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

Good afternoon, everyone. My name is Brendan Lynch. I cover the data centers here at Barclays, along with Tim Long. Very pleased to have Andy Power, CFO and President of Digital Realty here with us today. Andy joined Digital Realty back in 2015 as CFO, and just added the title of President in November. Andy, thank you, and welcome.

Thank you, Brendan, for having me. Glad to be here.

Great. Maybe we'll just start off with your new responsibilities with the additional role as President. Obviously, it's been a very recent change, but maybe you can give us some idea of what you're planning to focus on? Or are there any changes in operations that you envision?

Sure. So the change -- or I guess, expansion in my responsibilities is certainly hot off the press, and also a little bit compounded by the fact that we welcome the arrival of our second child, another little girl just a few weeks ago. So it's been a busy and fortunate November on multiple fronts. But by and large, I would describe it as really a consolidation of responsibilities and components of Digital Realty under 1 remit. I -- my time in Digital starting back in 2015, obviously, originated with the CFO hat solely. And over time, I would, in either interim or permanent capacities, take on more responsibilities including filling in for our Chief Operating Officer role for a time period, running sales and marketing for a time period and ultimately, take on incremental commercial responsibilities as well as international and IT. So what really this brings to the forefront is really in one collective house, our product and technology capabilities, our segmented approach for customers, both focusing on our enterprise customers as well as our hyperscale and service providers. And last but not least, our operational and delivery capabilities into one responsible leader against Digital to deliver on behalf of our customers. We've obviously gone through a fair bit of acquisitions and integrations over time. And I think this is really on -- close to the tail end of that work of integrating and looking and see how we can streamline, really, not being more efficient, but trying to see be -- simply to be more effective in terms of delivering the capabilities of the products and services our customers need around the world.

Great. And congratulations on the birth of your daughter. You may have the time to be President, but I'd imagine she's calling the shots for the time being.

You got that right.

Maybe just to dig in on one of those themes that you mentioned on the technology front. What opportunities do you see to expand your product offering and perhaps gain more wallet share from customers?

I would say on the technology or product front, we're tackling that through multiple lenses. One, it's being in the locations with the capabilities our customers need. So today, the portfolio spans 50 metropolitan areas, 25 countries, 6 continents. Over just the last year or 2, we've added numerous new markets. And we're continuing to expand in both an inorganic fashion with some tuck-in acquisitions such as Croatia, Greece, Lagos, Nigeria as well as organic expansion. Two, it's having the inventory runway in that market. So not just land acres to support the long-term growth, but also called the colocation suites, space power connectivity, our hybrid IT customers are desiring. We're innovating when it comes to a technology front, in terms of connectivity solutions. We've been -- our prior announcements included service exchange. We're onboarding incremental partner customers to increase the attractiveness of our offering. And we'll be announcing something later next year in terms of the connectivity front, along the lines of offering more seamless connectivity to both our various data centers and our various customers, as well as other service providers. And essentially extending our legacy cloud-connected service exchange capabilities to a next-level technology offering. And last but not least, I'd say Edge has been certainly a burgeoning use case. We're essentially doing that in various forms of open partnerships, whether it's with Vapor IO or Atlas Edge, making sure the 4,000-plus customers at Digital have ability to extend their workloads and capabilities to those future use cases down the road.

Great. One of the things that we've long argued about, Digital Realty and one of your stronger capabilities is the managing of your capital stack, your sourcing of attractive capital and your capital recycling. So in that context, maybe you could talk a little bit about the Singapore REIT where you recently disposed 10 North American assets into the Singapore-based REIT, and what made that structure the most attractive relative to other options?

I want to say we've really pursued a strategy to increase our value proposition and pricing power, and really, ultimately translating to greater growth, both for our customers and our platform and our shareholders at Digital. That's been through activities in terms of the numerator growth, in terms of leasing execution. And I think you see that over several quarters, but it's also been through taking almost a curation of our portfolio to make sure that we're invested in assets and facilities that we see robust and long-term value, as well as making sure we're most efficiently sourcing various forms of capital, including equity capital. We've done capital recycling in the form of noncore sales, i.e. outright sales. We don't -- we own and operate 300-plus data centers. We're the biggest in terms of megawatts or square feet that's out there. We don't, at the same time, need to grow our enterprise for additional scale. We've called it -- generate tremendous scale, and we want to focus our investments in long-term, value-add locations for our customers. So we've sold outright, over time, in various portfolios. In addition to that, the other flavor of our capital recycle had been -- we call it legacy private capital initiatives. And whether it was our joint venture that our CEO, Bill Stein, created close to 10 years ago with Prudential that just recently, call it -- was essentially wrapped up and monetized; or to what we did 2 years ago with one of the Singapore REITs. Really, the creation and launch successfully now of Digital Core REIT is evolving source of equity capital for our core assets, i.e., assets that are fully constructed, stabilized blue-chip customers with long weighted average lease terms, modest escalations, things that we view have very attractive locked-in return and looking for a capital partner that wants to provide the appropriate cost of equity capital to fund that. So we've essentially created a vehicle that is a partner vehicle, the Digital Realty in a perpetual format. We don't have to ever sell these assets because the vehicle came to an end of its fun life or anything like that. And we hope to grow in a win-win scenario for both our new Digital Core REIT shareholders and Digital Realty, and allows us to use that as almost a substitute to sources of equity capital at a lower cost. So just early innings in terms of successful IPO, I guess, 3 Singapore trading days in. So just the very beginning of a very modest IPO. But I think it's -- we're very well received in terms of investor receptivity and we've planned on that growing with Digital Realty for years to come.

