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

Good morning, or perhaps good afternoon if you're all the way in Europe. My name is Colby Synesael, and I am the Communication Services' Senior Analyst here at Cowen. This is our first virtual presentation for our Cowen TMT Conference. For this virtual presentation, we have Andy Power, who is the Chief Financial Officer of Digital Realty. We have John Stewart, who is the SVP and Head of IR at Digital Realty. So first off, both of you, thanks for being here. Appreciate it.

Thanks for having us, Colby.

I guess we'll just dive right into it, and I wanted to talk about demand. And actually, before I do that, this is, one, a 30-minute presentation fireside. And two is there should be an opportunity to ask questions, which should be at the bottom of your screen. And I have a separate window, I'm looking at to see as those flow in. So by all means, if someone has questions, please let us know. So again, just going back to demand. In the first quarter, Digital reported $75 million in bookings, which was the company's second highest ever. Could you help us unpack the contribution, if any, that first quarter '20 leasing saw, which was tied to COVID-19? There's been a lot of debate from industry perspective that the first quarter may have benefited from a pull-forward. I'm just trying to get more view on that.

Sure. Thanks again, Colby. Really appreciate just getting to spend some time with you and your investors virtually here. So quite pleased with the start out of the gates here for 1Q at Digital. Maybe I'll hit those in reverse order. Honestly, I cannot think of any material kind of pull-forward due to the COVID crisis. Maybe there was a tiny bit of slippage. Partly I think that had to do with -- I mean we went into -- we closed the Interxion deal, I think, on Friday, and we went into corporate headquarters shelter-in-place, kind of shut down everything, really 2 weeks ago. So it wasn't a whole lot of time during 3Q that we were really shut down. I would say, just taking a step back, again, 1Q, $75 million was the second highest. On top of that, our friends at Interxion, Digital Realty company did another $10 million. So it kind of gets close to $85 million. It was robust and diverse in terms of product lines, in terms of geos. Interconnection ticked up. I think it was the second or third highest in several quarters. If you kind of quickly go around the map, each of the regions have great colo, scale and hyperscale wins. North America on the colo connectivity side, New York metro and Atlanta were the lead horses. Down in Latin America, we signed a European partner into our colo facility, which was another great win from our partnership program. In Asia, we had some good -- smaller deals in the colo front in Osaka, which we kicked off not too long ago. And we exported some demand into Europe from our Asia team. So a more -- a smaller and budding APAC name landed our legacy Digital Frankfurt colo facility. You add on top of that a very healthy Interxion contribution where no deal was larger than about 180 kilowatts. And then you kind of go to the other bookend of the spectrum and you got the scale and hyperscale kind of filling in the gaps from some of the known names. We did, again, 90-plus of our signs for existing customers. But overall, a really great new logo quarter at the same time. When you count it all up, it's kind of close to 120 new logos.

So just going back to the initial question as a pull-forward, I mean, you're saying there really wasn't a pull-forward. In fact, maybe the opposite, which is the bookings could have been maybe even better had COVID-19 occurred. And I guess to that point, on your earnings call, Corey Dyer, who's your EVP of Global Sales and Marketing, seemed bullish on the demand pipeline exiting the first quarter. You think that your late-stage pipeline is up 50% quarter-over-quarter. How much of this increase is a function of opportunities that have naturally progressed through your pipeline versus incremental demand driven by COVID-19?

I would say the -- I really don't have a lot on the pipeline, or on the revenue generation side that I would pin on COVID positively and/or negatively. I don't want to get my last comment taken out of context. I can think of a handful of, call it, megawatt deals that may have slipped due to COVID, where it just took a little longer to get the paperwork. It wasn't like a deluge of deals slipped from 1Q to 2Q and vice versa or no pull-forward. But I would say, kind of echoing Corey's comments a little bit, we had a great start to the year, out of the gate strong early. And what I've seen is that momentum, which kind of -- Corey highlighted in his remarks, kind of continued into 2Q, maybe picking up a little bit of what is giving Corey confidence around his pipeline. I think he was specifically talking to enterprise demand and really kind of if you tie it back to what we've been doing, trying to enhance our execution around going after the enterprise, outsourcing, multi-hybrid customer, looking for colo and connectivity on PlatformDIGITAL. So a fit-for-purpose architecture, 20 countries, 44-plus markets, the full product spectrum. And what I left off in that last new comment, 120 new logos, I think just organically, apples-to-apples, 50 -- mid-50s of those were just Digital. I mean that right there was probably a close to 20% increase in our 1Q-over-1Q new logos if you kind of seasonally adjust the time. And so I think you're starting to see the green shoots of PlatformDIGITAL coming together. More customers, especially those enterprise colocation customers, seeing our value proposition. And it's still early days. This is something -- Corey came onboard a year ago. He brought on some key team members to join him along the way. We launched PlatformDIGITAL and our MarketplaceLIVE, reincarnation in the fall. It kind of dovetailed with our buyout of our partner, the Westin Building, a highly connected asset, our closing of the Interxion transaction, really opening up our portfolio for more highly connected destinations for our customers and really be able to deliver the full product spectrum on a global scale.

