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

Yes, hi. Good afternoon. This is Michael Funk from Bank of America, the Data Center Analyst here. And I want to apologize for the late start and the fact you can't actually see me, which may be better for some of you. I actually decided to work in the office this week, and I think they're trying to force me to work from home because the tele presence wouldn't connect. So I guess, work from home is certainly the new wave of the future, which I'm sure Andy and John and I will talk about. Kind of fits the Digital Realty from that trend. But wanted to once again thank Andy, Andy Power and John Stewart from Digital Realty for being with us here today. I don't know if John had any kind of disclosure to read before we kick off here. John, do you have one?

Mike, it's just me today. So you're going to be stuck with me and no disclosure, so we can jump right into it.

Good. So the training wheels are off. We can totally go. There are no guard rails for the conversation today, Andy?

You got it.

So just wanted to maybe kind of go back chronologically. One of the more recent events, Andy, was the equity forward sale, the 6.25 million shares. I think you raised about $1 billion through the equity forward sale. Can you just walk us through the thought process? Because I expected there would be an equity sale or an equity offering. This one was larger than I was expecting. So maybe just kind of thought process first on the size and the timing of the equity forward sale, please, Andy.

Sure. And Mike, thank you again for having us here and no sweat on the technical difficulties, happens to us all. We'll be getting with your IT internal team to help figure this out post this call. So just kidding.

Okay. Thank you.

Yes. So the -- really, the equity offer -- forward equity offering last week was really, I would characterize as opportunistic. We had some reverse inquiry that had come to us in the late summer months. We really were not in need of equity immediately in terms of our funding plan. But obviously, we're looking towards, call it, a rapidly approaching back end of this year and in 2022, as we disclosed on our last call, we have a sizable development pipeline, 300-plus megawatts requiring $3-plus billion of capital. The equity forward format, well obviously gives a little more complexity, is something that does have the convenience allowing us to draw down those proceeds as we need them. This particular forward has an 18-month duration, so it has a little bit incremental runway. So it's kind of lockstep with our, call it, balance sheet strategy of prudently funding our growth for our customers. And by and large, I mean, you can just look at our linear press releases over the last 6 or 9 months, we're continuing to grow our footprint on multiple continents, continuing to build out our campuses and highly connected destinations. And this is just one of the several kind of tools in our toolkit to prudently fund that growth in addition to other activity we've done over the last year in terms of accessing the Euro green bond market and the Swiss bond market.

Okay. And the decision, just once again, on the timing and the size, Andy, did the timing just reflect a relatively strong capital market and just wanted to get it all out of the way at one time, so you didn't have to come back to the market for, say, 12 months plus? Is that what drove the timing and then the size of the offering?

Yes. We just -- our stock had moved in a positive direction. We have received some inquiry of buyers. And we just said the forward construct allows us to take down the proceeds and the shares -- issue the shares at a time that it works for us. And we're a big liquid company. We've got a large pipeline of growth. So it was, call it, let's take some risk off the table and have locked in that cost of equity for a pretty long duration of time to fund our growth was really the -- where the time and the sizing came into play.

And then other potential sources of capital. I know there was a story in the press couple of months ago about a potential Singapore IPO. I think that the press reports put it something in the range of $500 million. I believe you have an asset in the market right now, another potential couple hundred million. So is the right way to think about it is potentially having that incremental $1.7 billion of liquidity that would take you into maybe 2023, if I'm just thinking about sources and uses? Is that the right way to think about how far out you're funded now?

So we are at a very strong liquidity position, well-staggered long-dated fixed maturities. What's in the rearview mirror are our Swiss bond, Eurobonds, locking and long-duration debt fixed rate. On the equity side, we've completed some noncore asset sales to date. And the equity forward will likely be drawn down in small increments, if at all, this year, depending on timing of some asset sale proceeds. So the only other, I'd call it, funding source that has a potential to close this year based on how late we are in the year at this point is really, call it some noncore asset sales. We've just closed about $700 million to date, including our EMEA portfolio, and our guidance at the high end is $1 billion. So I'm not sure we'll get all the way there. So in terms of impact to this year, rather modest and really is exclusively tied to those noncore asset sales. As we turn to early next year, where obviously, the equity forward will be a major funding source. But we're also always evaluating how we continue to diversify our sources of capital and find attractive sources of equity capital for some of our assets that are more core-like in nature, akin to what we've done in the past in some of our joint ventures.

Understood. Maybe just flipping to the other side of the equation on the usage of capital, Andy, you mentioned development activity, inorganic growth has often been a part of the Digital Realty strategy. It's been 2 years now since the Interxion acquisition and 5 years, I think, since DFT. So what's the right way to think about the mix of organic versus inorganic growth in the Digital Realty strategy?

