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

Good afternoon, and welcome to day 2 of Citi's Global Property CEO Conference. I'm Michael Bilerman, and I'm here with Mike Rollins from Citi Research. We're extraordinarily pleased today to have with us Digital Realty Group, and CEO, Bill Stein. The session is for investing clients only. If media or other individuals are on the line, please disconnect now. Disclosures are also available on the webcast. For those joining us here today, to ask management any questions at any point, simply type them into the question box that you see on the screen, and those are going to come directly to Mike and myself. Bill, I'm going to turn it over to you to introduce Digital and any members of management team that are here with you today, and then we'll kick it off with some questions.

Thanks, Michael, and thank you, Mike, also, for joining us. Andy Power is with me today. Andy is the company's CFO. He's been sitting in that chair since 2015. Prior to that, he was -- as some of the investors know, he worked at both BAML and at Citibank. Digital Realty is a data center REIT. We've been public since 2004. We have the largest footprint in the business, and we have a -- we are both geographically diverse and a broad offering from hyperscalers to enterprise. And with that, I'm happy to take any questions.

Great. Thank you for that, Bill. So we've started each of these sessions by asking the following question, coming out of the pandemic, if an investor were to choose only one real estate stock to own, what are the 3 reasons why they should invest in Digital Realty?

Sure. Well, first of all, the data center industry itself, as many of the people on this call know, is backed by incredibly strong long-term secular demand drivers. Digital itself is a global leader in the data center industry, servicing the full customer spectrum from service providers to enterprises, and they enable us to reach the broadest addressable market across a global platform that is well-positioned for growth. And finally, over the last several years, we've significantly enhanced the quality of our offering through a combination of recycling capital and reinvesting in highly strategic acquisitions such as Interxion, the Western Building up in Seattle, Altus IT in Croatia, and Lamda Hellix in Greece. We've also significantly enhanced our go-to-market engine, and we're making significant headway to become the global provider of choice for the enterprise customer segment. That might have been slightly more than 3, but -- sorry.

Well, well, maybe we can just start, you mentioned the secular demand drivers for data centers. How you feel the level of growth has changed with the pandemic? So do you feel like there's been acceleration of demand? And how would you quantify that?

There's been unquestionably an acceleration. I think you probably have seen it in the bookings of all the data center companies. I think what's happening is the enterprises that had a digital transformation strategy, we're ahead of the game in terms of their competitors coming into the pandemic. Enterprises that didn't have a digital transformation strategy understood the need to have one. So they accelerated their plans as well. And part of that digital transformation strategy includes moving applications to the cloud. So we've seen the cloud providers just increase their orders, if you will, too, throughout the world. It's been just phenomenal the amount of space they're taking down. So -- and I don't think this is a one-off phenomenon. I think this is going to continue for some time based on what we're seeing coming into 2021.

How many years do you think it accelerated in terms of that growth opportunity?

I think it might have pulled some stuff forward to move some -- I mean the companies that had it were accelerated probably 12 months. Those that didn't might have pulled theirs short a couple of years. And I mean, and we heard, I think it was the panel today, it might have been the panel yesterday, too, where you're going to have more employees working virtually, the Zoom platform. And some of that's going to be permanent. I mean, I think face-to-face does really matter for partnerships and customers. But I mean, next year, Mike, you're going to give people the option to dial in to this and do it virtually?

So I guess the question is, the companies know, right, we think that the in-person element is going to be very important. But I think what we're thinking about is, do you offer a hybrid, a virtual day, maybe at the end of the conference, right? And you selectively have different investors on meetings at different points of the day if that's virtual. A lot of planning -- we spent a lot of time planning this virtual conference. I'm not excited to figure out the hybrid conference.

But again, think about your conference -- prior conferences, you haven't had enough cubes for the companies that might otherwise present. And so this at least puts a platform out there for everybody. And same thing like we noticed at the NAREIT investor conferences because I'm just drilling us down to something that we're very familiar with. It used to be, if we were meeting with you and Mike, there'd be the constraints for the size of the room and the number of chairs in the room. We no longer have those constraints.

No. I just think an in-person meeting is much different than a virtual meeting.

No, totally. Totally. But then the question is, do you have some kind of hybrid where for the NAREIT meetings with sell-side analysts, is there a virtual component? We'll see how it works out. But all this is good for our business, though. More virtual meetings means more bandwidth and more storage. And anyways, we're not complaining about that aspect of the business.

