DigitalBridge Group, Inc. (DBRG) Earnings Call Transcript & Summary

Good afternoon, everyone. Eric Luebchow, senior analyst at Wells Fargo. Really pleased that you could join us today. We're now going into a fireside chat with Jacky Wu, who is the CFO of DigitalBridge. So Jacky, thanks for joining us today virtually.

Thank you. Thanks for having me.

So Jacky, DigitalBridge has made several big strategic moves recently on the investment management side of the business. It seems like you pivoted your focus to inorganic activity in IM versus on balance sheet. So maybe you could talk about what's driven that shift? And should we expect any of your priorities going forward to change as a result?

Yes, sure. That's a great question. And look, we've made very clear that we operate 2 segments. And we've always made it very clear that we were never going to hold any 1 particular segment back just for any sort of designation or if an opportunity to grow it much faster and more accretively for our shareholders were to come about. And those 2 transactions first being Wafra be able to buy back 100% of our own business, even better than buying back stock if we think of it that way is buying our own business, up the chain. We're preserving our earnings on our fastest-growing investment management platform out there was critical for us. And we really want to thank our partners at Wafra. They are now converted like all of you guys as shareholders into the business, and we are now 100% aligned, and we're all focused on growing the business in general. So that -- if you look at just even our historical returns, and growth in our investment management platform and the price that we paid, it basically implies an IRR of over 40%. So when you kind of stack that type of acquisition up against something that we could buy as an alternative, that one wins out all day. AMP was very opportunistic. It came about because we obviously have relationships with a lot of these limited partners. And certainly, as AMP was looking for a good steward of its equity platform as they were working through their own strategic initiatives and exiting this segment of their business. It made sense for them to find a good partner. A lot of their investments were also digital infrastructure, digitally focused, and they wanted to find a good steward for those assets. And we ended up becoming a really nice fit. And with the price point that we've ultimately are signed up to pay for this transaction. And again, it was wildly accretive for us and for our shareholders. So because IM is also a critical segment on additional operating and these 2 acquisitions were available at that point in time. We wanted to do what's best for our shareholders and maximize your return, and those 2 investments just made all the sense in evolve. We will continue to grow in the confines of these 2 segments period, whether it's organic or inorganic. And yes, our focus has shifted because of IM. We think that, that's very opportunistic even in this coming environment. Interest rates are going up. Inflation is going up. So to the degree we can form capital and still see through our strategy of convergence within digital infrastructure, partnering with very well-capitalized pension funds and sovereign wealth funds and partner with us to go and acquire these things without using as much of our balance sheet or forming our own capital where we will be subjected to higher risk or higher inflation or higher interest also makes sense as well, right? So go in a bit more asset light, partnering with well-capitalized counterparties. That combination, along with what we saw with those 2 investments just absolutely made all the sense in the world, and we're very pleased about it.

Great. That's a helpful overview, Jacky. So in more recent news, you announced a fairly material data center transaction in your IM business with -- and I know you're somewhat limited in what you can say about that specific asset. But maybe you could just talk about the build versus buy dynamic within data centers today, what made you guys confident to execute a large M&A transaction versus the greenfield building you're doing at a DataBank or Vantage or some of your other data center assets in the portfolio?

Sure. Our commitment to do greenfields. We're still very pleased with it. Certainly, where it makes sense within the confines of the market that both Vantage and DataBank serves. Vantage being hyperscale data centers with really 10 critical partners that are the largest in their respective segments and then DataBank, which really is more edge platforms and facilities, we will continue to invest in greenfield opportunities in those sectors. Where we have always said that we will go and acquire a platform, certainly at the right price, and we feel certainly as we underwrite them, our risk-adjusted returns implies that it was the right price for us and for our stakeholders. But it's to get into a market that we don't really serve whether it's a new geography or whether it's a new segment of the data center ecosystem and also if we're acquiring a team that we believe is best-in-class. And obviously, we love the team that we have entered into an arrangement with. We won't go into any more specifics to that. But obviously, we like that [ vaccine ] in that platform. And the market that starts within data centers is different than what we have today with Vantage and DataBank. It's not hyperscale. It's not edge but it is serving private enterprise networks and cloud. And we believe over the course of the next 5 or 10 years, certainly with IoT, certainly as more and more industries become digitized, enterprises -- enterprises and private enterprises will need to build out their own ecosystem. That is separate from the public cloud. And that's not to say that public cloud goes away. But it's unique situations like hypersensitive data sets like government or banks or certainly enterprises that compete against the likes of the Amazons, et cetera. So where they would not want to put it into a hyperscaler. So this is data sets that cannot be replicated. We believe this market is ever growing because of the needs and where networks are evolving. And we're very excited to work with that team, that platform to be able to continue to grow that segment of the market.

