Key Points
Governor-elect Gina Hinojosa plans to extend the suspension on new data center approvals and freeze electricity rates.
That’s bad news for neocloud companies, data center REITs, and AI-driven utilities.
The Democrats swept the U.S. midterm elections on Nov. 3, taking over the House and Senate while flipping the governorships of five states -- Georgia, Iowa, Nevada, Ohio, and Texas -- from red to blue. All five states host a massive number of data centers for the AI market.
Texas, the largest of the five states, was expected to host 41% of new U.S. data center capacity by 2028, according to SemiAnalysis. However, governor-elect Gina Hinojosa, who will be sworn in on Jan. 17, plans to extend and harden the state's pause on new AI and data center approvals. Texas' current governor, Greg Abbott, had already suspended environmental permits and grid connections for new data centers pending an audit in September.
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That suspension was expected to end after the audit concluded by the end of the year, but Hinojosa could freeze the market for the foreseeable future. That's bad news for any neocloud company, data center operator, or AI-driven energy provider that depends on Texas.
Which neocloud companies will struggle?
Neocloud companies buy and lease data centers, fill them up with GPUs, and provide raw computing power to process AI tasks. They thrived when interest rates were stable, and the AI market was expanding. However, most of these high-growth neocloud companies are unprofitable and highly leveraged, and they're issuing more shares to stay solvent.
The public neocloud companies with the most exposure to Texas include IREN (NASDAQ: IREN), Core Scientific (NASDAQ: CORZ), and Cipher Digital (NASDAQ: CIFR). If Texas extends its freeze on new data center approvals, these companies could struggle to increase their capacity to meet the AI market's soaring compute demands.
Which data center REITs will struggle?
Data center real estate investment trusts (REITs) buy data centers, rent them out to cloud infrastructure companies, and split that income with their investors. They need to distribute at least 90% of their taxable income as dividends to maintain a low tax rate.
Data center REITs are an appealing way to earn some steady passive income while staying exposed to the growing cloud and AI markets. However, Digital Realty Trust (NYSE: DLR) -- one of the country's largest data center REITs -- hosts about 10% of its data centers in Texas. If it's unable to expand its core hubs and campuses in the DFW, Austin, and Houston areas, it could struggle to raise its dividends or widen its moat against its more diversified competitors. Most of Digital Realty's publicly traded competitors, including Equinix (NASDAQ: EQIX), operate a much smaller percentage of their data centers in the Lone Star State.
Which AI-oriented utilities will struggle?
The data center market's rapid expansion generated robust tailwinds for energy providers over the past few years. However, governor-elect Hinojosa plans to issue an emergency executive order to freeze electricity rates on her first day in office.
Those frozen electricity rates, along with the suspension of new data center permits, will inevitably hurt Vistra (NYSE: VST), the largest electricity generator in Texas. Vistra owns gas-fired plants, solar energy plants, and battery storage facilities across the state, and it's been the prime beneficiary of hyperscaler Power Purchase Agreements (PPAs).
That slowdown will also likely affect companies like GE Vernova (NYSE: GEV) and Vertiv (NYSE: VRT), which build components for the expansion of that energy infrastructure.
Should investors avoid all of these stocks?
The data center market faces some tough near-term headwinds in Texas. But over the long term, the market should continue to grow as more companies expand their AI businesses. So if you expect IREN, Digital Realty, Vistra, and their peers to weather those challenges and keep growing, it could be a great time to buy their beaten-down stocks.
Leo Sun has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Equinix, GE Vernova, Vertiv, and Vistra. The Motley Fool recommends Digital Realty Trust. The Motley Fool has a disclosure policy.