Digital Realty Trust, Inc. — Q3 2013 Form 10-Q
Business context and period. Unaudited results cover the quarter and nine months ended September 30, 2013, compared with the same 2012 periods. Digital Realty owns, develops and manages technology-related real estate, principally data centers. Its portfolio comprised 130 properties and approximately 24.0 million rentable square feet, including space held for development and properties in unconsolidated joint ventures. The operating partnership holds substantially all assets and debt; the public REIT is its general partner.
Financial performance and position
- Revenue: Q3 operating revenue was $379.5 million, up 10.8% year over year; nine-month revenue was $1.101 billion, up 18.5%. Rental income and tenant reimbursements drove the increases, reflecting leasing, completed development space and acquisitions.
- Profit and margins: Q3 operating income fell to $85.2 million from $97.1 million; operating margin was approximately 22.4%, versus 28.3%. Q3 net income was $153.5 million versus $56.9 million, and net income available to common stockholders was $138.9 million versus $45.6 million. The increase primarily reflects a $115.1 million gain on contributing properties to a joint venture. Diluted EPS was $1.06 versus $0.37. For the first nine months, operating income was $283.8 million versus $271.4 million, net income was $264.8 million versus $160.2 million, and diluted EPS was $1.79 versus $1.12. Nine-month diluted FFO per share and unit was $3.47 versus $3.28; Q3 was $1.10 versus $1.13.
- Cash flow: Nine-month operating cash flow was $454.1 million, up from $356.5 million. Investing used $732.5 million, including $882.3 million for real estate improvements and advances; financing provided $277.3 million. Cash and equivalents were $55.1 million at quarter-end, excluding $42.5 million restricted cash.
- Debt and liquidity: Total debt was $4.780 billion, up from $4.279 billion at year-end 2012. Debt to enterprise value was approximately 38%; management stated an intent to limit it to 60%. Approximately 81.5% of debt was fixed-rate or hedged, with a 4.20% effective interest rate. The $2.0 billion revolving facility had $498.1 million drawn and approximately $1.5 billion available; the $1.0 billion term loan had $950.2 million outstanding. The company reported covenant compliance.
- Equity and distributions: The company issued $250 million of Series G preferred stock at a 5.875% rate. The common dividend was $3.12 annualized per share. A $500 million share repurchase authorization was approved after quarter-end.
Changes, outlook and matters to monitor
- Revenue growth included both same-store improvement and acquired properties. Operating costs rose faster than revenue: Q3 operating expenses increased $48.9 million year over year, including higher property operating costs, taxes and depreciation. Interest expense also increased.
- In September, the company contributed nine data centers to a Prudential-managed joint venture, retaining 20% and recognizing the $115.1 million gain. The transaction generated approximately $328.6 million in net proceeds. The company will manage the properties but does not control significant decisions.
- Management reported approximately 92.6% portfolio occupancy excluding development space and unconsolidated joint ventures. It described demand as strong in most key markets, while identifying potential oversupply risk in Silicon Valley. It expected 2013 lease renewals and new leases, in aggregate, to be higher than existing rents on a GAAP basis and flat on a cash basis; this is not a guarantee of future leasing results.
- Approximately 1.533 million square feet was under construction. Management expected $250 million to $325 million of development capital spending in Q4 2013, subject to demand, leasing and financing conditions. Construction work in progress was $909.5 million; reported expected total cost for projects under construction was approximately $2.0 billion.
- Unusual items and contingencies: Q3 included a $10.0 million non-cash catch-up straight-line rent expense related to a lease modification. Nine-month results included a $5.6 million insurance settlement gain. Sentrum contingent consideration was valued at approximately $73.1 million at quarter-end; construction contract commitments were $191.7 million. No legal proceedings were reported that management believed would materially affect the company.
- Key risks include tenant concentration and lease renewals, data-center demand and competing supply, substantial development and capital needs, rising utility and property costs, refinancing and interest-rate exposure, foreign-currency exposure, joint-venture risks, and maintaining REIT qualification. The filing gives no specific earnings or FFO guidance.
Important facts for investors to verify
- How much reported earnings growth reflects recurring operations versus the $115.1 million joint-venture gain and other unusual items.
- Leasing, occupancy and rent trends, including how the JV contribution affects reported same-store comparisons and exposure to Silicon Valley supply.
- Funding and expected returns for the development pipeline, construction commitments and Q4 capital spending.
- Debt maturities and refinancing plans, particularly the exchangeable debentures’ April 2014 holder put date, alongside covenant headroom and variable-rate exposure.
- Whether operating cash flow sustainably covers dividends, capital spending and debt service; management noted borrowing might be needed to fund distributions.