#$dlr

TierPoint, Peak 10 and other private operators blend services, models in data centers.

by Chris Nolter

Data centers and the infrastructure that underpin IT services have been fertile ground for private equity funds, such as GI Partners, Welsh, Carson, Anderson & Stowe, Oak Hill Capital Partners, Abry Partners, Catalyst Partners and others.

"Private equity has played very aggressively and significantly in the pure co-location part of the market," said Peter Hopper, co-founder and CEO of DH Capital LLC, a boutique that has brokered deals for many of the financial sponsor-backed outfits in the sector.

While many of the private companies started with an emphasis on co-location, which is essentially providing parking spaces for corporate servers in data centers, many have adopted more complex, hybrid models.

For instance, in addition to providing basics such as space, power, and temperature control for clients' servers, private companies have now added managed services, such as backup, network security, web hosting and monitoring servers. Private cloud services, in which dedicated servers provide remote computing capacity, are common. Hybrid providers can also package public cloud services of Amazon.com Inc. (AMZN) or others.

"The attitude is whatever you need -- whether it's co-location, whether it's managed services, whether it's cloud -- we are the person who can figure all of that for you," Hopper said. "Those models continue to be very good places for PE to invest in."

Five to 10 years ago, the lines were clearer, according to Structure Research analyst Jabez Tan.

"You did pure co-location or hosting or cloud or telecom-type networking or connectivity," Tan said. "Nowadays you often see a blend of everything, a smoothie of all of these different kinds of services."

Large public REITs such as Digital Realty Trust Inc. (DLR) Dupont Fabros Technology Inc. (DFT) and Equinix Inc. (EQIX) dominate the wholesale business, while companies such as Amazon.com, Microsoft Corp.'s (MSFT) Azure and Alphabet Inc.'s (GOOG) Google reign supreme in public cloud storage.

"[The REITs] have the economies of scale the global reach the global presence, the global footprint," said Tan. "Because they have that blueprint, they are able to drive down costs while still offering a premium product."

Amazon, Microsoft and Google have gained a similar position in cloud services.

"Is there an opportunity in the middle of the market?" Tan asked. "I would say absolutely so."

It's in this middle arena where private equity-backed players have thrived.

The hybrid group in the middle, for example, includes TierPoint LLC, which is backed by its chairman and cable entrepreneur Jerry Kent, RedBird Capital Partners, Stephens Group, Jordan/Zalaznick Advisers Inc., and Thompson Street Capital Partners.

TierPoint has been one of the most aggressive acquirers in the space. The St. Louis company agreed to buy Omaha, Neb., hybrid Cosentry Inc. in January, and purchased the data center operations of Windstream Communications Inc. (WIN) for $575 million in December.

"Our original focus, when we got into the space, was really on co-location," TierPoint's chief strategy officer,  Andy Stewart, said in a phone interview.

When the company expanded into Oklahoma City, Okla., which is considered a second-tier city, Stewart saw the need for broader offerings beyond co-location.

"You needed to offer cloud and managed services, as well, and be that trusted IT adviser," Stewart said. "Customers were coming to us for more solutions. They trusted us as a data center provider and they were outsourcing parts of the IT business to us."

TierPoint branched out into managed hosting, and then into cloud services, disaster recovery, storage and other offerings and, Stewart said, has found the Southwest and northern Midwest to be attractive markets. TierPoint is looking for organic growth for now, while it integrates Cosentry and the Windstream assets. But acquisitions will be part of the formula in the future.

Kent, the TierPoint chairman, has built companies before, having previously run Suddenlink Communications Inc. Just recently European group Altice SA bought a majority stake in Suddenlink for $9.1 billion.

Stewart suggested that PE backers have patience.

"We're thinking about growing TierPoint over a longer time frame than that three to five years that a PE-backed company would typically have," he said.

Another prominent hybrid is GI Partners-funded Peak 10 Inc. GI Partners acquired the company in 2014 from Welsh, Carson, Anderson & Stowe, which bought out Seaport Capital and McCarthy Capital in 2010. San Francisco-based GI Partners also manages funds for California Public Employees' Retirement System and California State Teachers' Retirement System that have acquired data centers, among other properties.

The company will continue to increase scale through dealmaking. In an email, Peak 10 CEO David Jones said the company considers several factors, such as financial performance, quality of infrastructure, reliability of facilities, the network and cloud framework and the quality and tenure of customer base, among other things.

"We look for quality of systems and process as well as how scale of operations is being addressed and achieved," he wrote. "The co-location, managed service and cloud sectors are dynamic."

