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

Hi. Good afternoon, everyone. I'm Eric Luebchow, senior analyst at Wells Fargo in the communications infrastructure team. Last but certainly not least, we are pleased to introduce Andy Power, the CFO of Digital Realty Trust. Andy, thank you very much for joining today.

Thank you, Eric, for having me. I'm delighted to be at the finale and hopefully not keeping everyone from their virtual conference cocktail hour. Delighted to be part of this event. Thanks.

Great. It's not quite the same when you're all at home, but we'll do our best.

So Andy, just diving right in. I'd say Digital had, in Q3, a pretty impressive bookings quarter, particularly when you account for the fact that Northern Virginia, which is your largest market, was effectively sold out. So maybe we could just go through some of the sources of strength. Your 0 to 1 megawatt bookings, your enterprise colocation, your interconnection were really strong in the quarter. How sustainable do you think that trend is going forward for Digital? Can you continue to do kind of north of $40 million in bookings across those kind of segments as you look into your pipeline?

Yes, definitely. I was really proud of the team, what the results we put up in 3Q. Obviously, a strong number overall, $89 million, coming on the heels of an all-time record, $144 million. I believe our largest deal in the entire or all [indiscernible] was like roughly 9 megawatt, not really weighted to any one market or one deal. It also had, as you mentioned, this core called the enterprise colocation and connectivity segment, it's just shy of 50% of our total signings. Record new logos, 130 new logos, which was a record off of a prior number, which was a record a quarter or 2 earlier. So a lot of momentum there. Listen, I don't think we have a ceiling or floor in that category. We've been, I think, working hard over the last few years now to put the puzzle pieces together from an inorganic and organic standpoint and then execute on our go-to-market for the more diverse and robust customer base that lands in that typically higher rate, higher profitability category of our new signings. There's a lot of other things that kind of are behind the scenes. Enterprise, in particular, was a strength. There's -- financial services was a strength as well as a few other industries, numerous multimarket, multisite deals. And I think we are executing against -- that execution is continuing on into the back half of this year, the final innings we're in now, and certainly on into 2021. So I'm looking forward to hopefully continue that momentum. And I think it very much kind of dovetails with our strategy of supporting that enterprise colo customer, in addition to those global hyperscalers, and often kind of takes some of the lumps out of the quarterly seasonal or seasonal signing momentum.

Sure, sure. And I guess related to that, I mean, just from a broader industry perspective, this year, from all the accounts that we've seen has kind of been, I think, a record industry-wide for new activity and bookings activity. And so sometimes, the question we get is around, given some of the lumpiness, is there going to be a moderation, an absorption period or cloud digestion, as we put it, in some of the larger markets? So do you think that's the case? Or do you think there's a pretty long tail in terms of what you see from hyperscale, from enterprise? And -- that would be helpful color.

Listen, I think that it depends on your portfolio or your offering to your customers in the space. Those that are much more concentrated or single-threaded to fewer customers in fewer parts of the world or fewer markets with less breadth or product diversity and runway of capacity. Obviously, you're going to be a bit holding to some of that concentration risk and digestion. In many ways, I think the setup here feels a little bit reminiscent in 2019, where we came off of another prior record year for the industry, in certain parts of the globe in particular. And I think at the beginning of that year, I was very confident in the fact that we have a tremendous global customer base that today now stands at 4,000 customers. We are helping some of the [ loss ] in 20-plus regions around the globe of our total 48 metropolitan areas where we are doing business. And all these customers are at different cycles in their growth in different markets. So last quarter was a great example. Last quarter, Ashburn took a quarter off, essentially, right, because we've done so well the prior 4, 5, 6 quarters in a row. And despite that, we had showed strength in North America. We showed strength in other major markets in North America, like at Toronto, Northern New Jersey and other parts of the U.S. We showed strength regionally outside of the U.S., North America, whether it's the EMEA or Asia Pacific. And we showed strength across our product diversity, which we highlighted on the less-than-a-megawatt signings in our interconnection signings. [ Certainly, I'd say ] the business, I don't [indiscernible] as a company.

Yes. That's helpful color. So one other thing you mentioned on your earnings call that I wanted to ask about is you have 17 megawatts, I believe, coming back to in Northern Virginia in the fourth quarter. So maybe you could just give us an overview of what led that customer to want to move their deployments? I believe it's not contiguous. It's over some smaller chunks of space. And what does the backfill opportunity look like? Will there be any kind of rent roll downs associated with filling that space when you think about new customers versus the exiting customer?