Okay. That's helpful, Jacky. To the extent that you do consider on balance sheet acquisitions in the future, and it sounds like you're open depending on the opportunity in front of you. Maybe you could talk about the verticals that you're particularly attracted to right now. Obviously, your 2 major investments are in data center platforms, DataBank and Vantage. I think in the past, you've talked about the potential to add a tower asset or maybe a dark fiber asset or do a corporate carve out. Maybe you could talk a little bit on whether that's still a priority for you given the fact that you have more recently pivoted a little bit more into the investment management business.

Yes. I would say -- I would say it's not necessarily a priority. But what I would describe it as is we are a digital infrastructure investor and owner of assets whether it's in the confines of a fund where we have GQ commitment, capital sponsor commitment capital into. So our shareholders play in those same private vehicles. when we go and monetize those funds, ultimately, our shareholders will get carried out of that and make a substantial amount of money alongside our limited partners in that regard. So we are aligned in a lot of that, and we have a balance sheet capital at work there. But the way I kind of look at it is a very CFO answer, which is to the degree the returns and the risk-adjusted returns make sense, we will go and make a digital infrastructure investment onto our balance sheet where it makes sense. And we've been patient over the last couple of years as long as I've been CFO, we've been very patient. Marc always talks about being patient. We don't want to go and buy something for the sake of buying it. But you're right, in terms of the verticals, it will continue to be things that I believe offer an appropriate risk-adjusted return that's commensurate for our shareholders and their expected returns. And that's going to be more things like stabilized data centers. That's going to be more like a power platform, specifically in more developed markets like the United States or dark fiber where it has longer lease terms. They are more tied to wireless growth than, let's say, subjected to a retailer or enterprise churn and write-downs that is oftentimes associated with lit services in fiber. So we want safety. We want yield. We want risk-adjusted returns that make sense for our shareholders and overall risk return -- risk-adjusted returns on an unlevered basis, certainly in the high single to low double digits. But those are things that we would seek in the balance sheet. And to the degree the price makes sense that can get those things. We will make investments where we need to.

Sure, sure. I think one question that's been debated this year is around private versus public multiples for digital infrastructure, and it seems like private market multiples have been kind of sticky to the high end. They haven't converged to the public markets where we've seen inflation and higher interest rates really kind of eat into a lot of the stock performance this year. So what's your opinion or DigitalBridge's opinion on whether or not we see some type of convergence? Or do you think the sheer quantity of private capital that's out there today chasing and ever shrinking pool of high-quality assets means that this may be more permanent or more sustained that private market multiples are going to be elevated relative to what we see in the public market? And to the extent that does happen, does it change the way you think about allocating capital?

Yes, sure. Look, I continue to be very and we continue -- obviously, continue to be very, very buoyant and long on our sector. And I'm so pleased that I'm CFO of a digital infrastructure investment management business than, let's say, folks that are focused on retail or on office, right? So real estate. So we are very long on it. There's a lot of factor tailwinds but make no mistake, we do believe that there will be -- there will have to be some level of convergence between private and public markets. Now I do believe that some of the publicly traded digital infrastructure stocks out there have been unfairly sold down or probably a little too much because people are forgetting that 5G is happening. These new demand services are happening. People don't get rid of their phones. In fact, they'll pay their cell phone bills before they pay for their car or their house mortgage, frankly, right? So the reality is we operate in a very recession interest rate inflation resilient industry. And I think some of the public sector pricing has been a bit over full. But at the same time, as private multiples, to your point, have not come down really much at all. Now over time, we do expect that it will have to come down. But good assets will continue to be good assets. And I think what you will see is there will be a more stark differential between certainly good assets that are sold in the private markets will continue to command really good multiples. Maybe they'll come down just a tad, but we don't think it's going to be material. But the ones that are really for tenders really not good assets really just poorly built networks, they will be exposed and those multiples will absolutely have to come down. Example being -- 1 example being if, let's say, what we have seen during the exuberant times where a lot of copper networks being sold as fiber plays where now those business plans not only were they at one point, commanding really high multiples, but they've implied spending a lot of capital to go and upgrade the copper in the first place to fiber. And that business plan, certainly over the course of the next 3 to 5 years is going to be pressured because of the rising interest rate environment, et cetera. So those are asset classes, I would say would be a bit more susceptible to contraction relative to what we had seen certainly prior to this environment that we're seeing today unfold.

