Business context and reporting period
Digital Realty Trust, Inc. and its operating partnership filed this unaudited Form 10-Q for the quarter ended September 30, 2016. The company owns, acquires, develops and operates data centers, colocation and interconnection facilities. Its portfolio comprised 144 properties, including 14 held through unconsolidated joint ventures; occupancy was approximately 89.9%, excluding space under active or future development. The company is a REIT; substantially all operations and debt are held by the operating partnership.
Financial performance and position
Unless otherwise noted, amounts are U.S. dollars. Income statement and cash flow amounts are in millions; balance sheet and debt figures are as of September 30, 2016.
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Operating revenue | $546.3 | $436.0 | $1,565.4 | $1,262.9 |
| Operating income | $115.8 | $104.1 | $346.2 | $360.5 |
| Net income | $222.4 | $57.8 | $335.7 | $318.2 |
| Net income available to common stockholders | $187.3 | $38.5 | $254.4 | $257.3 |
| Diluted earnings per share | $1.25 | $0.28 | $1.72 | $1.88 |
| Diluted FFO per share and unit | $1.31 | $1.28 | $4.08 | $4.10 |
- Q3 revenue rose 25.3%, while operating expenses increased to $430.5 million from $331.9 million. Operating margin was approximately 21.2%, versus 23.9% a year earlier.
- Q3 net income included a $169.0 million gain on property sales, principally the Paris property sale. Nine-month gains on property sales were $170.1 million, compared with $94.3 million in 2015.
- Nine-month net cash from operations was $631.5 million, versus $539.2 million. Investing used $1,072.4 million, including $873.3 million of real estate acquisitions and $549.4 million of improvements to real estate. Financing provided $420.6 million; cash ended at $36.4 million.
- Total assets were $12.30 billion and total liabilities $7.10 billion. Debt principal was approximately $6.09 billion; debt to enterprise value was approximately 27%. About 91% of debt was fixed-rate or hedged, with a 3.66% effective interest rate reported.
- The $2.0 billion revolving facility had $164.8 million drawn, $20.3 million in letters of credit and approximately $1.9 billion available. The company reported covenant compliance. Restricted cash was $11.7 million.
- The common dividend annualized at $3.52 per share. Dividends and distributions remain subject to board discretion and REIT distribution requirements.
Material changes versus the prior comparable period
- Q3 revenue growth reflected the Telx and Europe Portfolio acquisitions, as well as leasing; interconnection and other revenue increased to $53.9 million from $1.7 million, primarily reflecting Telx.
- The July acquisition of eight European data centers from Equinix cost $818.9 million. The purchase price allocation remained preliminary, including $448.1 million of goodwill, and could change.
- Q3 operating income growth lagged revenue growth, and nine-month operating income declined year over year. Higher depreciation, operating costs, general and administrative expense and interest expense contributed. The 2015 comparison also included a $44.3 million favorable contingent-consideration adjustment.
- FFO per diluted share and unit rose to $1.31 in Q3 but declined to $4.08 for the nine months, from $4.10 in 2015. Common shares increased following settlement of 12.0 million shares under forward sale agreements for approximately $1.1 billion net proceeds; 2.375 million shares remained subject to settlement.
- The company redeemed all 11.5 million Series E preferred shares in September for approximately $287.5 million, funded with revolving-credit borrowings. Related issuance costs of $10.3 million reduced income available to common stockholders.
Outlook, commentary and risks
- Management described demand as strong in most key metropolitan areas and reported positive renewal rent changes for the nine months: 10.8% for Turn-Key Flex and 23.5% for Powered Base Building on a GAAP basis. Management cautioned that past leasing results do not assure future rents or renewals.
- Approximately 1.3 million square feet was under active development and 1.1 million square feet held for future development. Management estimated fourth-quarter 2016 development-program capital expenditures of $325 million to $475 million, subject to demand, leasing and capital availability; construction commitments were approximately $279.3 million.
- Management intends to continue development and capital recycling, selling non-core assets to support core investment. It noted that lower market capitalization rates may reduce near-term single-asset acquisition activity.
- Key risks include tenant defaults or non-renewals, data-center supply and demand, power costs and regulation, development and integration execution, access to debt or equity funding, refinancing and interest-rate exposure, foreign-exchange movements and uncertainty following the U.K. EU-withdrawal referendum. Foreign properties generated 20.6% of nine-month revenue; sterling, euro and Singapore dollar were identified as principal currency exposures.
- The filing gives no clear numeric full-year revenue, earnings or FFO guidance. Legal proceedings were reported as none material; the company disclosed $279.3 million of construction commitments and a tenant option concerning expansion space at Convergence Business Park.
Important facts for investors to verify
- How much of reported revenue and earnings growth is recurring and attributable to acquired operations, versus property-sale gains and other one-time items; also confirm the comparability effects of Telx-related eliminations.
- Final purchase accounting for the Europe Portfolio, especially goodwill, acquired intangibles and deferred taxes, and the acquired portfolio’s realized operating contribution.
- Leasing, occupancy, renewal spreads and lease-up progress for development space, alongside the timing and cost of planned capital spending.
- Debt maturities, borrowing costs, covenant headroom, available revolver capacity and the impact of variable rates and currency movements; the filing reports about $136.4 million of the company’s pro-rata joint-venture debt outside consolidated debt.
- Settlement of the remaining forward-sale shares, dilution, dividend funding and the effect of the Series E redemption on capital structure.