So I do want to touch a little bit further on the cadence of enterprise demand with COVID-19. But before we go there, just to kind of fill it out. So from a hyperscale demand, I mean, how would you characterize -- I mean you saw a very strong 4Q. You've now seen a strong 1Q. Is that just the traditional or typical ebb and flow that we're seeing? Or would you say, broadly, you're seeing a step-up in the level of hyperscale demand in the last 2 quarters, and hopefully, that should continue?

What I would say is, we've seen an activity step-up and you saw in our 1Q results. But at the same time, I can't speak for the industry, but I can speak for Digital, the hyperscale tide just does not go in and out and we're left naked without signings. I mean 2019 is a great example where we obviously had a material step-down in the hyperscale demand relative to a record sales in '18. Some of the biggest buyers that are buying the 20- and 25-megawatt chunks took a pause for digestion. I think if you look at our 2019 results, overall, we were winning other places with those same hyperscalers and different hyperscalers. And the shape and size and form of those hyperscalers came in from many directions, and I think they were consistently buying with PlatformDIGITAL in many markets. And then look at Ashburn, Virginia, for half a second here. 3Q, 4Q, 1Q, I don't think anyone would have thought that trajectory in the back half of '19 and when people were writing that off as deadsville at the beginning of the year. So I think that's just a microcosm of the depth of our relationships, the numerous places we're helping these hyperscalers and the fact that they're not all in the same exact trajectory in the rates. They're buying in different markets, launching new product offerings of different size and scale. And that unevenness lends itself to provide a little bit more predictability into what could be a lumpy or chunky business. But to -- back to your question, when you have a quarter with the absorption I think we've had, it certainly has been the steady increase of the hyperscale demand has been moving in the right direction in our favor.

Okay. And then just going back to the enterprise demand, can you talk about any changes you saw in the enterprise demand, the last 2 weeks of the first quarter? But to your point, it's really that back half of March where this really became more impactful. And at a high level, what have you seen quarter-to-date? Has -- whatever was happening in that last 2 weeks, has that changed? Or is that still similar?

Well, I think the enterprise demand, like all demand, moved virtual is what you saw. So we had Zoom and BlueJeans and WebEx customer interactions that we had virtual data center tours because the customers could not physically get to the actual sites. We had probably an increase in activity on our portal versus human-to-human interaction. I think there was a very positive response to what Digital was doing as a company and the leadership team in response to the pandemic in terms of putting our customers and employees first in terms of safety. We had numerous inbound from our customers saying, "Hey, you're early with this, Digital. Thank you for taking the leadership role and putting our people first." Then we had a lot of resounding -- for our charitable contributions, from a financial standpoint and also from an incentive standpoint, from our partnership with Megaport in terms of incentivizing several sectors for use of our Service Exchange. When it goes back to particular enterprise demand, I don't think there's -- I saw a dramatic positive or negative shift in body, motion or behavior in those last 2 weeks. You saw what our new logos were, which is a leading indicator for the enterprise demand. We're not pick winning new logos in our global account segment. These are predominantly new enterprise customers. So I don't think -- I think the enterprise, while obviously doing a new work format and somewhat more cautious or broader economic landscape, are kind of saying, you know what, this is as good a time any -- take a broader digital transformation on, and I need to think about a new redistributed workforce. I need to think about what my workforce is going to look like tomorrow, not just today. And I think our capabilities plays right into that sweet spot on a global scale.

I think my takeaway because I want to shift over and talk about a different topic, but my takeaway from your comments on demand is you're really not going out of your way to highlight COVID-19 as being a huge driver of upside demand or downside demand. And while there may be some shifts, for example, in enterprise in terms of the buckets to where it comes from, some customers, for example, that might be more exposed to travel maybe not doing as much, it sounds like you're seeing other areas, maybe finance isn't a good example, picking that up. And the combination is that when we look at the net bookings number that you would have anticipated from enterprise, again, you're not really trying to signal any notable change either a positive or negative. Is that fair?

