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

Good afternoon, everyone. Again, I'm John Hodulik, Telecom, Media and Communications Infrastructure analyst here at UBS. And I'm very pleased to announce that our next speaker is Andy Power, the CFO of Digital Realty. He is joined by John Stewart, the Head of Investor Relations. Andy is in transit. So this session is going to be, from his standpoint, audio only. But Andy, thanks for joining us.

Thanks, John, and thanks to the UBS team for hosting us today. Again apologies you're going to have to deal with my voice and John's face. I think the audience made out been better fair on that format. We're very excited to be here with the crew.

Awesome. So as usual, we've got about between 35 and 40 minutes for Q&A. And I've got a number of questions prepared, but if anyone in the audience has additional questions or any follow-ups, please shoot them over. There's the app, which I'm sometimes able to see. Also you can e-mail me or text me above my phone and my e-mail ready, so I'll be able to weave them into the conversation. So Andy, obviously, a very busy year in many ways, unprecedented. One, how you're now navigating the COVID pandemic? And as you look out to next year, 2021, what your strategic priorities are for the coming year?

John. So I mean, definitely quite a year for all of us here. And as it relates to COVID, I don't think can thank anyone enough special thanks to the entire Digital Realty organization. Many of our workers are viewed as essential workers, keeping our critical infrastructure up and running in the of one of my colleagues, David Ruberg, keeps the Internet running to your grandmother. So doing great things in addition to all the health and safety in the hospitals and other technology that our team is doing day in, day out. Supporting critical infrastructure. Despite the pandemic, I think we rallied as an organization. We've done a lot, like I said. Turning to 2021, which it's going to be here before we know it, right? I think there's a couple of priorities that we're seeing for next year. One, we've done a lot of work on integrating interaction this past year, but we're not done yet, and we're going to make that our #1 priority and focus. We've made a lot of progress when into a leadership standpoint. Organizationally and various systems integrations, but we've got more work to do, and that will be priority one for Digital in 2021. Two, we're going to continue to focus and double down on PlatformDIGITAL and really amplify our opportunity within the enterprise colocation segment. I think we've made great progress there in terms of what we've done in the last 12, 18 months. And the results are very improved, but that's definitely a strategic priority for next year. And then three, I think we're going to continue to focus on some of our, call it, the hyperscale side of our business, some of our legacy successes and continue to try to widen that mode in competitive advantages, whether it's newer markets or longer runways to support those hyperscale customers and really trying to align as their trusted infrastructure partner as best we can. So those are really the kind of 3 priorities as we quickly turn to 2021 here.

Got you. Now on the last call, you guys provided some high level guidance. Can you remind investors what are sort of the, some of the puts and takes for the financials as we head into the new year.

Yes. I really wasn't trying to get ahead of our FP&A team who's really in the final stretches of 2021 budgeting process, but we did want to provide on that last call a bit of a preview before we kind of get to formal earnings guidance unveil on our fourth quarter call and I guess sometime early in February. I've tried to start at the top line growth and really tackle it by 2 ways. I mean, you now have had 2 reported quarters, the second quarter and third quarter of 2020 with the new signs of the combined business generating a high of 144 million, and most recently, a very respectable 89 million of signings that averages, call it, 115 plus million of signings. Just coincidentally, we crossed the $1 billion revenue mark as a business. So the math became really easily to kind of look at pre-churn or non retention kind of top line growth. You also have to just keep in mind is next year. We're going to have a full 4 quarters of interaction. So on non apples-to-apples growth as the top line will be a little bit better than that. When you kind of go down to the all way to the bottom line, I think we try to highlight a few things that, obviously, a little bit of benefits to 2020 may be somewhat of a headwind to 2021. The T&E outlook, depending on when we get back to traveling is certainly one of them, but repairs and maintenance is certainly another where we've been kind of went to critical staffing levels and dire and we're going to have to resume a lot of that in 2021, which presents a little bit year-over-year headwind. Net-net, I think we wanted to give it a little early read that we see mid single-digit growth for 2021. And really -- that's not the new normal. That's not the new bogey that we're seeking here. Just that's where we see between those headwinds I mentioned and also the fact that our capitalization has now finally settled in with the entirety of the equity forward in the share denominator, where we see the numbers taken out, and we'll be kind of consistent with our guidance come a couple of months' time.

