuation was the principal issue." Savvis refused to open its books for more due diligence until the price went up. On April 12, the two men discussed $40.00, and the data room opened three days later.
In April 2011, three months after Verizon's deal for Terremark, CenturyLink agreed to buy Savvis for $40 a share: $30 in cash and $10 in CenturyLink stock. That was about $2.5 billion of equity and about $3.2 billion including Savvis's net debt.At closing, each Savvis share became $30 in cash plus 0.2479 CenturyLink shares. CenturyLink also prepaid about $546 million of Savvis credit-facility debt. Savvis stayed in St. Louis under CEO Jim Ousley. The deal closed on July 15, 2011. "CenturyLink is now positioned to address complex customer needs with our colocation, hosting and cloud products," CEO Glen F. Post III said.
Bandwidth readers know CenturyLink as the rural telephone company that had swallowed Qwest. Savvis had paid $155 million for Exodus's remains in 2004. Seven years later, CenturyLink paid about $2.5 billion for Savvis.
Look at the pattern. In 2000, the carriers built or bought hosting businesses at the top of the market: Qwest with its CyberCenters, Global Crossing with GlobalCenter, my own Level 3 with its Gateways. Ten years later, the carriers bought hosting businesses again, at prices that looked a lot like another top. In Chapter VII, we'll see the carriers sell their data centers back out, to the investors who had learned to own them.
The 2008 Test#
In March 2008, J.P. Morgan Chase rescued Bear Stearns. In September, Lehman Brothers went bankrupt. As I wrote in Bandwidth, the Great Recession hit just as my new company, Zayo, was being launched. When we pitched our lenders at CIT in New York, few questions were asked, and the mood was somber. Was our timing bad, or was it an opportunity?
The data-center business faced the same question. In 2001, its collapse had come from the demand side. The forecasts had been wrong, and the buildings were empty. In 2008, the collapse came from the money side. The buildings were full, and the banks were broken. Which would matter more?
The Builder
DuPont Fabros Technology was the first to find out. Readers will remember the Du Pont Fabros name from the Savvis deal, when Du Pont Fabros Interests bought several of the old Exodus centers and leased them back. DuPont Fabros Technology had gone public in October 2007 at $21 a share, as a developer of big wholesale data centers in northern Virginia and elsewhere. Its business was building new space and leasing it to large tenants. Building new space takes borrowed money.
In November 2008, DuPont Fabros told investors it had planned to borrow $300 million to $400 million against one of its Virginia buildings, a project called ACC4 that had been appraised at $680 million. It got $100 million. The company mothballed a $270 million project in Santa Clara and suspended its dividend. Its chief financial officer, Mark Wetzel, explained why the money had dried up: "several banks we were in discussion with have merged or disappeared."
The shares fell 45 percent in a day, to $3. Eleven days later, after talks on a $150 million mezzanine loan ended when the lender changed its terms, DuPont Fabros halted construction in New Jersey and Virginia as well. "After a careful evaluation of our development initiatives we believe this is the prudent course of action at this time," CEO Hossein Fateh said. The shares fell to $1.93 in early trading.Santa Clara had been halted on October 28, 2008. The November 17 halt covered NJ1 in Piscataway, New Jersey, and ACC5 in Virginia. DuPont Fabros said it was negotiating a $150 million loan from a pension fund when it reported in early November; that is the mezzanine financing whose terms the lender later revised. At $3 a share, the company's Market Value was $101.5 million.
From $21 to $1.93 in thirteen months. That is a Bust-sized drop. But look at what the reports didn't say. None of them said the tenants were leaving. DuPont Fabros had run out of lenders. It still had its customers.
The Landlord
Digital Realty had tenants on long leases and buildings it had bought cheap. In March 2009, Data Center Knowledge quoted the real-estate trade paper GlobeSt: "Digital Realty Trust is living in a different world than most of the rest of the commercial real estate industry."
The numbers backed it up. The portfolio had grown to 11 million square feet and was 95 percent leased. New leases were being signed at three times the rents of the leases expiring. In the fourth quarter of 2008, as Lehman's collapse rippled through the economy, Digital Realty leased 276,000 square feet, to tenants that included IBM, Cisco, Cigna and NTT America.
"We haven't seen any material change at all to our experience with our prospective customers," Foust said.
Digital Realty was the best-performing data-center stock of 2008. In that year, holding still counted as winning.