Right. Bill, one of the things that you raised the issue of demand and some acceleration in demand. And one of the questions that we get, and I think in the past, Michael and I have asked you this as well, is can you frame the commentary around the strength of demand for the category relative to what you see in terms of the trends on pricing and development yields, particularly in hyperscale, but maybe you can provide some context of how to position those 2 things across your key verticals?

Sure. Well, I think first of all, that -- the pricing and the yields, they vary tremendously by geography, by product type and by size of deployment. Even within the U.S., it will vary by geography. So Virginia will have lower pricing than Silicon Valley. But certainly, Europe will have better pricing than the U.S. in general, as does Asia. And right now, from what we're seeing, Singapore may well have the highest yields for us anywhere in the world. But in general, I mean, just like in any business, really, smaller deployments have higher pricing and higher yields than bigger deployments. And the deployments in Europe tend to be smaller, even the hyperscaler deployments in Europe tend to be smaller than the hyperscaler deployments in the U.S., which is probably one reason the pricing is lower and the yields are lower. Another factor is, frankly, there's more supply in a place like North Virginia, you have a lot of private players there. And it's harder to acquire supply in most of these European markets. They're just greater barriers to entry. And the same is true in Asia. In terms of verticals, I mean, our 3 major verticals are the hyperscalers, the networks and enterprises. And then within the enterprises, we focus on the Global 2000, primarily. And drilling down from that, it's financial services, it's gaming. It's -- artificial intelligence will certainly play a part. Andy, I know I'm missing some on the vertical side here. Help me out.

Health care, media, just different various flavors of enterprise basically. Mike, did it hit your question?

Yes. And maybe just if you can unpack a little further. So if we take that hyperscale out of the equation, what are you seeing on pricing in general, small retail type deployments versus maybe the medium-sized enterprise deployments. If you can give us a sense of how that's been trending for digital?

Andy, do you want to take that?

Happy to. So we've seen pretty firmness in that pricing category. That segment of customer, more often than not, falls into some more connectivity dense locations. We're also selling platform opportunities. So global enterprises, landing in multiple markets across multiple regions. So incremental value proposition to those customers. And it's a more granular customer base, and we're bringing more value to the customer in terms of solving their pain points, improving their performance and efficiency. So it's still beholden to typical supply-demand dynamics on a granular market basis. But as we bring more value to the table for the customer, as we help the customer from an enterprise lens, in particular, across more locations, as we improve their performance, and we do so with a further differentiated product, which we've worked hard over now several years to kind of bring to the table, I think that translates into better cash mark-to-markets on those existing customers when they renew and also firmness in rates and returns for landing new customers.

And since closing -- oh, go ahead, Bill. I'm sorry.

We're also intent on building communities of interest. And to the extent we're successful in doing that, that will generate better pricing and better returns.

Within that context, actually, are there things that you're now doing post the Interxion close around communities of interest in the North American data centers that you're importing from the European experience?

We're importing it both in North America and in Asia. And that David Ruberg has taken on a global role with us, and that's one of the things that he's working on, as well as Giuliano who's in charge of segmentation and strategy, and that's basically building communities of interest around the world based on the Interxion model. And I would say, at this point, Andy, I'm estimating here, but I think probably 60%, 70% of Giuliano's team is from Interxion. So we have that...

It is a blended team. But again, just to put more color, a very segmented customer approach on targeting and curating the right customers for the right locations. Obviously, those activities, just to provide some more detail, certainly, we're behind our growth into both Athens and Croatia. I think you'll see more of that activity to kind of come to fruition outside of Europe. We have a press release that either just came out in Asia or is coming out on some work we're doing in the Tokyo market around subsea cables and really what we think will be a differentiated offering for the connectivity-focused enterprise customer landing on our Narita campus or out by -- or in Inzai. And so there's more to come, again, in North America, Latin America and Asia Pacific, really trying to champion some of the success and strategy from that legacy Interxion playbook.

And it's not just the customers in a specific location. It's also the -- which of the customers' applications we want in those locations.

That's very helpful. Just in terms of one of the questions we've been getting from investors is the core FFO per share growth indications are in the mid-single digits for 2021. The revenue growth is -- guidance is significantly faster. I think it's about 10%, if I remember correctly, at the midpoint for 2021. When does Digital get to a point when the per share profitability growth can meet or exceed the revenue growth.

Andy, do you want to handle that one?

