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

All right. Everybody can go ahead and please take their seats. I'm Matt Niknam, comm infrastructure analyst here at Deutsche Bank, and we're very pleased to be joined by Digital Realty's SVP of Finance, Matt Mercier. Matt, welcome.

Thank you.

So maybe to start, Matt is going to give a brief presentation before we get into the question-and-answer session. So Matt, I will turn it over to you.

Yes. Great. Well, thanks, everybody. Thanks for having us here. It's great to be back in person. We'll just do kind of by -- a little bit of background on the company, and then we'll go into the Q&A. But for those of who are less familiar, Digital Realty, we're the leading provider of cloud and carrier-neutral colocation facilities. We have over 280 data centers across 50 metropolitan areas in 26 countries. What makes digital unique is that we are able to provide the full customer spectrum from enterprise to hyperscale across our global portfolio. We are roughly $50 billion in enterprise value. We are part of the S&P 500, and we're a top 10 publicly traded U.S. REIT. The data center business is a great business. We have the good fortune of being levered to long-term secular demand drivers. This includes the continued growth of cloud in compute nodes as well as the continued acceleration, which has been on display recently with the world of remote everything as a result of the pandemic from digital transformation that our enterprise customers are embarking on, and we see and expect these trends to continue. So we have a tremendous demand backdrop and we're -- we feel fortunate to be in this industry and the prospects of growth to continue. As I mentioned, I think a big part of our value driver and what we bring to our customers is our global platform. Over 60% of our business and revenue is in North America, with roughly another 30% in EMEA and another 10% in Asia Pacific. We primarily own our real estate and that gives us the ability to recycle capital when needed in order to switch from investments that we feel are higher returning and really optimize our portfolio, which we've been going through over the last several years. We're also primarily unencumbered, which again gives us the flexibility to be able to execute on capital recycling efforts as well. And last but not least, we have over 4,000 high-quality customers, the majority of which are investment-grade rated or equivalent. And with that, I mean 2021 was another very successful year for Digital Realty. I think in terms of highlights, we had our largest bookings year on record, with over $500 million of bookings equating to roughly 13% of our annual revenue. In addition to that, we continued to have success within our enterprise segment, as noted by the almost 500 new logos, new customers that we brought into our portfolio. We also practically completed the integration of Interxion, which we closed on roughly 2 years ago right at the start of the pandemic. So did that during, again, a world of remote everything, which was quite a challenge, but I think has borne significant fruit in terms of the amount of success that we've had within our European market as demonstrated in -- specifically with the record bookings we had in the fourth quarter, driven in large part by our business in EMEA. We continue to innovate on the product side as well. And we are continuing to invest globally. We have over 250 megawatts under development across our global portfolio, the majority of which is concentrated in international markets, again largely EMEA as well as APAC, but also continuing to grow in select North American cities where we see robust demand. And last but not least, we continue to evolve our capital sources, most recently with the announcement of our Singapore REIT. So the S-REIT, we closed in early December of last year. Again, this is a continued evolution of our capital-raising efforts. This is aligning a long-term perpetual capital partner with our business. We sold roughly 10 assets or contributed 10 assets valued at around $1.4 billion, representing approximately a 4.25% cap rate, generating proceeds of almost $1 billion to Digital Realty. And this will be a perpetual vehicle where we have a global investment mandate with Digital Core REIT. It's also run by some long-term veterans of Digital Realty. The CEO, John Stewart, many of you might actually know who is Head of IR for Digital Realty for several years, as well as Dan Tith, who is in our -- a Vice President in our finance group. So we're excited about the ability to continue to partner with the Singapore REIT, which has traded up fairly substantially since the IPO in late December. And again, see this as a core capital partner for Digital Realty to be able to continue to work with in the future. Last, in terms of continuing to extend our global reach, we signed an agreement to acquire a majority stake in Teraco, which is a leading, highly connected set of facilities in South Africa. They have assets in Cape Town, Johannesburg and Durbin. They have over 600 customers that are highly complementary to Digital's core business today. And we expect this investment to close sometime in the first half of this year. So very excited about this investment. This gives us a, I think, a very strong foothold in the Pan African continent just given the strategic nature of these assets, where they have over 20,000 cross-connects, which is considerable given the number of facilities they have. It will -- this business will be able to connect with some of the -- some additional investments we've made both on the East and West Coast of Africa, in Nigeria and Kenya, and also complement and connect with business we have in EMEA through some of our highly connected assets we have in Marseille as well as in Athens, Greece. So very excited about this opportunity and what it will bring in terms of our growth profile for strategic assets in Africa. Last, again, we ended the year, I think, on a strong note. We had a record bookings quarter in the fourth quarter. We beat our expectations. Continue to strengthen our balance sheet and our cost of capital. And I think last but not least, we raised our dividend roughly 5% a couple of weeks ago on the back of strong earnings. So looking forward to the rest of this year, and we'll now turn it over for some Q&A. So thank you.

