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

Hey, everybody. Good afternoon. Good morning to Andy over there in San Francisco. We're really glad to have Andy Power from Digital Realty here with us today. He's the President and Chief Financial Officer of DLR. First off, Andy, congrats on the promotion to President a few weeks ago.

Thank you, Jon. Appreciate it.

Well earned. I thought we could just start, I could just give you a few minutes, maybe just talk just very briefly, I think most of you all are probably familiar with Digital Realty as a company. So maybe just a brief start there. And then just maybe talk about demand for data centers, just generally what you're seeing right now in the market.

Sure. Just the two-second infomercial in Digital Realty. We are the -- a leading and largest owner-operator of data center colocation and interconnection facilities with a global platform spanning about 50 metropolitan areas, 25 countries, 6 continents; catering to a customer base that totals in excess of 4,000, which we've grown at, call it, double-digit annualized rate most recently, including a record new logos quarter. Offering, call it, hybrid IT for the enterprise colo customers, occasion cabinet connectivity solutions, all the way to multiple megawatt dedicated data halls for our hyperscale customers, really serving as their trusted infrastructure partner around the globe. Demand, we've -- I mean we've -- not just recently, but I think we've -- the current environment of the pandemic certainly shined a spotlight on the long-term fundamentals on our business, which I'd call it point towards digital transformation and how our customers, enterprises, in particular, are using data to interact with their employees, communities, partners in all different shapes and forms, and really putting digital transformation in the data center at the middle of that. So we've now had a string of maybe 8, 9 almost fairly successful quarters with robust demand across the geographic markets, across our suite of products and cost of not only deepening our relationships with those hyperscale cloud service providers, who we serve in call it, 45-plus locations around the world, but also really penetrating the enterprise market with PlatformDIGITAL, and bringing to bear the key capabilities and solutions for those hybrid IT consumers. We're not done yet. We got 14 days until the end of the year, a little bit less if you're doing Christmas shopping this late in the game, like myself. But I think we're very proud of our 2021 results in terms of demand overall and the fruits of our labor of hard work leading up to it as well as our execution during the last year is what I think, set us up in a good position in terms of results.

Sounds good. I also haven't started my Christmas shopping. I told my wife, I was going to wait until this conference was over.

Good luck with that.

Yes. Enterprise versus hyperscale, you kind of touched on both right there. There's always this kind of push and pull on which one is kind of driving demand. Maybe we could talk about the U.S. and Europe separately on where you're seeing strength in both of those verticals?

Yes. I mean we're committed to both customer segments. That's first and foremost, which is important, I would say, at a thematic level, my view, as it relates to the hyperscale competitive landscape and arena, I feel like we're pulling away in terms of really a winning list of global trust infrastructure partners for those customers that do have ability to build on their own, occasionally, but really have looked at digital as a trusted bubble partner. And in enterprise, I would say it's an area where we've been playing catch-up and we've been putting the critical puzzle pieces together in terms of connectivity. We're going to continue to invest in that arena in 2022 and beyond in terms of our go-to-market, our branding, our thought innovation. And if you look at our most recent quarters, you call it blends and call it 40% of our new signings in the enterprise, majority in the larger deals, the lion's share of the new logos are all falling in the enterprise category, selling that we're accessing new customers and adding to that 4,000 list of customers. As we exit the year, both the U.S. and EMEA remain healthy. And I think both segments of those markets remain healthy. One, I would say EMEA is a little bit more growthy overall for a few reasons. But we're finishing out 2021 strong and optimistic on 2022 in both categories. And I think that just speaks to both of those customers converging on our capabilities and seeing us as the right solution to either -- to land with us as a new customer or to expand with us as an existing customer, given our capabilities.

Got it. And then I guess in the EMEA region, there's been a lot of hyperscale growth there. I think you -- it seems like there's a fewer number of providers in that region than there is in the U.S. But if you kind of rewind a few years ago in the U.S., it kind of feels like we're seeing the same surge in demand that we were seeing, I guess, in 2018, 2019 in the U.S. I mean, what keeps that region from kind of, I don't know, I guess, rolling over because of the competition and slowdown in demand kind of like what we saw in the U.S.?