Do you expect that you'll -- this will be one of your primary disposition channels going forward? Or do you think you'll just kind of continue to tap into a variety of different ways to dispose of assets and recycle capital?

We are getting down to the shorter and shorter strokes when it comes to data centers or facilities or assets that we view as noncore to Digital Realty. Now that definition will -- should be constantly evaluated and changed over time, because different markets and different customers, different facilities are always subject to change in a technology business like ours. But -- so you will see us continue to, I'd say, onesie-twosies noncore asset sales where we sell out 100%, and we don't view that as an appropriate asset for Digital Core REIT. Beyond that, assets that fit the criteria of Digital Core REIT, fully constructed, fully stabilized assets, north of 90% leased, high-quality customers, long lease terms, this will essentially be our vehicle or exclusive vehicle for that type of assets, so we choose to essentially contribute incremental assets or in the event that we want to acquire assets or companies where a portion of those companies would fit better with Digital Core REIT than Digital Realty.

Makes sense. And then in terms of the Prudential sale, in particular, but just more broadly in the market as well, that sale was a very attractive 4.5% cap rate. And my sense was that there are a lot of bidders and maybe even some that you haven't seen in the past. Maybe you can give us some color around that, and the broader disposition opportunity for the market as a whole.

I would say 2 things to that. One, you're just seeing this continuation trend of broader acceptance and attractiveness of capital towards our sector, and just a view relative to other infrastructure or real estate asset classes, the durability of this asset class, the benefits of the long-term demand trends. And really, that's just -- that's been building momentum. We're building wave or snowball for years and years now. And the pockets of that demand and the list of interested parties continues to grow for an investment landscape that I would say is rather consolidated. There's not a massive roll-up opportunity in data center lens. There's no moms-and-pops owners of data centers that can, call it, be rolled up over time like you might see in other types of asset classes. Two, that particular portfolio was, I believe, entirely power-based shelves. You really need very limited, if any, data center expertise to be an owner of those assets. And they're -- very fewer and fewer of those type of assets that are even being created. And the preponderance of data centers we build for our customers, the customers do not just want to shelf. They want the full fitted-out down to the PDU or cage or cabinet type environment data center. So I think those are some of the elements that drove the attractiveness of that valuation. And I can confirm that there was more than one bidder in the ballpark of that type of pricing. So it was not a shallow auction whatsoever.

Yes. As you mentioned, the industry is highly fragmented. And there are certainly a lot of assets available. My sense is there are fewer and fewer portfolios available, or at least that would meet your kind of the qualities that you're looking for in terms of growth potential and capacity expansion, et cetera. Maybe if you could just comment on what you're seeing out there in terms of available portfolios and kind of juxtapose that with your, perhaps, a preference for more development going forward.

Maybe I misunderstood it. I would say when it comes to data centers that we want to own, that we think are additive to our customers, our platform, a list of those good assets, portfolios, companies' platforms has been getting smaller and smaller and smaller over the last several years due to this consolidation theme. Ourselves and our other major competitor have been a major participant in that consolidation along the way. So that doesn't mean you can't go find a data center to buy, but I think the thing that we would view as a long-term investment profile of the Digital Realty and important to our customers, where we see long-term growth and benefiting our customers and our platform, that list is winnowing down and down and down to fewer and further between. Hence, last 2 years, we've primarily, dollar-wise, been focused on our development capacity spending $2 billion-plus a year, adding new markets and expanding our addressable market and our capabilities for our customers. Yes, we've had tuck-in acquisitions where a key connectivity platform or -- whether it's Athens or Croatia or Lagos became available. And after working those opportunities for years and years, we're able to onboard with our platform. The -- those have been, really, a minority of the overall dollar investments when you think of our activities. And I think this trend is going to continue, just a product -- all the most important puzzle pieces are, call it, falling into the permanent homes, is really what's happened here. Which in the end of the day, in my opinion, widens the moat from a #3 or #4 really ever creating value in a long-term way for customers in this arena.