Yes. Well, the genesis of that commentary was really twofold. One, really try to share our view of what we see the next 12, 18 months looks like in terms of expirations and potential non-retention or churn and try to frame it as what we see is -- kind of going to my diversity comments on the portfolio, diversity in our upcoming contract expirations, not seeing larger than usual non-retention or churn. The largest pockets of that, as I mentioned, were -- was in Ashburn, the second largest concentration of any given customer. Half of that 4.5 megawatts was in Santa Clara, which is an incredibly tight market, and broadly speaking, what we view as very manageable. In addition, obviously, for our customers and our sales teams and then for our investors, on the backs of a record -- a few good quarters in a row in Ashburn, where we're now 94% occupied in the operating portfolio and 100% pre-leased on our 42 megawatts under construction, we wanted to make sure people understood that we are not sold out. We have -- when you take that 17-ish megawatts, just over 40 megawatts of availability to be selling into. That particular customer, and we've got to be sensitive to confidentiality. I would say the rationale, I would pin on a desire for migrating workloads to larger, single contiguous data holes for their efficiency model. That is not a one-size-fits-all strategy, because I can tell you on that same exact campus, in those same exact buildings where the, call it, 1 megawatt, 2 megawatts, 3-megawatt compositions of that 17 megawatts are becoming available. We have neighboring customers of similar size and stature that are looking to grow into those suites. So I think it's fortunate -- in any given market, when you have a larger amount of capacity coming back, it's better for us as a provider if we're already tight, right? Because our demand, our international sales force and customer base is all pointed towards less capacity. So it kind of creates a little more tension there. And two, I think the same reason that -- I would be attributing our success in Ashburn in a market, which has been struggling for some time and kind of heading out of the woods here. We have this global sales force importing demand to all shapes and sizes from numerous customers. We have that installed customer base that wants to grow with adjacency. And we have the customers that value that longest runway of growth in Ashburn. So I think those 3 elements are going to continue to play out, like they did over the last 4, 5, 6 quarters in Ashburn. And I feel pretty good about re-leasing that capacity. And depending on the size and shape, we'll do some in smaller increments. Some of it will be colo-sized deployments, like sub-100 kilowatts, some will be in the 300 to 800 kilowatts and some will be in 1 megawatt or 2. So I think depending on the size, some will be higher, some will be lower than what we're getting it -- back. But net-net, I feel good about our ability to re-lease that capacity quite quickly before our next shell comes available in the second half of 2021.

Got it. And I guess, just broadly speaking, that you brought up kind of mark-to-market. I mean it seems like when I spoke to you at NAREIT a few weeks ago, that you feel more comfortable than you have in years in terms of what you see renewing the next few years. And I know you have some things that are renewing at close to $140 per kilowatt. But given the geographic mix and the type of customers that are renewing, you feel pretty confident that we won't see kind of any massive write-downs going forward. That all should be relatively steady. Is that how we should think about kind of renewal spreads looking out next year or even the next few years?

I'm not at a joyous level. I have not got the kind of holiday spirit yet on the complexity of our renewal spreads. Because as we've guided for this year, we're still not kind of pushing through into positive territory. But I would say that I look at what we, as a company, have traversed in terms of our expirations years in just the last handful of years, and I look at our outcome, which up until 2020, 4 of the 5 last years were positive renewals, one was negative. I look at the -- what we've done this year in terms of the momentum from where we thought we were going to turn out at the beginning of the year on cash and mark-to-market, which gotten slightly less negative. And then I look at what we've renewed historically and what I see in front of us, whether it's the mix that is some of our highest connectivity, highest price point destinations, even in our larger deals, greater and greater composition outside of North America, which is less competitive, higher price point contracts to begin with, that -- I think the rear-view mirror -- I think we're past a lot of the negative waves or headwinds on that front and heading towards better and better territory. And quite honestly, I think the picture -- I know we're always focused on that -- the next very quarter, that next very year. I think if you even look at these a little further, I think the picture continues to get better for us. And last but not least, I still believe we are in the innings of the industry where the new unit demand, new capacity from some of our repeat customers, and we do a tremendous amount of repeat business, behooves us to have a much more friendlier posture on our renewals of those customers, and let's just come to the table with other tools in our toolkit to help the system to win more of their wallet, more of their fair share of their business at attractive returns. So that won't happen forever. We'll -- the industry eventually will slow down. I'm hoping we got many more innings before I get to that point. But I think that posture also puts a little bit of a less umph in some of our renewal pricing. But I think that translates into benefits on our platform and our investors.

