Digital Realty Trust, Inc. (DLR) Earnings Call Transcript & Summary

[Audio Gap] Property CEO Conference. I'm Mike Rollins at Citi Research, and we're pleased to have with us Digital Realty and CFO, Andy Power. This session is for investing clients only. If media or other individuals are on the line, please disconnect now. Disclosures are available up here and on the webcast on the disclosures tab. For those in the room or in the webcast, you could sign on to liveqa.com, enter the code Citi2020 with a capital C to submit any questions, or you could just raise your hand or push the button on your microphone, and we welcome the opportunity to get you involved in the conversation today. I'm also joined by Michael Bilerman to co-host this session. And we're going to turn it over to Andy, who can introduce the company, the management team that's with you today, Andy, and if you could provide the audience with 3 reasons why investors should buy your stock today, and then we'll begin the Q&A session.

Because Andy just had a baby, and he needs the stock to go up to be able to handle being a father.

I got an education and probably a wedding to pay for, so I've been working.

Yes. Everyone should congratulate Andy on the birth of his first child.

Well, thank you, Mike, and thank you, Michael. Again, I'm Andy Power, CFO of Digital Realty. Our CEO, Bill Stein, sends his regards. He's quickly recovering from a common cold, and I'm sure he'll see us at the next investor event we're at. To my far right, we've got our Head of Investor Relations, John Stewart; and to my immediate right, we have our Chief Investment Officer, Greg Wright. We very much appreciate to see everyone here in Florida at the Citi Conference. Digital Realty, a leading global provider of data center and interconnection solutions, pro forma for our most recent combination across 20 countries, 44 markets and 6 continents. Three reasons why I am very much a recommender of Digital Realty's stock as investment, I'll say, one, we are very fortunate to be blessed by secular tailwinds in terms of demand. That's backed by our overall technology trends and underpinned by cloud computing and overall digital transformation. Within that, we've charted a strategy that goes after the largest addressable market, going after the enterprise colocation customer all the way to the hyperscaler cloud computing customer. Two, I think we are executing upon a transformation of our own here at Digital Realty, recrafting our portfolio on a tremendously global scale with full dedication across the full product spectrum that is creating a PlatformDIGITAL, what really differentiates us for our customers and from our peers. I think we are widening our moat against our customers. We are extending our global footprint. I think we're extending our commitment, our lead, helping the hyperscale customers, and we're going after an enterprise market on a global stage that's seeking alternatives and taking share from our smaller, more regionally focused private competitors. And three, I know I'm biased, but I believe we have the best balance sheet in the data center business. That's a balance sheet that I think could weather any storm, like the one we are somewhat currently in and one that really can fuel the growth opportunities for our customers.

Thanks for that.

We've been starting each one of these sessions, Andy, by asking about ESG, which obviously is an increasing importance for all company stakeholders. What is one thing that Digital is doing to improve the company's overall ESG score over the next 12 months? So looking to the future.

That's a tough one to net out to one specific item, but let me give it a try. I think maybe one for each of the letters in subparts. I think on the E part, we are pressing our advantage in terms of renewable power and greening our portfolio in how we design, build and procure power. Two, we are actively supporting diversity in our workforce, supporting women's leadership forms internally, hiring veterans from the local communities. And three, on a governance standpoint, we are diversifying, and our Board recently expanded with the additions of a retired Lieutenant General Dash Jamieson and also Alexis Black Björlin, 2 great additions to our Board from a leadership standpoint. So all recent events, and we put that together with our first ESG report, which we released in 2019 and we'll improve upon in 2020, I think, will be spreading the good word about our ESG efforts.

How do you think when you go back to 4Q results and guidance, now you weren't on the call, so I don't know, maybe you just didn't have the time and they needed you to bless guidance, but the company didn't do that, which is unusual even though you had the Interxion merger, which was uncertain, you had sort of put some goalposts around what the contribution would be. So I wonder why the company didn't at least give some form of guidance subject to this amount of earnings coming from the merger on an annualized basis when it comes. So maybe you can talk a little bit about the decision not to provide it and when it should be coming given that the merger seems to be on its way to close.

