Analyst: Hosting Price War Likely
Cites competitors' 'empty' data centers in downgrade of Exodus

April 24, 2001 -- Saying growth in servers connected to the Internet has "slowed to zero," a USB Piper Jaffray analyst Monday predicted a price war in the web hosting and colocation industry that will shrink revenues for data center operators.
"We believe an industry price war will occur during 2001 in order to drive facility utilization higher," USB senior communications services analyst Cary Robinson wrote in an analysis on the company's website. "If growth in demand for colocation space has slowed significantly while supply is still increasing, we believe the weaker players and lower cost providers will drive pricing down dramatically."
But other analysts disagreed. A white paper released Tuesday by telecommunications consultancy Tarifica challenges the notion that "pure" colocation and data center space may become a commodity.
"Rather than seeing any lowering of rack or suite prices in the U.S., we are witnessing the opposite," said Nicola Ainsworth, managing partner of The Phillips Group, which operates Tarifica. "Prices have in fact been rising, and so long as customers continue to be concerned with the quality of space rather than price this is likely to continue.''
A broad consensus of data center and carrier hotel operators report a slowdown in new customers since late last year. As some struggling facility operators seek to fill buildings to meet their debt service, prospective tenants are seeking concessions on either terms or rent.
Robinson's comments accompanied USB's downgrade of Exodus Communications, one of the largest publicly-held hosting service providers. Robinson issued his downgrade on a morning when Exodus shares were briefly buoyed by renewed rumors that the company may be acquired by British communications giant Cable & Wireless.
In downgrading Exodus, Robinson cited what he saw as a broad decline in the health of the Web hosting industry.
"We attempted to visit data centers of Exodus and its competitors and the companies were unwilling to let us visit the sites," said Robinson. "When visiting the data centers of other hosting companies, we found one empty and others lightly utilized."
Many data center companies maintain strict limits on access to facilities for security reasons. Exodus has also been the subject of critical media reports on the occasions when it allowed reporters from trade magazines to tour data centers.
But Robinson also noted an ominous change in monthly data compiled Netcraft, which has documented huge growth of the Internet since it began tracking web sites in 1995. (see chart below)
April marked the first month in the history of the Netcraft survey in which server growth was essentially flat, rising just 58,000 to 28.66 million after a lengthy trend of monthly gains of half a million or more.
"We believe the growth in the total number of servers connected to the Internet has slowed to zero," said Robinson.
That translated into a change of heart for Robinson, who had rated Exodus a "strong buy" with a price target of $50. On Monday he changed the rating to "neutral" and cited a price target of $6.
“We expect zero percent revenue growth beyond the second quarter of 2001,” said Robinson. "While Exodus is the leading company in the space, the company's financials will be negatively impacted by the weakening fundamental environment."
Debates about the "commoditization" of data center space are hardly new, and many providers' business models have focused on managed services as a revenue engine as margins tightened for basic hosting.
The Tarifica white paper found that 86 percent of colocation providers interviewed say they will offer value-added services as well as space in the near future.
"Data center offerings are centered around managed services and a total outsourcing solution so we are likely to see falling prices in this environment, but it will not impact the price for pure colocation or shell and core colocation,'' said Ainsworth.
Nonetheless, the concerns expressed by Robinson seemed to move the markets Monday. Exodus shares closed off 10 cents Monday at $9.87. Other publicly-held hosting companies' shares took a worse beating, as Equinix, Universal Access and Verado all had double-digit percentage losses on the session.