I'd say we've worked hard over several years putting together some critical puzzle pieces that you mentioned in your question. And today, we are very pleased with our global platform, PlatformDIGITAL, across, call it, 47 metropolitan areas, almost 25 countries, 6 continents with the full product spectrum. We have done some tuck-in activity in the last 12 or so months, be it Greece or Croatia. But by and large, we're very more -- much more focused on organically growing our platform, organically expanding our Latin America business into San Diego, Chile and Mexico City, organically expanding our APAC business into Seoul, South Korea with the first carrier-neutral highly connected downtown location and a campus to the western parts of Seoul. So I don't think there's any critical missing puzzle pieces at this point, very much more focused on that organic road map for growth. That doesn't mean we won't have tuck-ins here or there. But I think we've assembled most of the critical -- mission critical puzzle pieces to support our customers on PlatformDIGITAL with the full product spectrum across the globe.

Understood. And you've kind of touched on the piece part here, Andy, but you mentioned potential asset divestitures and obviously, development. And I expect that would shift the portfolio over time. So as you plan, where do you see Digital Realty's geographic revenue mix, say, 3 or 4 years out from today? How does that change versus where it is today?

Our strategy is to be the leading global provider of the full customer spectrum from these service provider, hyperscalers to the enterprise colocation customers. The global leg of that stool is incredibly important. It is incremental, more and more investments into higher growth parts of the world outside the U.S. It provides further differentiation where, I'd say, one of really 2 platforms pulling ahead with that global differentiation across the product spectrum. And listen, the portfolio today is about 60% North America, 30% EMEA, the rest of APAC and Latin America, not necessarily ever going to get to equal pizza slices here, but I see a world in 5, 10 years where we continue to be growing, even net of some of our dispositions, our countries, our markets and having a much more well-balanced split of our revenue contribution from contributions in Europe, Asia Pacific and Latin America to rival North America. That's where I see the puck is going. I think that provides incremental differentiation for our customers and it's being able to solve their problems in places where it's just not as easy and doing it in a global platform solution.

And I really do think that -- I think one of kind about the hallmarks of the data center industry, Andy, and certainly, of Digital Realty is that #1, the strong secular growth, and you've mentioned some of the stronger growth across regions outside the U.S. But then also, the ability to recycle the portfolio. Is it your view that based on that secular growth and an ability to recycle the portfolio, that Digital Realty can consistently, over time, drive high single-digit FFO per share growth, right? Just if you ride those twin waves of secular demand and then stabilized asset recycling, is that an achievable target?

Before I hit your question head on, let's just take a step back to say why we are selling some of our data center assets outright 100% or even majority interest. On the outright 100%, we are focusing our portfolio and platform on markets where we see the most robust and diverse long-term growth and the greatest pricing power. So if you look at what we sold outright in Europe, those are products and markets that didn't fit that bill and we recycle that into core investments for long-term growth. We've also have done some joint ventures around core assets, so find assets that are very well-occupied long-term weighted average remaining contracts and bringing more attractive cost of equity as a partner, but retain operational control. The former of that is not -- a never-ending journey. We're whittling down our portfolio into just what we view as carved for the long term. The latter of that is a tool in our toolkit, given we own fee simple ownership of some of these assets that I think will incrementally drive better returns. Net-net, we're trying to drive incremental pricing power near long-term growth and having that growth flow to the bottom line and increase our per share FFO growth. We've always been shooting for mid- to high single digits. We're just below. We're just at mid-single digits this year, 2021, and we're shooting to exceed it in the coming years, including 2022. But that's the formula that we're trying to architect here. By focusing our investments, we have the greatest pricing power and long-term growth. And those are the tools in our toolkit that we're using to kind of get there.

Okay. And you mentioned greatest pricing power and one of the markets that's been relatively strong, placed some leasing, I think pricing power too, has been Europe, right, EMEA has been a relatively strong market. I know when Equinix announced their xScale expansion, because maybe there was some initial market concern or angst that that might disrupt that more balanced market or relatively stable pricing. How do you think about that? And what -- how do you think the Equinix xScale builds in Europe will affect supply-demand put in context for us? And then maybe even just kind of talk about that market in general for a moment, as it has been so important in driving some leasing activity.