Sure. So I will spare the -- the guidance was with me in the delivery room and just couldn't get it back to the office in time, joke. Realistically, I think we took an approach when it came to guidance was give some guidance, but not our typical playbook. Really, that was on the heels of -- now could be weeks away from a highly strategic and complementary, including overlapping markets, combination for an $8.5 billion European company as well as the moving parts around our buyout of our partner of the highly connected Westin Building in the Pacific Northwest. Rather than give one set of detailed numbers then revise those numbers a handful of weeks later, we figured it best to delay the actual full guidance in typical digital fashion to our first quarter call when we firmly believe that those 2 transactions will have closed and instead give high level goalposts on revenue on an organic basis, margin, capital, financing ins and outs to give some confidence around the business as well as a few other forward-looking data points in terms of activity at least one of our key markets during the first quarter of 2020 and our thoughts in occupancy improvement during the year. Listen, that's a decision we didn't take lightly. We had a lot of thought going into it in advance, and I think it's the right decision. And I think the timing of our 2 strategic transactions I just mentioned, coming even a little bit quicker than we expected, is going to make that even a more prudent decision. And I think we'll be releasing that guidance in a little -- in a handful of weeks in the first quarter earnings call. So not too long to wait.

So you'll do it before the earnings?

On the earnings call.

Oh, on the earnings. So you won't do it as the deals close?

Correct.

So maybe as a segue, just to get an update in terms of where you are with the proposed transaction with Interxion and what steps are left in the process.

Do you want to take that question?

Sure. Let's go -- just go through it. So originally, when we started, we had 5 governmental requirements we needed to get through. There were 3 antitrust. We're through all 3. That was Germany, Austria and Amsterdam. We're through those 3. We then had 2, which called critical infrastructure, governmental approvals we needed. One was Germany, one was France. We had received Germany several -- 2 weeks ago. And then last week, we were fortunate enough to receive the approval from France. So at that point, we've received all 5. The reason that's important is on the 27th, both we and Interxion had our shareholder vote. They were both unanimously approved, over 90% approval from each of the sets of shareholders. But given that this is a Dutch domiciled company, not only do you just have the shareholder vote, we then have a tender offer. So our tender offer now is outstanding and it expires on March 9. As we look to this point in our process, one thing I want to make sure our folks are aware of, again that expires at 12:01 on March 9, which if you're looking at your calendars, that puts you at Monday. Well, clearly, you have Sunday and Saturday before that. So for those of you who are tendering, you need to get this done by Friday. And the reason we say Friday is important and make sure all investors understand is 2 things. One, if a shareholder does not tender here, they're subject to a 15% Dutch withholding tax. So we don't want people to incur that. And then, two, given the timing of when this transaction is coming together, we are paying dividends to shareholders of record as of the 17th. And if folks come in by Friday, they're going to be in a position to receive an $0.80 dividend. So again, we encourage investors out there who are Interxion shareholders to get your tender done by Friday. And that's basically where we are as well, Mike.

So maybe just taking a step back, can you review the priorities for Digital for the year and the progress that you're making towards those priorities now that we're a couple of months into the year?

Sure, a handful of products. I think, first and foremost, we're focused on PlatformDIGITAL, which is really our opportunity to go after the enterprise addressable market on a global stage and be a global alternative to what's available today. It's about the physical puzzle pieces we have been putting together, whether it's the Westin Building, highly connected destinations or Interxion combination. It's about the coverage geographically in the 20 countries we will be across, trimming from Tokyo and Osaka to Frankfurt. And it's really about making sure our sales team on the ground has the value proposition to identify the right target enterprise customers, identify their pain points and deliver value in terms of improved performance and cost as they look at the numerous challenges, adopting multi-hybrid cloud options, addressing security, re-networking, whatever it may be. So a lot of effort has been going into that. It was launched this past fall on the back of the reincarnation of our MarketplaceLIVE customer event. Our sales and marketing team go-to-market has been around that. We'll continue to invest that in bringing on the coverage and capacity with new colocation sites globally. So platform digitalization priority #1 by far. Two, I think we need to do the supporting work behind the scenes to continue to strengthen our portfolio. And geographically, that's been extending the footprint into new key places and destinations where both our enterprise and our hyperscaler customers want us to be. Prior to the pending transaction, our work has been entering countries like Seoul, South Korea, which will be the first truly carrier-neutral colocation interconnection location in that country. We've been in similar work in Japan, both in Osaka and Tokyo, and that's a new market entry. And also expanding our footprint, our Ascenty platform in Latin America has expanded into its second country with Santiago, Chile last year. I think you can expect a further growth in that region of the world to come. And then, obviously, in Europe, this transaction is highly strategic in terms of adding, I believe, 9 incremental countries to our footprint. And I think the platform will further grow from there into additional exposure in Europe. So being at the places where our customers need it with the capabilities is the second priority.