Jones said that Peak 10 will continue to focus on compliance, disaster recovery as a service and tools to expand its customers' cloud solutions and self-management capabilities.

Niche operator 2nd Watch Inc., which has backing from Madrona Venture Group, Columbia Capital and Top Tier Capital Partners LLC, manages Amazon's public cloud service. Other privately owned companies in the space include Denver co-location group Cologix Inc., EdgeConneX Inc., of Herndon, Va., and Tampa, Fla.-based vXchnge

Publicly owned operators have gobbled up some PE-backed companies in recent years, with Canadian cable group Shaw Communications Inc.'s purchase of ViaWest Inc. from Oak Hill Capital Partners for $1.2 billion coming in 2014. Oak Hill had itself bought ViaWest in a 2010 secondary buyout from Trinity Equity Investors, Goldman, Sachs & Co. and Quilvest. And last year, Digital Realty Trust purchased Telx from ABRY Partners and Berkshire Partners for almost $1.9 billion, while Boulder, Colo., fiber networker Zayo Group LLC (ZAYO) acquired Catalyst Investors-backed Latisys Holdings, LLC for $675 million.

DH Capital's Hopper explained that the publicly traded REITs tend to trade in mid- to high teens multiples of the latest quarter's annualized Ebitda because they have the advantage of favorable tax treatment since profits have to flow through to shareholders.

"Because the large REITs have been fairly aggressive consolidators, they have been able to pay higher multiples and still be able to do very accretive transactions for good private co-location properties," Hopper said.

Multiples have generally ranged between 11 times and 15 times Ebitda for co-location properties. Buyouts of the hybrid companies have been between 11 times to 13 times Ebitda.

Still, the lines between the IT infrastructure services, and the companies that provide them, are growing less distinct. So dealmaking valuations could change, too.

It has been a long time since a REIT has shown up in the bullish scan, but it happened today.  Digital Realty ($DLR) has been a steady as she goes stock to won for the past year.  Not that exciting, but hey, until August the market as a whole was like that.  The difference with Digital Realty is that it pays a 5.2% dividend.  

The stock had moved in a tight range from 64 to 67 for most of the year before a drift lower as the summer started.  Early September marked the low and it has stair stepped higher since then.  Going forward the momentum indicators are bullish and support more upside.

There are 4 price levels to use and keep an eye on as the stock moves higher.  The first is 65.40.  It just broke above this price making its first higher high to go with a higher low.  This can be used as a stop loss level now.  The second is the August high at 67.15.  A move over that adds confidence to the push higher as it will also be over the 200 day SMA at that price.  

Third is 69.50, the high price in July.  From the current price that is already a better than 4% move.  But this price unlocks the potential to retest the 4th level, the 2015 high at 74.60.  Each level as it is passed can be used as a stop loss to lock in profits as you sit back and collect that fat dividend.

I’m not wildly enthusiastic about the prospects for the broader stock market over the remainder of 2015. But I do think that REITs offer a pocket of value. I don’t see bond yields rising much in today’s market. If the Fed is too timid to raise rates, that tells you that there are enough macro risks out there to keep bond yields low. But if and when the Fed finally does get motivated to raise rates, I don’t see that translating to higher long-term bond yields, or at least not for a while. A higher Fed funds rate is disinflationary, which is good for bond prices.

So for the time being, we seem to be in a sweet spot for bonds where, irrespective of what the Fed does, bond yields should stay lower-than-normal for a while. And as long as bond yields stay low, REITs should outperform the broader market.

Source: Nasdaq

But there is one more reason to believe that REITs are due to continue their rally. Several of the names I follow are very heavily shorted right now. Short sellers have been punishing the sector for months in the view that higher interest rates would wreck the sector. But here’s the thing about heavily-shorted stocks. When you short a stock, you are obligated to buy it back. So when you see a heavily-shorted stock, you know that there is a lot of buying that must happen… eventually. And if too many short sellers try to close their positions at the same time, you get a short squeeze that can send the stock price sharply higher. To toss out a few examples from the list above, Realty Income has a short interest currently equal to more than 11 days’ worth of daily volume. VEREIT has a short ratio of 9 days to cover. And Digital Realty has an almost ridiculously high short ratio of 20 days to cover.

Short sellers have had a great six months shorting the REIT sector. It’s been a profitable trade for them. But with REITs showing modest strength right now in the face of broad market weakness, I expect those short sellers to start bailing… and soon.