I would say our strategic moves with our combination with Interxion, other investments on the heels of that, be it both inorganic and organic, be it tuck-ins or land developments or build-outs or expansive capabilities, allowed us to really catch that most recent wave of demand quite well. I think you got a few things happening there. One, you just looked at the size of GDP, size of population, U.S. comparisons, which that picture has been disproportionate for a while and catch-up is playing, i.e., an outsized growth is happening in terms of technology relative to people and trade. Two, EMEA is not a country. Europe is not a country, right? Language barriers, cultural barriers, data sovereignty, incremental decentralization of infrastructure requires net-net incremental demand. And I think that's a compounding element. And when you look at our activities, over half of our development pipeline is in EMEA, third-party prognosticators are selling like record years potential for in 2021, across the flat markets. We've been experiencing, has not just been a FLAP story. We've seen that growth in the FLAP markets and outside the FLAP markets of EMEA, which has been fantastic. We've also seen great demand from the European customers back into our global portfolio as well as U.S. and Asia Pacific and Latin America customers into EMEA. So a confluence of trends would benefit in that. So definitely, a stand out part of our portfolio. And going to your question, I mean, our actions just speak louder than our words. We didn't have to combine with Interxion. We had boots on the ground and assets and capabilities in those markets. But given what we saw is having the digital infrastructure, the talent and the capabilities to catch up in a market that has such rigidity that's greater than you see in the U.S. in terms of permitting, in terms of local municipalities, cultures, inroads to business communities, we don't -- we think there's structural barriers for competition that will persist. In addition to, I would say, much more attenuation towards -- we're almost metering of that supply data centers just being more judicious on that, which, again, not a good thing when you're trying to deliver for a customer incremental growth, but does provide incremental barriers for new competition and benefits in comments like digital.

Got you. And then can we talk about, I guess, rent growth for a minute? So you guys have -- leasing spreads have kind of been this big topic. I think you've actually held the line on those maybe, I think, better than people feared. But I mean, where are we at in terms of market rents and kind of expectations over the next few years?

Yes. Listen, I don't -- I'm not -- again, I'm not saying we're out of the woods on any roll downs whatsoever. But I've been saying for some time that we, as a company, have been working through our roll downs -- can you hear me still? I think my ear pod just...

Yes. Yes, we can hear you.

One of them just died on me. Let's see how long this one lasts, and I'll be doing microphone live through the iPad here. We've been chopping the wood here on hardest vintages, largest customers in the U.S., which had more competition than outside the U.S., more bigger deals in the mix versus smaller, highly connected, call it, granular level -- lower stickier type, higher pricing power locations. So the front view mirror is looking better than the rearview mirror. Not proclaiming victory on the topic, but it does feel, and this is an amalgamation of data points that, that mix of portfolio plus what's going on in the environment, whether it's the inflationary trends, moratorium, supply chain bottlenecks that leverage is shifting back and literally just in the last 24 hours, we were updating our pricing -- our price book for going into 2022. And there was a fair bit of price increase locations based on those facts and circumstances. Listen, we're not trying to -- we're doing 2 things. We're being responsive to our cost model, right? There's prices are going up in the world in many places, and we have to be responsive to that. And two, where we're being responsive to supply/demand dynamics in a dynamic pricing model. And it's not -- I can't tell you every markets like Singapore, where we've increased rates 5x in the last 18 months or whatever it was. But it does feel like the pendulum is slowly moving back in terms of the incumbent pricing power. And that's going to play out over time. I can't -- I'm not going to tell you it'll show up in February's earnings call with a massive spike in rates or anything like that. But it does feel like we're moving into firmer territory on this topic.

Got it. Okay. All right. That's good. I think in your sector, M&A has just dominated the year. You've seen 3 of your public competitors go private or merge with companies in other sectors. I guess maybe to start the discussion, can you talk about DLR's approach to M&A and why you guys have focused on other investments versus some of these large portfolios?

