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

Good afternoon, everybody. This is Jon Atkin. I lead the communications infrastructure investment research team at RBC. Along with my colleagues, Bora Lee and Rashim Jain, pleased to welcome you to our fireside chat with Digital Realty. And with us from the company are Chief Executive Officer, Bill Stein; and Chief Financial Officer, Andy Power. I want to welcome you both to this fireside chat.

And maybe kick off with a couple of high level questions, starting with kind of operational initiatives, and if you could maybe give a flavor for the major efforts underway that we could see benefit your cost structure and hence margins going forward, whether it's through automation, workflows, organizational initiatives, tax assessments, energy efficiency or whatnot. Any categories of spend that kind of standout above others that can help benefit margins medium to longer term?

Jon, thanks for having us. We hope everyone is safe and healthy out there. I think that when you look at the effects of the pandemic, it's forcing everyone to rethink how they do their business and what's important. And clearly, remote working represents a comprehensive shift to digital, which we think is here to stay. Digital and Interxion have both had distributed work teams for some time well before the pandemic, so the work-from-home adoption curve is probably not as steep for Digital and Interxion as it is for other companies. And for example, we've also been conducting virtual tours for our customers, which has proven to be both efficient and popular. As you might expect, we've curtailed our own travel as a team, and we've made extensive use of various video conferencing platforms, many of which are growing customers of ours. And we expect to continue that trend even after our stocks -- even after our offices are reopened. As far as energy efficiency, I mean we've been very focused on sustainability for a long time. And that means both procuring renewable power and designing and building our data centers to be as efficient as possible. We also -- in fact, Andy, why don't you -- I'll let you -- you want to handle the tax question, but Andy has been, as you might imagine, very proficient at minimizing our taxable income. So Andy, you want to cover that and the EBITDA margins?

Sure. Thanks, Bill. So obviously, Jonathan, we're looking at it at a property level and a corporate level. So we've been in the data center business for quite a long time. So making sure we're as efficient as possible, seeking appropriate abatements from the various jurisdictions from the ground up. And then obviously, being an investor across now 20 countries and 44 markets, you can imagine we're dealing with numerous jurisdictions and currencies in terms of navigating to have as low as a possible corporate tax rate wherever applicable. And then lastly, given that we have really well-established presence across the 4 major geographic regions where we operate, tremendous scale across all those different countries, whether it's APAC, North America, Latin America or EMEA. We do view that there's opportunity to continue to scale the business without the redundancy, growth of corporate headcount and the like. But that being said, I think that's a longer-term trend because consistent with our Interxion combination, we're very much more focused on accelerating growth right now. So trading that near-term increase in EBITDA margins for greater top line growth, and we feel that we can harvest the scale benefits in the EBITDA margin down the road.

Are there areas of the business around maintenance OpEx, maintenance CapEx that might have kind of fallen a little bit off the radar and seen less emphasis during COVID, given just the overall disruption, where we might then have to see a little bit of a bounce back towards higher, more normalized levels of maintenance expenditure once we're on the other side of the pandemic?

Andy, you want to cover that one?

Sure. The answer to both of your questions are yes. Our data centers are designed, obviously, to full redundancy, and we've been maintaining 100% uptime, while at the same time, first and foremost, prioritizing the health and safety of our employees, customers and partners. And I can tell you a very big kudos goes out to the entire Digital Realty global operational staff for the kudos we've received from our customers, the anecdotes that have kind of flooded our inboxes as an executive team about our proactive approach and our consistent communication throughout this crisis. So given our design and overall redundancy, we do have some flexibility in our maintenance. Consequently, when we've kind of yielded, throttled back to only essential personnel on the ground, we are not going to put anyone's lives at risk on maintenance that could wait for another day. So we've -- and we've communicated that to our customers. So if you kind of look at how that flows through our P&L or cash flow statement, I should say, I think you'll see a little bit, compared to lighter spend in 1H, the first half of 2020 when it comes to our repairs and maintenance and recurring CapEx, and I think it maybe could pick up later in the year. I don't think it would be a material impact either way. And I think we've made sure that we are planning ahead for these types of disruptions across the board in our disaster preparedness and continuity planning. So I don't think it'll have a material financial impact or -- and more importantly, an operational impact to our customers.

So I want to kind of shift over. This would be probably for Bill. So at the organizational level, you're 1.5 years plus into having a new Chief Investment Officer in place, a new Chief Revenue Officer in place. And who knows what other organizational changes below the C-level you've introduced. But just wondering, in general, as you think about the business, how you sell, how you operate, how you develop and deliver inventory, how you allocate capital, what is different today than, say, 2, 3 years ago?

