Will Cyrus One Be The First “Hot IPO” Of 2013?

Each year, the IPO market grinds to a halt from about December 15 to January 15. Investment bankers apparently like to celebrate the holidays, too.

Given that it’s now January 17, it’s time for them to get back to work. And sure enough, five companies plan to go public this week.

At first glance, CyrusOne (CONE) stands out as the most compelling of the bunch.

It’s a newly formed REIT that owns datacenters and rents them out to blue-chip companies, including nine of the Fortune 20 and 108 of the Fortune 1,000. As such, it’s operating in the sweet spot of the “big data” boom.

Remember, by 2020, IDC expects the amount of data that businesses handle to balloon 44-fold. And all that data needs to be stored somewhere.

Of course, being tethered to a confirmed hypergrowth trend doesn’t mean we should automatically invest in a company. We need to be a tad more particular.

With that in mind, let’s run CyrusOne through our gauntlet. That is, the five hallmarks of a hot IPO that we previously identified.

If CyrusOne doesn’t measure up, we shouldn’t bother with the stock when trading begins tomorrow. No matter how much hype surrounds the deal.

So let’s get to it…

~Hot IPO Hallmark #1: Age
The older and more established a company is when it goes public, the better the stock tends to perform. And at first blush, CyrusOne’s SEC filings suggest that the company is less than one year old, founded on July 31, 2012. But it’s actually been around for over a decade, run as a separate unit of Cincinnati Bell (CBB).

Management recently decided to spin off the operations as a separate entity. Long story short, despite appearances to the contrary, CyrusOne passes our age requirement.

~Hot IPO Hallmark #2: Verifiable Growth Opportunity
An IPO is an investment in the future growth of a company. So the company better be growing – and positioned to keep growing. CyrusOne passes muster.

In the last quarter, revenue increased 22%.

As for the future, given the enormity of the Big Data boom and the resulting demand for storage, the only thing that can hold back CyrusOne’s growth is its ability to secure physical real estate to build datacenters. The good news? It’s sitting pretty in terms of space to develop.

In addition to its 1.63 million net rentable square feet (NRSF), the company is developing vacant properties and new facilities to add another 379,000 NRSF in three attractive markets. It has about 762,000 NRSF of space that’s powered, connected and ready to be developed to a client’s specifications. Plus, it’s sitting on 146 acres of land to build even more datacenters on.

~Hot IPO Hallmark #3: Revenue
Research from University of Florida professor, Jay Ritter, shows that shares of companies with more than $50 million in sales before they go public perform best in the aftermarket. CyrusOne easily meets this requirement. Over the last 12 months, the company generated over $210 million in sales.

~Hot IPO Hallmark #4: Profitability
As I’ve said countless times before, share prices ultimately follow earnings. And IPOs are no exception.

As for CyrusOne, it’s been profitable on an annual basis since 2009. Although results for the fourth quarter of 2012 aren’t in yet, the company is on track to report another year of profits. That is, if we strip out one-time impairment charges related to a 2007 acquisition of GramTel.

Given capital spending in excess of $100 million each year, there’s ample opportunity for the company to keep increasing its profits as it brings more available space online.

~Hot IPO Hallmark #5: Valuation
The most important factor for investing in IPOs is valuation. We never want to overpay.

In this case, it’s easy to determine a fair value range for CyrusOne, because another similar-sized datacenter REIT is already publicly traded – CoreSite Realty Corp. (COR).

CoreSite is a solid proxy, too. It operates about the same amount of datacenter space (1.2 million NRSF), generates about the same amount of revenue ($197 million) and is increasing sales at a nearly identical rate (21% in the last quarter).

Based on CoreSite’s price-to-sales (P/S) ratio, CyrusOne should be worth about $10.90 per share.

Since we’re dealing with REITs, price-to-earnings ratios aren’t relevant. Remember, REITs must pass 95% of their income on to shareholders, so they shouldn’t be showing big profits. Instead, we focus on funds from operations (FFO). Based on CoreSite’s price-to-FFO ratio, CyrusOne is worth about $10.25 per share.

Add it all up, and the proposed pricing range for CyrusOne of $16 to $18 looks a bit steep.

If I compare CyrusOne to larger datacenter REITs, a valuation up to $20 per share can be justified. But that still doesn’t leave much room to profit if the stock begins trading at $18.

Bottom line: Wait to see if a more attractive entry point materializes (below $12 per share). It might not. But if it does, we’ll definitely be getting a bargain. At the same time, we’ll be earning a higher yield, too.

As a REIT, CyrusOne plans to pay an annual dividend of $0.64 per share, which represents a 3.6% to 4% yield based on the proposed price range. That’s in line with CoreSite’s yield of 3.6%. But if we can scoop up shares for $12 or less, CyrusOne’s yield would top 5%, which is much more attractive.

So be patient and don’t overpay.

If a price drop never materializes, don’t worry about it. With more than 115 IPOs in the pipeline, we’ll have plenty of opportunities to profit in 2013. Speaking of which, we already singled out three potential “hot IPOs” to track in 2013 in our special report. (All you have to do to access the free report is click here.)

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