Update: Switch Inc.

September 29, 2022 | Premium Service | This week, The Institutional Risk Analyst takes a look at the battered fintech space. Most of the names on our surveillance list are down double-digits for the year. But one name, Switch (SWCH), a provider of “colocation space and related services to global enterprises, financial companies, government agencies, and others that conduct critical business on the internet,” is up double-digits so far this year. But is SWCH really a fintech company? And why is it going private?

In November 2021, SWCH approved the pursuit of a real estate investment trust (“REIT”) conversion with a target of electing REIT status for the taxable year beginning January 1, 2023. We have a position in SWCH. As with other industry sectors, the providers of enablement to the fintech sector such as SWCH may have better prospects than some of the participants. The slide below shows some of the recent metrics from SWCH.

While SWCH has good financial performance, it lacks the hyperbolic aspects of many fintech business models and related high market betas, a measure of volatility. The basic play here is providing servicers for a variety of customers with somewhat of a focus on the financial sector. The fact of the REIT conversion, however, gives you a good way to think about the opportunity, namely stable cash flow based upon a growing customer base. SCHW has delivered double-digit revenue growth between 2015 and 2021.

Computer hardware, and finance and banking, each provide about 30% of top contracts, while the other sectors are smaller and more diverse. The guidance provided by SWCH to investors is for continued growth in revenue and EBITDA, a far cry from many of the new entrants to the fintech space. While the costs and revenue of SWCH are relatively stable, many of the resident of Fintech are experiencing significant volatility in terms of interest rates and revenue.

SWCH is trading at a lofty multiple to earnings, but given the rate of investment a growth, this is not surprising. While the market value of equity has risen 32% over the past year, the stock is still at a 0.6 beta vs the S&P. This is not a racy hyperbolic story like so many of the names in the fintech space. It is, however, a way to benefit from the growing need for colocation and other services to support financial and other firms that value state-of-the-art capacity. Our fintech surveillance group is shown below.

Source: Bloomberg (09/28/22)

While at present SWCH has only a 0.62% dividend yield, we expect to see that number grow in absolute terms and relative to revenue over time. That is, after all, the point of the conversion to an equity REIT effective at the start of 2023. We liked SWCH for the same reason we entered Block Inc. (SQ) years ago, namely a new entrant that is plying an established route but with better strategy. But sadly now SWCH is being taken private by DigitalBridge Group, Inc and an affiliate of global infrastructure investor IFM Investors.

Ultimately, SWCH is not a fintech play and should be compared to other specialized operators of industrial and logistics facilities in the equity REIT sector. SWCH is performing above the rate of total returns for the data center REITs, according to Nareit. That portion of the equity REIT space that avoids legacy urban office and multifamily assets and focuses instead on commercial, industrial and specialty applications such as finance and technology is in our view an ideal sector for growth in the near term and income medium to longer-term. And that is precisely why this attractive company is being taken private.

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