Thanks for that, Matt. So maybe just to start, I mean, you referenced $500 million in bookings. Record year. What are you seeing in terms of the customer demand backdrop across your 3 operating regions?

Yes. I mean customer demand has been strong. I think we've seen -- so from a regional orientation, Europe was, I think, one of our strongest regions. I think in 2020, '21, we have roughly half of our bookings from outside the U.S., so that includes EMEA as well as APAC. We continue, I think, to see strong demand in Europe from cloud providers, but also continue to have strength, which we've had for some time, with the combination with Interxion within the enterprise segment and grow the communities of interest that we've built there across the several markets we have in Europe. Within APAC, again, another record year. I think in terms of signings we had in Singapore, Singapore has been a very strong market for us in APAC both from a cloud and cloud service providers as well as starting to see some growth in our enterprise segment as we've deployed some initial colocation facilities within that region. So that's a relatively new mix for us within that product segment. And then in North America, I think we've also continued to have success within key segments A lot of people like to talk about Northern Virginia, which is a number of -- has a very competitive market, but we've been very successful in Northern Virginia. We're well over 90% occupied. The space that we do have under development has a high percentage of lease, I think well over 50%. So we continue to see strong demand within Northern Virginia from a North America standpoint. And have also, again, from an enterprise perspective, continue to see an acceleration or an upward trend in our bookings within North America as well, given some of the highly connected assets we have in Chicago, in Seattle and New York. So business overall has been strong from a regional perspective, and it's been strong from both a scale or a plus 1 megawatt type deployment, all the way down through the 0 to 1 megawatt deployment segment, which is largely tied to our enterprise business.

So 2021, if it was $500 million in bookings, that's a really tough act to follow. And so the follow-up to that is, how should investors think about trends, bookings trends for this year? And I guess more specifically, what I'm getting at is in terms of long activity of demand, right? There's always been this debate of are we in an up-cycle that's headed into a digestion phase? Or is this more of just a secular tailwind that's multiyear in nature?

It's -- I'd say we feel good about where we're heading into from 2022. We've continued -- we've had, I think, 5-plus consecutive quarters of over $100 million -- somewhere between $120 million -- $100 million to $120 million of annual bookings a quarter. Q4 ended on a high note that was -- that surpassed that average. But overall, I mean, the trends that we're seeing are not transitory. We believe they're long term in nature. So we feel good about the position we're in, about the demand we're seeing and that we expect that to continue into '22.

Just one more on the back of that. In terms of the Russia-Ukraine conflict, has there been any sort of impact on customer demand, bookings activity from within your European region?

No. I mean obviously, it's unfortunate what's happening there in Ukraine and our thoughts go out to people that are impacted. From a Digital Realty perspective, we don't have any business in Ukraine. I think our closest market is likely, I think, Vienna, Austria. And the -- in terms of exposure to Russia or Russia related, it's I think less than a handful of customers. Although the list of sanctioned businesses continues to evolve, but it's highly immaterial from an overall perspective in terms of business we have today with customers that are Russia or Russia-linked. So we have not seen it have a material impact on our business, and we don't expect it to have a significant impact to us going forward, notwithstanding I'm sure how this all unfolds in the end.