Sure. Sure. And on to -- related to some of your renewals, I mean, have you -- in some cases, I know one of your large customers, I think you renewed them with kind of a shorter contract duration. Is that a way of somewhat expressing confidence that Ashburn and some of these more competitive markets will heal in the next 3 to 5 years, and you might actually have some pricing power as you look out -- further out than one year?

I think I have a very sober assessment of Ashburn, but not a negative one. And that view is, in my opinion, Ashburn, on the one hand, is not back to 2018 fundamentals. On the other, it certainly feels a lot better than it did 12 months ago. And I think, as you can see -- you see this steady demand, that includes record years. But even without a record year, the demand has been attractive and net absorption is progressing, that I think over time, there will be a return to better pricing power as this pockets of oversupply does get absorbed over time here. There will be a time where we will run out capacity in Ashburn, and it's not an easy spillover effect to the next neighboring county. So given all the infrastructure and the workloads that are already domiciled on the likes of our lab and campus, so I'm optimistic on it longer term. I'm realistic about that we're not out of the woods yet, but I do feel like we're heading in the right direction and we're making progress.

Okay. That's fair. So I guess if I look at your development table, like I believe the cash yields in your North America portfolio, they're a little bit north of 8%. I know they've ticked up a little bit in the last couple of quarters, but they're a little below the kind of 9% to 15% range that you've laid out in some of your tables. So maybe you could help us unpack that. Does that just reflect, in part, customer mix? Obviously, you've kind of over-indexed with some of the hyperscalers, and particularly in Ashburn, which, as we've mentioned, is a more competitive market. I mean do you think a 9% yield in some of these U.S. markets, particularly with the hyperscale focus, is difficult to achieve, at least what you see in the near term?

I -- a few things there. One, I think that return is very achievable if you have a few ingredients that we do at Digital. One, we do not -- I don't view what we're offering as a commodity-like offering. We bring, I think, a tremendous amount of value to our customers, and that value is approached from multiple angles. It's the experience from operational standpoint. It's the long-standing relationships. It's how we make sure we future-proof those hyperscalers' runway for growth, so they don't need to get -- they can't get -- they won't trap them to replicate the network and other infrastructure investments when they want to grow. It's how we not make this just a single site, single country, single market-type story and a more global partnership. And how we deliver some of the other services, whether it's on sustainability front or the health and safety front or other elements we bring the table and raise the bar along with our customers as they -- that -- if you look at the full -- I think new data points, I'd point out. One, Ashburn. One, I should say, the returns are actually up, I think, almost 50 basis points quarter-over-quarter. So moving in the right directions, albeit in, call it, $8.5 billion area. Two, [ Ashburn ], that's 100% pre-leased. North America, I think, is like 2% pre-leased, so very high pre-leasing to the point where those buildings will likely be almost completely full by the time we open them. So you are -- haven't seen a larger exposure in that development pipeline to larger footprint, long-term deals. Kind of goes part and parcel when you have a record $144 million a quarter in 2Q, a lot of that being in North America, you're signing some very large deals, so long-term contracts, which obviously kind of drags those yields down a little bit. Conversely, if you look at the rest of the table, that you look to EMEA and APAC, you see the pre-leasing is a little lower but the returns are a fair bit higher. That's due to mix. There's a lot larger contribution from our colo connectivity footprint. And quite honestly, it's larger contribution from higher-pricing power markets, where we have a much more competitive offering or more distinguished offering with less competition Singapore is a market where I think we've got 40 megs in total, and that's a market where we've raised prices 2x in just the last year, and a hyperscaler deal could probably be well into the 13% returns kind of areas. So -- and last but not least, what's not on that table that flows through our unconsolidated joint venture, is Ascenty, which, as you know, is a platform. We're very proud of our returns and the value we offer to our customers. But those -- obviously in emerging markets, parts of Latin America, and those returns are a fair bit higher, higher than your more stabilized North America markets for sure.