Yes. I mean, we've been obviously -- given that we're the largest acquirer of data centers in the last 5 or 6 years, we've been incredibly active on this, we really put it filter -- one, I would say we see -- I still believe we see everything in terms of opportunities, given our size, scale, diversity of product offerings and the map where we operate. We put everyone through our lens with that strategic and complementary is coming at the helm. We don't need to -- the enterprise value does not need to be larger. We've got tremendous scale and efficiency that's driving the stock price higher, not the EV higher. So making sure we filter our opportunities through that lens and what's really additive to us and drives incremental value to our customers, pricing power and short, medium and long-term growth is really the solution we're focusing on here. The M&A, I think, is a natural trend in our industry. There's been broader and broader acceptance to the longevity of the asset class, the long-term fundamentals. And I think that accrues to us being the largest provider in this asset class and making sure or having more people interested in investing with us or in us. We've more recently been more in tuck-in, filling the maps, filling the capabilities modes, whether it was -- our most recent U.S. acquisition I think was the Westin Building, a highly connected Seattle destination or to that areas. And after that, most of the activity has been inorganic and organic outside of -- outside the U.S., whether going to Croatia or Greece or entering India in a greenfield playbook or what we've done similarly in Seoul, South Korea or most recently in Lagos, Nigeria, really adding capabilities in parts -- places in the world where our customers need us today or in the future. And that's really about strengthening our platform and offering to our customers and accelerating our pricing power and long-term growth.

Got it. So I guess even though these people -- these competitors you talked about, you got QTS, CyrusOne, CoreSite, might as well name them, even though they're -- these portfolios still exist, right? Just under new management, I guess. I guess, is there anything to call out in these portfolios? Or I guess, what are the risks of having private equity guys throw a lot of money at this business? Like do you expect them to be even more competitive on pricing? Or does it go the other way? You think there will be more reasonable competitors in that regard? Anything to think about there?

I don't -- maybe CoreSite, to a side, that they're almost completely dynamic we can chat about, but the QTS or CyrusOne take privates, I grew up -- I've been at Digital, coming up in at least 7 years this spring, but spent a world of my career in the financial arena. And private equity guys are pretty shrewd financial investors. They know how to use a calculator. So I don't -- I'm not sure it really changes the overall dynamic. I think the most recent activity, whether it's QTS or CoreSite -- or excuse me, CyrusOne, not highly strategic companies or platforms or really fierce competitors based on their size, limited market, limited capabilities and having more private money versus public money, which some would say those companies I know have been able to have great access to public capital, and probably the data center has been one of the biggest issuers of capital from their businesses of any asset class, I imagine, in the more recent times. So I am not sure there's really any change in the dynamic. They're going to run these vehicles with more leverage to generate higher levered returns, put more risk in the business. They're going to -- at least one of them is going to cut up the portfolio into 2 parts or so. So I'm not sure there's a market change in this. The probably -- the one thing I love, that I have one less competitor that has to play the quarterly game of what my signings are. So they may be able to hold the signing on 12/31 or 9/30, maybe be a little less important to a Blackstone or a KKR, than it is to the pressures on management teams or public companies that they are under the microscope on a quarterly basis, that could be a potential positive. But by and large, I don't see this to take private being really change in this. If this were to happen 5 years ago or 10 years ago, I think it could reshape the industry dramatically. But I think what's transpired, ourselves and quite honestly, Equinix, in my opinion, have hobbled together or collected the most precious puzzle pieces in our industry. And I know I'm biased, but separated ourselves from the pack and the true platforms to stay in the test of time for our customers.

Yes. And I guess that was kind of my follow-up question is those portfolios on their own were obviously not close to the same scale. But if -- I guess, is there enough pieces in the U.S. market, probably in the U.S. market more than anywhere else, but also around the world to kind of roll up something that can be more competitive and on the scale of what you guys have and you mentioned Equinix, them too?

Again, I'm bias, I think that door is kind of shut unfortunately, rightly or wrongly. I mean this is -- I mean, Digital is a 20-year-old company almost, right? So I mean, the industry has had rapid consolidation along that time, especially in the most 5 to 7 years or whatever. And I think we and our other major competitor, I mentioned, I think we kind of got to the best first.

Yes. So I guess sticking with this M&A, let's kind of close the loop on that. The other deal, the CoreSite American Tower deal, I think, was one that felt very kind of -- maybe a little out of left field for most people. It seems like the tower REITs have done more talking about edge computing and the data center REITs not as much. Just curious, you see a deal like that -- does that, I guess, change the formula for Digital really and how you guys think about towers and 5G play into the next wave of data?