Happy to. So a couple of comments to unpack that, Mike. We are, as you saw from our guidance table, expanding our development CapEx. We've opened incremental addressable markets. We're shifting that CapEx to more and more non-U.S. markets, higher growth opportunities where we have a differentiated playbook and competitive advantage, both for larger footprint and also for enterprise-oriented opportunities. I need to turn my ringer off of my landline. Antiquated at this point. Top line growth is accelerating. We have a little bit of apples and oranges because we have a partial period with Interxion. But even when you normalize that, it's accelerating in the top line. It's called, as reported, call it in the teens, like we said, and high single digits apples-to-apples with Interxion full year. We have a little bit, as we described, activity or headwind episodic to 2021 via the share count closing of our equity forward at the end of last year for $1.1 billion coming to our share count as well as some COVID-related timing on repairs and maintenance that kind of lands us at a mid-single digits. But I think most importantly, what we said before and what we stand by is we're not happy with that. I mean we're not lowering our bar to that be the new normal. So we're continuing to push that growth. And I think we're hoping to keep that revenue growth at that same top line trajectory and narrowing that gap that flows through the bottom line growth as some of these things -- these episodic things go away, and we'll continue to accelerate the fruits of our labor essentially.

One question that we're asking all the companies at this conference is with regards to ESG. And the question is, what are your top 3 priorities to improve your ESG score next year?

Sure. Well, so we established very recently the carbon reduction targets within the science-based target initiative. And so to meet these targets, we'll continue to prioritize our global renewable energy solutions. So that's sourcing renewable energy. We're a very large user of that, 100% in Europe. We got green building design and supply chain sustainability. And as an example of other things we've done in that area, we gave back -- well, we ran our Texas data centers on the gen sets during the energy crisis. So we went off the grid, allowing the grid power to be used for the benefit of the consumers on the grid down here. And we were actually able to give some power back to the grid from our gen sets. With respect to DEI, diversity, equity and inclusion, we've established an in-house DEI council. So that's a grassroots program. It's led by our employees. The 2 executive sponsors are core global -- well, our Chief Revenue Officer, and Cindy Fiedelman, who's our Chief HR Officer. We recently added DEI as a fourth pillar within our philanthropic focus. I personally signed the CEO action pledge for diversity and inclusion. And I'm also co-chairing NAREIT's dividends through diversity program along with Tom Baltimore and Debbie Cafaro. We also think, in this area, that disclosure matters a lot, too. We're hearing that ESG investors are clamoring for summary of the E1 report, the racial make up of boards and officers, board oversight of ESG and disclosure of political contributions. But finally, the third item would be to continue to emphasize all 3 pillars of the ESG stool at the Board level. And so at Digital, we've had a consistent policy of board refreshment. We have 3 women that have been appointed to the Board within the past 4 years. Mary Hogan Preusse is Chairman of our Nom and Gov Committee and she's a well-regarded and well-known former sell-side analyst and portfolio manager who hails from really one of the leading ESG-focused investment managers. So she brings that perspective and that focus both into our boardroom and as Chair of the Nom and Gov Committee.

Bill, you mentioned the Texas storms and the electricity. Can you just talk a little bit about are your electricity costs hedged? How much of it's just a pass-through? And was there any impact from what happened in Texas on a direct impact to your own OpEx?

We are hedged. I think we're about 70% hedged on power, and I believe about 90% is pass-through. Andy, you might...

91% in Texas. 91% in Texas.

That's close. So I think in terms of impact, we actually might be getting a check back from the grid because we sold excess power from the gen sets back to the grid. We'll see. It's no guarantees in the world down here. That's -- it's quite a -- there's a lot of press every day about ERCOT and questions of overcharging. But theoretically, we could get money back.

Michael, just to pick that up for one last second. I mean, often not discussed at these conferences is just call it the operational excellence and resiliency of our services because usually, it's only a bad day when these topics come up. But I'll tell you, numerous customer accolades in terms of response to this crisis, no different than we've responded during the numerous hurricanes that hit the southeast or the winter or the storms that kind of hit New York City years ago. I can tell you firsthand, the CTO of one of the largest food and beverages companies called me out of the blue, saying, "Hey, we're with you in this location, but we have an on-prem data center. Can you help us? We're running low in diesel." And the power of our platform, our supply chain, our prowess had our fuel contracts getting 2,500 gallons of diesel to them within hours of that phone call. And I think that our scale and operational expertise really shine through when it matters. And I'm sure that really is going to change the difference in that customer. And that's just 1 example, but we don't often talk about these in terms of investor context, but I think with the investment we made in that area is certainly paying dividends for a customer in their time of need.

Would you find that competitors are not that way? I mean, I guess, how do you segment -- is there an opportunity to pick up share? That portends to happen in times of crisis, right?