Sure. And you brought it up a little bit, Jacky, the talk of inflation and the recent inflation numbers that came out are the highest we've seen in over 40 years. So maybe you could talk about kind of how your business is set up to deal with inflationary pressures. Obviously, a lot of your leases have escalators that are typically lower than current inflation, but a lot of your costs are fixed as well. And I imagine you're managing the supply chain pretty tightly to keep those relatively in line. So how do you kind of think the business performs if inflation remains high, and that's sustained over a longer period of time? And does that change how you allocate capital or business strategy? I think you alluded to the fact that may have played into the decision to maybe pivot some of your recent investments into IM versus on balance sheet.

Yes, sure. At least in the context of our shareholders is going to be a bit more immune to inflation and interest to the fact that it's certainly much more asset light. In fact, it's completely asset-light, right, an investment manager, and you also have really well-capitalized partners that form capital alongside you to go and acquire these businesses. So it's a lot less strain for our public shareholders, for example, then, let's say, I go in to go and buy and build data centers and towers and fiber on my own using shareholder money, for example, and levering up the corporate balance sheet. So the risk level is certainly a bit different there. I'm going to break out your question though into 2 areas. From a -- certainly from a build perspective, Marc talked about this. And we have, obviously, our portfolio companies are going to increase prices. That's just the bottom line. As certainly as we build new data centers, certainly, as we build new towers and the new leases that come on it that we do need to factor in to back-up price points and input costs have gone up. So that's going to be coming in the form of higher lease costs, certainly, with respect to a new lease, some contemplation of higher adjustments in the future, whether it be escalators or pricing on amendments. And certainly, with respect to any capital contributions that we would ask for to mitigate not just the build costs associated with it, but also coming in the form of a prepaid rent, right? That will also be higher than where it was before. So that's the new build side of the shop. I would say that from a recurring risk perspective, you're right, the escalators, a lot of these things were signed up well when we had a 0 interest rate interment effectively, were 2%, 3%. And we were making money off of that relative to where inflation and interest were at certainly then. We believe in long-term valuations and long-term growth. And yes, unfortunately, this has flipped to the other side of it, whereas before, we've enjoyed where we're making accesses for a long time. So that's just the natural -- a cycle that we see in any economy over a long period of time. But make no mistake, what we have -- what we do have as buffers are a couple of things. One is data centers, a lot of our inputs like utility costs. A lot of that gets passed through. So that's viewed risk from the construct of our losses, for example. And that's where a lot of the cost increases have come from, for example, is on the utility side of the shop. And that side has been -- obviously, we're protected because of the nature of the leases in the back that pass through. So that's kind of how we look at it from a management perspective. We certainly have created and asked all of our portfolio companies to be vigilant during these times, be absolutely on point with who you're signing leases up with, making sure that they're creditworthy customers. We don't want to be overly exposed to the churn risks as a result of this potential market. So being hyper disciplined which all of our CEOs and CFOs are already. So we're very pleased with the performance there and the things and the protective measures they're doing there. And then the last aspect of it is really when we underwrite. And as we're underwriting new investments, whether it's the one we kind of talked about before or whether it's anything going forward. we do bake in a risk premium in our required rates of return for it. And that's adjusting for higher interest, higher risk levels overall because of the macro environment that we're facing. But also, we're disciplined with exit multiple assumptions, and we're very disciplined and Marc talked about this before, overleverage. We will not overlever any of our particular portfolio companies. And I think these protective measures from an underwriting perspective also safeguards us, our franchise, our funds and our LTV.

Sure. That's really helpful. So interesting point at the end there, Jacky, on leverage levels. I mean, maybe you could talk about either for fund investments or on balance sheet acquisitions that you would contemplate? Have you been adjusting your comfort or your leverage levels in terms of debt-to-EBITDA or loan-to-value ratios? And do you think that's happening across the industry? Or do you still think there's people out there that are perhaps levering things up a little bit more than would seem to be prudent and such a volatile macro economy?