Well, I mean, first of all, you're right. We're 18 months into Greg Wright having joined us as Chief Investment Officer from BAML and Corey Dyer having joined us as our global Head of Sales from Equinix. And frankly, both have been tremendous adds to the business. I think they're definitely leaving their mark on the organization, and it's really just beginning. So I mean, we're -- I think we're very fortunate that we are in the position that we are, where we can invest in the business. I think there's no question that through these hires, we've solidified our position in the industry. And I think the industry has also proven its mettle in this current crisis. But all of this, I think, has really enhanced our ability to both attract and retain senior talent. Clearly, this combination with Interxion is going to have a big impact. There are leaders on that team, who, I believe, are capable of playing a global leadership role within this broader organization. Interxion clearly has very strong relationships with their customers, including most of the target cloud platforms. They have pioneered the communities of interest. As a result, our sales teams, the sales teams on both sides, are working very closely together. And we're seeing out-of-region referrals to both sides to take advantage of our mutual platforms. I don't think there's any question that Digital has done an extraordinary job of balance sheet management and capital allocation. That really represents our DNA from the very beginning. I think we've also been successful recently at fine tuning our inventory management. So I don't anticipate any major changes in those disciplines. Last November, I think, Jon, you were there, when we rolled out our global data center platform, which we call Platform Digital, which has services that are specifically geared to meeting global demand from the enterprise customers. And in that platform, Digital has been gaining, I think, substantial momentum since its launch late last year. And customers spanning many different industries, geographies and business objectives are making that migration. I think some of these organizational changes that we've made below the C-level have driven positive change in the way we sell. It's clearly helped with the creation of Platform Digital. And it's a way that we're making it easier for our enterprise customers to do business with us. Do you have anything to add, Andy?

No. Bill, I think you nailed it.

Yes. I mean, unless you want to talk about development, construction, inventory delivery, you can pool that into the next question I'm about to ask as well or just move on. But the question I was going to pivot to is just Interxion, you mentioned that deal closed during COVID, it's 2 months since we last had a chance to chat with you. And any kind of an update now that we're just that many more months post close? Social distancing is still in place. Travel restrictions largely still in place. So had you had to kind of go a little bit more slowly on some aspects of the integration? What is the kind of -- what's the status on that?

Well, look, clearly, we'd rather meet face-to-face with our new colleagues in EMEA, but we can't do that right now. But I would say the integration is well underway. It's our top priority for 2020 without any question. We've launched and announced an updated award structure for the combined company with Dave Ruberg as the CEO of the EMEA business, along with some changes that we integrate, what we call the classic Digital EMEA team under David. The functional teams are being brought together with representation for both companies. The sales teams from both sides are working closely together. As I mentioned, we're seeing out-of-region referrals that they're taking advantage of our global footprint. And I think in general, the teams are doing very, very well together despite the constraints imposed by social distancing and travel constraints. I think there's -- I don't think there's any question that this combination between Digital and Interxion has the potential to materially alter the global data center landscape. The combined organization is extremely well placed to meet growing demand from cloud and content platforms, IT service providers and enterprises looking for colocation, hybrid cloud and hyperscale data center solutions. These are global long-term opportunities. And we are in a great position to address the needs. This new company offers a comprehensive global platform for our customers and gives us runway for substantial growth. Obviously, there's work to do over the next several quarters as we knit these companies together. This is the largest acquisition, and I think the most complicated acquisition that we've done, but we're very pleased with the progress to date, particularly given the constraints that COVID has created.

So on the topic of COVID, everybody has had to pivot. This conference is virtual. That's an example of it. Has -- have both customer behavior and your operations reached a sense of semi-normalcy, now that we're several months into this, where this already kind of is the new normal? Or has it been more the case where customers have had to kind of bootstrap certain things around purchasing and you've had to, obviously, pivot as well where there's really more evolution to come before we can kind of assess how this business and industry looks on the other side.

Andy, you want to cover that one?

Yes. Sure, Jon. So I mean, I think the landscape of how we see things is very relevant to this crisis for us. I would say Digital was very early and proactive in its response. I think we're among the earliest to kind of go to essential workforce in our data centers and also work from home from all of our global corporate offices. Our customers on the one hand were also in the early category in terms of moving to virtual work planning using the various forms of online work sharing and video conferencing communication tools. And I also think we're in an industry that kind of kept its eye on the ball despite broader disruption in various more granular enterprise verticals as to what our core business is and what our customers are procuring from us, the connectivity, the capacity, is really what's keeping the economy thriving and the world spinning in many regards. So I think the adoption to the new normal wasn't a big step. I think people kind of slid into that quite well. I didn't see a major disruption from a customer behavior or operational standpoint. So the move to stabilization happened, and we're here and still continue to do business. And I think this is potentially a real comprehensive shift to Digital that's probably going to be here to stay. I mean you're seeing the various kind of announcements of portions of remote working becoming more permanent life fashions. I think this dovetails what the journey of digital transformation many of our enterprise customers were already on in a pre-pandemic environment, thinking about accessing their customers, their suppliers, partners, employees in a distributed infrastructure fashion. And I think we're well positioned in our breadth of portfolio around the globe, the diversity of our product offering, a 4,000-plus customer base and really able to support so many customers in accelerating their own digital transformation plans, whether it's the new normal that we're living in today or what comes down the road even further.