Got you. So one of the things -- yes, that you mentioned here to call out is the -- some of the additional expenses. So you're saving on the cost side now both from T&E and the repair and maintenance. But in terms of how that comes back next year, I mean, it would -- does it make sense to think of it as -- I mean, unfortunately, the pandemic is still with us. It looks like it's going to still be with us at least for the -- probably the first quarter, if not, the first half of the year. Can you help us think about the sort of recovery in those expenses from a timing standpoint? And does it take till sort of '21 until you get to back to sort of a full run rate on at least on the T&E side? And then on the repair and maintenance, is there any sort of catch up you have to do. So maybe it overshoots what we saw in '19 because of some repair and maintenance that wasn't now, but just any commentary on the -- from a margin trajectory standpoint, would be great.

Yes. I would -- I mean so we're being pretty cautious on returning workforce to offices and pretty safe on the assumptions around when we'll be back together as a team. Hence, our sales kickoff at the beginning of the year will be virtual and we don't know when exactly we'll be back to normal, but some of will come back back into 2021 on the back half of the year. I would imagine some of the activity that we as an organization that are highest spend in those categories, whether it's our leadership summits, maybe back half of the year or midyear sales kickoff resumes as well as our marketplace live event returns to a more normal course in the back half of the year. I just -- I give the sense that people are going to want to come back together in safe, but the collaborative formats once we're in a more safer territory. That's probably smaller dollars. Repairs and maintenance, I think how do operations kind of view this as -- you can only drive the car, drive the car with past the oil change date for so long. So this year, we certainly scaled back our staffing and enhanced our repairs and maintenance to what was mission-critical to keep our facilities up and running. And we cut off more optional or extended timelines on various components. Nothing that would be detrimental to our operations, but are obviously dollars that will go to repairing the critical infrastructure. We are going to have to bring that back in '21, regardless of where we sit with a vaccine. It will be done in a prudent, safe fashion with staging of resources and timing of employees. Hence, that is definitely going to be maybe a little bit of catch-up, but certainly, going from almost a year where you had benefits to our P&L this year on that category to be in something that's going to be an expense in 2021. I think we didn't really put a firm number around that. But I think that is one of the major contributors to a mid-single-digit growth rate on -- relative to where we're coming out to this year relative to what we think the business can do in the long run is mid-to higher single digits on the FFO or FFO per share.

Got it. Makes sense. Maybe just keeping with COVID, a couple of questions, and then we'll move into some other areas. But obviously, the country and globally going through another round of lockdowns, especially in Europe. Are you seeing -- maybe first on the operational side, any impact from this latest round, maybe as it relates to construction or sort of supply side of the equation?

Yes. The -- if you look at the various components of where we have been or could be impacted on the construction side, we did run into a few hotspots around the globe where we're bringing on inventory capacity. The Singapore market was 1 impacted with a rather large migrant workforce living in dormitory style housings that impacted our deliveries in that market. And of the, call it, 20 to 24 or so markets were developing capacity, there's 1 or 2 that caused us delays in 2021 due to things like I mentioned Singapore or other municipality restrictions. We have not seen that return in this more recent flare-up and this more recent shutting down, you could call it, of many jurisdictions. We have spent a lot of time with various municipalities and government organizations to make sure that they understand that the operation of our existing facilities and the delivery of our new facilities are both really viewed as essential to the internet infrastructure, i.e., we are bringing on capacity that is going to support research and development longer term. It's going to support healthcare and hospitals, emergency workers. And we have not seen any incremental delays on the construction side. Part and parcel of that being an essential workforce is our team, as I mentioned, call it, critical staffing levels in the data centers and operating. And then last but not least, our supply chain did do a really terrific job way before the pandemic getting out in front of this with vendor-managed inventory programs, really flexing our scale to make sure that our critical physical components would be delivered on time. So we have not run into any hiccups yet. Obviously, I'm not going to whistle past the graveyard on that topic whatsoever. We are, obviously, as a country and in a world, still navigating what looks like there'll be a tough cold weather months. So -- but so far, so good for Digital.