Definitely a head scratcher, personally. Was I -- we're big believers in edge use cases and commercial Internet of Things and the whole host of technologies that are -- someone's going to dream up of that's going to be needing incremental footprints in a distributed fashion. I'm not convinced it has to be at the foot of a tower, but I do believe in the edge. I think Digital Realty is going to be at the middle of that edge use case with 4,000 customers and 300 data centers and 50 metropolitan area markets, many where we have, call it a hub-and-spoke footprint to our data centers. We don't have one data center in many markets. We call it cover a good portion of the metropolitan area. We don't need to own every data center in planet Earth. You were -- we were chatting before we got on this call about one of the other coverage names that has a specialized use case in building data centers for that probably in places that have very little relevance to the location. Similarly, Edge is going to be very distributed in many shapes and forms, and it feels very unknown. And the way we've approached this is we need to extend our customers' capabilities and footprints to those edge use cases in various shapes of strategic partnerships, some acquiring some type of investments, some not acquiring any investment. So bringing PlatformDIGITAL customers to the edge in that various shift and forms like we've done with AtlasEdge, like we've done with announcements in partnering with Vapor IO. And I think that list is going to grow and grow and grow as this new version edge opportunity just continues to get shape here. And we're going to do it in an open format, right? We want our 4,000 customers, hopefully growing to 5,000, 6,000, 7,000 soon, be able to get those -- to be able to put their compute, their core, their edge network deployments and then be able to extend to the edge use cases seamlessly. And we think our platform can do that. And I think Digital is going to be at the center of the -- empowering that.

Got it. Okay. All right. Maybe we could talk about -- we got about 10 minutes left here. I did want to touch on the bigger news you guys had recently was the Singapore REIT, which launched Digital Core REIT in Singapore, and you sold a 90% stake in a $1.4 billion portfolio. Maybe just can you talk us through the economics on that deal. What does that mean for DLR shareholders? And what does that mean for maybe potential feature sales into this vehicle?

Yes. So what this is not, is not an IPO or jettison of our APAC business. In fact, this portfolio didn't have any APAC assets in it day 1. What I would describe this is a continued evolution of our historically private core capital sources dating back to, I think, 2013, with our first, call it, JV with Prudential, the insurance company, which coincidentally just came to the end of its term and it was recapitalized. More recently, about 2 years ago or so, with one of the Singapore REITs, Mapletree, around $1 billion portfolio. And now today, the creation of a perpetual vehicle, be it public, externally-managed extension of our brand, digital core REIT, ensuring seamless customer experience, no interruptions to house core access to digital, long-term holds, parts of our campus but assets that are fully stabilized, this portfolio is 100% leased, 6 years weighted average lease terms of only 2% escalations, high credit quality customers. So almost like a partner vehicle to allow Digital Realty to offer Digital Core REIT investors attractive returns, attractive investment opportunities that allow Digital Realty to have higher risk, higher return, higher growth pieces of our business, i.e., we're an active developer, thousands of acres of land, leasing up, developing colocation and the like. So think of it as our newest, latest and greatest global capital partner for core assets. It started small. It's $1 billion portfolio. We are retaining a direct 10% interest. It has an appraised valuation in the low 4 cap rates. We are -- we put a very modest, call it, 27% loan-to-value leverage on it out of the gates, unsecured. We raised a $600-ish million IPO, I think, plus the $630 million, $640 million retained a, call it, sizable 35-ish percent stake in the REIT vehicle day 1. But we think this is going to be a long-term platform -- or excuse me, long-term perpetual capital partner of Digital Realty that's going to scale, it's going to scale as we contribute incremental assets over time to it that fit this core mandate. And it could be an additive partner in potential M&A that has assets that fit this mix. So we're again looking to -- this is core assets. These are not noncore assets [ dispos ] that we've sold outright, like we did early in the year with the portfolio in EMEA. These are assets we believe in supporting customers we need to support and have just a little bit slower growth than Digital Realty has that allows Digital Realty to more -- even more efficiently accelerate its growth at the bottom line as really as an alternative to issuing stock in Digital Realty or DLR.