I remember from one of our conversations that the focus incrementally from a sales and bookings perspective is more enterprise customers that might be smaller but offer better yields. Is there progress on that over the first couple of months post the sales kickoff?

So I think the enterprise market is a place where we've been applying this focus because we see a large opportunity because we have the core competencies and capabilities in place that we have delivered a tremendous amount of value to that customer base, and it's a large and growing customer base. There's some 30,000 enterprises that have are spending over $100 million -- or have $100 million of revenue, excuse me. There is 5,000 of them across 2 to 3 countries. So a large addressable market where we have core competencies, and we hear from our customer base that they're seeking alternatives to the one global option they have today. I think that is an area where we've tackled it in many parts of our business. It's been about our brand to the third parties and industry influencers, those who are helping the IT executives on their decisions. It's really about equipping our reps with the right content. It's been the right -- about having the right destinations, those highly connected destinations that we've had at Digital, being our 350 Cermak, 56 Marietta, the ones we're picking up through these recent combinations or partner buyouts. And it's also having the full product spectrum to help an enterprise who is landing in a new topography than it did in prior generations, more distributed, distribution of workloads between networks and compute. And we have the full product spectrum to help those enterprise customers.

And one question that we've been asking in the sessions today is just how you see the potential impact related to coronavirus, both to your company and operations as well as how it might affect your customers and their business dealings with you.

One, we obviously take it very seriously, and we're still in very, very early days. Maybe I can talk to the customer side and the supply chain side. On the customer side, I would say, to date, we've seen limited impact. We've been doing business very recently with customers into APAC and out of APAC. We are obviously big believers in a virtual world. It's thriving through our data centers every day, and business is getting done in a virtual format in many fronts. That being said, we have no idea where this current scenario goes, and there's always a potential impact to business. My glass half-full on that is the breadth of our customer base, 2,000 today, going to close to 4,000 with our combination or depth of relationship, both personally and contractually, with some of these top buyers, allows for easy repeat buying and allows us to keep continuing to support their business in the event that they don't have the physical ability to go to a new location as they've seen most of our sites. They know our capability. We're on board as a vendor with them. From a supply chain standpoint, we obviously have the potential risk of impact given numerous components within our 4 walls, could be manufacturer or importer for some of the countries impacted. From our advanced discussions that well predate today, where we are on this coronavirus, we feel that we look -- appear to be insulated, whether it pertains to batteries, UPS, switchgear, for at least 12 months' worth of time. So, so far so good. But again, as I mentioned in the opening statements, we don't know where this is going. We take it very seriously. And lastly, and I probably should put this front, from a people front at Digital, we are relatively small in the people front. Today, only 1,500 employees, but we are very international. So we've taken steps to shut down all travel into and out of APAC. That happened several days ago, and we'll obviously evaluate this step-by-step as things need to be evaluated for other international parts of the world.

There's some questions that came over live QA and through the webcast. One of which is during your last earnings call, you said that disclosure would evolve. Does that mean that you will no longer guide to same-store NOI and guide to overall EBITDA like Interxion and Equinix have done historically, which obviously would be less disclosure? Could you please clarify what you mean? Because historically, your disclosure has been very good.