Okay. Maybe moving over to the demand side. Just broadly, how has the pandemic changed conversations with customers? Maybe first starting with hyperscalers. Obviously, it seems like a lot of demand out there. Has it -- it's hard to believe, but has it shifted in any meaningful way what customers are asking for on lead times or discussions that you're having with that segment in general?

I think the hyperscalers as a whole were very ahead of the game when it came to disaster recovery, technology, tooling, just basically not letting either the broader backdrop or the volatility or the uncertainty interrupt their road map for infrastructure growth. And I think you can see that based on the overall signings demand. I do not think it's a pull forward. I don't think they rushed the grocery stores and ordered or anything like that, but they've certainly been very steady and consistent in the demand profiles. And that's been for mature markets, certainly some of the major markets in North America, Ashburn's case point It's from growing higher growth parts of the world in our international markets, certainly in India. And it's also been in more emerging market opportunities. Where during this pandemic, we entered Mexico with hyperscaler as a partner on our opportunity to trust two sites for them. So very mature buyers, obviously, benefiting longer-term from this acceleration of digital transformation as a whole. I do think they -- I view this -- I believe this as a lesson or as something to take away as to partnering with large-scale wealth funded global organizations with key capabilities, operational excellence and really business partners -- trusted business partners or trusted infrastructure partners that can stand the test of time, brings value to them, especially in tough times like this. When we have the boots on the ground across numerous European countries or South America or numerous countries across Asia Pacific, where it maybe a little more challenging for them to kind of resource or fly their team numbers in a time like this. So by and large, quite pleased with the progress. I don't view it as a pull forward. I do see it as continued steady path of their demand.

Got it. And maybe shifting to enterprise. I mean, with the Interxion deal, you guys have sort of, I think, exposure to that colo/enterprise side of close to around 40% at this point. So any changes there, especially, again, in Europe, I mean, where you might have some higher exposure and we've seen more severe lockdowns. But has there been any change to that segment in terms of, again, elongated either installations or contract periods or any changes to the trends?

I was -- I was particularly nervous around the enterprise segment out of the gates called sprint time as it relates to COVID, having spent a fair bit of my career inside corporate enterprise, large financial services companies. I've seen the ups and downs and the volatility and what that is typically -- how that's played out within your corporate enterprise. By and large, I would say that our demand pipeline and trends have remained intact throughout this crisis over the last several quarters. I don't want to chalk this up as just a completely rosy enterprise backdrop because I do think we as a company have been doing several things over numerous years and executing quite well against the enterprise opportunity over the last several quarters. That I believe we're taking more share of that opportunity. So obviously, when you look at our results and you see things like record new logos a couple of quarters throughout the year. Adding to the more than 4,000 customers that are digital at a clip of, call it, 130 in the most recent quarter or, call it, 49% of our size at less than a megawatt in your connection or enterprise segment, in particular, beating its prior records a few quarters in a row here. You're seeing a pretty good strength in the enterprise segment. But I can't tend it to whether the broader enterprise segment entirely is bucking any COVID volatility? Or if we are just taking share from more private or regional or subscale or non-global providers as we roll out PlatformDIGITAL, as we provide our capabilities across approximately 48 metropolitan areas on 6 continents. As we continue to execute our go-to-market strategies, which I think are something that's helping us in the broader enterprise backdrop.

Any particular sort of industries that sort of spring to mind that are particularly strong coming out of the COVID pandemic on the enterprise side or colo?

Financial services has been something that I see most strengthened since the -- going way back to the financial crisis. And we've seen that broad-based in terms of financial services from banks to private equity hedge funds, fintech trading exchanges. It's been very robust across the board. It's been a very geographically diverse, so activity in North America activity outside the states. That's one that comes to mind. Beyond that, I can't pin a specific sector that I would say, out signed another. It's been very broad-based. When I look at our 130 new logos every quarter or I look at our key contributors in terms of signings within the enterprise segment. Each and every quarter has almost like a new standout here or there. So it's not -- I wouldn't say I could pin it on one particular business cycle. Obviously, you have segments that are being impacted the greatest from the world we're living in. We are fortunate to have a very modest exposure to leisure, lodging, oil and gas, the kind of frontline most impacted by everything being closed. But outside of those names, I'd say that the demand has been pretty robust and diverse.

