One REIT IPO Without Much of a Yield

Mark is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Hardly a week goes by these days without a company going public with a decent yield. A couple of weeks ago CyrusOne (NASDAQ: CONE) joined the party with a highly successful IPO pricing above the expected range and trading higher for the week. The REIT though has a meager expected dividend yield of only 2.9%.

The company is a spin-off data center operator from majority owner Cincinnati Bell (NYSE: CBB). The parent will continue to own 72% of the outstanding stock with a requirement to hold those shares for 12 months after the initial offering.

CyrusOne operates 23 data centers mostly in Ohio and Texas. The company is the process of transitioning to a REIT joining other data cent REITs such as Digital Realty and DuPont Fabros (NYSE: DFT). In addition, major data center operator Equinix is the process of transitioning to a REIT.

IPO details

The company raised $360M by offering 18.975M shares, which included 2.475M shares exercised by the underwriters. The stock priced at $19, above the $16 to $18 range, on January 18, 2013. It traded as high as $22.10 on the initial day before closing at $21.20 for a solid 11.5% first day gain. After some follow through, the stock now trades near the opening day closing price.

The proceeds will be used to fund expansion while the company raised over $500M in debt to pay back Cincinnati Bell.

What the company offers

As previously discussed, the process of transitioning to a data center REIT has juiced the stock of Equinix and likely the IPO pricing of CyrusOne.

The company owns and operates enterprise-class, carrier-neutral data center properties. These facilities are built with redundant power, cooling, and telecom systems. It offers access to data center growth via 23 centers in mostly Ohio and Texas collectively providing approximately 1.6M net rentable square feet (NRSF) powered by 125 MW of utility power. The customer base is comprised of 108 of the Fortune 1000 that provide 79% of annualized rent.

At 62M shares outstanding, the company now has a valuation of over $1.3B. The valuation is comparative to DuPont Fabros that trades with a valuation over $1.5B. DuPont though expects revenues to reach $332M in 2012 or more than 50% higher than that of CyrusOne. The expected DuPont growth at 16% is slightly lower, but still comparative to question the valuation of CyrusOne. DuPont only yields 3.2% so it doesn’t offer much more in the way of yield.

With 379K NRSF under development and 762K NRSF of additional powered shell space under roof and available for development, CyrusOne has plenty of growth opportunities in the pipeline.

Better to buy majority owner?

A big debate will be whether investors should own the hot data center stock directly or the parent that owns 72% of the stock. Any investors doing a sum of parts analysis could likely justify owning the parent that is now valued at virtually nothing for the non-CyrusOne assets.

Cincinnati Bell now has a valuation of around $950M while the ownership portion of CyrusOne adds up close to that figure. To be fair, the other assets have relative low valuation potential, but something north of zero would be expected. A relatively low 1-2x EBITDA for those assets would still yield several hundred million dollars in value.

Without the company being able to unload the CyrusOne shares as the sector continues on a hot streak, the parent might be stuck with the inability to unload shares when the value is best presented during 2013.

Stock Valuation

Being a REIT, the real valuation is in the distribution. The company plans a $0.16 quarterly distribution through September 30, 2013 or $0.64 for the year. The current yield is only 2.9% though the company only plans to distribute 68% of the funds from operations providing for some upside to the yield.

As noted with DuPont, the other data center REITs all provide higher yields questioning why investors are willing to chase this newly minted IPO.

Conclusion

While the prospectus makes the case that the operator is difficult to replace and barriers to entry are massive, the company along with the competition appears to offer no more than power and space. Without proprietary technology, the business model doesn’t provide a lot of margin protection. The biggest long-term concern is that technology advances at a rate that smaller servers and storage devices eventually lead to the need for less power consumption even with growing computing needs. 

At this point investors need to be careful rushing into this sector. If the sector remains hot all year, than Cincinnati Bell will become an excellent option to gain relatively value as the timeline shrinks for the ability to spin-off the shares. Until that point, investors will do better being more selective with a REIT that offers more yield.


Mark Holder and Stone Fox Capital Advisors, LLC have no positions in any stocks mentioned. The Motley Fool owns shares of Cincinnati Bell. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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