Podcast: Following the Money to Project Our IT Infrastructure Future

Follow the Money to Predict The IT Infrastructure Future
Follow the Money to Predict The IT Infrastructure Future

All forms of data center, cloud, and IT infrastructure decision making involve informed speculation on the future. Organizations seek to handle growth and mitigate risk by forecasting customer demand, business conditions, technology trends, and other factors that will influence their future infrastructure requirements. Service providers and end users alike commit significant resources to what the future entails in order to effectively position themselves for success moving them forward.

Matt Heinz, vice president of equity research for Stifel, is a respected analyst focusing on the internet and telecom infrastructure space. A significant part of Matt’s role is determining what direction IT infrastructure demand is headed, and if the companies he covers are positioning themselves well to meet the future expectations of the marketplace. Matt spends a lot of time talking to enterprise end users about their future plans as well as to executives in the infrastructure space as they try to meet those end user needs.

In this conversation Matt shares with us insight on potential growth areas in the market. His informed perspective on public cloud, hybrid cloud, interconnection, edge data centers, the wholesale data center space, and other areas of the infrastructure world are illuminating, and may provide insight to the decisions your organization is facing as well.

The audio of this interview can be listened to in the player, and the transcript is below the player.

 

 

Transcript:

Kevin O’Neill, Data Center Spotlight: This is Kevin O’Neill with Data Center Spotlight, and with me today I have Matt Heinz. Matt is the vice president of equity research at Stifel. Matt, thanks for joining me today.

Matt Heinz, Stifel: Sure, Kevin, thanks for having me on, I really appreciate it.

Data Center Spotlight: Well, can you tell us about Stifel, and what you folks do there?

Matt Heinz: Yeah, absolutely. So, Stifel is a broker dealer and investment bank with about $2.5 billion of annualized revenues, and my role here at Stifel in equity research involves performing fundamental equity analysis, including earnings, cash flow forecasts, and really making investment recommendations to our institutional clients. So I focus on publicly traded equities in the Internet and telecom infrastructure sector, which includes data centers, cell towers, cloud infrastructure, and internet backbone companies, sort of like such as Akamai.

Data Center Spotlight: Okay, great. Now, Matt, did you come from the investment side and gravitated towards the data center cloud IT infrastructure space, or did you start as a technologist and sort of make your way over to equities?

Matt Heinz: Yeah, so I started my career in 2006 on the investment side as a fundamental equity analyst covering fintech companies, and over time, have kind of migrated over to the technology space, or fully migrated to the technology space through a series of twists and turns in my career. So it’s certainly been an interesting ride, and I’ve been a senior analyst in the tech sector now for about two and a half years, and just in that short amount of time, it’s crazy to think about how much the world has changed and the different things we’re talking about today, versus just two and a half, three years ago. So it’s been a lot of fun.

Data Center Spotlight: Well, that’s exactly what I want to talk to you about today, and I know that you talk to providers, and you talk to some major end users, and I know that a lot of people aren’t ready to fully trust the public cloud, although the public cloud is pretty much what everyone’s talking about. They’re not ready to fully trust it as their sole solution, but they want to utilize the public cloud, so there continues to be a big movement towards hybrid infrastructure solutions, but in a previous discussion with you, you’ve sort of narrowed your definition of hybrid. What is that definition, Matt, and how do you see the trend toward hybrid playing out?

Matt Heinz: Sure, so that’s a great question. I think there’s still a lot of definitional gray area surrounding hybrid cloud, and it might mean different things to different people, but to me, hybrid is about combining multiple service providers, and different types of data center infrastructure to form a solution that sort of maximizes control for the end user, or the enterprise, while optimizing the distribution of workloads across various types of infrastructure, whether that be public cloud, or on-prem data center, colocation, and I think there’s still quite a bit of, again, gray area about what constitutes private cloud.

