Rare REIT Conversion May Help Data Center Firm Raise Capital Needed To Upgrade Portfolio

Data center operator Cyxtera is set to restructure as a real estate investment trust, joining a dwindling field in what experts say is a move to raise capital necessary to maintain an aging portfolio.

Cyxtera will become the third public data center REIT on the stock market after a year that has seen four such companies acquired in take-private deals or absorbed by larger listed operators. It is an outlier — far smaller than data center REITs Equinix and Digital Realty, operating a portfolio of older assets, mostly leased, with few of the credit-grade tech tenants that have become the industry's backbone. 

Analysts say that for Cyxtera, the decision to convert to a REIT structure is likely driven in part by the need to raise the capital necessary to maintain its aging infrastructure and keep operations going at a company that may be of little interest to private equity or other buyers. 

“They probably will need to use the cash just to kind of keep the lights on rather than investing in new projects,” said Sami Badri, a senior equity analyst specializing in data centers at Credit Suisse. “One of the big challenges they have is just generating a lot of cash flow and then investing that cash flow into their business to make sure that the health factor of their assets is good enough for their customers and good enough for the market standard. “

Founded in 2016 with a strategy of spinning off older telecom data centers into a retail colocation business, Cyxtera currently operates 61 data centers across 29 global markets. The company went public in 2021 through a merger with SPAC Starboard Value Acquisition Corp. 

Cyxtera’s conversion to a REIT structure is due to be complete by the start of 2023, the company said in its announcement last week. The transition comes after a 15-month stretch in which all but two pure data center REITs exited public markets. QTS and CyrusOne were taken private by Blackstone and KKR, respectively, while CoreSite was acquired by tower REIT American Tower. In late 2021, Las Vegas-based Switch Inc. began the process of converting to a REIT structure before its take-private acquisition by Digital Bridge. 

While Cyxtera’s restructuring may run counter to the prevailing trend, the company has remained vague as to the forces driving the transition. A press release said only that the decision was made “for federal income tax purposes.” 

“Following a thorough analysis of the impact a REIT election would have on our business, we are confident the REIT structure will best position us for continued growth while maximizing long-term shareholder value," Cyxtera Chief Financial Officer Carlos Sagasta said in a written statement announcing the move.

But the tax benefits of REIT status are just part of what is driving Cyxtera’s decision-making, experts say. Industry insiders tell Bisnow that Cyxtera’s announcement likely signals that a major capital raise is on the horizon.

REITs have more avenues to raise money than other corporate structures, such as the ability to issue so-called unsecured debt that isn’t backed by any tangible assets. And while any public company can raise capital by issuing new shares, analysts say converting to a REIT dramatically expands the pool of potential shareholders to include real estate-focused investors, particularly in a niche market like data centers with few alternative investment opportunities.

“You've lost four public data center REITs in the last year — there's two left now — so now there’s a tremendous amount of capital that wants to invest in data centers and the choices are just Digital Realty or Equinix,” Green Street Senior Analyst David Guarino said.

“You’re already leaving a lot of potential investors out of the equation if you’re a real estate company but not structured as a REIT, and from the position Cyxtera is in they’re going to draw more investors just by the simple fact that there's not a lot of names to invest in," Guarino added. 

Even with record demand for data centers and supply constraints across key markets, analysts say it is highly unlikely that Cyxtera is looking to raise capital to fund new development — at least not on a significant scale. The company has little experience building out its own facilities and isn’t going to start in a market where supply chain and labor shortages are extending timelines and increasing risk profiles for experienced developers.

Perhaps more significantly, industry insiders say Cyxtera needs more capital just to maintain and update its aging data center portfolio. Primarily operating older facilities with what analysts call poor health factor, Cyxtera has to spend significantly more to ensure that its data centers continue to function and meet the evolving needs of tenants for everything from IT infrastructure to energy-efficiency. 

“They have a lot of items on their bucket list right now that are going to continue to consume a lot of cash,” Credit Suisse’s Badri said. “They're most likely not going to take that fresh capital and go out and build brand-new sites. They’re more likely to reinvest in existing sites and focus on their existing portfolio to meet the market standard.”

This perception that Cyxtera will issue new equity, diluting shares, without developing new properties has been a major factor in driving down the company’s stock price since the restructuring was announced, experts say. Its aging assets may also help explain why the company was not swept up in the past year’s wave of M&A, despite actively fishing for a buyer as recently as April.

“I don’t think there’s a logical buyer for Cyxtera, at least right now,” Badri said “It comes down to the health factor — no one wants to take on assets that require much more investment."