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Are data center providers in trouble?

A paradigm shift promises to help cloud providers, but may be harsh on facilities providers and other IT outsourcing businesses.

The third quarter of 2011 has been rough for data center providers. Several prominent data center companies, such as Digital Realty Trust, Equinix Inc. and Rackspace US Inc., saw double-digit losses to their stock values from July through September, raising eyebrows among prospective clients concerned about their stability.

Several data center experts saw the losses as a symptom of a larger market problem, rather than a problem with the data center industry per se. In fact, stocks prices at some data center companies did better than the market as a whole through a Q3 that was rough across the board. From July 1 through September, the Dow Jones Industrial Average dropped 1501 points, or 12.1% of its total value. Standard & Poor’s 500 Index, which gives a broader view of the market, was down 14.3% for the quarter. Through that same time, Digital Realty Trust lost 10.7%, Equinix was down 12.1% and Rackspace dropped 20.1%.

Further, those losses at large data center companies came after each saw huge increases through the first half of 2011. Digital Realty Trust had been up 19.9% from Jan. 2011 through June, before dropping off in Q3. Likewise, Equinix was up 24.3% and Rackspace had seen a 36.1% rise in its stock value over the same period.  

Since its dismal Q3 performance, the Dow Jones Industrial Average has rebounded, and so have data center stocks, many of which have completely rebounded and look to be on pace to finish out 2011 on a positive note.

Not out of the woods yet
However, some industry experts expect to see storm clouds ahead for data center companies.

“The industry is in an interesting place right now,” said Chris Steffen, principal technical architect at Kroll Factual Data.  “If you’ve been to a tech conference in the last 12 months, pretty much the only topic of discussion that is universal is cloud computing. When you take into consideration that many companies and industries are moving–or believe the trend is moving–toward the cloud, you have to wonder exactly what that will end up meaning for many of these mid-tier data center companies.”

The wide-spread buzz around cloud computing – not only among data center pros, but also in the consumer market – is leading to a shift in mentality  with many C-level executives, who are beginning to come to terms with the idea of a third party hosting option, Steffen said.

That could mean more business for large managed hosting companies, such as Racksapce, as more companies look to outsource their data center operations.

“I really do believe business for [cloud hosting companies] is going to increase in the long run,” Steffen said. “But, if you are a data center construction company, the analysis really could work the other way. If I had a new tech company that was previously going to build a data center, it is very unlikely, in this day and age, that I’m going to spend that capital in order to build a new data center when there are cloud opportunities I can take advantage of for pennies on the dollar.”

The industry shift to cloud computing may also mean tough times for some colocation providers, according to Kelly Morgan, senior analyst at Tier 1 Research.

“The plain vanilla collocation provider – those that build the space and rent it out without any managed services – they are having a harder time,” Morgan said. “They’ve relied on start-ups, or small businesses starting out with a single cabinet and growing. Now, a lot of those folks are going straight to the cloud.”

Widespread outsourcing to the cloud is still in its early stages, evidenced by SearchDataCenter’s State of the Data Center report, which showed that 64% of data center professionals say they are not considering cloud computing for their data center.

That said, 36% of respondents are considering the cloud in some form or another. That explains the rush of data center companies that have introduced their own cloud service or acquired a cloud provider.

“Companies stuck in the physical space, that don’t have a clear path to cloud computing are going to remain stagnant, go downhill or be acquired. Other companies that are more cloud-centric are going to do well and improve,” said a virtualization architect at an IT consulting firm, on condition of anonymity. This dynamic is already leaving its mark on the data center industry. “You’re going to see this very clearly as a divider within the industry as we move forward. I would estimate that five or six years from now, a lot of the companies we know today won’t be the same. They will either have to restructure or close their doors.” 

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