We read surveys and get feedback from enterprises that indicates that nearly three-quarters of the enterprises out there are using some type of private solution, and I think that could range from simply just virtualizing a portion of the servers running in the enterprise data center to a fully outsourced and managed hosted solution, such as a deployment with Rackspace, or one of their competitors. So there’s a lot of different types of hybrid and private workloads being talked about there, but I think at the end it comes down to patching together multiple different types of solutions in a cohesive manner that sort of allows for that greater control over the infrastructure while still kind of optimizing cost and performance.

Data Center Spotlight: Do you see people moving towards gaining more trust in the public cloud, and moving more of their workloads to the public cloud? We see surveys that indicate only about 20% of major enterprise workloads are in the cloud right now. Do you feel that’s accurate, and how do you see that change?

Matt Heinz: Yeah, I mean, I’m seeing the same type of numbers that you quote there. I think it has been a very slow and gradual move for most established enterprises to getting workloads into the public cloud. I think there are still security and concerns over losing control of the critical data within the enterprise, that may be misplaced, but nonetheless it is a factor influencing these decisions, and I think the first thing people look at is the cost, and the cost savings of the public cloud move, but it’s not always going to be cheaper, depending on what you need to run. If you have a very large, mature, predictable workload, that’s generally not going to be well-suited to moving into a public cloud environment, whereas something that’s a newer application, that’s much less predictable, and bursty, and is still in its infancy, that’s something that’s very attractive to be brought into a public cloud environment, where you can take advantage of the elasticity of the infrastructure.

Data Center Spotlight: And the newer application is much more likely to have been built with the cloud in mind, as opposed to maybe some legacy applications that might struggle in being implemented in the cloud environment.

Matt Heinz: Absolutely, there’s no doubt about it, and there are some legacy applications that just simply won’t live to make the move, and it’s too important to certain enterprises to keep those things running, and keep them secure, and it may never leave the enterprise data center. So, yeah, those are some of the challenges today, but I think they’re evolving solutions today that make that much easier, and are able to kind of consolidate and integrate workloads across multiple different environment.

Data Center Spotlight: At the very beginning, you mentioned that two, two and a half years ago, we were talking about a lot of different things that we’re talking about right now. What trends are not apparent right now, that you think we’ll soon be hearing about, and how people are structuring their cloud and data center solutions?

Matt Heinz: Yeah, sure, so I think one of the most important trends going on right now is the migration to edge computing. As more content is being consumed in disparate areas away from the core of the network, this inherently drives more latency into traditional hub and spoke networks. So there are many platforms such as Netflix, Comcast, all of the major broadcasters, and those in the OTT space that just simply need compute nodes in suburban, and sometimes rural areas, where content needs to be delivered at low latency, but those areas don’t currently have the data center infrastructure required to really push that content out to the edge. So that’s something that’s happening now and I think data center providers are certainly very, very aware of, although not all are extremely well-positioned, because these facilities need to be much smaller, they need to be more energy efficient, and it’s a different type of engineering process for some of these micro data centers that are being put out at the edge.

Data Center Spotlight: Yeah, the big data center providers that we hear about talked about all the time, they’re largely doing well as a result of scale, and being in very large data centers, and taking advantage of scale and the edge computing game is just 180 degrees different from that, isn’t it?

Matt Heinz: Yeah, that’s right, it really is. What we’ve all been trained to think is that large facilities are more efficient, cheaper to run, and build on a per-KW basis, and those are the ways really that providers today in the wholesale space, and in the retail space, are increasing profitability. A fewer number of larger facilities is kind of the trend that we’ve seen over the last five years, but we’re starting to see that reverse a bit when we talk about the edge being pushed further and further away from the traditional data center hubs. So, I think the next big wave for this, really, is for edge computing, is IoT, which is another term that gets obviously tossed around a lot, and means a lot of different things, but I think the bottom line for the data center space is that this will require an even larger number of edge nodes to process and store the massive amount of data that’s being created by all these connected devices.

