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Our Picks in the Data Center Industry

The firms that hold network-dense properties are best positioned.

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Matthew Dolgin: We recently took a deep look at the data center industry, and it reinforced our views that the firms holding network-dense properties are best positioned.

Several secular trends are driving an increase in demand for data centers that is likely to continue. Among the growth drivers are increased use of the cloud, artificial intelligence, and the "Internet of Things." However, we see many data centers as undifferentiated, so with an abundance of capital chasing the growth, only data center providers with unique portfolios are likely to see attractive returns.

We call data centers network dense when they have many different network service providers connecting into them. Typically, only a couple facilities in each city are network dense, and they would be very difficult and costly to replicate, so the firms holding them have a big advantage. Network density attracts other networks and cloud providers, which in turn attract their own customers, leading to a network effect, the strongest moat source we see for data center firms, and a moat source we’ve assigned to CoreSite and Equinix.

Digital Realty also owns many network dense properties, though they are often overlooked in its huge portfolio and its historically different business model. However, Digital Realty owns a lot of valuable land in many places, and it's the landlord for companies like CoreSite and Equinix.

Many data center stocks have had big runs in 2019, and we’d hesitate to chase them. We think they are fully pricing in the growth drivers. But the long-term story is real, and CoreSite, Digital Realty, and Equinix have sustainable competitive advantages, so whenever opportunities present themselves, which they often do for data center companies because of near-term tenancy fluctuations, we think they’re worthy additions to a portfolio.

Matthew Dolgin does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.