Yes. I would say, one, we didn't see a drop-off in our enterprise bookings in our pipeline. And I think people need to remember to look at this little lens that the velocity that changed our industry is not like people stopped going to the data center store or stopped consuming our product. So positively or negatively, it's not like you do a rush, impulse buy on what we're offering in terms of connectivity and capacity. I do think the longer-term trends on our workforce and our society from the crisis like this does further lend itself to aligning yourself with a global partner like Digital. When this may not be the first or last pandemic that shuts down our work and travel, why would any enterprise or hyperscaler in the long run wanted to put their people all around the globe in different markets and locations to support their critical infrastructure when we can do this in a seamless, safe fashion and support numerous customers? I also think this crisis may play out, not tomorrow, but in the medium term, as to customers that we're dealing with wanted that repeat business. They want that existing contract. We're not -- because sales engagement is not personal. They're not flying up to these customers' locations right now. So I think that lends itself to the incumbent like a Digital who has 4,000 customers, including our combination with Interxion who has existing long-term agreements across -- around the globe with these customers. So I think that does lend itself to the incumbent certainly in this medium term, as we kind of walk out of what the world looks like in a post shelter-in-place environment.

Shifting over to impacts on guidance is how I put this topic. Post earnings, Digital added a new $1 billion ATM program, having issued $650 million already in the first quarter and noting you will draw down your $1.1 billion for ATM in the second quarter. So before the $1 billion, you'd already taken down, what's that, $1.750 billion. What you noted, provided about $0.08 of dilution in 2020. Can you talk about your current leverage and potential need for incremental capital this year?

And just one clarifying point on that question. So we didn't go issue another $1 billion of equity. We basically brought the size of the program of availability back up to $1 billion because we've issued roughly $650 million under it. I think we -- in the backdrop of where the world currently sits, I think, we saw 2 things. One, we did not see a diminishment in our medium- or longer-term demand outlook. So we didn't pull back on our development CapEx spend guidance. We still see a significant amount of runway of opportunities out there. And we also saw a world, where there's likely capital is and going to continue to get more precious. So these activities, whether it was opportunistically activating or opportunistically accessing our ATM and making sure we have $1 billion of capacity kind of sitting there at already or bringing down our equity forward a little sooner than we previously expected, our balance sheet strengthening moves, albeit with the near-term pain of dilution, but I think, ultimately, will set us up for longer-term growth. When it comes to our leverage, and I can assure you we're on the way out of the woods on the moving parts in terms of -- I don't think I see another quarter or 2 where we close an $8.5 billion transaction, buy out a JV partner, sell $650 million of assets and issuing the ATM. So the complexity is in the -- more in the rearview mirror than front-view mirror or front-view windshield. And we're right at our 5x number today. I'm going to leave -- isolate that from 5 to 5.5x. So we think with our embedded EBITDA growth, the capital we brought down via equity, a liquidity profile that's caused it, when you add all those funds up, including our revolver capacity, I have to call it almost $4 billion. We think the balance sheet is in a great place to fund, which we still see as strong growth opportunities for the company.

Okay. I wanted to shift over and talk about your long-term core FFO per share growth. In the past, management has said that it aspires to grow core FFO per share in the mid- to high single-digit range, which we have interpreted as plus 5% simply. And on your recent earnings call, I believe you affirmed this view. Based on our math, and it's not your math, it's our math, it implies that you need to achieve annualized bookings of about $360 million, or said differently, $90 million a quarter. And in our assumption, I'd point out, we've assumed about 5% annual churn, including Interxion, and then 2% of GAAP renewal spreads. Does -- the math that we've done, does that seem correct? And if so, do you believe that you have the appropriate sales force, the go-to-market strategy and the geographical exposure to achieve this level of consistent -- on a consistent basis?

And so I would say, I read the math from your note, a week or 2 ago. I have not made it all the way through the 350 pages on the edge yet, but it's by my bedside table.

It's great if you're having a hard time falling asleep.