Got you. So I think the backdrop that -- we're both referring to it's been a very strong year for the company from a leasing standpoint. How does the funnel look today? And maybe how does it compare versus earlier in the year? And do you -- and again, we're at a period where we don't want to little in front run your sort of guidance too much, but do you -- is all the pieces in place for it to continue to be strong as we look at '21?

Yes. I don't -- I feel like we're in a pretty attractive demand backdrop. It feels -- the shape of it feels a little bit different than 2020. We're obviously a little tighter in our Ashburn market. And conversely, I'd say we have a much superior runway in our non-North America markets. Because I mean standing at this time of the year, a year ago, I think we were literally debating whether the Interxion deal was going to actually close. We hadn't purchased the other half of the Westin Building. We hadn't expanded into Greece or Croatia. We hadn't seen success in India outside of the traditional flat markets. We hadn't , I believe, expanded into Mexico City, and we definitely did not have this runway of capacity coming online in the likes of Tokyo, Seoul, Hong Kong and Singapore. So the complexion deals shifting, it seems equally robust, but the mix of that complexion seems more international affair. And also, I sit here with a lot more confidence in our execution against our enterprise colocation and connection opportunity than I did heading into 2020.

Got you. Maybe we could just single out in Europe. We've heard from some other providers, vantage a little bit earlier in the day that Europe was going just gangbusters. I mean, is that -- are you feeling the same thing? I think the CFO there suggested that he could see a day where the European business was larger -- meaningfully larger than the North American business. Can you talk a little bit about demand and maybe overall market dynamics in EMEA?

Knowing how big our North America business is and knowing how well positioned we are across all of EMEA. I hope he is right. Because that would definitely been -- that would definitely check the box and probably certainly exceed our underwriting of what we thought the combination of Interxion in Digital really meant. I think -- and I don't think I touched on this, kind of working from the smaller to the larger. We've been putting some pretty good EMEA colocation or connection quarters up successively now. Both pre-Interxion and now 2 quarters post-Interxion and what I'm seeing coming into the end of the fourth quarter here. So the enterprise in Europe is not, in my opinion, taking a different tact than the enterprise in North America to date. So quite pleased with that. I think we have the best footprint capacity across EMEA for most highly connected sites for those global enterprise customers that we're seeking to service in EMEA abroad. And I think more and more customers are availing themselves of that offering in our combined companies. And I touched on the second part is a little bit. The hyperscalers I think you've seen a little bit in our signings, and you've seen a little bit in our activity. One, the flat markets, particularly Frankfurt, Paris and Amsterdam have continued to be competitively robust. Where we've executed there with tremendous offerings and those are -- those play right into our sweet spots, places where we're going to help these customers with our connected campuses and significant run with the growth. I've also been pleasantly surprised in the non flat contributions, call it the Zurich's, Austria's, Madrid, where we've kind of made some incremental investments to future-proof our runway for growth and provide those highly connected destinations. The Interxion legacy team have done such a fantastic job perioding with the right customer base and network density and then providing runway for the cloud depute to follow suit in those markets and I think that trend is going to continue in some of the newer markets that we've recently entered as well. So I'm definitely pleased with the demand backdrop and really excited about the power of our combined platform, servicing those EMEA customers, both on the ground in Europe and around the world.

Got you. You mentioned the North American market. Obviously, biggest -- largest -- I'm sorry, Northern Virginia market, biggest data center market in the world. That you're having some tight -- you were tight from a supply standpoint. I think you did have some space free up in a legacy DFT center. Maybe is there -- do you have demand for that particular space? Maybe if you could talk about just your pipe, your development pipeline in that market and maybe some of the supply demand characteristics. I think you guys have been very active in acquiring land and developing some new properties. So when will you have more space to sell and and just anything you could tell us about the health of that market.