Thank you. I think we owe that to our guy 2 seats over, leading the way on disclosure. So that comment does not pertain whatsoever to our guidance table or our same-store NOI table or any redaction of the disclosure. That table, which if you -- I want to take the time and go back, I think, 2 additional earnings calls ago to, which we've been trying to get previous for, is how we see the business evolving. And just like our platform spans the full whole product spectrum and catering to enterprise customers, legacy rack and cage cabinet type buyers to dedicated suite buyers, we see the lines between the products blurring between colocation, scale and even hyperscale in some regards. So our disclosure that is going to evolve is how we disclose our new signings and the granularity at a product level basis. And in lieu of bucketing things, this is colocation and this is scale, we're going to go to more of a size-based type of disclosure deals under 200 kilowatts, 200 to 600 kilowatts, less than 1 megawatt. So you still have the same granularity around pricing, but it actually removes friction, I believe, from our customers and from our internal team members who are looking at these stats as they will. That was really that -- is that really colocation that really help us form a scale deal? Was that really scale? Now the use case felt more like colocation, so that was really the genesis of evolution of our disclosure.

Another question that came in through here was why should we think that this hybrid global campus approach of putting retail next to wholesale will work for you when your largest competitor, Equinix, does not believe that to be the case?

As I think -- I think we're not wholeheartedly betting our horse on this retail next to colo. We have these -- some of the most network-dense locations, which pro forma for our buyout of our partner, Interxion combination will be roughly 50%, and the other part of our portfolio, which is what you described as the Connected Campus has much more flexibility and agility around what we can deliver in terms of size and scale and density. We are here to address the broadest addressable market and not try to squeeze customers into a legacy colocation format that doesn't work for their business model today.

Right. As I think about just sort of deal volume, I think Digital has always been a deal-oriented company. Both of you were advisers to Digital in a lot of the transactions that the company has undertaken. And you can never know when deals come about, right? You could be working on something for multiple years and stars align and things occur. Can you just talk about -- it has been very active over the last 12 months, whether it's Ascenty that closed, whether it's Interxion, you did this deal in Seattle. You had the joint ventures. There's been a lot of activity. How should we think about the stuff that's been in the works maybe for the last couple of years? Or is it really quiet at this point? And the next, let's call it, I don't want to hold you to 5 years, let's say, the next 12 to 18 months, is it going to just be more about seeing the execution of all these things that you've done? Or will we see other things pop up? Talking to 2 former investment bankers that are probably hungry for a deal. Sorry.

We're hungry for growing revenues and cash flow. That's first and foremost. Maybe we'll emanate this one a little bit. Listen, Michael, I think the way we looked at this really under our CEO, Bill Stein's strategic direction over the last 5-plus years was really try to differentiate this platform to make it -- distance ourselves from our competitors and make us more value-add to our customers. And that was about being more global, having more scale and have a commitment to the full product spectrum. And along the way here, we did a lot of that organically. The close to 1,000 acres of land capacity adjacent to our campuses to future-proof our customers' growth is key to that as well as our development pipeline. But we also participated in inorganic M&A activity to really put together critical puzzle pieces, which I think strengthens our portfolio and do it in a prudent fashion along the way. And I'm a firm believer, the actions we've made have continued to widen the gap relative to our competitors in the long run and make us at the table with the customers as they mature their buying and want to align with true global multiproduct partners and along the way picked up, I think, some puzzle pieces at attractive valuations and returns that will be quite irreplaceable for our industry. So luckily, we've taken approach prior to that and during that with true prudence towards the balance sheet, maintaining our target leverage levels with every transaction, more than ample liquidity along the way, not gaining interest rate risk or access to capital, running our dividend payout, which we -- a dividend which increased every year for, I believe, the last 15 years at a very conservative runway so that we can tolerate some interim dilution and set ourselves up to put the puzzle pieces together. I'll let Greg speak to what he sees as the next -- your 5-year forecast for M&A.

But I want to go shorter because I just think that there's an element that is the puzzle done, right? And if you look on a historical perspective, your stock has not outperformed the peers. And so the question is at this point now that you've put all these pieces in place, will the execution of now this global platform with the right balance sheet and the joint venture partners and everything together lead to that outperformance? I mean you're not happy where the stock is, and so how do you balance those things?