Yes. In the past, I've had conversations with your management team, and it's kind of been suggested that acquiring a portfolio of carrier hotels could meet some antitrust hurdles related to elevated control over Internet traffic in particular markets. There aren't too many carrier hotels portfolios available, especially domestically, but maybe you could share your thoughts around that potential hurdle that you might overcome if you were interested in expanding those capacities.

The asset class as real estate, in general, really, often, call it, does not run afoul with this, call it, type -- this topic all that often, right? And going back to my comment of the list of high-quality addition or strategic additions to our portfolio, maybe fewer and fewer and farther between. There are data centers out there that if you look at the universe of data centers and there's data centers -- there's on-prem data centers inside office buildings today, right? So it usually doesn't, call it, jump in that arena. From my -- just speaking to my background, where we certainly spent a lot -- a bit -- a fair bit of time on this in our combination with DuPont Fabros. We spent a lot of time with a certain combination with Interxion, less so in entering South America with Ascenty. It really comes down to the customers more than anything. And not to debunk the years of legal -- law school with -- for antitrust lawyers, but my layman's understanding and my layman's perspective of this is if you're doing something that customers are going to complain, expect the light to get shined on you quite brightly. And if you do things that you don't think customers are going to really complain, i.e., this is -- you didn't really upend the pricing world or nothing else tremendously changed, you probably have a lower likelihood of having a bright light shine on you. So I never even thought about going to law school or sniffing a pre-law class to be the least, so take all this with a grain of salt.

So I guess the takeaway is you got to get the deal done before you start messing with the pricing, if I understood correctly.

I didn't say that.

Maybe you could just touch on kind of longer-term growth as well. I'm sure you're very cautious about giving guidance prematurely. But if we just look at your history over the past 10 years, you're growing AFFO and high single-digit CAGR, say, from 2011 to 2016 or so. And then more recently, it's kind of been low single digits over the past 5 years. I think a part of that has been just the time it took for all of these large acquisitions to become accretive, maybe with a little bit less of that in your mix, you can kind of return to a higher growth rate going forward. Maybe just give us some of your thoughts around that.

The bottom line is we've worked hard over the last few years to really strengthen the attractiveness of our platform and our capabilities and our near, medium and long-term growth profile of our business. And in doing so, we've had to suffer headwinds or dilution to our earnings or earnings growth, right? And that's a public market phenomenon more than anything. When you sell an asset that has lower growth prospects and you sell it at a yield that takes a lot of the earnings away, it's tough to replicate that earnings. But I still think, on an IRR basis, if you look at it over a several year time frame, it is -- what we're looking at it as accretive to our investors' returns. So we went -- and last but not the least, we're getting a lot bigger, too, right? We've got a denominator impact that's happened over time. So if you look at where I'd say we've been in the last few years, as we kind of scale up to this larger enterprise, as we first feed it through some dilutive transactions that are ultimately have turned accretive or are turning accretive, as we've chopped our wood through our capital recycling initiatives and we've now sourced incremental source of equity that can be used in lieu of our shares to fund our growth in the future, combined with -- we've had some market episodes of pricing dislocation and softness that created headwinds in our business over time as well. Net-net, I think we've kind of chopped a lot of this wood. So I don't -- like you said, I'm not giving our 2022 guidance here as an early holiday present for anyone. But I've been -- I think, consistent on that is on many of these elements, we're heading in a better territory. And if you just look, when -- we've increased our earnings growth rate from our guidance to our results this year up, call it, 100 basis points from the beginning of the year to when we had our call 3 weeks ago or 4 weeks ago, so whenever it was. So we're trying to do our best to make the best long-run decisions for our business and also put sustained consistent increasing growth to our bottom line.

Yes. Okay. I want to talk a little bit about your relationship with Equinix. They're a top 5 customer of yours. But in recent years, your business models have kind of been converging, with you involved with colo and interconnection in Europe and them getting more to the hyperscale JVs. I wonder just what your perspective is on how this relationship is evolving and where you see coming from or going forward?