That's an interesting perspective, and I guess we'll see with each passing month. I wondered, as we sit here now, can you give us a little bit of an update on what's happening with customer decision cycles, particularly around hyperscale? Has they -- are they making faster decisions? Are they getting off the fence faster? Is it elongated? I suppose one could argue either way on that. And then lastly, on construction challenges in the various parts of your footprint. Obviously, some specific disruptions that may be unique to particular countries. But in the typical European or U.S. market where you're delivering inventory, are we talking about just identifiable challenges that are really nothing different than what we saw in March and April? Or are there greater uncertainties on the construction delivery time frame compared to what we've already seen?

So Jon, I think it's really hard to generalize about customer decision cycles. There are some customers whose businesses have been adversely impacted by COVID-19, and they have clearly put their transformational projects on hold. The obvious ones there would be retail, travel and leisure. And energy, too, for that matter. On the other hand, though, there are customers whose businesses have remained healthy. But perhaps underinvested historically in their IT architecture. And I think there's an acceleration there of their digital transformation journey. So it's -- you just can't -- you can't generalize across the board there. Relative -- and I guess, speaking of the CSPs because that's obviously another large group of customers, from what we've seen, they're continuing to buy. And in some cases, I think they're -- they've been accelerating their buys. Relative construction challenges. We mentioned that there were scattered delays in the last call. We mentioned Toronto, Hillsboro and Singapore in the earnings call. But I think, certainly, in North America, now we're seeing things open up. And we're cautiously optimistic that the construction challenges are easing. Andy, anything else you want to add to that?

No, I think you hit it up spot on. I think also the 2 pieces of the construction, I think we were ahead of the game and insulated when it came to our global supply chain. It's about being proactive, which lends itself to our scale and global purchasing and relationships with so many vendors and partners. And the delays, I think when it came to the labor, was the kind of key fly in the ointment for -- and ad hoc markets. I think you see as the U.S. economy opens up, people are getting back to work, as Bill said. I'm not sure we're going to make up the time lines for the lost days. But I don't see a further degradation of deliveries, which is a good thing. And so I think net-net, our construction is kind of getting back on track.

Great. Turning -- maybe related to what you talked about in the U.S. with people kind of going back to work at a greater pace. On the call, you noted that 2% of your MRR is from customers who've asked for payment flexibility. And I'm just interested now that we're several weeks more into kind of the cycle, have these discussions increased in frequency? Or not?

It's accounts receivable, Andy.

Yes. Yes. I got it, Bill. The -- I don't think we've seen a material change in the amount of kind of customers raising their hands, seeking some type of relief. As I mentioned on the calls, about 2% of revenue represents the total amount of customers who even had any type of inquiry. And the relief we've granted were in the, call it, single [ digit ] basis points range. And it's the usual suspects in terms of the various sectors, be it retail, travel, lodging or energy, which in total, represents, call it, just 5% of our total portfolio's revenue concentration. So -- and I think what we found is in many scenarios and the exceptions where we'll be able to help those customers, even modest forms of relief for, as an example, a university customer that is seeing lower volumes is really kind of stemming them to kind of get to the next month or 2. They very much appreciate the support we're giving, and it's not a material impact to Digital. So we're still doing this case by case. I don't think it's gotten worse at all. I think our overall exposure is quite limited. And I think it's usually for pretty good causes where we're able to kind of lend a further helping hand to support our customers.

You recently refreshed your -- the ATM. And I'm interested in how active the company has been in utilizing it for either investments in the business or to extend your overall funding horizon.

Andy?

Yes. The -- so just to refresh the facts here on this one. So we've had a $1 billion ATM program, which we technically have not used for over 5 years prior to this most recent March and April this year. We issued about $650 million under that program, bringing the remaining capacity down to about $350 million. The reason for it was, we really kind of -- we're looking at a broader market -- capital markets investment backdrop where we certainly saw that capital seemed to be and continue to be getting precious, and we still saw a pretty robust outlook for investments. So look to really take some opportunities to [ retap ] the equity markets through the ATM program. Shortly after our results came out for 1Q '20, we just essentially did the paperwork, the SEC and our bankers to refresh that program, re-upping the authorization back to $1 billion. And we have not been active under that ATM since that mid-April announcement. Overall, the liquidity profile is quite strong. If you look at our balance sheet on the end of March, we've had $250 million of cash on hand, another $1.7 billion of equities coming into the company post quarter end through our equity forward primarily. And then we have $2 billion of availability on our global revolving credit facilities in addition to any free cash flow we retain. So close to $4 billion of total liquidity and a balance sheet on a leverage standpoint that I would say is very strong, right in line with our target leverage that's about 5x net debt to EBITDA.