You mentioned Teraco, you mentioned S3. So there are a couple of moving parts. -- as we think about 2022. So I know the company has talked about 6% to 8% consolidated growth for this year. Can you maybe help us unpack any additional sort of moving parts? And then I guess, what can Digital Realty's longer-term growth profile look like on a more normalized basis?

Sure. I mean I think you -- I think you've highlighted the main moving parts, which is that we did, at the end of the year as I discussed, we sold 10 assets. We sold a 90% interest in those outright. We still own a 10% direct interest. In addition to that, we also own roughly a 35% interest in the public vehicle. So we still maintain a considerable ownership interest in those 10 assets. But again, we did sell 10 assets at $1.4 billion. We earned proceeds of roughly $1 billion. So we do have the income loss associated with the share that we do not own today with those 10 assets and the S-REIT. But then on the flip side, we expect to close the Teraco transaction the first half of the year, and we'll have the revenue associated with that business that will come in. Timing dependent, those 2 should almost roughly offset each other kind of from a year-over-year. Again, that somewhat depends on the timing of close of Teraco, but those will have offsetting impacts in terms of loss of revenue versus bringing on additional revenue from Teraco. But I think from a -- taking a step back from a longer-term perspective, we -- as you mentioned, we did $500 million of bookings in 2021. If you look at that from a percentage of revenue, it's roughly 13%. So not all of that will happen within the calendar year. But assuming we are able to maintain a healthy level of bookings, that's kind of a rough area of where I think we'd like to be. You then look at some of the other major components that are -- that drive revenue, you have our mark-to-market or our renewal spreads on business that renews within a given calendar year. We're seeing, I think, positive trends in that area. We guided last year to slightly negative on cash renewal spreads. We came in, I think, at negative 0.3%. So slightly better than we maybe initially guided in '21. For '22, we've guided to roughly flat. So I think, again, we're starting to see positive momentum in the mark-to-market category area. And then you look at -- and then you kind of look at churn as the last component of major component of our revenue growth. And I think in the last couple of years, that's been slightly elevated as we've had some episodic churn that we've discussed within our portfolio, including some churn at the beginning of '21. Now the good thing is that we've re-leased a significant amount of that capacity already. It's just a matter of commencing the leases associated with that space, which will happen over time through '22. And I think if you unpack all that, I think we're in that high single-digits area of revenue growth that we think we should be able to target on a long-term basis.

Okay. Got it. The enterprise opportunity is really interesting, and I think that's one aspect that's relatively newer and I think underappreciated when we think about Digital Realty and the evolution of the platform the last several years. So can you talk about the opportunity you see within the enterprise colo market for the company?

Sure. We've -- we really I think -- we've always had some element of enterprise. We speak about it in terms of how we report the 0 to 1 megawatt segment. That, I would say, probably took on greater significance back in 2015 with the -- when we acquired Telx. That was largely a North American portfolio, but that gave us, I think, access to some very strategic, highly connected sites, including sites like Atlanta. In Atlanta, 56 Marietta as well as assets in New York, 111 Eighth. And then we've continued that over time with buying out our partner in Seattle at the Westin building. Again, one of the most highly connected facilities on the West Coast. And that's overall has complemented assets we've owned for several years like 360 East Cermak (sic) [ 350 East Cermak ] in Chicago, as well as other sites of Dallas that we have. So the enterprise segment has been a continued and emphasized focus for us. And that has extended then more recently with the combination with Interxion in EMEA that we closed 2 years ago today. They had always had a very strong foothold within the enterprise segment, within the various markets throughout Europe. And then we've then more recently extended our reach into APAC within the enterprise segment. We've just recently brought on our first carrier-neutral facility in Seoul, Korea. We've deployed some initial colocation sites within our assets in Singapore. And then continue to look for -- strengthen our Hong Kong and other markets within APAC. And we see that as, again, a very strategic business for us. The enterprise segment tends to be more predictable in terms of demand. And we believe that we've been able to kind of win shares. We've not only I think, increased the value proposition of our portfolio for our customers, given the amount of highly connected assets that we have now, which we're approaching roughly 50% of our portfolio, especially with bringing on Teraco. And we're seeing growth in segments such as gaming, health care, overall software applications. And it continues to be a high focus for us as a business, where we've seen a steady and healthy increase in the amount of our bookings coming from the 0 to 1 megawatt category. I think in 2021, it was roughly 40% on average, including interconnection. And I think we'll continue to see a focus for us on the enterprise segment going forward.