Data Center Spotlight: Okay, so we have edge computing, we have IoT and IoT is feeding into the edge computing a little bit, or vice versa. What else are we going to be talking about in a couple of years that we’re not talking a lot about now?

Matt Heinz: Well, I think it’s interesting, I also cover the cell tower companies, and I think there’s more and more talk about using cell tower sites as a destination for miniature colo sites, and actually perform computing at the base station of the tower, and so we’re not really seeing much of it today, but there are companies out there like EdgeConneX which is a private colocation company focused on edge computing, they are trying to integrate cell tower sites and colocation and this OTT content push to make these systems more efficient, and I think we’re headed down the path of many multiple, many data center sites. So I think it’s just very interesting to watch as the companies that I cover, positioned in certain ways that they are, and I think interconnection is still really at the heart of this evolution in content delivery, so companies like Equinix, CoreSite, and Interactions are still very well-positioned for this trend. All of this content being cached at the edge, still needs to get back to the core network at some point, so I think the carrier dense colo segment will remain highly important in this type of ecosystem.

Data Center Spotlight: That’s interesting. Now I know you’ve had some pretty good perspectives about what business is good to be in at any one time, and how it relates to stock valuations and stuff. In fact, I remember a couple of months ago seeing all of the multi-tenant data centers, their stocks got hit one morning, just a little bit, not a ton, and the market was up as a whole, and I was just kind of thinking, I wonder what this is all about, and I read your daily email, and I saw that you expressed a little bit of concern that some of those stocks were a little overvalued at the time, and obviously you do have a little bit of influence in the markets, people are paying attention to what you’re saying, so let me ask you, what’s a good business to be in right now. Interconnection business, you mentioned a couple of companies that are well-positioned for the edge data center move. What else? What are some other industries that would be good to be in right now?

Matt Heinz: Yeah, like I mentioned, I think interconnections and those carrier dense retail providers are still really very well-positioned for what’s on the come here. I would not be shocked to see many of the data center reads that I cover today venture into some of these smaller sites as a way of monetizing what they’ve built around the network core, but again, it is a different mindset in terms of how the data centers are engineered, and how they’re operated at a much smaller scale. So it’s going to take time to figure that out, and have the right business model for that demand trend, but I think wholesale, to me, is still a critical part of all this, because at the end of the day, you are benefitted by scale at the site level, but the problem I think right now with wholesale is that it’s still, at the end of the day, is kind of a real estate game, and that’s where I have to put on two hats. I have to put on a tech hat, and a real estate hat in some sense, and think about supply and demand, and we’ve come off a period here of extremely high elevated demand from the hyperscale cloud providers in building out their infrastructure, and wholesale has greatly benefited from that.

So, yes, stock valuations have risen fairly substantially in the first part of this year, and our view on that space has been that maybe it’s a little bit too much too soon, and my personal opinion on cloud demand has been that we’re kind of at the peak of a mini-cycle, and in the next few quarters, we will see a digestion period, if you will, of all the data center capacity that has been absorbed by many of these hyperscale firms, and I think what tends to happen in periods following elevated demand is that we see increased supply, and supply has been fairly well held in check over the past two years, really coming out of the downturn in 2013. There hasn’t been a whole lot of spec supply out on the market, and absorption has been high, and that’s resulted in fairly lean inventories across the major US markets. So I think we’re getting to a point now where demand has been elevated, returns are still very good, in the low to mid-teens for most wholesale providers. So I think that will bring more supply out of the woodwork, and that’s kind of how we’re positioned now in terms of the stocks. We think we’re a little more cautious on wholesale, we think with demand potentially ebbing here a little bit in the short term, and then followed by an increase in supply, we think that could impact rental rates a few quarters out, and so we’re more cautious now on the wholesale data center space. We continue to like the network dense interconnection focused retail providers, but yeah, that’s kind of how our investment thesis shapes up right now.