Yes, for sure. That's -- we absolutely have always been disciplined with our LTVs and our loan-to-value ratios. So even though we do basically 0 interest rate for a very long time, and we are in the asset-backed securities market for the most part. We typically will hold back some of that max leverage, so that you have a room to grow to the degree there's opportunistic M&A at that portfolio company that we can do or to the degree that a bad outcome or a bad macro environment happens, and we now have sufficient dry powder and/or buyer bubble and/or buffer to be able to withstand some of these types of macro shocks like what we're seeing today. So that's usually comes in the form of -- if you look at leverage, usually by the 10% lower than where most other people probably could -- are and could be. Do I believe more boats and more investment managers as well as digital operating businesses out their digital REITs are starting to be more disciplined. I think you are seeing that, and I think people, in general, are a bit more risked off but some folks have already unfortunately, overlevered, and they are already there. And that's going to put a strain on their ability to deploy capital over the course of the next 3 to 5 years, realize their business plans, certainly high-growth businesses and digital offering where they are originating a lot of stuff and require a lot of capital that now can't get it. They're going to be pressured in terms of their ability to grow. And certainly, that's going to impact their shareholders and/or investors. So I think there's still, unfortunately, a lot of folks out there that didn't learn from the lessons of other bad macro environments like what we saw in dot-coms, like what we saw with the downfall of the CUx, like what we saw in '07, '08, '09.

Sure. Sure. Yes, it will be interesting to watch. So in your IM business, you have talked publicly about more carried interest flowing through in the next few years, I know it's pretty minimal today as you start to monetize investments, particularly in DBP I. So maybe you could just remind investors about how the carry works, how they benefit from the carry as you realize it? And then maybe any color on the type of IRRs or returns you're targeting across some of the different funds even if it's just broad ranges?

Yes, that's a great question. So we, on the balance sheet will have a commitment to our loans. And we actually deploy capital no differently than our limited partners as a show not just a good base, but also to show that we believe in our underwriting. We believe in the people that make up our investment management business. We believe in the investments that we're making and what we're underwriting to. And so we invest upwards of $200 million, for example, in each of our DBP I and DBP II funds just like any other capital call for a limited partner. And as we realize those investments, and it will take some time because these are long-dated funds rightfully so because we invest in digital infrastructure, right? We're not a 2-year holder and we cut G&A and then we sell it off and flip it. We incubate, grow businesses, greenfield, M&A and grow these platforms and then ultimately strive towards an exit or some form of the monetization of them, whether it's an IPO, whether it's a sale to a strategic or a sale to another fund, whether it's our own or whether it's somebody else's, there will be some sort of monetization event. And as long as it meets required hurdles of the limited partners for these funds, we will get carried interest on top of that, effectively excess returns that come back to the general partner to us. And that's you. That's our shareholders. And the way we do well, and we expect to, based on everything we've seen, our track record, what we've marked up, consistently mark up, we expect that we will get there, but that's a matter of time. It's not an if, it's more of when. But when we do get there, we will get excess gains, we will get our excess returns in the form of carried interest, and that goes straight to the bottom line, and that accrues directly to the benefit of our shareholders. So we're aligned with our limited partners, and we're expecting good outcomes here. So -- and we're excited about that because once we start getting there with our DBP I fund, right, we want -- we really launched in 2017. These are 10 plus -- 10- to 12-year funds with renewal periods, and typical hold periods are 7, 8 years on average for our portfolio companies. That would put, over the course of the next couple of years, some real monetization events that should accrue carried interest to the benefit of our shareholders for our first fund over the course of the next couple of years. And that's an exciting time because that will facilitate more new products, whether it's ventures, core, whether it's the new DBP type of instruments that will foster this type of growth similar to a Blackstone or KKR, et cetera.

Sure. Sure. And I was curious if maybe you could talk about some of the recent IM product additions, credit, core ventures, how you're progressing in terms of fundraising and deploying capital? And then do you think there are any other IM-related products that DigitalBridge is missing after some of the recent acquisitions? Or do you think you now have the platform in place. It's just a matter of fundraising and then finding appropriate investment opportunities?

Yes, sure. I don't think -- I don't think anything is missing but we're always trying to innovate and expand our franchise and our capital stack. If you look at our 2 DigitalBridge partners, 1 and 2 funds, right? That was a $4.1 billion DBP I fund. We have an $8.3 billion DBP II fund. And this is standard equity funds that are expected levered returns in the mid to high teens. We have continued to expand beyond that, to your point, Eric. We've now incubated a -- hired a team, but incubated investments, that are sitting on the balance sheet that will be contributed to realize new products and funds when it comes about, but in credit, in ventures and in core plus strategic asset fund what is what we call it, opportunities and gone ahead and hired the teams for each of those product sets. We've outlined that in a number of our Investor Day and earnings presentations, and we're very pleased with the progress we've made. We've already done some investments sitting on the balance sheet. And it is a matter of time that they will ultimately get contributed into vehicles that will now generate long dated fees for our shareholders. And also 1 day carried interest and for those funds. So if you look at the expected returns associated with them, they range, like I said, the equity vehicles, GBP I and II target that return range in that mid-teens to high teens range, core plus strategic asset fund opportunities still a little lower than that. It's going to be in the 10% to 12% low teens part of the range. Credit, obviously, will be lower, slightly lower than that, but albeit a different product and in credit. And then ventures is much higher than that because of the nature of where it fits. Now not missing, but as we innovate, where could we go? Marc's talked a bit about this, but there are funds out there that have non-traded REITs and they have even more core like -- strictly core like products that have return profiles lower than that in the single digits. And there's demand for it. And then compensate private equity, which skews above that high teens range -- typically high teens to low 20s range. That's also an opportunity to move up the stack. So it's not missing. We're very pleased with the investments, the people that we have -- what we made. But as you know, Marc Ganzi, we never stopped, and we will always innovate and we will always do right by our shareholders, which means we will continue to grow this franchise and continue to be the fastest-growing investment manager out there bar none in the space.