Theres' no way that everyone is on the same playing field here, right? We have 290 global data centers. We're the largest in North America, 1.8 gigawatts of power under operational control. The relationships holistically we have with our -- all of our partners and vendors and the supply chain is unparalleled. Certainly, we're a step up against smaller, more regional or private or subscale players. And any new entrant is going to be nowhere near getting a phone call picked up in their time of need because everybody in the state of Texas was in dire constraints, right? So I think you don't -- it's one these things like concerns, you don't need it until you need it. And I do think that will pay dividends, and we'll be packaging that up and using that as a testimonial to our broader customer base of something that we can bring to the table.

And can you talk a little bit about sort of the overall transaction markets? And there is a fair amount of interest in the data center space as an investment, both on the infrastructure side and just as an alternative from a real estate perspective. And I would say data centers' time is no longer a specialty asset class. It's a critical core asset that is driving our digital economy. And so how are you funneling that institutional capital demand, either taking assets off your balance sheet or for new investments? And how active is that today relative to 3 or 6 months ago?

I mean, Bill really braced the trail on this, predating my 6 years ago arrival to Digital, with, call it, the first kind of core-like joint ventures in the space. A lot's changed in the 15-plus years of our being a public company and certainly the last 6 years. I think we come to the table with a very holistic view in terms of our cost of capital, in terms of both our public cost of capital and access to private cost of capital. We've used -- I've said this, it's kind of hokey, but I'd like to have our fishing pole in all the different pools of capital, right, because different pools of capital will heat up and cool down and have different uses for different opportunities. And we've used things like derisking emerging market risk when we went to Latin America and brought a world-class asset management platform with Brookfield as our investor, not just because they could invest that size of capital but because they brought intellectual capital and history and experience to the table. We've also kind of -- I've been a leader, I'd say, in evolving our capital sources to take advantage of the truly definitional core-like capital, which is -- and I know that's more of a real estate term flowing into our asset classes. And Michael, I still think we're special even though we're maybe not specialized. But we've been...

Special on my heart.

Thank you. Thank you. But we've been using that. Over a year ago, we did a joint venture with Mapletree, and -- prior to that, and we've been using tapping into our network of buyers of these assets in a noncore disposition framework as well, i.e., we want to make sure that we're focused on the right markets, the right product and capacity that really is creating a differentiated platform. Near term, our funding plan includes more of that next leg, the noncore dispositions that is already baked into our guidance for 2021, which we feel pretty good about getting the low end of the disposition elements think analogous to the power-based shells that we've sold before, but outside of the U.S. for this next leg. And then longer term, having the ability to continue our, call it, core-like capital and joint venture formats. I mean we own the lion's share of our 290 data centers, but a handful of these large assets, these hyperscale assets that we can harvest merchant gains from and use that as an equity substitute so that we're not beholden to equity to fund our $2-plus billion development cycle. So that's been our migration of call it -- I call it shrinking the denominator while accelerating the numerator.

You're discussing the benefits of your platform for your customers. And just curious, when you describe the evolution of Platform Digital, and I think there was a recent manifesto that the company published as well along these lines. What does that mean for your customer? And what does it mean for Digital Realty's operations?

Do you want to pick that one up, Andy?

I knew you were going to give me the manifesto question.

The manifesto, by the way, it sounds like it should be out of like a mafia.

It was a very distinct thought leadership piece authored by our Chief Technology Officer directed towards our customer audience and as well as the industry influencers and less probably insightful or useful for this investor audience. But I can tell you, the response we've gotten from it as well as other activities in the space, whether it's been our -- the launch of the Data Gravity Index has really put us more and more on the road map of the right people and the firms we're targeting to grow our enterprise business. And that's been a litany of things that go with putting the portfolio together with the critical assets, be it Platform Digital, Marketplace Library, [ coordination ] and 24-hour all the sun event, Data Gravity and leading up to this most recent piece. Tying it back, Mike, I think, to your question was, one, it's making sure that the enterprise CIO, executives, CSO, IT leader is aware of our platform and our offering on a global basis and our capabilities, where we believe that across now 49 metropolitan areas, 24 countries and 6 continents, we're in the right markets with the right highly connected capacity and runway for growth, Operationalizing that. At the end of the day, that is just more of a repackaging and repurposing. Just we are operating today and have a history of being the operational hands and feet to the biggest cloud service providers on the planet, operating to the most demanding service level agreements to some of the toughest customers there are with -- I think on average, the top 5 CSPs have called 40-ish sites, locations with us. So we already -- the bar is high from that operational standard, and that's what delivered those -- the kind of example I gave you in terms of the Texas storm and responding in hours' notice. So operationalizing that is now to take that with our highly connected colo locations and further just expanding our productization, which we've grown now to APAC, where I think we're launching 5 or 6 productized colo markets across APAC, including Seoul, Tokyo, Osaka, Hong Kong and Singapore and essentially delivering that into an enterprise customer that takes in different shapes and forms of requirements, cage and cabinet and more connectivity-rich profiles. So I do not view that as a heavy lift or a heavy transformation in our support of those enterprise customers.