The Operator
Equinix grew right through it. Its 2008 revenue was $704.7 million, up 68 percent. It earned $131.5 million, helped by a one-time tax benefit.The 2008 net income included a $104.9 million tax benefit in the fourth quarter. Fourth-quarter revenue was $190.7 million, up 4 percent from the third quarter. It ended the year with $307.9 million of cash and investments and guided to $855 million to $875 million of revenue for 2009.
"Equinix delivered exceptional results in 2008, creating a strong platform for continued growth in 2009," Smith said.
Five years earlier, Equinix had booked $117.9 million of revenue and lost $84.2 million. Now its revenue was six times larger, and the company was profitable in the year Lehman failed.
Even Terremark's lost summer proved the point. Its sale died partly because a buyer couldn't finance it. Its revenue kept growing.
The Verdict
In 2009, the market caught up. Data Center Knowledge tracked the sector's stocks and found that every one of them gained at least 53 percent that year. "Share prices of many key players in the sector finished with triple-digit gains for 2009," it wrote. DuPont Fabros, the one that had nearly run out of money, led the group. NaviSite, Rackspace, Switch and Data, Savvis and Equinix all more than doubled. Digital Realty rose about 53 percent, the smallest gain, because it had never fallen very far.
What should we take from the 2008 test? The Bust of 2001 had taught that buildings survive and balance sheets don't. The crisis of 2008 added a second lesson. A building full of real tenants on real leases survives even when the banks don't. The companies that suffered were the ones still building with borrowed money. The ones that owned finished buildings, full of customers who couldn't easily leave, barely noticed.
Cash flow was king. It always is.
The Chorus Returns
The analysts noticed. In 2001 and 2002, Tier 1 Research had counted the empty floors. In June 2010, the same firm's Antonio Piraino told Data Center Knowledge, "Demand is far outweighing supply." The brokers at Grubb & Ellis could find only six single-story buildings in the country with more than 30,000 square feet of raised floor built out and available.
The skeptics had history on their side. Data Center Knowledge reminded its readers of the old strategy of "build it, and they will come," and of the years from 2001 to 2003, when WorldCom and AboveNet built "barns" of more than 100,000 square feet at about $100 million apiece. Was this the same movie? Piraino said no. "We do not see oversupply in this market," he told a hosting conference at the Bellagio in Las Vegas in September 2011. The difference, he said, was the balance sheets: "Companies were incredibly leveraged. Now people are tightening their belts." The new buildings went up in pods of 8,000 to 10,000 square feet, a phase at a time, as tenants signed.
This time the bull was right. The chorus doesn't always sing the wrong part.
Notice what was missing from the Phoenix, too. Nobody in this chapter raised money on a forecast. Equinix bought finished buildings for a fraction of what they had cost. GI did the same and leased its buildings to companies like IBM and Cisco. Rackspace waited until it was profitable to go public. In the Gold Rush, as we saw in Chapter III, the forecast was the asset. In the Phoenix, the lease was the asset. When we get to the AI forecasts at the end of this book, that difference will be worth remembering.
From Phoenix to Cloud#
Let's run the Bandwidth scorecard on the Phoenix years.
Equinix went from 30 cents a share and a Singapore rescue in 2002 to eighty-seven centers in thirty-five metros in 2010. GI Partners turned $280 million of equity and twenty-five unwanted technology buildings into Digital Realty, a company the market valued at about $6 billion. Rob Roy turned a $930,000 Enron leftover into a $350 million SuperNAP. Savvis bought fifteen of Exodus's data centers for $155 million and sold the company to CenturyLink for about $2.5 billion of equity. Terremark went from a going-concern warning to a $1.4 billion sale to Verizon. Rackspace went public eight years late, and profitable.
The Phoenix had risen. The buildings that the Gold Rush paid for were full, and the people who bought them in the wreckage had made fortunes.
But look again at the customer lists. IBM, Cisco, Cigna, Starbucks, Reebok, 31,000 small businesses at Rackspace. These were companies renting space and servers one rack at a time. The biggest buyers of computing in the world hadn't shown up yet as tenants. They were about to show up as something else.
On August 24, 2006, while Equinix was waiting for Steve Smith and Digital Realty was buying AboveNet's buildings, Amazon opened the beta of a service it called the Elastic Compute Cloud. BusinessWeek reported that it cost about 10 cents per server-hour. "Amazon EC2 changes the economics of computing by allowing you to pay only for capacity that you actually use," Amazon said. Tymshare had sold a version of the same idea in the 1960s.
The glass house was coming back one more time. This time it would rent itself out by the hour, from buildings bigger than anything Exodus ever imagined. And it would change who owned the data center, who paid for it and who called the shots. The table was set for the cloud.