The world’s biggest technology companies are quietly embracing a huge new growth industry – one that was hatched with the birth of the internet and has soared ever since.
You probably won’t read about it in the news, though. After all, these companies aren’t making or selling anything for consumer use. And it’s not what you’d call “sexy” or “exciting.”
But it’s absolutely critical to our everyday habits.
That’s because in our tech-laden, always-connected lives, and with the incredible growth of mobile devices, we continue to generate an ever-increasing amount of data.
As we do, we need places to store, safeguard, and process it.
Namely, in those faceless buildings called data centers.
A Home for Our Digital “Stuff”
Alongside the very first computers in the 1940s came the data center. A cavernous room with an advanced air conditioning system to keep the air cool and clean, and with connections so that people could use the machines.
Whether it’s a massive building in Utah like the National Security Agency uses, or a back room at your local auto dealership, these places are critical for the internet, businesses, and consumers. It’s where information lives.
But as the internet has exploded – and with it, our data usage – data centers have become even more important. Indeed, the very meaning of a data center is changing, with big consequences for both companies and your experience on the internet.
The Rise of the Mega Data Center
As the amount of data being created has soared, many businesses have neither the desire nor the expertise to manage their information. Instead, they’ve outsourced site hosting and data management to companies that specialize in operating mega data centers.
Even very large technology companies will outsource management of their hardware and often even their software to outside firms.
Giant companies like IBM (NYSE:IBM), Equinix (NASDAQ:EQIX), Google (NASDAQ:GOOGL), Amazon (NASDAQ:AMZN) and others are building these mega data centers. Some smaller companies are building them, too. And there’s even a REIT with exposure to this growing industry – the QTS Realty Trust (NYSE:QTS).
As a result, whether it’s a site dedicated to just one business or available to many customers, the number of data centers has exploded over the years, rising to over eight million in 2013.
But there’s a big shift afoot. In the future, the number of data centers will decline, while the overall size of the data centers that do get built will go way up, as more and more companies participate in the outsourcing trend.
There are a few trends driving this data center growth:
- Cost: Mega data centers are extremely expensive, but are much cheaper per unit of computing power or speed. They’re cost-effective in terms of hardware purchases, utilization of that hardware, air conditioning, and real estate – many of these data centers are purpose-built in areas with relatively low land, power, and water costs. The savings allow data center operators to pay for high-speed fiber connections, even in places where such connections are rare and expensive.
- Access to Better Hardware: Because these mega data centers share resources among their customers, those customers have access to more powerful hardware than they could afford on their own.
- The Cloud: Utilizing mega data centers is better for cloud computing because these centers are often directly wired to each other, separate from the public internet. In fact, many of these centers specialize in cloud computing.
- Speed: Getting data quickly to the people who need it is paramount. The inter-connection among mega data centers and their ability to purchase high-speed communications hardware is highly valued and increases a network’s speed. Indeed, most of the United States’ outbound internet traffic already originates at one of these mega centers and is connected directly to ISPs, without ever touching the “old” network that people think about when they imagine the internet.
- Reliability: Even very large companies are starting to realize how difficult it is to run their own data centers reliably. There are just too many variables. Even the most well-run data center is vulnerable to a guy with a backhoe and an old cable map in the back of the building! But large, secure data centers protect customers from downtime with instant backups, multiple points of communications entry, and more.
- Ubiquity of Software: It used to be that many companies wrote their own data management or information technology software, or used highly customized versions of commercial software. But many industries are moving to common software with relatively little customization. That’s because it’s both easier and cheaper to maintain, and allows themselves, auditors, regulators, and others to compare companies’ IT backbones on an “apples to apples” basis. The trend allows more companies to outsource the management of that software, and big data centers are one place to do that. Once a company has outsourced its software, the decision to outsource the hardware to run it is simple.
How to Play the Rise of the Mega Data Center
There are a few ways to play this trend as an investor…
Data Center Companies: The most obvious is to invest in companies building these large data centers. However, many of those companies are so large that it’s not a direct play on the trend, and would merely be one of several areas that propels stock prices.
Others, like QTS and Equinix, are very expensive by traditional valuation metrics, although they may make attractive acquisition candidates as the industry eventually consolidates.
Data Center Service Companies: Another way is to invest in companies that provide hardware, software, or services for these large data centers. Server companies may see mixed results, as new sales to these centers are offset by falling sales to more traditional data centers. But some companies make specialized hardware for data centers, and the ones at the highest ends of their product specialties will benefit from these centers’ no-corners-cut philosophy.
In our technology-based Digital Fortunes newsletter, I’ve highlighted two companies that should benefit directly from this trend, plus another one more indirectly. And in my VentureCap Strategist premium advisory, I just recommended a little-known small-cap firm that should also be a direct beneficiary.
As for pick-and-shovel-type plays, you might think that air conditioning companies would benefit from the data center trend. But these big centers are increasingly finding ways to use unchilled outside air to cool the buildings. And of course, one major plus point of these centers is that they can use less air conditioning per unit of computing power. So while local installers will benefit, large air conditioning manufacturers aren’t likely to see much advantage from the shift.
Overall, the move towards mega data centers promises better utilization of existing hardware and software technology. It also brings huge pressure to deliver even better technology, as the centers seek to differentiate themselves from each other and from more traditional data centers.
And just as there are semiconductor companies without fabrication facilities of their own, in the future, you may see a major computer company that doesn’t own any of its own computers.
To living and investing in the future,
by Greg Miller