Yes. Northern Ashford, North Virginia is a market where I think a lot of people wanted to totally write it off at the beginning of 2019 and I think we were very sober that the market was impacted and was going to continue to be impacted by supply demand, but we did not totally write that market off in terms of demand and the opportunity. And we certainly have confidence in our odds given what we thought was bringing something unique to the table and not a commodity like offering like some of the newer more private outfits that are offering single sites in those markets. And not just a record 2Q of '20, but I think we put on, call it, 4, 5, maybe 6 or so quarters of consecutive solid results, 10 megawatts, 15 megawatts, 20 megawatts on leasing that ultimately accumulated at the end of 2Q or 3Q of this year, where we're rather tight. We're 94% occupied on the operating portfolio and 100% pre-leased from almost 50 megawatts that's under construction as we speak. That market, in my opinion, is not fully healed. We're not back to more rosier 2018 type of rate or return levels. But I do think we are in a better place today than we set a year ago. We're heading out of the woods. And I think that's a testament to our global platform was that international sales force? Was that on the ground, large installed customer grade that wants to grow with adjacency and that future-proofing that runway for growth with the layer capacity that we own and control in that market. I'd highlighted on the call that the shelves are not completely bearing we have about just over 17 megawatts coming back by the end of this year. When you add that to our existing vacancy, that gets to just under 40 megawatts. These are in data halls that are being sought after as we speak because they are legacy digital and legacy DFT, where existing customers have an easy growth path because they're operating in live environments in the adjacent halls. And we always find that in pursuing our customers' growth opportunities. When you can give them runway next door in the same suite, runway that store in the adjacent building, runway on adjacent connected campus. And continue to show them that future runway of growth when they're going to come back in the future for more capacity, that's Eisais Inc. competitive advantage to our offering that I would say was giving us our success in a highly competitive market over the last 6 or so quarters. So that's where we're going to be focusing on with the team and selling into that move-in ready capacity, high flow-through revenue contribution because we're already staffing the operations teams. The capital is already deployed. The building is already built because I don't have to wait to commission a facility. And that is until really in the back half of 2021, called June -- like Junish area, when we have our, I think, it's called building R, that's where we are in the Alphabet, I believe. Coming online on the Loudon campus as a new -- as the newest facility to launch. So if any market -- as I always like to have just the right amount of capacity for our sellers to be selling into and our customers to be grown. But if there's any market to be a little bit on the tighter side which I think accrues to our advantage and has accrued to our advantage. Ashburns one right now because we're not out of the woods yet in terms of overall supply-demand dynamics.

Got it. Mean given the backdrop in terms of the demand characteristics, is there any reason to think that the pace of development -- maybe in terms of the entire platform, could shift for the company over the next few years? And maybe more specifically, where do you expect dollars to be focused in '21 sort of either by region or by market?

I think the the 2 themes are international and colocation connectivity will have a higher percent spend of our capital. And then just you can see it, we're just we're focusing on kind of going back to the strategic priorities. On the international piece, it's building out in markets where we're seeing the highest growth rate. We have the most -- the largest competitive mode we provide the greatest amount of value to our customers that are on the ground with local language speaking teams that know the business on these facilities. So more and more of our CapEx as a percentage of business, especially relative to our pie. We'll go into Europe. We'll be going into South America, and we'll be going to Asia Pacific. That doesn't mean we won't be investing in North America. But the pie is going to continue to be more development CapEx internationally? And secondly, as a follow-on to PlatformDIGITAL, you guys -- the success we're having -- the enterprise customer is giving us more confidence in building out more capacity for our colocation enterprise customers. So you're going to see larger sweet formats for those customers, and we're going to make sure we have the run rate of inventory growth for those customers. And not to the dollar size of international relative to domestic, but the colo footprint will be a larger percent investment than it was in prior years based on success and the reshaping of our overall portfolio mix.

Got you. Andy you said in the -- sort of your outlook for 2021. The priority, number one, for the company is going to be the moving forward with the integration of Interxion. Could you just sort of give us a lay of the land in terms of where you are now and sort of how far you are with the integration and sort of what are the boxes you need to check over the next 12 months to get where you want to be?