Yes. So come back to me in December of 2022 to see if I've gotten through that. But kidding aside, I think your math is -- it's in the ballpark. I think -- I mean, maybe on the margin in terms of the GAAP spreads or the downtime assumptions depending on the quarter, I think you're relatively in the ballpark, which, quite coincidentally, when you add $10 million from Interxion or $85 million just this quarter, at the same time, I don't think it can be -- that's not going to be our new ad hoc quarterly guidance because there's going to be quarters below that and there's going to be quarters above that. And I think when you go to the heart of your question as to do we feel confident, we're doing the right things to achieve or exceed that growth, be it top line or bottom line, I would say, I think we've worked very hard on multiple fronts to be in that position. And it has been about getting the right puzzle pieces, whether it's Interxion or Ascenty or all the way back to Telx. It's been about investing in human capability and resources. I talked a little bit about our sales and marketing leadership, our PlatformDIGITAL, our customer events, and we're going to continue to invest in that. And I think, you're starting to see some green shoots of tapping into a broader addressable market, an enterprise customer, seeking what we've been offering and a global alternative to what's available today. I also would say, we've also not just been asleep at the wheel of doing other things to make that growth more achievable or outperform that growth, which has been things like capital recycling. When you sell or JV $1.4 billion of assets that are 100% leased, meaning you cannot drive other -- you can hardly drive another ounce of revenue out of the buildings and recycle that capital or retain capital and do inventory capacity or growth that can be leased, that moves the denominator as well, right? So things like that have also gone along with the less physical investments in talent and go-to-market and the right reps and the right value proposition selling to a platform proposition.

Talking about asset recycling, last year at our TMT conference -- so you participated last year as well. Thank you. You noted that Digital is going to revisit tools in its toolkit, including both outright asset sales and potential JVs. I think that Digital could generate a couple of billion dollars over multiple years. And I guess to this point, included in your 2020 guidance is an assumption for a $600 million to $1 billion in asset dispositions. Given the current market environment, do you believe the market is still supportive of asset sales?

Yes. So just to recap, we've -- in the fall of last year, we sold a joint venture interest at about $800-ish million of proceeds. At the beginning of this year, we sold $600 million, $100 million has been outright as well. So that tallies up to $1.4 billion completed. Our guidance is a calendar guidance. So the range of $600 million to $1 billion, that includes the transaction we closed in January. So even my good friend, our CIO, Greg Wright, I don't think can undo that sale. So I think we'll definitely come in at the low end of that guidance at the very least. And I think, we're being prudent and practical to make sure we're ready to sell one-off assets here and there, where the timing is right and also probably some portfolios at the same time. I think this is something that's really at our discretion, given that strong balance sheet. This is not a must-do at this very minute. So we're not -- we don't need to brush assets to market in a dislocated market. I would say the private markets certainly have faced more of dislocation than the public markets when it comes to data centers. As you've seen, the data center sector as an asset class has outperformed most other asset classes, whether it's REIT, infrastructure or just general S&P 500. Part of that is going back to credit sources, where I think private lending to private outfits has been a little bit less flowing than it had been prior to the crisis. But I do think that there will be a private market asset sale market for data centers. And I think at the right time, we will be able to continue to prune our portfolio and recycle capital like we've been doing to the extent of $1.4 billion...

What are the asset that are most likely the best for you to sell. I imagine it's ones that are largely full, stable, generating good cash flow, hopefully good tenants long term, but not really providing the growth, if you will, that maybe you're looking for.

Yes. I would slice the characteristics into 2 examples that we just completed, plus probably one other. The joint venture we completed, 80% interest and $1 billion assets, that was a core asset to Digital. Those were core customers on a campus in a major market we want to be for the long term. And we sold a majority ownership, but we retained operational control and have various rights to protect the long-term home with that asset. So that's one example. The outright PBB, or Power Base Building sale was assets where we did not operate the asset. They were occupied from some of our reseller customers where -- so sometime a customer and sometime a competitor. So those are kind of fully leased. We just renewed the contracts for, call it, almost 15 years. Kind of the juice had been fully squeezed. And we were able to trade -- or sell those assets at a very attractive valuation because they want the markets or the operational capacity or the growth that was requisite to our go-forward story at PlatformDIGITAL. I think in addition to that, so I think we still have more of those kind of Power Base Buildings, kind of buildings that we do not operate long-term leases that are prime disposition candidates. And then we'll also look at some, call it, market pruning. Like we -- in the past, we've exited Philadelphia, Sacramento, St. Louis, markets that I would say are much more focused or wed to regional demand. They don't have all top 5 CSPs. They don't have other hyperscalers. They don't have network diversity. They don't have the enterprise customers claiming to go there. So I think there's a handful of those type of markets where we'll continue to dispose of over time as well.

