Equinix Earnings Preview: Focus on Cross Connects

By David Gross

After Equinix (EQIX) fumbled a call where they dropped revenue guidance all of 2%, expect a much more rehearsed, well-prepared event this evening.   But with that last call coming just three weeks ago, there really is not much to talk about regarding the common financial metrics.   Expectations for revenue and Adjusted EBITDA have been overanalyzed already, and reacting one way or the other based on those metrics is a great strategy for an investor who wants to buy and sell with the herd.   Investors who instead want to gauge the future health of the company need to consider that it has got a growing competitor, Telx, which has an exclusive right to operate the interconnection areas in the ten Digital Realty (DLR) buildings where it offers service, a benefit of being part of the GI Partners family.   This is an issue because the biggest threat to Equinix is not missing revenue by 2% one quarter, but someone else matching its ability to connect co-location customers to one another and to telecommunications providers.

As it was telling us odd stories three weeks ago about credit memos and the challenges of building internal financial models, Equinix did make a point in its warning call about the desirability of customers who buy cross-connects with their cabinets.   Now it didn't say which kind of cross-connects it likes best - high revenue extended cross-connects, cross-connects between cages, or higher-bandwidth fiber cross connects - just cross connects.   I agree with where they're going with this though.   Plenty of companies can build data centers, but few can match the network connections that have accumulated inside existing Equinix (and Switch & Data) buildings.  This is why we here the cringe-worthy term "network density" constantly from co-lo providers.   That catchphrase is the new, updated version of "network effect", which got a lot of play in the 90s after Ethernet creator Robert Metcalfe starting mesmerizing audiences with the concept.

In addition to providing a competitive barrier, cross-connects sell for higher margins than cabinets.   There are very few recurring costs associated with the links, with most of the Cost of Goods Sold associated with them coming from an allocation of networks operations staff, many of whom are at Equinix's San Jose NOC, as well as depreciation on the network ports used to provision them.   Their cash variable costs are extremely low.   Additionally, prices have held steady around $300 a month for a typical cage-to-cage cross-connect, even though network equipment prices have fallen dramatically over the last ten years, because Equinix has a monopoly on the connections within its IBX facilities.    

In North America, Equinix has about a 1:1 ratio of cross-connects to cabinets.   However, last quarter it sold nearly twice as many cross-connects as cabinets - 1,200 to 600 - and interconnection revenue increased as a result to nearly 20% of the corporate top line.   Now, if this ratio were to fall back for some reason, it would be reason for concern, because it would suggest the company is not executing its strategy of focusing on customers who buy cross-connects, and is setting itself up for greater churn in the future.