It's -- I would say the dynamic on Equinix coming to our business, to date, has been -- I wouldn't say anywhere near disruptive or a major negative, right? They're one of a cast of competitors we've competed against, and I can't even give this single market where anything really changes the dynamic on that front. And I think their approach to how they're tackling it probably puts them in a little bit disadvantage to how we or other providers, who really fully embrace that product offering, support the global hyperscale of, just, service providers. So net-net, I think that's more news than any skirmish between our companies in a competitive landscape. In addition to that, they are a major customer of ours. They're major customers predominantly in multi-customer locations where we own the building, where we operate the Meet Me Room, where we and they have numerous connectivity destinations on-ramps and customers. And the history that this industry has led us to be in this type of a symbiotic relationship. When they order across -- their customer order across -- we -- they order across or vice versa sometimes, and it is what it is. And at the same time, listen, it's no state secret that we've essentially charted a business strategy that says we think the world deserves, and our customers deserve a second alternative global, colo or interconnection provider, right? And we're tactically, in a slightly different way, we're playing catch-up. We haven't been on top of enterprise IT executives' minds for nearly as long as them, but we're trying to innovate our capabilities with more agility and flexibility, and we're going to certain countries where they're not sometimes. And we think that there is a large growing market. And this is not just a Coke versus Pepsi battle, in my opinion. I think we both are benefits of this trend towards customers going with scale multiproduct providers around the globe. And I think we're taking a lot of share from smaller private colocation, enterprise colocation providers. So I'm trying to think the last time, I think, I was at a dinner with Keith back springtime before the COVID shutdowns happened. So it's -- I think the relationship is fine. We certainly compete in some areas and certainly compete -- don't compete in other areas. And I think it's just natural. And I think the bigger theme is we're both, I think, hopefully pulling away from some of our smaller providers -- or smaller competitors.

Yes, for sure. I think everyone can recognize the pie is getting bigger. There's going to be more interconnection going on, more hybrid deployment. So it's certainly a tailwind for both of you. They have indicated an interest in owning more of their assets and leasing less. And as you described, that relationship, they're on a lot of the multi-tenant buildings that you have. I just kind of wonder what your approach is where you could either maintain the status quo with them as a tenant or there's going to be kind of a battle over the tenants that they currently have as they try to pull them out to their owned assets versus you kind of satisfying their interconnection needs and needs going forward with your Telx product offering and trying to make that an opportunity to take market share.

As I -- these -- the data center is incredibly sticky, right? Just normal data, like your average data center deployment is incredibly sticky to begin with, right? The overlap of our footprints are in the most magnetic locations in our business in terms of connectivity providers, service providers, cloud providers. And I believe the magnet is not Equinix. I believe the magnet is the asset. And I just -- I don't think -- I don't think this migration of customers left, right, to, fro, is really a viable long-term strategy. I just -- putting your customers in payrolls is just the last thing we want to do in our business, right? We are the trusted infrastructure providers. Like, they have to count on us to be there, right? So -- and I know there's been certain examples that -- of lease exits and things like that, but I think that's really relatively small and in a broader scheme of our interlocking relationships, not a long-term viable path personally. But that's just one man's opinion, so take it for what it's worth.

Great. Maybe just one more on promotional activity. In the past few months, I've noticed a real uptick in promotional activity from multiple data centers, including Digital Realty. As an example, I think you're offering a 90-day free trial in PlatformDIGITAL. And it seems like you're also generating a lot more web content or co-marketing your capabilities with some of your partners. As an example, I think there was one with Google Anthos and Megaport. Maybe just kind of help us understand the changing dynamic here and what's behind it.

This is -- I'd go -- I'll go back to executing our strategic game plan we've put in place for several years now. It was a physical game plan. We had to get the right locations on the map, the runway of critical assets and platforms. We had to integrate. We had to make people and leadership changes that we should have done over time. And we had to essentially make sure we reorient our go-to-market initiatives and marketing initiatives towards a broader customer base. So really -- obviously draft off of some of what Equinix has done in terms of, call it, spurring innovation demand from the enterprise IT executive, but also come up with our own thought pieces and original content and exposes on how we're helping customers create value, reduce costs, improve performance. So that -- it's been culminated whether it's our Data Gravity Index, PlatformDIGITAL, a whole host of activities where we're just trying to make sure the broader addressable market that we think we can really go out there and attack and be an offering to knows who we are, what we're about and how we're similar to Equinix in many ways and how we're different than Equinix in other ways. And so I think that drumbeat is what we've essentially been applying here in terms of, really, hopefully taking our enterprise success to next level. And that's an area -- well, I'm not sure I can say that hyperscale or outsourced providers, cloud compute. I think we're a leader in that category, I think we do very well in that category. But enterprise, we're playing catch up. I'll fully admit it, and I think we can do better. I think we can continue to, call it, raise the ante of what good looks like in that kind of Digital Realty. And that's after several successful quarters in the, "less than 1 megawatt," interconnections category, record new logos, multimarket wins. You can hear the list of named customers in my prepared remarks in any given quarter. So that's after tremendous progress and success to date. I just think we can -- the trend is our friend, and we will continue to take that to the next level.

Great. I think that's a good point to leave it for today. We're just about out of time. Andy, thank you very much. Really appreciate the time.

Thank you, Brendan. Hope everyone has a happy holiday.