Even though they generally have a low correlation to the broader market, REITs are still stocks. And if we have another volatile rough patch like August, you can expect them to fall alongside the rest of the market, at least temporarily. But I still expect REITs to massively outperform the broader market for the remainder of 2015, particularly if the shorts get squeezed.

Has the stock correction mostly run its course? Or are we in the early stages of a bear market? 

Frankly, I have no idea. There’s really no way to reliably know ahead of time. Popular bear-market indicators like the “death cross” have a mixed record at best, and strategies that reliably avoid bear markets also unfortunately tend to miss the most profitable parts of bull markets too. 

If your portfolio returns depend entirely on selling to a greater fool, then this is a perilous time to be in the market. I wouldn’t want to own a highflying momentum darling like Netflix (NFLX) or Amazon (AMZN) if I thought the market might roll over because expensive stocks often fall the hardest. But if current income is a part of your investment process, then a little market volatility is nothing to worry about. 

A portfolio of attractively-priced dividend stocks with high and growing payouts will to allow you to realize a decent cash return while waiting for the market regain its footing. And if you reinvest your dividends, you automatically average in at lower prices. Today, we’re going to take a look at 10 dividend stocks to hold for the remainder of 2015, come what may in the market. All pay solid dividends, and most are dividend-raising champions.   

Apple (AAPL)

AAPL Dividend Yield: 1.8% 

I’ll start with Carl Icahn’s darling, iPhone maker Apple (AAPL). Apple has become something of a punching bag of late, with fears of a China slowdown casting a shadow over the company. 

There also is a growing sentiment that the company Steve Jobs built into a wellspring of innovation might have lost its mojo. The iPhone is now nearly a decade old, yet it remains Apple’s primary cash cow. 

Guess what? I don’t care. 

Even if Apple never invents a major new product again, the stock is still attractive at today’s prices. AAPL stock trades at a very modest forward P/E of 11.5. And if you strip out the roughly $35 per share in cash and investments, you get a forward P/E of 7.9. That is absurdly cheap. 

Meanwhile, Apple has quickly evolved into a shareholder-friendly, dividend-raising machine. Apple’s current dividend yield is a modest 1.8%, but Apple has proven its mettle as a hiker. 

Since initiating its quarterly dividend in 2012 at 37.9 cents (adjusted for its split), AAPL has bumped it up by 37%. And if the stock price slides much further, you can bet that Icahn will be agitating for another large stock buyback.

Microsoft (MSFT)

MSFT Dividend Yield: 3.3% 

Next up is Apple’s erstwhile rival from the PC era, Microsoft (MSFT). Given the decline of the PC as a computing platform, Microsoft might seem like an odd choice. But under its savvy new CEO Satya Nadella, Microsoft is successfully transitioning itself beyond the Windows. Along with Google (GOOG) and Amazon (AMZN), MSFT has become one of the “Big Three” in cloud computing and services. And given Microsoft’s much longer history serving the enterprise market, my bet is that Microsoft’s cloud business eventually leaves Amazon’s and Google’s in the dirt. 

Microsoft is really a king among dividend stocks. It sports a dividend yield of 3.3%, making it one of the highest-yielding mainstream stocks in the S&P 500. And it’s also raising that dividend at a blistering rate, even while managing to lead the industry in capital spending. 

Over the past five years, Microsoft has raised its dividend at a 19% clip. Can Microsoft keep it up? Absolutely. Don’t be put off by Microsoft’s seemingly high dividend payout ratio of 82%. Microsoft took a bath last quarter writing off bad investments. Once earnings normalize, the payout ratio should fall back below 50%.

McDonald’s (MCD)

MCD Dividend Yield: 3.5% 

Next, we have a stock whose establishments I (somewhat embarrassingly) frequent more than my doctor would like: McDonald’s (MCD). 

I know, I know. Fatty fast food is passé in the era of chic and healthy fast-casual options like Chipotle Mexican Grill (CMG). But sometimes I just really want a Big Mac and a Dr Pepper. Yes, it’s lowbrow. And I really don’t care. 

Wall Street hates McDonald’s right now. MCD stock has gone nowhere since late 2011, and analysts are about as bearish on the stock as I’ve even seen. But guess what: McDonald’s has been here before. Back in the late 1990s, its menu had gotten stale and its stores were starting to lose customers. Well, the company adapted, spruced up its menus and its locations, and then proceeded to have one of the most profitable decades in its history. 

Right now, McDonald’s sports a dividend yield of 3.5%, and it has boosted that dividend at an 18% clip over the past 10 years. For that kind of growth to continue, McDonald’s will need to see some healthy profit growth too. But given this company’s past record of turning things around, I see that as being very likely.