Yes. And that was kind of going to be my follow-up question. It reminds me a little bit of Prologis in the warehouse space. They have kind of funds all around the world, develop on their balance sheet, sell into these funds and just recycle it and generally don't need to come to the capital market -- don't need to come to the equity markets for new equity unless it's a large M&A deal. I mean, is that kind of the end goal with a lot of these -- of what you're talking about there, whether it's the Mapletree transaction or this vehicle in Singapore? I mean would you like to get to that point where the equity markets aren't really necessary for your growth?

I would say a few things here. One, imitation is the greatest form of flattery. So we didn't -- we're not inventing the wheel on this concept. I think maybe we're taking it to a different -- slightly different format in terms of a vehicle that is truly perpetual. This is not a vehicle that's going to have a finite fund. I'm not even sure where the likes of Prologis is in terms of perpetual capital sources. They may already have a private version of that, that exists today.

Mostly perpetual...

Yes. So it's a version of that. It's an avenue that allows us to create a tax-efficient avenue for APAC investors to invest in these types of assets. I don't think we'll ever scale this to the size of Prologis fund complex, to be honest with you. And this is -- we're all -- this is our horse that we're picking. We're dedicated this as our sole vehicle for this type of global mandate. We're not going to have umpteen different funds and create incremental complexity. But thematically, yes, it's 100% exactly right. If I can -- all right, I think I'm totally dead, once this one [ ends ] up.

We can still hear you though.

All right. All right. If I can essentially raise efficiently-sourced capital in this vehicle versus giving -- sharing the upside in Digital Realty, that accrues to all of our current Digital Realty investors or anyone who buys in stock market today in terms of accelerating the growth at the bottom line.

Got it. Okay. And then I wanted to touch on the balance sheet, but I also want to touch on ESG a little bit. Actually, after you, we have 2 ESG-focused panels, and that kind of concludes our conference here, but maybe a good bridge into that. So you guys have the sustainability-linked global credit facility you announced recently. Just curious if you could just briefly talk about how that works, what metrics you have to deliver on? And then maybe just more high level, you're obviously a huge power user, you have goals of becoming carbon neutral and moving to 100% renewable power. I guess where are you at on that path? And just give us an update there.

So I mean, ESG overall sustainability greening of -- has been part of our DNA for some time. It's how we design, build, own, operate procure power, use of water, it's a holistic fashion. And I'm quite proud of our finance and accounting department for several years now, really putting our money where our mouth is. So I believe when I joined in the spring of '15, my very first financing we even did at Digital was the first U.S. green data center bond. We weren't the first REIT to do a green bond, but I think we're up there on the list. And I think I believe today with the largest issuer of green bonds by any data center, maybe U.S. REIT, I'm not positive on that. And we've done this across U.S. currency. We've done this across euro currency. We've done this across Swiss franc currency. I know for a fact, we're the largest U.S. Swiss franc green bond -- data center bond issuer. And I don't think that title will ever get taken away from us, given that market.

Congratulations.

This latest credit facility is the continued evolution of again, putting our money where our mouth is, are very proud of our Head of Sustainability, Aaron Binkley, who's done a fantastic job of driving this through the culture of Digital in a global scale, multi-facet approach. I don't have the precise details, but I know it is a penalty -- it's a carrot and stick model, i.e., spreads widen or improve. So we are financially incentivized to live by the commitments we've put in there, which I think is a holistic fashion of how we improve from our current posture, whether it's green power, carbon usage, water impact. When it comes to green power, I -- we're not in the end zone, the ball's not on the back of the net yet when it comes to agreeing of our power, but we're making great progress. I think we're in the 50-plus area category. And I believe we're doing it in a most legit way, especially given the size and breadth of our portfolio. It's really easy to green a portfolio that's $1 billion of data centers, when you're doing at $60 billion and the power number is gigantic. And quite honestly, I don't think the world has generated enough projects yet that will efficiently do this. And we're doing it in real ways, not just buying recs and credits and on the mess up to line which hit light green or green washing. We're really entering to power, pursuing these 10-, 15-year agreements that's getting new green power created in this country and around the world. So quite proud of the progress. We still got ways to go. But I do view us as a leader in this category, and I think we're going to continue to innovate and extend that lead.

Sounds great. All right. Well, we better end it so we can get on to the next panel. But Andy, thanks so much for your time. It's great to see you.

Great to see you. Have a happy holiday season. Thanks a lot.

All right. Happy Holidays. See you. Thanks, everybody. Bye.