Digital Realty Trust, Inc. — Q3 2017 Form 10-Q
Reporting period: Three and nine months ended September 30, 2017. Unless noted, financial amounts are in U.S. dollars. Digital Realty Trust, Inc. is a REIT whose operating partnership holds substantially all assets and debt.
Business context
The company owns, acquires, develops and manages data centers. At quarter-end, its portfolio comprised 159 properties, including nine held for sale and 14 held through unconsolidated joint ventures; occupancy was approximately 90.8%. The September 14 acquisition of DuPont Fabros Technology (DFT) added 15 properties and materially expanded the portfolio.
Financial performance and liquidity
- Revenue: Q3 operating revenue was $609.9 million, up 11.7% from $546.3 million. Nine-month revenue was $1.726 billion, up 10.3% from $1.565 billion.
- Profit and margins: Q3 operating income was $66.2 million versus $115.8 million; operating margin was approximately 10.8% versus 21.2%. Net income was $12.5 million versus $222.4 million, and diluted EPS was a loss of $0.02 versus income of $1.25. For nine months, operating income was $334.1 million versus $346.2 million, net income was $176.6 million versus $335.7 million, and diluted EPS was $0.73 versus $1.72.
- FFO: Diluted FFO per share and unit was $1.23 in Q3 versus $1.31; nine-month diluted FFO was $4.16 versus $4.08. Total FFO was $214.6 million and $694.4 million, respectively.
- Cash flow: Nine-month operating cash flow was $681.6 million versus $627.1 million. Investing cash outflow was $718.0 million; cash spent on improvements to real estate was $763.9 million. Cash, cash equivalents and restricted cash ended at $210.3 million.
- Debt and liquidity: Consolidated debt was approximately $8.55 billion, up from $5.84 billion at year-end 2016. Cash and cash equivalents were $192.6 million, with $17.8 million restricted. Approximately $1.9 billion remained available under the $2.0 billion revolving facility. Debt to total enterprise value was approximately 24%; management reported compliance with debt covenants.
- Development: Nine-month capital expenditures, excluding indirect costs, were $694.5 million versus $471.3 million. Management estimated $0.3–$0.4 billion of development capital expenditures for Q4 2017.
Material changes and unusual items
- DFT was acquired for approximately $6.21 billion of equity consideration. The transaction added approximately $2.59 billion of goodwill; purchase accounting remained preliminary.
- Q3 results included $42.8 million of transaction and integration expense, including $32.9 million of DFT merger costs, and a $29.0 million real estate impairment charge. Nine-month transaction and integration expense was $60.4 million, including $42.3 million of DFT merger costs.
- Comparisons with 2016 were affected by property-sale gains of $169.0 million in Q3 2016 and $170.1 million for the first nine months of 2016. This materially contributed to lower reported net income in 2017.
- The company issued new senior notes and preferred stock to help fund DFT debt repayment and merger costs, while redeeming its Series F preferred stock. The nine-month common stock and unit base also increased substantially, partly due to the merger.
- At quarter-end, nine properties with $132.8 million of carrying value were held for sale. A subsequent October sale of a Northern Virginia property was expected to generate an approximately $15 million gain before noncontrolling interests.
Outlook, risks and contingencies
- Management reported strong demand in most key metropolitan areas and expected 2017 expiring leases to renew or re-lease at higher rates on a GAAP basis and slightly higher on a cash basis, on average. This is an expectation, not a guarantee; the filing provides no specific full-year earnings or FFO guidance.
- Key risks include customer concentration and lease renewals, data-center supply and demand, development costs and leasing delays, access to capital and refinancing, interest rates, foreign currency exposure, energy costs and regulation, and successful DFT integration. Northern Virginia represented 21.7% of annualized rent.
- Construction commitments were approximately $437.8 million, including reimbursable amounts. Four merger-related stockholder lawsuits had stipulated dismissals filed, pending court approval; the company considered the claims without merit.
- In October, the company announced a 50/50 Japan joint venture with Mitsubishi Corporation, with seed assets valued at approximately $350 million. It also agreed, subject to closing conditions, to acquire a 250,000-square-foot Illinois data center for $315 million.
Important facts for investors to verify
- Track post-merger operating performance and integration costs separately from DFT-related acquisition and financing effects.
- Review debt maturities, variable-rate exposure, foreign-currency exposure and remaining revolver capacity alongside planned development spending.
- Assess whether occupancy, leasing spreads and development delivery convert into durable cash flow and FFO growth.
- Monitor held-for-sale dispositions, the impairment charge, preliminary DFT purchase accounting and the pending lawsuit dismissals.