Okay. Great. That's helpful. And I guess just related to that, one follow-up. I mean is your cost of capital, which has meaningfully improved, especially the stocks traded well this year, you've been able to issue some very low interest rates, debt. Does that impact at all your targeted yields if you look at it on a spread basis based on where your cost of capital is? Or is there more like an absolute return target that you look at?

I would say we seldomly -- listen, I think we have a very good grasp of what we view our cost of capital as an entire public company. And we also are pretty active in the capital recycling front, the private capital front through joint ventures and on the M&A side. So we see cost of capital, access to capital from various shapes and forms. We, I think, triangulate on our return thresholds, less having to do where Digital stock is trading or where our bonds are priced and much more opportunity-by-opportunity, country-by-country, trying to almost boil it down to, call it, infrastructure- or asset-level returns to make sure that the risk on our capital that we're putting out is adequately rewarded for that risk. So that's a long-winded way of saying when our stock price pops or interest rates get lowered a little bit or spreads converge, we don't go rush to reset our pricing. It's much more supply demand-driven. It's much more done on a longer-term basis. And we try to be a little bit more analytical. And quite honestly, we do that for two reasons. We do that, one, because we think we can generate returns that are in excess of our cost of capital, which we want to bring back those excess returns back to our shareholders. And two, because based on our offering, we don't think we have to erode our value of our offering to a spread type of investing-type of game.

Okay. Yes, fair answer. So maybe I'll shift to Interxion and the integration process. So what else -- what other major benchmarks do you have to hit before the platform is fully integrated? Has that been slowed down at all because of the COVID pandemic? And then related to that, David Ruberg is kind of stepping down from his day-to-day. So maybe how is management shifting in Europe with David? Certainly, I imagine knowing David will be very involved in the company for probably forever. But just wondering how that dynamic shifts as well with David stepping down.

Yes. I'll touch on David last. I don't think stepping down is not -- I don't think David's ever stepped down. He only steps forward enough, but I'll touch on my -- I'm excited where he's going in terms of leadership with our company. But listen, I think in the broad scheme of things, we certainly didn't expect and didn't -- certainly didn't hope for having to do a large-scale global integration in the face of a global health pandemic, where travel was completely restrained. On the other hand, I'm incredibly proud of our organization, letting this be a binding event, coming together. And the progress we've done on the integration front, from a leadership standpoint, bringing together a combination of legacy Digital and legacy Interxion leaders and rippling that through the entire organization. Everything we do, everything you see, this is Interxion and Digital Realty company is that -- is our united EMEA business. So those are -- that's not 2 separate companies operating independently in Europe whatsoever. We -- during this integration of bringing the people together, bringing the processes together, uniting under a new brand for EMEA with Interxion, I'm also quite pleased with the progress we've made in just running the business. And that's been on the execution side in terms of new revenue generation, which you can see through our new signings. And EMEA now has a substantial amount of legacy Interxion, but the collective EMEA organization has put up 2 very strong quarters, and I'm very optimistic where they're going to go on the rest of this year and on to 2021. In addition, you can see we've had several press releases, whether it was playing -- a combination of offense and defense. We've done some land purchases in Frankfurt and we've been supporting our customers' growth in that market, or markets like Madrid. I think just this week, we put out an announcement around growth in Zurich. Quite pleased to see some growth outside of the flat markets where I think our offering is even further differentiated relative to any competitor. And then last but not least, we've also kind of moved forward with some tuck-in acquisitions, which I would say was very much following the legacy Interxion playbook of the most highly-connected destinations in the up and coming markets, very akin to what they've done in the south of France, and really not bringing just assets or land, but teams to kind of further our platform at the same time. Getting back to David, as we -- this is really much in line with what we said over a year ago from the announcement. David was -- always had a plan to come stateside. I think he's been promising his wife that for many, many years. She's finally making them [ a little slow ] although it'll be [ slow ] up a little bit here until it's safe to do those travels. And I think he's going to have the opportunity now to let go to some of the more mundane responsibilities, the day-to-day of [ line ] responsibilities. And for something -- someone of David's stature and experience and everything he's done for this -- our business and this industry, I think he's going to play a very pivotal role now. He's going to continue to help drive our market -- new market entry and growth, kind of very akin to what we did in Croatia and Greece. He's going to be on the forefront of our new product development. And last but not least, he'll bring on his thought leadership to some of our largest and global customers. So I think that's a perfect job for someone of his stature if you want to be working later a new career. And going back to my first comment about David, this is not a part-time gig. This is not a David trying to work a little less. He's got just so much fire in the belly as he always had. So he's excited to, I think, move into this new role.