Michael, I think you actually asked a couple of questions there. One, let's be clear, I mean, in terms of the near- to intermediate-term integration and execution are our primary objectives, okay? So that's one. I think you asked a couple of different questions in that question. Two, you also worked in dispositions as part of your -- let me have questions there you went through. Look, I think it was at this conference last year when we first started talking to the market about dispositions and how we thought about it. And look, I think we're strong believers, as we conveyed then, and we remain strong believers today that capital recycling is a smart part of capital allocation. We also said at that time that we thought there'd be a few billion dollars over a few years. So we did roughly $1.5 billion, $1.4 billion this year. I know -- so when you sit there and say, when does the next piece come? We're not sure. And I think the same thing we said at this time last year, we constantly look at our portfolio. We try to figure out what are strategic assets for us. Just like last time I went through whether it was the power-based building assets we sold, but then we ended up JV-ing assets that were the turnkey assets we decide to keep. We'll take that same kind of prudent approach, and we're only going to sell assets, one, if we think we can get fair value for these assets. These are not fire sales. So we'll continue to look at that. And so it's hard to give guidance, if you will, on timing and amounts because of that. But we will continue to extract capital from assets that are good assets, by the way, maybe good markets that are just not core to us and then recycle that capital, whether it's in a Westin-type transaction or into development type transaction. So I think it's important when you ask that question to understand there are different pieces there. But if you're asking if we're going to turn around and go do a $10 billion deal in short order, the answer is no. I mean right now, our focus is going to be on integrating Interxion and executing on the business plan.

There was a question that came in about sort of the broader infrastructure space. You think about towers and data centers supporting that growth. And the question is do you see towers being a strategic partner with 5G as compute moves closer to the edge?

I think towers are a strategic part of the critical infrastructure business that we're in. I'm not sure they have to 100% be under the same ownership house. But I think the way that question was phrased about critical partnerships, and I look at the towers, no different than many other partners in our ecosystem. Fiber providers, system integrators are really extending our capabilities and making it easy for our enterprise and our cloud service provider customers to do business. So I look at this extension, I look there is a true partnership, but I'm not sure it has to be one wholly owned complete business together.

So one of the things that stood out of the S-4 when you were discussing the transaction with Interxion was just the quantum of capital spending over the next few years, both for digital stand-alone in the reported business plan as well as for the Interxion business plan. Can you talk to how you're looking at these capital deployments and development over the next few years that was the premise of those plans? And how you think about -- as we're talking about capital allocation earlier, just how you're thinking about the funding and the returns that you're looking to get out of the pipeline?

So I think there's 2 components. Obviously, the Interxion leadership team put together a plan, which I would say is a strong continuation of their playbook, which has proven highly successful across Europe to date. And it's very analogous to expanding campuses and continue to cultivate and curate communities of interest, bringing more and more values, always with the customer at the heart of the story. And I think in that plan, you saw 2 things. You obviously saw scaling of CapEx. I think that dovetails nicely with the commentary you've heard from that team as they sell this business, everything getting bigger. That's not a 2019 or 2020 trend. That's been in the works and it's going to continue to accelerate. That's partly, just globally, our business has gotten more capital intensive. And two, Europe is in a stage, I would say, somewhat behind North America in terms of its geographic buildout. And lastly, I would imagine the plan also includes adding new locations in the not-too-distant future to be -- which will further strengthen our combined company platform. At Digital, I think you see a lot of the same. Our capital intensity is going to build out the land holdings we already own or control at our campuses as well as cultivating our version of communities of interest, just same concept, different lingo across North America and also in other major international markets. I look at Asia Pacific, that's a market where it's probably pro forma 6% of our pie. That could be double to triple in the next handful of years. We've just mentioned we're likely -- we just entered a new South America market, we'll likely enter another. The same goes for Asia Pacific. I think North America is probably the one part of the portfolio where we've kind of covered the waterfront. We have the key capabilities, especially accented in the Pacific Northwest addition we're just about to close. And I think -- but you look we're adding new markets, adding more capabilities, and we think that there's a promising investment opportunity. And I would say those return profiles still kind of bucket that same range that we've had in our goalpost from last year, 2019, 9 to 12-ish was the range. They all obviously differ depending on product segment and vertical and country. Different countries have different risk-free rates, and bigger projects in more stabilized economies with wellness contractual lease terms towards the 9s. And numbers that have higher risk or greater timing to achieve those stabilizations could be north of 12s. So I think, combined, we think this platform could fund that CapEx more efficiently from a supply chain standpoint and across the capital standpoint.

