Short seller Jim Chanos is betting against “legacy” data centres that now face growing competition from the trio of tech giants that have been their biggest customers.
Chanos, who remains best-known for predicting the collapse of energy group Enron two decades ago, is raising several hundred million dollars for a fund that will take short positions in US-listed real estate investment trusts.
“This is our big short right now,” Chanos said in an interview. “The story is that although the cloud is growing, the cloud is their enemy, not their business. Value is accruing to the cloud companies, not the bricks-and-mortar legacy data centres.”
Data centres owned by groups such as Digital Realty Trust and Equinix are vast warehouses of servers that power large swaths of the internet.
The growth in demand for data centres has been a big theme for institutional investors, who are seeking to tap into the global expansion of cloud computing. Last year $915bn alternatives manager Blackstone bought QTS Realty Trust for around $10bn, at the time the largest deal in data centre history.
Mike Forman, managing director of Blackstone Real Estate, said in February that the deal was designed to capitalise on “exponential” growth in data creation and storage requirements. “‘The cloud’ is not literally in the clouds; it is in physical datacentre assets. This all translates into unprecedented demand for data centres that is expected to grow at double-digit rates over the next decade in the US and internationally.”
The three biggest cloud providers, Amazon Web Services, Google Cloud and Microsoft Azure, are by far the largest tenants of data centres. Chanos’ thesis is that these three “hyperscalers” prefer to build data centres to their own design rather than moving into existing ones; and when they do outsource, they typically offer low returns to their development partners. Chanos also said he believes that the real estate investment trusts are overvalued and are in for a period of declining revenue and earnings growth.
“The real problem for data centre Reits is technical obsolescence,” said Chanos. “Their three biggest customers are becoming their biggest competitors. And when your biggest competitors are three of the most vicious competitors in the world then you have a problem.”
Chanos has built a career out of trying to identify corporate disasters-in-the making. In 2020 he made $100mn from shorting the Germany payments company Wirecard, which filed for bankruptcy that year after admitting that €1.9bn of its cash probably did “not exist”. But he has also been burnt by a high-profile short position in Elon Musk’s electric carmaker Tesla, whose share price has soared.
The past decade has been a challenging one for short sellers, as trillions of dollars of central bank stimulus turbocharged a bull market for US equities and lifted asset prices indiscriminately across the board. Chanos has struggled to raise money in this environment: the firm’s assets peaked at around $7bn after 2008 when its short-only Ursus fund — named after the Latin for “bear” — gained 44 per cent net of fees, and have been slowly declining since then. The firm now runs around $500mn.
In 2020 Chanos sold a minority stake in the management company to boutique investment firm Conlon & Co. Since then he has hired a team of options traders to help structure its short positions and rebranded Kynikos Associates, the investment firm he launched in 1985, as Chanos & Company.
Chanos said that years of soaring equity valuations have made investors complacent. “One of the things that amazes me is how sanguine inventors are,” he said. “People just shrug their shoulders and don’t seem to notice where equity valuations are today versus historically and that there are so many flawed business models. It’s a little bit baffling that no one seems to think they need financial insurance because it’s pretty cheap. It’s another reason to be more cautious — no one is beating down the door of short sellers these days.”
Tech stocks have been pummeled this year as investors grapple with higher inflation and interest rates. This has been a boost to Chanos, who has described the current environment as “the dotcom era on steroids,” luring investor capital into lossmaking unicorns, special purpose acquisition companies, cryptocurrencies and non-fungible tokens.
This year Ursus is up about 30 per cent, compared with a fall of more than 25 per cent for the technology-heavy Nasdaq Composite share index. Two of the biggest contributors to the fund’s performance have been its short positions in cryptocurrency exchange platform Coinbase, and online used car retailer Carvana, both of which have suffered steep losses. Meanwhile a “tail risk” strategy, designed to protect investors against extreme events, is up more than 200 per cent in the same period.
Chanos believes that as the market cycle turns and a sell-off in stock markets continues, it will be a fertile environment for short sellers: “We’ll be feasting on the returns of these stock ideas for years — very similar to the post-dotcom era.”
Additional reporting by Tabby Kinder and Kaye Wiggins