Yes, doesn't surprise me at all, having known David. So I guess related to that, Andy, this will be the first year in quite a while that you haven't announced a major strategic acquisition, even though I know Interxion closed earlier this year. So as you look out in the M&A landscape, I mean, are you kind of less attracted to maybe acquiring assets given kind of the very high asking prices that we've currently seen? And then what would your criteria be to do acquisitions? Obviously, we've seen you do some tuck-in smaller acquisitions, but nothing of the scale of Interxion or DuPont Fabros or anything like that.

I mean I'm happy to -- I said this at NAREIT, which is probably a little premature, but I can say now, we're like 23 days of shopping left and a little bit more until the new year. And I'm quite confident you're not going to see a large-scale M&A transaction of Digital Realty. And I said in [ just ], obviously, but I think that there's 2 reasons behind that. One, we're obviously incredibly focused on the integration with Interxion still. I'm very proud of the progress to date, but that will still be a lot of work for 2021, probably much more behind the scenes, whether it's IT or operational system alignment, less in front of our customers and investors and the like. But that's still a major priority for our company, and we are not taking our eye off that ball for one minute. But probably two -- some reason more so, when I look at our portfolio, I really believe the -- our hard work over several years now putting these puzzle pieces together, these irreplaceable components, in a series of both inorganic and organic activity, I feel like most of the major geographic regions, we have the waterfront covered with the full product spectrum. I feel very confident in that in North America. I feel the same in EMEA with maybe a tuck-in here or 2 kind of like we've just recently done, but not a whole lot of that. In Latin America, we've done it on a very organic approach with customers and to growing that platform now to 2 incremental countries. And Asia Pacific is probably the one place that is an exception to what I just described. But I'm really excited of what the team has done, whether it's in Seoul, South Korea, Tokyo, Osaka, Hong Kong, Singapore City or Melbourne, probably a market or 2 new Asia Pacific to come in the next 12 to 18 months. And quite honestly, there's just no major M&A opportunity in Asia Pacific. There's no interaction of Asia Pacific that I can put my finger on that fills that gap. So I think it's going to be a much more organic runway as we double, triple or quadruple our existing footprint in Asia Pacific.

Okay. Great. And then I guess, I'll ask one more. I think we're almost out of time. But you put out some preliminary guidance for next year, kind of mid-single digit FFO per share growth. I guess over time, how should we think about what the kind of target is for the company? Because you've done a couple of transformative acquisitions that were maybe slightly dilutive upfront. But presumably, over time, you underwrote those to be accretive. So at some point, should we expect Digital to become a company that can grow in excess of kind of mid-single digits as we look out beyond 2021, where you did point out a few headwinds from higher maintenance expenses and a few other things?

Yes. The -- we wanted to give just a little bit of a preview, albeit we're still in the final strokes of our budget process for 2021 is where we saw next year coming out in rough order of magnitudes call it, mid-single digits relative to, call it, to our guidance. We just updated and increased, I think, now by $0.10 at the low end of the range throughout the year. And really, I wanted to point out some, call it, headwinds. Obviously, capitalization movements, which again are much more in the rear-view mirror with the final pull down of all of our shares under equity forward and refinancing activity behind us. And also some -- some of the benefits of COVID in terms of expense, [ BP ] and especially repairs and maintenance in 2020, we just don't see it happening again in '21. So we wanted to call that out. We are not lowering our targets or our goals, and we are not happy with mid-single digits growth that -- we believe the business -- we -- the portfolio and platform we're putting together and continuing to improve our execution, which I think we've demonstrated now over not just 2 quarters since Interxion, or a record quarter here and there. But we consistently over -- call, at least a good 6 quarters, I feel like, that we continue -- can do -- believe we can do better. And we think that this business can generate mid- to high single digits earnings or FFO per share growth, like we said previously. So not content. We're not lowering our standards and striving for that higher growth. And I think we can achieve that post '21.

Okay. Well, Andy, I think we're out of time. So thanks again for taking some time to speak with us today, and we look forward to keeping in touch.

Thanks so much, Eric. Really appreciate. Hope everyone has a safe holiday season.

Yes. Thank you.