Great. I've -- we got just over 5 minutes left. I'm just going to ask the questions and you can kind of allocate by time as needed, but the biggest one would be just around big picture around the guidance, which you provided on your 1Q call and looking at the trends in your business, everything we discussed on the call. Is there any indication that you're seeing that can lead you to think that you'd come in at or below the midpoint of the current outlook? So that's kind of the guidance question. And then a couple of real maybe staccato answers you could give. Amsterdam, does the permitting freeze get unfrozen next month or not? Singapore, they're going -- the migrant workers, I think, are starting to go back to work early in the month. Is that also your understanding? And then any kind of an update on Korea and India within APAC? So those would be kind of the balance of my questions and you can attack it as you wish.

Andy, you want to start off and I can take Korea and India at the end.

Yes. Well, let me try to do the lighting round here on the first 3. So guidance. So we had a little bit of a different year this year. We didn't -- we essentially put our initial guidance for 2020 in conjunction with our 1Q '20 earnings call, which was really just a few weeks ago and that was really due to the many moving parts in the business, whether it's our Interxion combination, which closed a little ahead of schedule, our buyout of our Westin partner -- Westin property partner as well as our sale of some assets. So our guidance, I would say, Jonathan, is pretty fresh, and we were certainly well into COVID environment by the time we put it out. So as a result, I would probably say, we probably saw a lot more of the change leading up to that guidance release. And I don't -- I wouldn't say there's any material update to that guidance in just a handful of weeks' time. Going through your list here, I'll kind of hit on it at a high level. Amsterdam, I'm not going to take a hand at handicapping the odds there. But I will say, in any event, I feel very well positioned to support our customers in that market through our combination with Interxion. I think we have some of the most highly connected destinations and most fantastic campus builds. And we have a runway of growth that we have either owned today or have tied up in various formats that are outside the jurisdiction that has been facing the restrictions. So I don't see that majorly impacting our business. Singapore. I think we had -- kudos to our Asia Pac construction team for going pedal to the metal up into this crisis. And we've made -- essentially put our lights on -- or power-on, I should say, announcement for our SIN12 site on the eastern side of Singapore. And that location is already off to a great start, where we've signed some anchor contracts with a major cloud service provider and also a top-tier Asia Pacific bank. And I believe that the read on the ground we're seeing is that the resumption of work is likely in fairly short order. And I also know that our government affairs team has done a really nice job of working with the local jurisdictions and government authorities to show that the customers that we are essentially bringing online at that facility, which is a total of 50 megawatts when fully constructed, are really essential to the economy and really important to be able to allow us to continue with that work. Bill, do you want to hit on India? And I'm happy to help with Korea as well or you could tackle it.

Sure. Well, relative to both countries, we're actively evaluating opportunities in both markets. But Jon, we don't have anything new to announce yet. Korea is a very attractive market. It's been part of our APAC strategy for some time. We believe there's a robust demand for carrier-neutral data centers in South Korea. That's based on the increasing requirements of both the global cloud service companies and mobile technology. In India, we're making progress -- continuing to make progress with Adani under the MoO -- MoU that we signed. And we just extended that by another 3 months. We're conducting marketing studies. We're looking at the underlying supply and demand. We're looking at the cost of construction. We're trying to understand what the rents are. And we're understanding -- we're speaking with customers to understand what their needs are. But I don't think there's any question in India, the current environment has affected our return expectations and probably not in a good way in terms of both the country and currency risk. But despite that, both teams remain very excited about the venture and the market opportunity that India presents but this process will take time due to that region's complexity. Anything you want to add to that, Andy?

Yes. Just one last point on Korea. I think while the India opportunity will be the full product spectrum, I think what we're doing in Korea is particularly unique in that we're looking to really [ braise the trip ] with the first fully network-neutral location. And it's a modest amount of capacity, called sub-15 megawatts, but we've already receiving significant amount of inbound inquiry on this location and really looking to create a truly network-neutral facility for this market and highly connected for our numerous colocation customers.

That is a great way to wrap it. I appreciate both of you participating in this fireside chat. And I will let you get on with the rest of your day. Thanks very much.

Great. Thanks. Jon, thanks for having us. Appreciate it.

Thanks, Jon. Take care.

Bye.