Data Center Spotlight: Now let me ask you, I know you’re talking to providers, and talking to end users. When we talk about the hyperscale data centers, and the hyperscale data center demand from providers. Is that really being fueled by the cloud providers, or are enterprises that are not necessarily cloud providers, are they still taking down big swaths of data center space that have helped to drive the market alongside the cloud providers, or is that slowing down, and they’re not taking out the same amounts of space as they used to, because they’re a little more focused on using the cloud themselves?

Matt Heinz: Yeah, sure, so it’s a very interesting observation. So I think what we’ve noticed is that larger traditional enterprises such as the global banks, insurance companies, the oil and gas companies, companies that you’d think of as traditional Dow Jones type components, not really in the IT business. These firms used to be very big customers of wholesale data centers, and they still are there with legacy contracts, but increasingly, we’re seeing the incremental demand going directly to cloud providers, and in many cases, interconnectioned or network-dense colo as kind of a connection point, right? So there still is plenty of enterprise demand for smaller deployments inside a data center such as Equinix or Interactions type footprint that provides that interconnection, but the larger scale wholesale deployments really, there’s a substitute effect I think of who your end customer is for a DFT, or digital realty, and really, you’re seeing the cloud provider as the end customer, and that capacity is simply just being rented by a service provider, and then the end user is coming in through the service provider.

Data Center Spotlight:   Okay, now let me ask you about moving away from the wholesale space. You mentioned the trend towards edge data centers, and particularly media companies needing to utilize edge data centers to deliver their content close to the end user, especially in large suburban markets, and you mentioned rural markets as well, which I haven’t really thought a whole lot about, but I guess there are people out there who are using the same content, but let me ask you about retail data center colocation, and being driven by edge data centers, and sort of in non-core markets. Is that going to be just an EdgeConneX, or maybe a couple of other companies focusing on that, or will local data center providers and regional data center providers benefit from that as well?

Matt Heinz: Well, yeah, sure, I think it definitely creates an opportunity for retail colocation providers to establish a foothold in kind of a growing and very important segment of the market. I do believe that it will take time for many of the larger publicly traded companies to make this transition, assuming that it’s not done via M&A. It really is a different business model, and I think a good way to think about it is really, you’re replacing the old central switching office for the telcos, and it all revolves around broadband, and you’re basically substituting the old switching office for a multi-tenant mini-colo site, and it’s simply just pushing these bits, and the compute closer to the homes and businesses out in these markets where there’s simply just, you don’t see Equinix setting up shop in Jacksonville, or in Detroit. They’re in the major hubs, and it probably will remain that way for the time being, because the content, again, still needs to be pushed towards those hubs eventually, where the carriers are set up for peering, but it needs to be captured closer to the end user, and yes, absolutely, I think EdgeConneX does have seemingly a nice head start in this market, but I think that certainly creates an opportunity for several local providers in those markets that we don’t think of as big data center hubs.

Data Center Spotlight: Is there a segment of the data center and cloud industry that you’re a little bit bearish on, that you think just isn’t going to benefit from the trends that we’re talking about today, Matt?

Matt Heinz: Well, like I said before, we’ve been more cautious around the wholesale segment of the market just from a supply standpoint, and a short-term demand standpoint, but I think the secular trend is really still in their favor. I just see it as a filter, right, and those who benefit the most from these trends are kind of the highest point in the filter, and there are less opportunities to disintermediate some of these players with strong market positions around interconnection, and around edge markets, but I think the larger, more commoditized wholesale data centers, there will be opportunities to circumvent those larger deployments that we saw for years and years and years that when enterprises needed space, that’s where they went. We’re just seeing less of that today. So I think, again, the secular trends are favorable around surrounding data creation, but I think at least from a near-term cyclical standpoint, it could be very competitive in the wholesale arena.

