Monday, November 9, 2015

U.S. Telcos Exiting Data Center Business?

Several developments confirm a shift of strategy by large U.S. telcos and the apparently-secure role of specialists in the data center business.

Digital Realty Trust, the second-largest data center REIT after Equinix, is adding more capacity, bringing online a two-million-square-foot property in Ashburn, Va.

At the same time, the large U.S. telcos either have concluded that data center ownership no longer is a “core” asset, and have sold, are trying to sell, or might sell, their data center portfolios.

It is a truism that communications service providers are in a race to replace declining legacy revenues with earnings based on next generation services that largely center, one way or the other, on Internet apps, services and devices.

Along the way, some approaches that seemed appealing in the past are being revised. For the most part, few large telcos, cable TV or other service providers have had much luck creating big new businesses in consumer over the top services, even if that effort continues.

Most large U.S. service providers, for example, also seem to be concluding that data center operations are not “core assets.” They understand that data center services must be bundled with other enterprise and business customer offers.

But they also seem to be concluding that capital is better deployed elsewhere, and that data center services can be supplied on a “lease rather than own” basis.

Verizon might be the first large U.S. service provider to conclude that its extensive global network assets might also be “not core assets.”

Verizon Communications now is said to be exploring a sale of its “global enterprise assets” built on the former MCI-Worldcom global network plus the data center business (Terremark).

Verizon Chief Financial Officer Fran Shammo said, during the company's third-quarter earnings call on Oct. 20, 2015, that it continues "to work through secular and economic challenges" with its global enterprise division, which posted a 4.9 percent decline in revenue in the quarter ended Sept. 30, 2015.

In many ways, that trend speaks to changes in the ways enterprises globally have changed “what” they buy in the connectivity arena, as well as “from whom.”

There is declining demand for legacy connectivity of every sort, and growing demand for IP connections and bandwidth. Need for data center support also is changing as cloud computing becomes mainstream and public computing resources from Amazon Web Services and others become viable options.

Verizon spent $8.4 billion to acquire MCI-Worldcom in 2006. Verizon bought Terremark Worldwide in 2011 for $1.4 billion. Altogether, that represented $9.8 billion in acquisition costs.

Some think the assets could be sold for $10 billion. Some estimate the assets produce about $2 billion in annual revenue, implying a sale price about five times annual revenue.

Of course, Verizon has a revenue profile distinct from other large U.S. service providers, as 85 percent of its total revenue is earned from its U.S. mobile segment. All consumer operations and fixed network enterprise together represent just 15 percent of revenue.

Still, the trend to divest data center assets, mostly acquired over the past decade, suggests a belief on the part of large service providers that sustainable advantage cannot be gained by owning such assets.

If so, we might also conclude that large U.S. telcos no longer see the data center business as a path to future growth, in the same way that most large telcos have had scant success creating large new businesses in the consumer over-the-top domain.

In addition to the possible sale of Verizon data center assets, AT&T and CenturyLink likewise are trying to sell their data center businesses.

Windstream already has divested its data center business.  

So what is going on? There appears to be nothing fundamentally “broken” with the data center businesses. But most larger U.S. telcos seem to believe they can obtain the benefits (services for their enterprise customers) without owning the facilities.

CenturyLink appeared to believe colocation center hosting would provide a boost several years ago when it bought Savvis.

While it plans to continue offering colocation services, CenturyLink says it is looking for alternatives to owning nearly 60 data centers around the world that support colocation, managed hosting, and cloud services.

Cincinnati Bell also is monetizing its data center assets, selling ownership shares of its CyrusOne data center business and raising cash to reduce debt.

CenturyLink business segment revenues might be “driven principally by increased market penetration of our network, hosting, cloud, and IT solution service offerings,” as CEO Glen Post said.

But capital might be better deployed elsewhere, CenturyLink suggests. “We expect colocation services will continue to be a service our customers will look for us for, but we do not necessarily believe we have to own the data center assets to be effective in delivery of those services,” said Post.

CenturyLink’s revenue for the cloud and hosting  business is about $600 million annually, and the company says it seeks to sell or otherwise restructure the data center operations, not the cloud and hosting businesses that use data center real estate.

Experimentation is to be expected. Large service providers must expect to replace half their existing revenue sources about every decade, and the diminution of all the legacy core services implies a future revenue base build nearly completely on “new” services.

Finding big new revenue sources will be complicated by changing value and roles within what we used to call the “communications” ecosystem. Simply, value and revenue growth are migrating to cloud apps and software products, and away from managed communication services.

One is reminded of moves many large telcos made, in past decades, in the “computing” industry, again without long-term success.

That is just part of the continuing evolution of the business. Many efforts will prove disappointing. And it appears we now can add “owning data centers” to the avenues that have proven disappointing. No matter. The search will continue.

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