A Data Center Recovery?

Red Herring thinks so. In a feature story this week, the well-read technology mag asserted that the data center meltdown was coming to a close and "an industrywide turnaround might be just a few months away." The article raises two important questions: is this analysis correct, and will the industry benefit from this shift in analytic sentiment?

The article's author, Om Malik, writes regularly on communications for Red Herring, and has also written for Forbes and The Wall Street Journal. Back in May of 2001, he penned a piece titled "Data centers run for cover" chronicling the collapse of the market. Less than a year later, Malik suggests a dramatic turnaround is on the horizon, citing improvements in data center fill rates, as well as slightly improved valuations for facility sales.

Those trends hold true for the best-positioned companies and the best-engineered data centers. And it's clear that the level of activity in the sector is accelerating. In the past month, we've seen a significant surge in inquiries through our Data Center Exchange and Colocation Guide web sites, as well as a pickup in advertising on the Carrier Hotels web site. Clearly, some insiders believe it's the right time to go shopping for data centers and start marketing facilities and services.

At the same time, in the past 18 months I've had a front row seat for the carnage in this sector. The distress is much deeper and broader than high-profile indicators - like the performance of either Exodus or Rackspace - might suggest.

The underlying health of the telecom industry isn't getting any better, either. Just this week, both Light Reading and Network World published analyses suggesting a telecom recovery is a long way off.

Yet there is one factor that could help the data center industry get better in a hurry - money. In that respect, feature stories by Red Herring can make a difference. The magazine and its web site have an influential readership, especially among venture capitalists.

As the dot-com boom proved on the way up, sentiment and momentum are important in technology investing. It'll never be 1999 again. But as the industry makes the transition from the Era of Overbuilding to the Era of Frugality, even a fraction of that kind of funding would make a big difference.

The Terremark Premium

There are tons of investors who bought shares in web hosting companies and ISPs at high prices, only to see their holdings diminish as share values plunged in the Internet stock meltdown. If they'd known the company's shares would fall below $1, they wouldn't have bought at a higher price. Right? In recent weeks Terremark has stood that logic on its head, and has twice raised money by selling shares of its common stock for substantially more than their listed market value.

On April 1, the Miami-based developer of carrier hotels and network access points announced that it had raised $7.5 million by selling 10 million shares to company employees and investors at 75 cents a share. At the time, Terremark shares were trading on the NASDAQ at 46 cents, after falling as low as 22 cents earlier this year. By this week, the company's stock had rallied to 68 cents, raising the prospect that the insiders who paid a 50 percent premium less than a month ago may soon be "in the money" on their investment.

On Thursday, Terremark announced a deal to develop a NAP in Madrid, which included a provision in which its Spanish partners will pay $1 a share for 5 million shares of common stock - again, a 50 percent premium to the market price.

It remains to be seen how this strategy will work out over the long run. But in a dreadful capital market, the developers of the Technology Center of the Americas have been able to create confidence among insiders and business partners, and leverage that confidence into cash.

It's Raining Shoes

Never mind waiting for the other shoe to drop. In telecom, shoes are falling from the sky at an alarming rate. On Monday morning Pinnacle Towers said it would file for bankruptcy. Telecom issues - especially WorldCom - were pummelled throughout the trading day on Wall Street. Monday night saw Williams Communications file Chapter 11. It's hard to imagine that MFN is far behind. Is there any good news out there? Well we found a couple bright spots.

Forbes this week profiled two providers who they think will be around for the long haul. In the wake of today's improved earnings report, Forbes Online projects Level 3 as a survivor, citing its liquidity (which includes $1 billion in cash and a $650 million credit line). On the newsstand, the latest issue of Forbes reviews improving fortunes at Loudcloud, which is recognized for its cost controls and ability to refocus its business after its initial business model died along with the dot-com sector.

One interesting tidbit from the Loudcloud piece underscores the challenge facing today's struggling service providers. Loudcloud execs told Forbes it typically takes 150 days to close a sale. Given the current rate of disintegration in the data center sector, that's an eternity. Five months ago Sigma Networks was hailing the completion of its buildout, Exodus was looking for a buyer, and Global Crossing was announcing new customer wins. Now Sigma is liquidating, Exodus is part of Cable & Wireless and Global Crossing is in bankruptcy.

Life After Bankruptcy

What will life after bankruptcy look like for data center service providers? We're getting a better idea of this as more companies emerge from Chapter 11, shorn of most of their debt and a fair percentage of their employees. The latest examples are McLeod USA, which emerged from Chapter 11 today, and ServerVault, which was acquired out of bankruptcy yesterday with its management intact. Going forward, the telecom and data center industries may become the largest test yet of Chapter 11 as a business tool.

With much of the industry either in bankruptcy or headed there fast, there's no question that Chapter 11 no longer has the stigma it once did. Customers who shun companies with a recent bankruptcy will find thinner pickings. Of course, there's always IBM, EDS, Sprint and WorldCom. But hosting with these huge corporations generally means paying a "stability premium." Many price-conscious customers will continue to scan the New Economy providers for hosting solutions.

This raises a key question for customers. Which provider should you trust with your data: the one working to avoid bankruptcy, or the competitor who has been there and back already? The post-bankruptcy provider may have lower overhead, and be more aggressive with pricing.

