Digital Realty Trust, Inc. — Q2 2017 Form 10-Q
Business context and reporting period
Quarter ended June 30, 2017; financial statements are unaudited and compare the three and six months ended June 30, 2017 with the same 2016 periods. Digital Realty owns, develops and operates data centers. Its portfolio comprised 145 properties, including five held for sale and 14 held through unconsolidated joint ventures, across the U.S. and international markets. Reported results are consolidated for Digital Realty Trust, Inc. and its operating partnership.
Financial performance and position
- Revenue: Q2 operating revenue was $566.0 million, up 9.9%; first-half revenue was $1.117 billion, up 9.6%. Rental revenue was $412.6 million in Q2 and $816.7 million for the half year. Interconnection and other revenue rose to $58.3 million in Q2 and $115.5 million for the half year.
- Profit and margins: Q2 operating income was $130.7 million versus $112.3 million; operating margin was approximately 23.1% versus 21.8%. First-half operating income was $267.9 million versus $230.4 million; margin was approximately 24.0% versus 22.6%. Net income was $79.6 million in Q2 and $164.1 million for the half year. Net income available to common stockholders was $57.8 million, or $0.36 per diluted share, in Q2 and $124.0 million, or $0.77 per diluted share, for the half year.
- FFO: Diluted FFO per share and unit was $1.44 for Q2 versus $1.36, and $2.94 for the first half versus $2.75.
- Cash flow and investment: First-half operating cash flow was $519.3 million versus $396.6 million. Investing activities used $463.5 million, including $476.1 million for real estate improvements; cash capital expenditures excluding indirect costs were $431.7 million versus $281.9 million. Financing activities used $19.4 million. Cash, cash equivalents and restricted cash totaled $41.3 million at period end.
- Debt and liquidity: Principal debt was approximately $6.49 billion; debt to total enterprise value was about 25%. Approximately 81% of debt was fixed-rate or hedged, with a 3.42% effective interest rate and 4.8-year weighted-average term to initial maturity. The $2.0 billion revolving facility had $572.0 million drawn and $20.4 million in letters of credit, leaving approximately $1.4 billion available. The company reported compliance with debt covenants.
- Balance sheet: Total assets were $12.58 billion and total liabilities $7.55 billion at June 30, compared with $12.19 billion and $7.06 billion, respectively, at December 31, 2016. Net real estate investments were $9.36 billion.
Material changes versus the prior comparable period
- Revenue growth reflected the European portfolio acquisition, completed development leasing and growth in interconnection revenue. Stabilized portfolio revenue increased more modestly: $6.6 million in Q2 and $12.9 million in the first half.
- Operating expenses increased $32.7 million in Q2 and $59.9 million for the half year. Transaction and integration expense rose to $14.2 million in Q2 and $17.6 million for the half year, including $9.5 million of costs related to the proposed DuPont Fabros Technology (DFT) merger.
- Interest expense declined $2.3 million in Q2 and $4.1 million for the half year, principally due to mortgage paydowns and higher capitalized interest.
- Common earnings benefited from lower preferred dividends after redemption of all 7.3 million Series F preferred shares in April; the related $6.3 million of previously incurred issuance costs reduced earnings available to common stockholders.
- Common shares increased following settlement of the remaining forward equity sale: 2.375 million shares were issued in May for approximately $211.1 million net proceeds. The company also issued €125 million of floating-rate notes in May.
Outlook, management commentary, risks and unusual items
- Management reported approximately 89.1% portfolio leasing, excluding development and future-development space, and an average remaining lease term of about five years. About 91% of leases had fixed or inflation-indexed rent escalations. Renewals signed in the first half showed GAAP rent increases of 5.1% for Turn-Key Flex and 24.7% for Powered Base Building space.
- Management expected rents on 2017-expiring data-center space, on average, to be higher on a GAAP basis and slightly higher on a cash basis, subject to market supply and demand. This is commentary, not formal earnings guidance.
- Management expected $0.4 billion to $0.6 billion of development capital expenditures in the second half of 2017, subject to demand, leasing results and capital availability. Construction contracts carried approximately $327 million of open commitments, including reimbursable amounts.
- On June 8, 2017, Digital Realty agreed to acquire DFT in a stock-and-unit transaction at an exchange ratio of 0.545 Digital Realty shares or units per DFT share or unit, subject to approvals and other closing conditions. The filing cautions that completion is not assured. Four shareholder suits alleged inadequate merger disclosures; the company considered the claims without merit and intended to defend them. A separate lawsuit over a released sublease guarantee was dismissed in July, and the counterparty indicated it would not appeal.
- Subsequent to quarter end, the company issued GBP notes and, on August 7, USD notes and Series J preferred shares to help fund DFT debt repayment and transaction costs. The notes include special mandatory redemption provisions if the merger does not close by December 15, 2017 or is terminated earlier.
- Key risks include data-center demand and competition, customer defaults or lease non-renewals, development and leasing execution, power and regulatory costs, interest rates, foreign currency exposure, access to debt and equity capital, geographic concentration, and the pending merger. Management cited Brexit-related uncertainty and climate and energy regulation as additional potential risks.
Important facts for investors to verify
- Merger approval, closing conditions, litigation status, financing uses and the special mandatory redemption terms of post-quarter-end notes.
- Development spending, project delivery and leasing progress, particularly the $0.4–$0.6 billion second-half capital expenditure expectation and open construction commitments.
- Occupancy, lease expirations and renewal spreads, including whether rent increases translate into cash revenue and returns on invested capital.
- Debt maturities, variable-rate exposure, available revolver capacity and covenant compliance as financing needs evolve.
- Underlying earnings and FFO trends after acquisition, integration and merger costs, preferred-stock changes, and share issuance effects.