And when you think about share gains, I mean, is that taking share from maybe smaller competitors who have less scale? Or is this just literally winning logos in enterprises who have never -- who are maybe on on-prem who are beginning to sort of migrate to carrier-neutral?

I think it's a mix of both. I think we are likely taking some share from smaller competitors as the industry evolves. And I think we've demonstrated the capability and the product offering that we have as a business and the assets that we have that are highly strategic, highly connected. I also think you're seeing a growth in that segment overall as that customer base begins to move through a digital transformation cycle. As we talked about, again, part of that being accelerated as a result of COVID and the pandemic and the world of remote everything. So I think we're -- and then we're also -- I think it's also expanding again that capability in new regions, new markets like APAC that I discussed, where then we're starting to be able to really round out our product offering across our global portfolio and start taking share in those regions as well.

Power and energy costs, huge, huge focus of late. Maybe to start, can you talk about any expected headwinds that are baked in into your '22 outlook?

Yes. So the way that our contract -- I mean, we're in -- I would say, from the beginning, we're in, I think, a pretty favorable position related to energy costs. Our -- the way our contracts are structured, the vast majority of our power is passed through to our customers. So in the high 80s to low 90% of our power costs overall are reimbursed from our customers directly. On top of that, we also seek to lower the cost of utility for our customers. So we are also highly hedged in terms of our power costs within a given market. So we focus first on unregulated markets in order to hedge our exposure in those areas. We're roughly 85% hedged. A vast majority of that is markets in EMEA, which have seen some of the larger increases in power cost of late. So we've taken a very proactive approach to our hedging strategies. We're looking to add additional hedges on top of that as a result of what we're seeing in the market more recently. But that's been -- hedging has been part of our playbook for quite some time. Again, as we also want to make sure, even though we're -- pass through the majority of our power costs, that the cost of occupancy for our customer, which power being one 'of them is one of the highest, that we were able to provide that benefit and seek to lower the overall expense to our customers as well throughout our portfolio. And then last but not least, we also have power -- you might have heard we do have some power purchase arrangements. The way I think about these, these are more like -- it's almost like an umbrella policy, if you will. They're not tied necessarily to any specific region or market. They're put in place more to access renewable power and be a source of renewable power for our customers and our portfolio. But what they've also done is because we put in place these power purchaser arrangements, where we buy at a set rate. If market prices move up or down, we either benefit or we have some additional costs associated with those agreements. Given the rise in power cost, we've actually been a beneficiary of those contracts where we receive funds as a result of where we struck utility costs in certain markets. So those have acted to kind of also as, again, more of like an umbrella policy against energy costs in order to offset some of the increases we've seen as well.

So it sounds like in the interim for '22, with the hedges in place, maybe less relative impact. But maybe as those hedges begin rolling off beyond '22, there may need to be some pricing actions on your side to maybe recoup some of that elevated costs.

Yes. I mean we'll -- we tend to have rolling hedges, so we'll continue to look at those as those roll off. We feel pretty good about our position through '22. And then I think there's a mix of, hopefully, we'll see some fallback in energy costs. And then in addition to that, again, I kind of go back to almost 90% of our power costs are reimbursed. So the impact to us, I think we've talked about on our recent earnings call, could be in the range of like $0.03 to $0.05 of an impact to our bottom line, which is relatively small on the grand scale things. So we'll continue to -- obviously, energy costs are top of mind for everyone these days, so we continue to monitor that. But we feel pretty good about the position we're in for '22. We continue to monitor for '23 and beyond as those hedges come up for renewal. But we feel like energy costs, given the structure of our contracts and the large amount of pass-through, that we're well insulated for '22 and beyond.