Will the future reward those companies that have worked hard to manage their debt load and make good on their obligations? Or will they now find themselves at a disadvantage to leaner competitors who filed Chapter 11?

I'll wager that in years to come, when scholars and analysts study the effectiveness and fairness of the bankruptcy code, they'll look to telecom as the testbed of how well Chapter 11 has balanced the dueling interests of businesses, customers, investors and creditors.

Verizon and Sept. 11

Six months later, recovering from the World Trade Center disaster remains a huge job for Verizon, which had to cope with damage not only to its central office on West Street, but also to underground phone lines throughout Lower Manhattan. A recent issue of Dow Jones' excellent Rebuilding Wall Street (pdf format) newsletter chronicles the huge challenge facing Verizon, which must shift 100,000 phone lines to a new, rewired system encompassing 25 miles of copper lines. The company has dedicated 400 workers to the task for the remainder of the year. But not all of Verizon's responses to Sept. 11 are as noble.

A story in today's Boston Globe details how Verizon is citing post-Sept. 11 security concerns in seeking to lock down many of their central offices in the state, in the process barring access to companies (read competitors) who have colocated equipment in those COs. That would force CLECS and other network service providers to rely upon Verizon to maintain their equipment. What's more, Verizon wants its colocators to pay for the cost of enhanced security at these COs. Predictably, Verizon's competitors are screaming.

Sounds like a good argument for carrier hotels, eh?

Stumbling over Customers

Remember Jim Ryun and Mary Decker? Both were world-class middle-distance runners who made the wrong kind of news in the Olympics, finishing out of the money after stumbling over competitors (Ryun in '72 in Munich, Decker in the '84 Los Angeles games). As the Internet gold rush turns into an endurance race, even the most promising New Economy competitors are struggling to maintain their balance as bodies fall around them.

Too often those spent carcasses belong to customers, and when a big one collapses in your path, it's a tough hurdle to clear. Just ask Loudcloud, which late Friday announced that one of its large customers, the foreign exchange trading portal Atriax, was ceasing operations. Loudcloud suspended its revenue guidance for 2003, and its common stock is paying the price today.

Loudcloud has had one of the highest profiles in the managed hosting arena, from its birth as the brainstorm of Internet pioneer Marc Andreessen right through to its much-ballyhooed IPO, which many see as the last gasp of Wall Street's Net euphoria. After a case of the post-IPO blahs, Loudcloud in recent months had begun to exceed expectations. Now, like Universal Access, that hopeful trajectory is imperiled by a customer bankruptcy.

These companies may still get the gold. But perhaps the endurance race isn't exactly the right analogy.

In my younger and thinner days, I competed at every distance from the 100 meters to the marathon. I was never the fastest or fittest athlete, but found my niche in the 400-meter intermediate hurdles. About 350 meters into the race, most runners experience the phenomenon known as "rig" - short for rigor mortis. Your leg muscles tighten up, your stride shortens, and everything starts to hurt. And there's still one more hurdle to clear.

I liked this part of the race. Being fast and fit was fine for the first half of the race. In the final stretch, the odds tilted in favor of those who could endure the most pain and find a way - any way - to clear that last hurdle.

The current market reminds me of those last 50 meters. The field has thinned, and those that are still upright are stumbling and gasping for breath. The winners will be the those who can stay nimble in a harsh environment, and thrive when the gut-check arrives.

Valuing Data Centers

"Pennies on the dollar." That's the phrase you often hear about the price of finished data center space. By any measure, these facilities are available at huge discounts. But the recent sale prices of three former Exodus data centers suggests that pricing is best measured in dimes on the dollar, or even quarters.

Venture Asset Group arranged the sale of the former Exodus data centers in Herndon (Freddie Mac), Austin (Dell) and Toronto (Q9). In a press release, the company noted that Exodus spent $120 million on the facilities. A story by The Deal put price tags on the sales - $25 million for Herndon, $21 million for Austin and $15.7 million for Toronto. That's a total of $61.7 million, or 51 cents on the dollar.

Since these are quality buildings in premium markets, that valuation probably represents the market's ceiling, rather than the floor. But it's a slightly higher ceiling than might have been expected. And you know how folks in this business love high ceilings.

Gains and Gaffes for Microsoft

Despite its dominance of desktop computing, Microsoft has long trailed in the market for web server software, where the open source Apache is the market leader. But recent data from Netcraft shows Microsoft making huge gains, as two leading domain registrars switched to Windows web servers.

Platform transitions at Network Solutions and Register.com helped Microsoft pick up 5 percent market share - more than 2 million domains - in just one month. Apache still leads with 53.7 percent of the server market, according to Netcraft, while Microsoft now has 34 percent.

One reason for Apache's lead is ongoing concern about the security of Microsoft web products. As if to underscore such concerns, hackers redirected thousands of Network Solutions domains last month, sending surprised domain owners to a web site run by the digital vandals. It turns out the break-in actually occurred on Microsoft IIS servers hosted at Interland, which provides outsourced domain hosting services to Network Solutions. This allowed NSI to retain some deniability ("OUR servers weren't breached!") but was probably little comfort to the domain owners. File this one away in the "Outsourcing Disasters to Avoid" file.