I don't take any competitor lightly, but I would say, as you leave the U.S. and go to Europe or other parts of the world, the bringing on of data center capacity is a much more complicated story. And I think you can look at our actions to speak about in my words, we could have gone head-to-head with Interxion and tried to create our own platform and said, "You know what? It'll take us years and years and years to have penetrated all these countries who have created network density, connectivity density to assemble land parcels and supply chains and leadership on the ground to landed availability zones, compute and on-ramps and essentially created this tremendous momentum that's driven our success." So I don't think the xScale is going to be a massive disruptor. There are several other competitors in Europe that we're competing against over xScale. And I would say the competition in Europe is less, due to some of those dynamics and our head start, where we've invested in our people, in our infrastructure, in our land banks to really differentiate for customer landing in Europe. So I don't -- I'm not over-indexed into one particular competitor there. And I still like the European and outside the U.S. competitive dynamics and the tremendous value we bring. Just think in the last global pandemic, when people couldn't even fly to the continent, I think with real boots on the ground leadership, not just a joint venture financial partner and a small team supporting you, I think we bring a tremendous amount of value to our enterprise customers and our hyperscale customers in Europe and broadly.

Yes. No, understood. And then, Andy, flipping back to the U.S. quickly. I know you had asked this all the time, but I think the commentary on markets like Northern Virginia, did see maybe some more pricing power, at least from 2018 through early 2020. But the recent commentary from yourself and others have been that pricing has stabilized in that market. Is that still true today?

Yes. I mean I think Ashburn still remains a tremendously large and diverse customer market. And it's gone through its pain and it's had its competitive supply pressures. But it's certainly been working its way to better footing quarter after quarter and really almost year after year now. So I think that trend is continuing. I also think during even a soft period for that market, I am incredibly pleased with the way our platform performed importing demand from around the globe, supporting a large or a robust and diverse set of customers that already positioned their infrastructure on our connected campuses and who would desire to grow their footprint really tapping into the customers that saw the value prop of not just our global platform, but the long runway of growth that we can control for them in the Ashburn market. So listen, Ashburn is not back to peak Ashburn by any means. But I do like the way it continues to heal. And I really like the way that we've executed in a down marketplace. And it's easy to -- it's easy to execute when supply is tremendously tight and you're the only game in town. But when there's competitors encroaching and you have high stakes on the table, I'm really pleased with the way our platform shined through this Ashburn recovery.

And I wanted to maybe hit the opposite side just of the return equation because clearly, pricing is important. One component is also cost. And there's been a lot of talk about not just supply chain breakdown delays, but inflation. I think Caterpillar, I think for one, was out today saying that their cost to build is increasing, and there are probably hundreds of others sort of similarly pointed out increases in material cost. Are you seeing -- I guess, 2-part question. Are you seeing increases in your build cost, whether through raw materials or labor? And then have your customers seen supply chain breakdowns that are maybe delaying some of their installs beyond what they expected?

Let me take them in reverse order. On the customer side, we've not seen any flow-through delays due to their supply chain. So their equipment servers, network gear, et cetera, tripling into, hey, we need to move in later or we need to push back a start. Honestly, in my, call it, 6.5 years in the business, the customers have always, call it, pressed for early access, tight timetables and the momentum of their demand has really kind of always pushed us. And it's a way we differentiate with the customers. So I've not seen anything likely or trend potentially could happen there in our portfolio. On the -- our construction supply side or our labor supply side, that's a topic that's very top of mind. It's certainly playing out in this world. Fortunately, and I'm in dialogue with our team that runs this department on a regular basis, we've fared quite well, i.e., in terms of insulating ourselves from hard cost inflation, labor inflation. And listen, I'm not sure in the scheme of time, we'll ever be fully bulletproof, but I think we're faring much, much better than a lot of our competitors, especially subscale, private, regional, newer entrants. And we've been able to really insulate the impacts to our, call it, 300-plus megawatts of projects under construction. If this goes on for a long, long time, nobody is going to be fully protected from these scenarios. But I think it's going to much more impact that those that are not at the top of the queue with our major providers, those who are not bundling their projects for their GCs and subs and consistently building in these markets for many, many years with a longstanding relationship. So I think we're going to fare better than anyone. And so far, so good. But I'm not taking my eye off the ball of this risk potentially impacting our business down the road.

Okay. And I think early in the pandemic, we talked about this, Andy, that Digital Realty does a good job of even prepurchasing, prepositioning kind of the equipment or the raw materials that you need. Are you still seeing the same ability to have a good inventory of the material you need? Or is that running closer to just in time today?

Listen, we do a -- I mean when you have a massive portfolio and you have 47 metros, you're developing across half of those, there's issues where you can't just shift gear country to country. But within certain regions, we have a lot of fungibility, and we essentially are able to prepurchase with some flexibility as to which sites certain components get delivered to depending on our needs. So we make sure our supply chain is insulated to our shocks in addition to our VMI programs, our providers or vendors are essentially inventory-ing or warehousing some of our inventory of our components. So we've not bled down the reserves to date, and we're like a hawk staying on top of this, making sure that doesn't happen. So again -- but so far, so good, where -- it's been a long time since we saw inflation in the U.S., inflation in the world, so we're definitely keeping very focused on it, given we do have a large-scale development pipeline.