One other question on sort of topical issues supply chain. And I know I think throughout 2021, you guys did a great job sort of procuring what you needed, getting things up and running on schedule. Have you seen any worsening of impacts from supply chain constraints following some of the recent events that have taken place in 1Q? And then has the supply chain issues also impacted the timing of deployment from some of your major customers?

We actually haven't seen a material change to date in our -- at least our deployments. Again, we have over 250 megawatts of development underway across our global portfolio. We're -- we've guided to spend $2.3 billion to $2.5 billion on CapEx in 2022. We have been, for quite some time, very strategic in getting ahead of supply chain issues just because of the amount of development activity that our company does across the world. So we have in place what we call vendor-managed inventory, where we seek to lock in terms and pricing, and that includes delivery of large -- some of the large mechanical electrical equipment that goes into our facilities. And so we're often buying ahead for our -- ahead of our needs and have that equipment shipped or held ahead of when we will actually need to install them within our various locations. So this has been part of our supply chain management for several years. We continue to look at those contracts in order to optimize those given the development activity we have across our multiple markets. So we've been pretty fortunate in that we're -- our customers rely on us as a global provider to be able to deliver on time as they have critical needs, and we've been able to satisfy those through the strategic procurement of infrastructure. It remains to be seen, depending on how the supply chain, how this unfolds, but we feel very confident in the construction and the development that we have underway through '22. That we're well insulated. We believe we'll be able to deliver on time those projects. And that should extend into '23 as well as those contracts with our suppliers extend into '23 from a time frame perspective.

Got it. Got it. You talked about some of the organic activity. One of the bigger inorganic moving parts is obviously Teraco, which you referenced in the initial presentation. Can you talk about the acquisition, both in terms of what attracted you to these assets and then some of the strategic advantages that this brings to sort of the broader platform digital?

Yes. Yes. I mean as I kind of reiterating some of the things discussed earlier, I mean this is, again, a continued evolution of our strategic narrative, which is being global, being connected and being sustainable. So Teraco kind of, I think, checks all the boxes there. This is a portfolio of some of the most highly connected assets, the most highly connected assets within the African continent and some of the most highly connected assets globally. So this is a very strategic acquisition and set of assets for us. Again, as I mentioned, over 20,000 cross-connects, which given the number of sites, just demonstrates the high level of connectivity they have there. We see this as part of our growth strategy within the African continent, and this gives us a strategic and, I think, an almost irreplaceable advantage in that, in what is we expect to be a high-growth area. Again, helps -- complements some of the other smaller acquisitions that we've made within the African continent, including acquisitions we made in Nigeria as well as Kenya and you can see that -- you kind of saw a map that we're able to -- with the connectivity points that those investments have along the coast of Africa, it gives us access to several subsea cable landings as well as then back into EMEA with VM Marseille, which is one of our more highly connected assets within EMEA. So this is, again, a continued evolution of our global strategy. We see high growth prospects for the African market. We saw this as one of the key strategic pieces available. And it's also a great management team. The management team, we're buying a controlling interest, roughly 55% interest in Teraco. The management team has done a great job in building that customer base that again is, I think, highly complementary to the types and sizes of customers that we have within Digital Realty as well. And we expect them to be able to continue to grow that business, not only within South Africa but also the broader African continent.

As we think about bottom line growth for Digital. So core FFO per share, I think you've talked about 5% growth this year, a couple of puts and takes that we've discussed throughout our conversation. But maybe as we think over time, with the evolving platform, some of the improvements in terms of cash renewals. What can core FFO per share look like -- core FFO per share growth look like for DLR given the improving mix shift?

Sure. Yes. So we -- first, looking back at 2021, we did come in around 5% growth, which is above where we initially guided. For 2022, on a reported basis, we're looking at also 5% growth, which does include impact from not only selling assets into the S-REIT, but also the acquisition of Teraco, which we said would be roughly 1% dilutive. But when you look at that 5% on a constant currency basis, because we are expecting some headwinds from FX this year, that's -- we've got roughly 150 basis points of headwind. So really, on a normalized basis, that's north of 6% growth, which again, we see as accelerating on a normalized basis and then also in the face of some portfolio optimization work we're doing and have done. And again, we're also seeing, I think, improving fundamentals from a pricing perspective. We're seeing record signings that we put up. So I think all in all, our view is that we should be in the mid- to high single digits on a long-term growth trajectory from a bottom line perspective.