And can you discuss what you're seeing on the pricing front in your major markets of operation? Virginia has been a focus for the companies and the buy side for some time, but if you can give us some broad views of what's happening, whether it is by product or by size or by market? And how you see the pricing dynamics right now?

So let me try to do this very quickly in time on the clock. So Northern Virginia, Ashburn, largest market in the world. That is a market that obviously came off a record 2018 step down in demand overall. Some of the biggest buyers going to digestion mode, coupled with an influx of some private supply that certainly put that market in balance. First half of this year, while we were quiet because we had sold out from the year prior, we certainly didn't write it off. And I think we've proved successful with our platform shining through in the back half of the year, call it, 14 megawatts in the third quarter, 18 in the fourth quarter. No deal in those markets north of 6 megawatts. And then we also highlighted on the earnings call that we've signed 20 megawatts early in the first quarter of 2020. So I think we bought -- we fought above our weight class here, winning more than our fair share of market. The returns and rates were obviously lower than our initial underwriting. But we do see some signs of stabilization. And I still think the returns we're generating there are pretty attractive, close to 9%, which I think speaks to our global sales force importing demand from Asia Pacific, importing demand from enterprise customers across London and Europe, that installed base that wants to grow with us on our campuses and customers that value that long runway of growth. Outside of that, in North America, every single market is less competitive than Ashburn by a mile. So I would say better pricing environments, most accentuated on the coast of Santa Clara, which I'd say the tightest markets to big premium. When you leave North America and go out to these other parts of the world, be it Europe, Asia Pacific, Latin America, less competition, harder to do business, tougher to deliver supply, which I think has been helpful to holding rates and returns in all those markets.

Are you ready for some rapid fires?

No, we got 2 minutes and 40 seconds. We've got plenty of set...

We can get that out of the way and we'll get back...

Oh, we'll get back.

So real quick, in your property sector, more or fewer public companies a year from now?

I think in a couple of weeks, there's going to be one fewer.

Don’t. Let's put the exclusion of Interxion on that.

Exclusion of Interxion? What do you think?

Fewer.

What will same-store NOI growth be for your property sector overall, not Digital, in 2021?

2021, low-single digits positive.

What will the 10-year treasury yield be exactly 1 year from today?

1.5.

And in what year will the U.S. enter a recession?

John, you call that one.

2024.

What was that?

2024.

'24.

There was a question here in terms of will the travel restrictions posted by the hyperscale customers, could that affect the sales bookings going forward?

I -- these are some of the largest, most financially sophisticated customers globally. I find it hard to believe that they're not going to figure out a way to do business virtually, given virtual is their business. I know that's a glass half full, and I'm sure to they'll some impact, but I only see if it comes to total travel lockdown, our -- strength of our relationships in places where they already have installed infrastructure or on campuses where they've already visited where we have existing legal agreements and operational SLAs in place, we make it a very easy choice to virtually expand their footprint and not disrupt the growth of their cloud compute business as their partner.

And then do you see China as a strategic market of interest as you expand your global footprint?

We are not in China today. Hong Kong is our closest exposure with one asset. I would say we're monitoring cautiously. And I think we have a few other priorities, whether it's South Korea, expanding in Tokyo and Osaka, growing in Singapore, Sydney and Melbourne. And also, we had an announcement a few months ago about an MOU to look at expanding in India. So I think China is further down the list.

Okay. What did you name your baby?

Madison Elizabeth Power.

I like it. All right. Thanks.

She is perfect, by the way.

Of course, she is. All right. Thank you very much.

Thank you.

Thank you.