DIGITAL REALTY TRUST, INC. quarterly report, Q3 FY2018

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Digital Realty Trust, Inc. — Q3 2018 Form 10-Q

Reporting period: Quarter and nine months ended September 30, 2018. Digital Realty is a global data-center REIT; its operating partnership holds substantially all assets and debt. Amounts below are U.S. dollars.

Business context and performance

At quarter-end, the portfolio included 198 data centers, including 18 held through unconsolidated joint ventures, with approximately 33.4 million rentable square feet. Portfolio occupancy was approximately 89.5%, excluding development and future-development space; average remaining lease term was approximately five years.

  • Q3 revenue: $768.9 million, up 26% from $609.9 million. Operating income was $139.1 million versus $66.2 million; net income was $90.3 million versus $12.5 million. Net income available to common stockholders was $67.3 million, or $0.33 per diluted share, compared with a $4.1 million loss, or $0.02 per share.
  • Nine-month revenue: $2.268 billion, up 31% from $1.726 billion. Operating income was $426.9 million versus $334.1 million; net income was $288.5 million versus $176.6 million. Net income available to common stockholders was $218.7 million, or $1.06 per diluted share, versus $119.8 million, or $0.73 per share.
  • Operating margin: 18.1% in Q3 versus 10.8% a year earlier; 18.8% for nine months versus 19.3%. The Q3 improvement in reported earnings included higher property-sale gains and lower transaction and integration costs.
  • FFO: Diluted FFO per share and unit was $1.57 in Q3 versus $1.23; nine-month diluted FFO was $4.83 versus $4.16. FFO is a supplemental, non-GAAP REIT measure and excludes, among other items, property-sale gains and real-estate depreciation.
  • Cash flow: Nine-month operating cash flow was $1.034 billion, up from $681.6 million. Investing used $793.8 million and financing used $208.5 million. Cash, cash equivalents and restricted cash totaled $54.3 million at period-end.

Balance sheet, debt and liquidity

  • Total assets were $21.46 billion and total liabilities $10.68 billion at September 30, 2018. Cash and cash equivalents were $46.2 million; restricted cash was $8.1 million.
  • Consolidated debt principal was approximately $9.24 billion, up from $8.65 billion at December 31, 2017. The effective interest rate was 3.57%; 87.1% of debt was fixed-rate or fixed through swaps, and weighted-average time to initial maturity was about five years.
  • Approximately $595 million was drawn on the $2.0 billion revolving facility; after about $44.6 million of letters of credit, approximately $1.4 billion remained available. The company reported compliance with applicable debt covenants.
  • Nine-month capital expenditures, excluding indirect costs, were $866.1 million, including $771.3 million for development. Management estimated fourth-quarter 2018 development capital expenditures of approximately $0.2–$0.4 billion, subject to demand, leasing and capital availability.

Changes, outlook and notable items

  • Growth was driven principally by the September 2017 DuPont Fabros Technology merger: acquired properties contributed approximately $136.5 million to Q3 revenue growth and $454.4 million to nine-month growth. Stabilized-property revenue increased 0.5% in Q3 and 1.2% for nine months.
  • Interest expense increased $9.2 million in Q3 and $52.0 million for nine months, primarily reflecting debt issued in 2017 and the $650 million 4.45% notes issued in June 2018. Depreciation and amortization also rose substantially, largely due to the merger.
  • Property sales generated $291.7 million gross proceeds and $80.4 million net gains in the first nine months. The company recorded no real-estate impairment in 2018, compared with $29.0 million in 2017.
  • Leasing activity for the first nine months included 1.1 million square feet of renewals and 1.7 million square feet of new leases. Renewal rents increased on a GAAP basis by 8.6% for Turn-Key Flex and 16.1% for Powered Base Building. Management described demand as strong in most key markets, but expected rents on 2018 expirations to be generally higher on a GAAP basis and slightly lower on a cash basis.
  • The company agreed to acquire Brazil-based Ascenty in a transaction valued at approximately $1.8 billion, expected to close in Q4 2018, subject to customary conditions. Brookfield committed to fund half of the estimated $0.6 billion initial equity investment for a 49% joint-venture interest, subject to closing conditions and Brazilian regulatory approvals. Digital Realty expected to use proceeds from its forward equity sale to fund its portion.
  • In September, forward purchasers sold 9.775 million Digital Realty shares; the company received no proceeds at the offering date and expected approximately $1.1 billion net upon physical settlement by September 27, 2019.
  • After quarter-end, the company issued £400 million of 3.75% notes due 2030 and refinanced its revolving and term-loan facilities on October 24, 2018, including a new $2.35 billion revolving facility maturing in 2023. These are subsequent events, not quarter-end balances.
  • Key risks include leasing and occupancy, data-center demand and competition, development cost and execution, customer credit and lease renewals, access to capital and refinancing, interest rates, foreign currency, energy costs and regulation, and integration and closing risks related to Ascenty and its proposed joint venture. Management reported no legal proceeding expected to have a material adverse effect.

The filing provides no formal full-year earnings or FFO guidance. Its stated 2018 outlook item is the estimated fourth-quarter development capital spending noted above.

Investor verification priorities

  1. Confirm Ascenty’s acquisition funding, closing status, and Brookfield joint-venture approvals and economics.
  2. Track settlement timing and net proceeds from the $1.1 billion forward equity sale, including dilution.
  3. Assess the enlarged development pipeline, remaining cost to complete, lease-up timing and returns on invested capital.
  4. Reconcile GAAP earnings growth with FFO, property-sale gains, merger-related comparisons, depreciation and rising interest expense.
  5. Monitor debt maturities, variable-rate exposure, post-quarter refinancing terms, covenant headroom and cash available after dividends and construction commitments.
  6. Evaluate occupancy, upcoming lease expirations and cash-versus-GAAP renewal rent trends, especially in concentrated markets.