Okay. That's great to hear. So a couple of balance sheet questions for you, Jacky, before I let you go. So you're obviously sitting on a pretty substantial amount of liquidity. Do you have some high coupon preferred still out there on the balance sheet? So is that something that you'd like to address in the coming year or 2? And then you also, as you look at the balance sheet today, you also have a stake in BrightSpyre, and you've been fairly patient with that. But that seems to be another lever you can pull strategically, either for M&A or if you wanted to deleverage. So how do you think about those items and when or if you want to address them?

The answer on the preferreds is yes, simply is yes. We have a series IMJ that will come callable over the course of the next couple of months, this year. And our plan is to use a combination of trading out the high coupons there with lower forms of capital, cost of capital, like our whole business securitization structure and/or outright retirement of it. And I'll get into what that calculus will look like, how we figure out that amount. But make no mistake, our plan is to retire/replace them with lower forms of capital. On the BrightSpyre side, we aren't starved and in need liquidity, right? So we have everything that we need, certainly, as we shifted towards more of an asset-light type of model with investor management, especially in these times, we aren't starved for capital. We're not -- we've got the cash and all the cash and the stuff and the resources we need to realize our plan. We've already gone and made the hires that we need to hire. But make no mistake, it is noncore to our digital future but we will be responsible sellers. Marc Ganzi has done a ridiculously nice job with his team, both hiring and promoting from them but also from outside, he is growing the business. He has certainly fixed a number of positions that were challenged previously, and he's increased that dividend pretty healthily, and we're a happy recipient of that dividend, which is upwards of an 8%, 9% yield. So I'm a map guy to the degree that it makes sense at the right price, to sell as well as it could be to a good counterparty, then we will execute on it, working alongside BrightSpyre in a responsible way. But if not, then we'll happily collect a dividend and it's a good yield. And the way I kind of look at it is that there's M&A that makes sense, that still want to give us a well above return above that and our press will do what we need to do.

Sure. Yes, that makes sense. So last question, Jacky. As investors look at DigitalBridge today, it seems like you're positioning yourselves to be valued more against alternative asset managers like a Blackstone like a KKR perhaps versus other digital REITs. And obviously, you have recently derated so what metrics do you think are the most critical to assess the future health of the business? Is it FRE? Is it distributable earnings? Just what is your perspective on how investors should look at kind of the new DBRG as you rotated out of the legacy assets, as you pivoted into digital IM?

Yes, sure. I think our fast-growing businesses like ours, certainly, fee, income, revenue, those are critical measures AUM because that's speaks to the overall fast growth aspect of our platform faster than anybody else, whether it's a digital REIT or whether it's an investment manager. We made it actually easier on the bottom line. Our definition of distributable earnings, which is consistent as we have looked at it with other investment managers is actually the same as how we define AFFO. And as we continue to have -- to be a leading digital infrastructure investor out there, whether it's on balance sheet or whether it's within the confines of the funds, it's going to be AFFO on the digital REIT side of the shop, and it's going to be distributable earnings on NFRE on the investment management side of the shop. But the definitions actually are pretty consistent. And as it should be, right? Because you can't fake cash flow that's a proxy for cash flow for our shareholders ultimately, and both are the most reasonable measures of that. So I would say it's really very in a nutshell, very simple 6 measures. It's going to be AUM, it's going to be our rev, fee, income, which is our IM revenues, our digital operating revenues. And then certainly, it's FRE and FFO and digital earnings. And those bottom 3 are very similar, and the top line is just revenue.

Yes. simple enough. So Okay. Well, we're out of time, Jacky. So really appreciate the time today, and obviously, look forward to continuing to trip active progress in DigitalBridge. So appreciate it.

Thanks so much, Eric. Take care.

Take care.