Okay. I want to talk about capital allocation. Just we talked about development. There's obviously funding the Teraco acquisition. How does the company prioritize uses of cash?

So we've -- I think you kind of hit the major -- I mean the major items that we -- first, we're looking for the highest and highest risk-adjusted return for our business, so -- and really continuing to evolve our portfolio and our platform to make it more strategic and increase the value proposition for our customers. And one of those was the Teraco transaction that we talked about. The other, I think, major use is our continued development program, which is -- which we expect again to spend roughly, call it, $2.3 billion to $2.5 billion on development across our global portfolio in 2022. So those will be the major uses of cash and funds for us in '22. I think we have a number of ways that we are able to fund that growth. First and foremost, we have our forward equity that's still available. That's roughly $1 billion. We have cash flow that will be available from operations after our dividend, which helps. We have a $3 billion revolving credit facility that was roughly $400 million drawn at the end of the year. And then we have, I think, access to multiple markets from a debt perspective, which we showed, I think -- early in January, we issued some additional euro bonds and redeemed some of our higher coupon debt in the U.S. And then on top of that, we have one of our kind of latest sources of funds is the S-REIT. Again, we raised roughly $1 billion from selling assets into the S-REIT at a very attractive rate. And going forward, we see that as another vehicle that's at our disposal in order to continue optimizing our portfolio and give us access to perpetual capital, I think, in an attractive rate in order to redeploy that into higher returning investments.

How do you think about sort of target or optimal leverage for the business? And as you think about the prospects for rising rates now, how has that maybe impacted, if at all?

Yes. I think we have -- for a long time, we've targeted roughly 5.5x in terms of our leverage. I don't -- I think for our business and where we are ratings-wise, which is BBB across all the agencies, I think that's still a good long-term target. We're a little above that now. But I think between the various access to capital that we just discussed, the continued growth and earnings that we expect over the next year or several years, we'll be able to bring that back in line within that, call it, 5.5x area. And again, go back to the majority of our debt today is long-term fixed in nature. So I think we feel like we're in a pretty good position from a debt perspective. We have no maturities in 2023. We have minimal maturities in '22, which will -- which are in the euro market, lower rate notes, which we believe we'll be able to refinance or pay off with our revolving credit facility. So again, access to a number of different ways to fund our business, to manage our debt profile, grow our earnings, which I think should be able to -- should -- we feel pretty good about our ability to manage leverage in a growing rate environment. I think last, our fixed charge coverage is, I think, well over 4x. So overall, again, feel very confident about our leverage profile and ability to maintain that going forward.

And then last question. As we think about sort of future growth opportunities, you hear a lot about the Edge from a lot of your peers. How significant of an opportunity is this Edge or maybe more localized compute infrastructure? What does it sort of represent for DLR? And then do you see the company taking a more active role here over time?

Yes. I mean it is definitely something we are we're looking at. We continue to monitor. We've made some -- I think our view is the Edge is still unfolding as an opportunity. It's hard to say exactly where the -- I think if you ask 3 different people, you might get 3 different answers in terms of the size and scale of the Edge opportunity. So I think it's something we're actively monitoring. We've made some investments in some Edge companies through Vapor IO and AtlasEdge. AtlasEdge is actually where one of our leaders went to run that business relatively recently. So I think we're looking at ways that we can partner with other companies at this time given the stage of where the Edge opportunity is. But we're making ensure that we keep an eye on it. And again, I think we also feel part of our -- a good part of our portfolio is really tied to the Edge, given the highly connected assets we have within major metropolitan areas. So to some degree, we have, I think, Edge assets in our portfolio today, and we'll continue to monitor to see how that extends out into other areas.

That's great. I think we're just about out of time. So we'll end it there. Matt, thank you so much.

Yes. Thank you.

Yes.