Data Center Spotlight: Now are you, and the people you talk to, the providers who keep a close eye on sort of consumer trends, both in the consumer market and the B2B market, is everything still trending in the direction of just explosive growth as far as things that we do today being done digitally, or more and more things that are not being done digitally now, being done digitally moving forward? Is there any cooling off of those user trends that concerns anyone, or is it going to continue to just be as it has been the past few years, just up, up, up?

Matt Heinz: Well, it’s interesting, so we don’t closely track consumer device trends. Our semiconductor team here at Stifel and some of our hardware team do a lot of that work, our folks that cover the handset makers, the chip makers are paying very close attention to those consumer trends, but it’s an interesting question because sometimes I think about the devices that are available that I use in my everyday life, and I wonder, is this really revolutionary? Does this really change my day to day, or maybe, is this something that’s just kind of a nice little trinket that eventually kind of fades into oblivion, and/or does it ultimately make my life more complex? So I think you’re seeing a lot of this now, at the kind of tail end of an innovation cycle. We’re kind of at the peak of the hype cycle around IoT, and we’re seemingly at the end of a major innovation cycle involving consumer technology, and there are a lot of technologies being marketed today that simply just, not really sure how much they move the needle, so it’s a very interesting observation that you bring up, but I think the one trend that is really undeniable is the rate of data creation, and whether that’s at the consumer level, or at the enterprise level, I think really the next wave in that innovation cycle is at the enterprise level, and how data is being collected, how it’s being analyzed, how it’s being stored, and really how that data can be applied to generate revenue?

Data Center Spotlight: Let me ask you one more question, and I’m going to go back to IoT, maybe I should have asked you that at the time, but in the tech media, there are concerns about the security aspects of IoT, and I think a lot of opportunity to create security solutions in the IoT space. You’ll have consumers using devices, consumers don’t always follow the best security protocols, and password protections, and all that sort of thing. Do you see the security in IoT being a broad-based concern, or is it just something that sort of around the edges people have to button up a little bit? Will it slow down the adoption of IoT?

Matt Heinz: I think it will definitely be a barrier, and it’s a problem that needs to be solved. I think only so much of that security protocol can be solved at the infrastructure layer. Obviously, public internet is something that a lot of enterprises struggle with today, just in terms of deploying cloud resources, and how their data is stored and moved across the internet, and a lot of enterprises are opting for private networks, which they can achieve through a colocation site with cross-connects– or some type of a port that connects them with multiple service providers on a private network. So I think the same principles will be applied at the infrastructure layer when we talk about the proliferation of IoT, and I also think that it will be very important as we think about the next evolution in wireless connectivity, surrounding 5G. I think today most of us tend to rely more on Wi-Fi than we do on cellular networks for computing needs and the content we consume on our tablets and phones, but I think that carriers and the tower companies and small cell companies out there are working to create a more secure environment to move bits around using licensed spectrum, as opposed to the unlicensed Wi-Fi protocols that are mainly used today. I think public Wi-Fi definitely is an issue, and a barrier for a lot of the enterprise policies around bring your own device, and really just once that data leaves the network, there’s not much that companies can do to control it, and so right now many companies that are highly security focused simply just don’t allow for those freedoms, because the security risk is too great. So, yeah, I do think it will definitely be a problem that will need to be solved, and I’m sure there will be multiple different startups and companies out there looking to benefit from that concern, or that barrier.

Data Center Spotlight: I’ve got about six follow-up questions just to your last answer, but I think we’ve spent a good bit of time on this today. Matt, I enjoy reading your stuff and consuming your content, and your analysis. If someone wanted to get in touch with you, or explore what you do, how could they do that?

Matt Heinz: Sure, I appreciate that Kevin, very nice of you to say and anyone that wants to reach out, probably the best way is just on email at heinzm@stifel.com.

Data Center Spotlight: Some really interesting stuff, Matt. I appreciate it, and I appreciate your time today.

Matt Heinz: Thanks, Kevin, take care, bye.