DIGITAL REALTY TRUST, INC. annual report, FY2016

Full document

Digital Realty Trust, Inc. — 2016 Form 10-K

Business context and reporting period

Annual report for the fiscal year ended December 31, 2016, filed jointly by Digital Realty Trust, Inc. and its operating partnership. The REIT owns, develops and operates data centers and provides colocation and interconnection services. At year-end, its portfolio included 145 operating properties, including 14 held through unconsolidated joint ventures, across 12 countries. Portfolio occupancy was 89.4%, excluding development and future-development space.

Financial and operating performance

  • Revenue: $2.142 billion, up 21.5% from $1.763 billion in 2015. Rental revenue rose 13.8% to $1.543 billion; interconnection and other revenue increased to $204.3 million from $40.8 million.
  • Profit: Operating income was $497.3 million, versus $401.9 million; operating margin was approximately 23.2%, compared with 22.8%. Net income was $431.9 million, versus $301.6 million. Net income available to common stockholders was $332.1 million, or $2.21 per diluted share, versus $217.3 million, or $1.56 per diluted share.
  • FFO: NAREIT FFO available to common stockholders and unitholders was $867.7 million, or $5.67 per diluted share and unit, versus $687.9 million, or $4.86. FFO is a supplemental, non-GAAP measure.
  • Cash flow and investment: Operating cash flow was $912.3 million, up from $799.2 million. Investing activities used $1.299 billion, including real estate acquisitions and improvements. Capital expenditures were $654.2 million, compared with $626.7 million.
  • Margins and cost trends: Total operating expenses increased 20.8% to $1.645 billion, including 22.6% higher depreciation and amortization and 44.7% higher general and administrative expense. Interest expense rose 17.4% to $236.5 million.
  • Debt and liquidity: Year-end consolidated debt was approximately $5.9 billion; debt to total enterprise value was approximately 26%. About 90.3% of debt was fixed-rate or hedged, and the weighted-average interest rate was 3.62%. Cash and cash equivalents were $10.5 million, with approximately $1.8 billion available under the $2.0 billion revolving facility, net of letters of credit. The company reported compliance with debt covenants.
  • Dividends: Common dividends were $3.52 per share in 2016, up from $3.40 in 2015. The March 2017 declaration set a quarterly common dividend of $0.93 per share.

Material changes versus 2015

  • Revenue growth largely reflected the Telx acquisition, completed in October 2015, and the July 2016 acquisition of eight European data centers for $818.9 million, as well as new leasing. The European properties contributed $55.3 million of revenue after acquisition.
  • Rental revenue increased, but tenant reimbursements were slightly lower. Interconnection revenue expanded substantially with the Telx platform. Stabilized rental and reimbursement revenues were broadly flat, partly offset by weaker sterling and euro exchange rates.
  • Net income included $169.9 million of gains on property sales, versus $94.6 million in 2015. The 2016 gains included the Paris property sale. These gains boosted GAAP earnings but are excluded from FFO.
  • Cash from operations increased, while investing cash outflow narrowed from $2.526 billion in 2015, when the Telx acquisition drove investment spending. Financing cash flow fell to $351.9 million from $1.749 billion.
  • Common shares outstanding increased, including a September 2016 settlement of 12 million shares under forward sale agreements that generated approximately $1.1 billion in net proceeds. The company also redeemed all Series E preferred stock for $287.5 million.

Outlook, commentary, risks and unusual items

  • Management described demand as strong in most key markets and expected rents on 2017 lease renewals, in aggregate, to be higher on a GAAP basis and flat on a cash basis. This is commentary, not quantified earnings guidance.
  • Management expected to spend approximately $0.8 billion to $1.0 billion on development capital expenditures in 2017; actual spending could change materially with demand, leasing and capital availability. Year-end active development was approximately 2.0 million square feet, with $320.9 million of construction-contract commitments.
  • Management targets debt to Adjusted EBITDA at or below 5.5x, fixed-charge coverage above 3x and floating-rate debt below 20%; the filing text provided here does not give a clear actual debt-to-Adjusted-EBITDA ratio.
  • Fourth-quarter 2016 included a $29.2 million non-cash gain on lease termination when a tenant conveyed colocation and turn-key improvements. Quarterly net income was $96.1 million, down from $222.4 million in Q3, when property-sale gains materially lifted results.
  • Key risks include leasing and development execution, data-center supply and technology changes, reliance on large tenants, power availability and cost, service or security failures, interest-rate and refinancing exposure, foreign currency movements, Brexit-related uncertainty, environmental obligations and REIT qualification. IBM represented 7.8% of annualized rent; the 20 largest tenants represented 43.4%.
  • The European acquisition’s purchase-price allocation remained preliminary, including $445.1 million of goodwill, and was expected to be finalized in early 2017. Management and the auditor excluded the acquired portfolio’s controls from their 2016 internal-control assessment; controls were otherwise reported effective. The financial-statement audit opinion was unqualified.
  • No legal proceedings were identified as likely to have a material adverse effect. A dispute concerning release of a sublease guarantee was disclosed; management said amounts were not expected to be material, while noting the outcome could not be reliably estimated.

Most important facts for investors to verify

  • How much revenue and FFO growth is recurring organic growth versus acquisition contribution, property-sale gains and the lease-termination gain.
  • Whether development projects are completed on schedule and within budget, and whether available and newly completed space leases at expected rents.
  • Tenant concentration, renewals and the potential impact of CenturyLink’s announced plan to divest its data-center and colocation business.
  • Debt maturity and refinancing requirements, revolver availability, covenant headroom, and performance against management’s leverage and coverage targets.
  • Final European acquisition accounting, integration results, foreign-exchange exposure and any material changes in environmental or other contingencies.