Yes, the team has done a really admirable job in a world where they cannot fly across the pond to not get together even those living in the same cities and done -- and really went to a Microsoft Teams, Zoom, Blue Jeans type format of all kind of communication collaboration. And where that's gotten us so far is great progress from a people side and the leadership side, announcing leadership of a combined business for EMEA. We've hung that under the Interxion of Digital Realty banner. Everything that you're seeing from every press release of key customer wins or new solutions or supporting growth in new parts of EMEA with various investments. That is a combined EMEA business, legacy Digital and legacy Interxion from a leadership standpoint, people standpoint, product standpoint. So we've come together quite well. And I would say the next step for 2021 is going to be much more of a behind the scenes, take it to the next level in terms of tying our IT systems together, tying -- operating in a unified go to market, i.e., have a full 12 calendar months starting with a sales kickoff for the entire organization, virtually all together at the very beginning of January. So all of our sellers beating to the same exact drum. And also, I think, doing a lot of other work that you'll see much more -- much more behind the scenes and out in front of our customers and investors in terms of aligning our operational models and making sure that we're delivering that operational consistency across the globe, while at the same time, making sure we're very adept and attuned to local nuances that we need to deliver in addition to that operational global consistency.

Got you. Okay. With the small amount of time, we have left, just a couple of questions on M&A. You've done some smaller tuck-in acquisitions recently in Greece and Croatia. Maybe what attracted you to those deals? And could we see more of those deals in other parts of the world as you look to fill out the portfolio?

I mean, the really goes back to the power of our combination, in my opinion. These are opportunities very much sourced and in the strategic vision of the legacy Interxion team, including David Ruberg, and they -- I don't know if it's exaggeration, but they feel offer a lot like me to many interactions or interactions 10, 15, 20 years ago, highly connected destinations management team and leadership teams on the ground for each of these countries on the burgeoning outlook of compute and hyperscaler growth to follow in addition to global enterprises seeking to penetrate those markets and have a more broader global footprint that kind of touches further into Eastern Europe. So those 2 deals have worked collaboratively between the legacy Interxion actually digital team members. And I think that's definitely going to be part of our playbook on a more global scale. As we look to continue to grow our capabilities across more countries and more metropolitan areas around the globe. They were tuck-in in nature, smaller dollars relative to our, call it, $55 billion enterprise, but highly strategic and very much growth oriented. And I view some critical puzzle pieces that are going to be irreplaceable opportunity if you want to service those type parts of the world.

And are there -- is it a target rich environment? I mean, are there a lot of these little, very promising, highly connected data center companies out there in these markets that look attractive, that where you could see more of these here in '21.

I think that these are always far and few between. These are, call it, most of these have fallen into permanent homes it at Digital or Equinix realistically over time. That doesn't mean all of them are locked away forever. But I think you need to keep a close eye on these opportunities. You've got to understand what ones next and when. And I think you need a part of the story is selling the virtues of joining our platform. Which I think we've been quite successful in some of these more recent additions. And this doesn't mean this is the only tool in our toolkit or arrow in our quiver here to continue to grow that footprint. There are other markets in EMEA and outside of Europe that we're looking on an organic fashion to do something similar just because there is not a team or a critical business or asset on the ground that has created that connectivity dense location that route into the subsea cables, that footprint for the hyperscale compute growth does have to have all the ingredients so we have the same skill set to do this organically on a new market expansion basis, and that you could see a fair bit of that to come from Digital as well.

Got you. And last question. Just consolidation in the U.S. Obviously, the market is still relatively unconsolidated, but we have seen a number of deals over the -- as we were talking before, going back 20 years, frankly. Do you expect to see more consolidation of the U.S. data center market?

I just think that the long-term trends that have been playing out is that being global, having large scale, having full product diversity are -- is creating a widening moat between the large -- the businesses that fit those categories like a Digital and those that do not. So whether you're smaller, subscale, private, handful of markets, just U.S., just one product line and not kind of aligning yourself of those trends. I think for some time, the rising tides looked at all ships, but I'm not sure that's going to last forever in terms of building a really defensible business model to generate longer-term returns in growth. And I think that would lend itself to a consolidation theme over time.

Perfect. Well, Andy that's the time we have time for. I really appreciate you dialing in from the road.

John, really appreciate you having us on board. to let John answer some of these questions, but because I wasn't worse, I forgot hopefully, you got to see the two Johns on screen and hear me not interrupted. So thank you, guys, again for having us here, and I hope everyone has a safe and happy holiday.

Absolutely. All right. Take care. Thanks, everyone.

Thank you.