Prospect Capital (PSEC)

PSEC Dividend Yield: 12.7%

Prospect Capital (PSEC) may very well be the most hated stock on Wall Street. It seems that investors have never fully forgiven the company for cutting its dividend a year ago. 

Today, the stock trades for just 76% of book value. And book value is not just an arbitrary accounting term in this case. Prospect’s book value represents real debt and equity investments that the company has marked to market every quarter by third-party valuation firms. Prospect’s book value is close to the real value you could get for its assets if you were to buy the entire company and sell it off for spare parts. 

It’s hard to lose money buying a dollar for 76 cents. But that is exactly the pricing we have today in Prospect Capital. And if it takes the market months or even years to realize this value, that’s OK. We’re getting paid — a lot — to wait, via PSEC’s current yield of nearly 13%.

Realty Income (O)

O Dividend Yield: 4.8% 

No list of safe dividend stocks is complete without Realty Income (O), also known as the “Monthly Dividend Company.” 

I’ve said it before, and I’ll say it again: Realty Income is one of the very few dividend stocks out there that I believe you really can buy and hold forever. 

Yes, the stock price will bounce around. That’s inevitable. But given the safety and quality of the underlying real estate portfolio, it’s hard for me to see a scenario short of the actual end of days that would cause Realty Income to cut or eliminate its dividend. This is a REIT that owns a portfolio of high-traffic essential retail sites, such as your local convenience store or pharmacy. 

A bear market this year would knock a few dollars of the stock price, for sure. But frankly, who cares? Realty Income sports a nice dividend yield of 4.8%, and it has raised its dividend for 72 consecutive quarters. 

Bear market? Bring it.

VEREIT (VER)

VER Dividend Yield: 6.8% 

Along the same lines we have VEREIT (VER), formerly American Realty Capital Properties. Like Realty Income, VEREIT owns a diversified portfolio of high-traffic retail properties. The portfolio isn’t quite as high-quality as Realty Income’s, though; as a case in point, one of VEREIT’s largest tenants is struggling dining chain Red Lobster. 

But VEREIT is also what I would call a “special situation” stock, and one that I consider a solid turnaround play. About a year ago, this REIT was embroiled in an accounting scandal that was absolutely devastating. The board of directors suspended the dividend and essentially fired the management team. As a result, a lot of investors are understandably wary of VEREIT. But herein lies our opportunity. 

The portfolio is solid enough to essentially run itself. During the past year of management uncertainty, the underlying properties continued to perform as expected. And under its new management team, VEREIT reinstated its dividend. 

At current prices, the REIT sports a dividend yield of 6.8%. The bad news was priced into this stock a long time ago. At current prices, VEREIT is priced to outperform, come what may in the market.

Digital Realty (DLR)

DLR Dividend Yield: 5.3% 

I’ve been a fan of data center REIT Digital Realty (DLR) for a long time. I’ve never been comfortable investing directly in social media stocks given the crazy valuations usually found in the sector. But Digital Realty offered a nice, low-risk way to get exposure to the underlying trend. As more and more computing moves onto smartphones and into the cloud, demand for data centers should only rise. And in Digital Realty, we have a cheap dividend stock yielding more than 5%. 

But there is another reason to like Digital Realty in today’s market. It is one of the most heavily shorted stocks you can find, with more than 19 days worth of trading volume sold short, according to the most current short interest data. Remember, when you short something, you eventually have to buy it back. So an exceptionally high short ratio like this makes DLR a good short-squeeze candidate. Any small sliver of better-than-expected news could send the shorts running for cover. And that many shorts all running for the exits at the same time can send the stock price sharply higher. 

So, even if we do have a real bear market, I wouldn’t be surprised to see Digital Realty bounce like a spring.

Teekay Corp (TK)

TK Dividend Yield: 6.8% 

As the price of crude oil has continued to slide, the proverbial baby has been thrown out with the bathwater. Stocks that really have no direct exposure to oil and gas prices have gotten slammed. It’s guilt by association. 

But herein lies an opportunity for us to buy high-quality dividend stocks trading at temporarily depressed levels. A perfect example is seaborne energy transporter Teekay Corp (TK). Teekay is a quirky company. In addition to owning its own tanker assets, Teekay is the general partner of two MLPs, Teekay Offshore Partners (TOO) and Teekay LNG Partners (TGP) and the controlling shareholder of another corporation, Teekay Tankers (TNK). 

But this is where it gets interesting. Rather than continue as an operating entity in its own right, Teekay is transitioning into a pure-play general partner by dropping its operating assets down into its MLPs. 