The question that we get along these lines, too, is as data centers, including Digital, layer on more services or functions for the customers, does that mean there could be a multiyear incremental investment in SG&A? And just -- because there's more things to operate and to do. How should investors think about that for Digital?

I mean my view is and what was, I think, the most pointy pieces of that -- the manifesto document that we put out to our customers was we're doing this in a path to sticking to our core competencies, physical infrastructure services and connectivity services and driving towards an open an active world where all of our customers can bring their technology and their layers of services on top of our platform. We're that trusted safe pair of hands, the physical delivery of those infrastructure services. But if it's a bare metal solution, a network solution, we welcome all those types of customers to our environment, whether it's an edge use, which we made press releases with Vapor IO, or high velocity in the bare metal side, where numerous other customers that want to take advantage of our global platform. That doesn't mean we have not scaled our investment into the go-to-market engine are behind this, and we've been doing that over time organically and through our acquisitions. So we've been harvesting efficiencies from our broad scaling business and reinvesting that in growth. But it's not a place where I see us going to the business, up the IT stack into our competitors' business and rolling off different customers because they say, "Hey, that's now our business, it's no longer yours." That, I would say, is a difference in what -- how we approach the business.

So relying on partners, not incurring the cost ourselves.

And one other question for you -- oh, Bill, I'm sorry, go ahead.

I said we're relying on partners rather than incurring the cost ourselves, but our partners are our customers. So it's a virtuous cycle.

And one other question before we get to our annual rapid fires. The question is the bookings for the last 9 months of 2020 took a step up post Interxion being completed and the JVs coming through over the last 12 to 18 months. Are there certain aspects of changes that you made to the sales process, distribution process that might just be underappreciated in terms of getting to those booking results? And how do you view the durability of being within the range of bookings, quarterly bookings that you hit during those last 9 months of 2020?

I think Corey Dyer, our new sales leader, has just taken a much better approach to the processes used to lead our sales organization. And examples are, our prior sales leadership would basically set a uniform quota for certain types of sellers. Hyperscalers will all have the same quota. Now Corey looks at what the opportunity is among the customer set for the various sellers, and you'll have different quotas for different sellers. And what's happened is that there's now a much higher percentage of our sellers that are achieving quota, and there's a far lower churn of sellers. I mean, sellers leave when they don't make quota. They need to earn a living. So I do believe that we just have much better leadership in place, and that's made a huge difference in the productivity as well as having the Interxion portfolio and the access to that portfolio to sell into as well as that customer base.

All right. We got our 4 rapid fire. So the first one is, when we are sitting physically together in Florida a year from today, so you will have to make that West Coast flight, what will be the one thing that will have surprised people the most about your business over the prior 12 months?

I mean, I hope, Michael, it will be the recognition of how much our portfolio has transformed to a network-based, network-dense, highly connected portfolio.

What do you think your corporate travel budget will be in 2022 as a rough percentage of what you spent in 2019?

Do you want me to take that Bill or -- go ahead, please.

It's not an easy answer because of the Interxion acquisition.

I think in the spirit of the question, I think it will be, call it, 80% or so of a normalized number. Obviously, we had a combination there, but I think what you're trying to get is more apples-to-apples comparison.

Yes, exactly. Trying to get a rough sense. That's why we asked 200 companies what their travel budgets are, get to a number and then we say, all the CEOs believe. Same-store NOI growth for the data center sector overall in 2022?

Look, I think the demand will continue to be strong for our space. I think for Digital, I know you just -- you don't want Digital in particular, but we think our numbers will be particularly good because of Interxion and Weston because that will then be going into the same-store pool. But I'd say for the group as a whole, you're looking at 1% to 3%, so call it 2% at the midpoint.

Andy, do you want to take the over under? Or you're in agreement?

I support that.

10-year treasury a year from today. So 1.55% right now.

2%.

Great. Well, thank you both. Have a great rest of the conference and meetings, and we look forward seeing you soon.

Thank you, guys.

Thank you both.