Okay. And timing when investors might see it, I mean you mentioned the development in progress and presumably when you signing the contract, you're hopefully locking in a large portion of the cost. So I mean would it be more of an effect on, let's say, if inflation persists, both labor and raw materials, would it be more of an effect on, say, 2023, late 2020? Is that the right way to think about it just based on development in progress and already contracted? Or is there a variable cost component where labor and raw materials go up in development and progress and that gets passed on to Digital Realty?

Listen, the -- on the actual costs of construction, be it hard or soft costs, due to the risk mitigation strategies I mentioned, I think that is a much more of a 2023 story if the current environment was to persist. On the OpEx cost -- I'll just block that call there -- on the OpEx cost, if we do have inflation that flows through to our staffing, which has not happened yet, or to date, that would -- that could happen as early as 2022, right? But that's just more of labor -- of a different labor set, not labor that is building buildings or installing equipment. It's labor that's remote hands, it's security, it's engineering. That could have an earlier impact. But we've not seen that to date. And again, we are the largest provider of data center -- third-party data capacity in the world and -- as well as the U.S. So I think we're getting tremendous efficiencies, time to scale. We have a long -- a team that's been with us for many, many years. We're always tapping into new sources of talent including some of community colleges and veteran groups. So we're doing things to try to get ahead of that potential threat. So that's not coming to the movie theater tomorrow, but that's the risk that would be out there if you had continued labor inflation.

Yes. Just trying to stay ahead of that. That makes -- that makes a lot of sense. And Andy, I'd be -- I have to ask the confirmation that Digital does not intend to do any kind of large acquisitions in the next 12 months. There's always discussion and speculation around potential deals. Is that still true?

I mean -- I think I'll refer you to our CEO, Bill Stein's response to the first question on our call. I don't think you could get more a frank than that answer. So listen, the word -- go back to -- we really think we put together over several years a tremendous platform for our customers across 6 continents, 47 metros, the full product spectrum. We're rolling out incremental colo capacity across, I believe, 4, 5 or maybe even 6 APAC markets. We've done some tuck-in acquisitions. There's -- Bill said it best in where we are in terms of where we think we are a platform, and we're not looking to make any investments that will be redundant with our capabilities, and we certainly don't think we need to get bigger for the sake of getting bigger. We're about driving near-, medium- and long-term growth from the top to the bottom line.

No, that'll be good. I think it -- I mean it's very clear. And one last one, if I could. In the last couple of years, we've seen a lot of different -- a lot of these structures coming to this space, if you want to call it that, private companies that are levering up more. Obviously, the Blackstone take out of QTS with higher leverage. You have DigitalBridge that runs at higher leverage, a lot of the private operators using their balance sheet, right, and that higher level of leverage to drive returns. And you and your peers, the public companies have, for the most part, looked to achieve investment grade for the lower cost of capital, which makes all the sense in the world, but have maybe set leverage targets below where a lot of your REIT peers are and certainly, where some of the other private data center operators are. So do those leverage targets put you at a return disadvantage or a disadvantage the companies that are levered higher? And do you think over time that, that leverage target should increase, at least hopefully, as the rating agencies get a better understanding and set their own thresholds higher? What are your thoughts on that?

Listen, we have a -- one, I'm still of the belief of the old M&M theory that the cap structure shouldn't really influence the value of an asset. And I don't think these quantities of leverage that we're talking about really are -- yes, they'll create higher levered returns to those investors, but I'm not sure justifies paying higher for an investment in my book because there's incremental risk to following that path. The -- we have an active business with massive development across multiple countries, multiple product lines. And I think we have a prudent financial strategy and balance sheet strategy to maintain conservative leverage, ample liquidity, diversified source of capital. I think it's the right balance sheet for our business today. I do think we are deserved of upward trajectory at the rating agencies, but I think it's the right balance sheet for our strategy today. And I don't think these newer entrants that put a little bit more leverage on is really any much of a disruptor. Yes, they may win a deal here or there, but they're not really building a global platform that I think is going to stand the test of time at the end of the day.

Okay. It's a great place to end it, Andy. I really appreciate you once again being here with us and look forward to next year, hopefully, being back in person out in Beverly Hills.

Absolutely. Thanks so much, Mike. Really appreciate it.

Thank you, everyone. Have a good day.