So I got a question and I think it ties into where I was going to go as well. But my question was going to be you mentioned M&A a little bit there and recognizing you recently competed -- completed, excuse me, the Interxion deal, how long do you think it would be before you could absorb another sizable transaction? I'll just tell you the question I got. Telx was retail, DuPont was wholesale, Interxion was retail. What do you want to be? And then it says, Equinix is pure retail, cloud service provider, on-ramp strategy, confusing thoughts on Asia. I mean it's basically I just think he's asking about your M&A go-forward strategy or maybe what you've already done.

I think all those puzzle pieces were really about -- or going towards our strategy, which, really, under Bill Stein's leadership over 5 years ago was we want to be more global, we need to have more scale to compete in this industry, and we want to be a dedicated full product spectrum, the full addressable market, because we saw a consolidation within our top customers and opportunity from new customers seeking that out. So it was across those various continents, really trying to put the puzzle pieces together to have a platform offering that has the full product spectrum. We filled in holes in our connectivity footprint in 15, with our Telx acquisition in North America. We did much of the same with network-dense and very heavy cloud on-ramp, almost dominant in Europe with Interxion. We did more of a scale and runway for growth in combination with our DFT transaction, in addition to reaping financial and expense synergies. We grew our footprint in Latin America, which I would say is a combination of the product lines, hyperscale and colo connectivity really adding a new continent and numerous markets on the map, which we've recently grown into Chile and will likely be growing into a third Latin American country in the not-so-distant future. And then over in Asia, which is now the smallest piece of the pie, we see a highly fragmented part of the world when it comes to our industry, where our customers have been seeking us out for the full product spectrum. And we've done that in various shapes and forms, organically going to Singapore, where we now have an East and West side of the island of Singapore multimegawatt campus, with our newest campus going to be up to 50 megawatts that will have colocation and connectivity launching on it very soon. And that's a location where just this last quarter, we signed the top 5 CSP and a major APAC international bank, so enterprise, PlatformDIGITAL, [indiscernible]. Much of that seems happening out for Asia. But -- so I think there are 2 questions between what you said and what your listener said. Right now, the focus is integrating Interxion. And I think most of the puzzle pieces are now in place when it comes to North America, when it comes to Latin America, when it comes to EMEA. Asia Pacific is probably where I would see the most potential for inorganic growth. But quite frankly, the inorganic opportunities are limited. So we may have to go in a much more organic fashion like we did in Japan, first going to Osaka, building out our campuses, contribute that to a joint venture with Mitsubishi Corporation, now having the full product segment across Tokyo and Osaka with MC Digital Realty.

You don't want to buy AirTrunk for 35x?

No, I think that is a very successful business in Australia, very DFT-esque in success. But I don't think, we were the perfect match, especially at that valuation.

But it sounds like you're saying -- and I was obviously joking, but it sounds like you're saying that right now, obviously, the focus is on Interxion. It sounds like you're suggesting if you had your choice, because you don't always get your choice with M&A, Asia is probably the most likely place, where you'd want to fill in some holes, given that opportunity. But in terms of timing, it sounds like right now is not the right time. But as we exit 2020, could you be in that situation where you could start to look again?

So I think we're big believers for what we've acquired are really irreplaceable assets that are falling into permanent homes. And whether ourselves are on the consolidating end of that or Equinix is on the consolidated end of that, these are not being traded among private equity firms that will flip again in 5 years. And I think we've gotten our hands on what we view as the lion's share of these replaceable, highly connected, critical infrastructure assets. So that means you'd have to always keep an eye out for the opportunities. But I think we've done a good job of saying no to a lot more than we said yes to, getting our hands on the right assets, the right valuations and bring them together with a true platform offering for our customer. And when I look to end of 2020, I still think our hands will be full with Interxion. But we are a global organization with a lot of talent across numerous regions, and we have to kind of make sure all these opportunities are sized up. But the scale of these are just getting smaller, right? There's no Interxion of Asia. There's no same size $9 billion companies across 10 Asia Pacific countries with that connectivity density. So the puzzle pieces, in my opinion, are falling into piece -- into place and setting up a competitive dynamic where, I think, in the long run, to global fully multiproduct scale players will be the most relevant to our customer base.

Great. Well, with that, we are out of time. Andy, John, thank you so much for joining me. Wish you guys both the best, and hopefully, I get to see you soon sometime.

Thank you, Colby. Really appreciate. Stay healthy and stay safe.

Bye guys.