And this means massively higher dividends. As part of Teekay’s strategic shift, it boosted its dividend by 74% earlier this year, and management expects annual dividend growth of 15% to 20% over the next three years. Between that stellar growth rate and Teekay’s current 6.8% dividend, you’re looking at a healthy heaping of income in the years to come. Not too shabby!

Kinder Morgan (KMI)

KMI Dividend Yield: 6.7% 

Along the same lines, we have pipeline superstar Kinder Morgan (KMI). Kinder Morgan has been beaten like a red-headed stepchild this year, down roughly a third from its 52-week high. But this is absurd when you actually bother to look at Kinder Morgan’s prospects. The company increased its project backlog by $3.7 billion in the second quarter to $22 billion, meaning that KMI has no shortage of growth prospects in front of it irrespective of what happens to the prices of oil and gas. 

During its reorganization last year, management said that it intended to raise KMI’s dividend by at least 10% per year from 2016 to 2020, and it reiterated that call this past quarter. And at today’s prices, the stock sports a fantastic dividend yield of 6.7%. 

Between the current dividend yield and the expected growth rate, you’re looking at potential gains of 15%-20% gains per year, roughly doubling your money in the next 3-4 years. That alone would be worth considering in a market that is expensive and priced to deliver almost nothing in the way of returns over the next decade.

StoneMor Partners (STON)

STON Dividend Yield: 9.2% 

And last but certainly not least, we have StoneMor Partners (STON). StoneMor is one of the largest owners of cemetery and funeral home properties in the world. And as morbid as this might sound, business is about to get kicked into overdrive. 

Death is coming to America in a big way, and no, I’m not talking about war or pestilence. I’m talking about demographics. The aging of the baby boomers means that there will be an unprecedented demand for funeral services in the decades ahead, and no garden-variety bear market is going to change that. 

StoneMor currently sports a dividend yield of 9.4%. Dividend growth has been modest in recent years, but that’s OK. We can enjoy the high current dividend yield while we wait for the demographic growth to kick in. 

In a broad bear market, StoneMor will probably take its lumps. But given that it is a small cap off the radar screen of most investors and that it pays a truly mammoth dividend, I’m betting any downside will be minimal.

Charles Lewis Sizemore, CFA, is chief investment officer of the investment firm Sizemore Capital Management and the author of the Sizemore Insights blog.

Continuing from yesterday’s post, I thought it might be interesting to review some trade setups I posted here this month (here and here, but also this post on the euro is also relevant). The video blog is about thirteen minutes long, but the point is not to review whether trades were wins or losses; the point is to move toward understanding the art and some of the subjective trade decisions that discretionary traders must make as the trade unfolds.

Our trading ideas, “setups”, if you will, must change with market conditions. Certain types of trades are more relevant at certain times. For instance, if the market is dramatically overextended, maybe we look for Antis, trend termination trades, or points to fade overextended individual names. If the market is strongly trending, maybe we look for pullbacks in strong stocks in strong sectors. One pattern that might be a bit more timeless–applying in a wider range of market conditions–is to look for stocks that are consolidating near price extremes. (This is one of the stock screens we publish in my research with Waverly Advisors. If you think you might find a list like this useful, why not give our research a free trial?)

Here are some individual stocks that are showing tight consolidations near recent highs (or, for the short idea, recent lows). How do you actually execute these? Well, there are many possibilities: perhaps you could simply buy them (or, for the short, short) at current prices with reasonable stocks under the consolidation area. Another possibility would be to wait for an upside breakout (or, for the short, a downside breakdown) and enter with the momentum of the market. The second choice sacrifices trade location for confirmation–perhaps a reasonable trade off, but one that must be understood. If you trade options, there are other possibilities: Patterns like this are ideal because implieds often crater when stocks consolidate like this, so simply buying calls (or puts) can be more attractive. Call spreads are a good idea for longs, and put spreads (made particularly attractive by higher skew) are also a reasonable alternative.

These are interesting patterns that combine several technical factors: pullbacks or consolidations, relative strength, and volatility compression. The end result is a set of patterns that have a statistical edge, and may point out stocks that are ready to somewhat “disengage” from broad market direction. Here are four ideas for your consideration:

Long idea: Digital Reality Trust (NYSE: DLR)

Long idea: Royal Gold Inc (NASDAQ: RGLD)

Long idea: Vipshop Hldg Ltd (NYSE: VIPS)

Short idea: Finisar Corporation (Nasdaq: FNSR)