DIGITAL REALTY TRUST, INC. annual report, FY2012

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Digital Realty Trust, Inc. — 2012 Form 10-K

Business context and reporting period. This is the annual report for the year ended December 31, 2012, not a standalone quarterly filing. Digital Realty owns, develops and operates technology-related real estate, principally data centers. At year-end, it held 117 properties with approximately 21.9 million rentable square feet, including 2.4 million square feet held for development; operating space was 94.4% leased. The filing combines Digital Realty Trust, Inc. and its operating partnership, which holds substantially all operating assets and debt.

Financial and operating performance

  • Revenue: Total operating revenue was $1.279 billion, up 20.4% from $1.063 billion in 2011. Rental revenue rose 20.7% to $990.7 million; tenant reimbursements rose 28.6% to $272.3 million. Construction management revenue declined to $8.4 million from $29.3 million.
  • Profit and margins: Operating income increased 20.3% to $366.1 million; operating margin was approximately 28.6%, broadly unchanged from 2011. Net income was $216.0 million versus $162.1 million. Net income attributable to the company was $210.3 million, and income available to common stockholders was $171.7 million versus $130.9 million. Basic and diluted EPS were both $1.48, compared with $1.33 basic and $1.32 diluted.
  • FFO and distributions: NAREIT FFO available to common stockholders and unitholders was $557.7 million, up from $449.3 million; diluted FFO per share/unit rose to $4.44 from $4.06. Common dividends were $2.92 per share for 2012, compared with $2.72 in 2011. The board declared a $0.78 common dividend in February 2013, an annualized $3.12 rate; future dividends remain discretionary.
  • Cash flow: Operating cash flow was $542.9 million, up from $401.0 million. Investing activities used $2.476 billion, primarily reflecting $1.560 billion of property acquisitions and $845.8 million of real estate improvements and advances. Financing activities provided $1.949 billion. Year-end cash and cash equivalents were $56.3 million, excluding $44.1 million of restricted cash.
  • Debt and liquidity: Total debt was approximately $4.279 billion, up from $2.940 billion. Debt to enterprise value was approximately 32%; 78.6% of debt was fixed-rate or hedged, while 21.4% was variable and unhedged. The effective interest rate was 4.24%. Of the $1.8 billion revolving facility, approximately $1.0 billion was available at year-end, net of letters of credit. Management reported compliance with debt covenants.
  • Quarterly context: Fourth-quarter 2012 revenue was $349.7 million versus $270.6 million in fourth-quarter 2011. Net income available to common stockholders was $44.8 million versus $36.0 million; diluted EPS was $0.36 versus $0.34.

Material changes versus the prior comparable period

  • Portfolio expansion drove much of the growth: the company acquired 13 properties in 2012, and year-end portfolio size rose to 117 properties from 101 in 2011. Acquisitions totaled approximately $1.571 billion, including the roughly $1.139 billion Sentrum portfolio in London.
  • Rental revenue increased through acquisitions, new leasing and development space placed into service. Same-store revenue also grew; management attributed leasing activity to strong demand in many key markets. Renewed rents increased on a GAAP basis by an average 5.2% for Turn-Key Flex space and 20.3% for Powered Base Building space.
  • Operating expenses increased 20.4% to $913.0 million, including higher property operating costs, property taxes and depreciation. Interest expense rose 5.2% to $157.1 million. Operating income grew in line with revenue, leaving the operating margin broadly stable.
  • Debt increased alongside significant acquisition and development spending. The company issued $300 million of 3.625% notes due 2022, drew on a new $750 million multi-currency term loan, and raised equity, including approximately $797.2 million net proceeds from a July common-stock offering and $176.2 million from Series F preferred stock.

Outlook, commentary, risks and unusual items

  • Outlook: Management expected to spend approximately $850 million to $950 million on development capital expenditures in 2013; the amount could change materially with demand, leasing results and access to capital. It reported strong demand in most key markets and expected rents on 2013 expirations generally to exceed existing rents, but gave no formal earnings or FFO guidance in the supplied filing text.
  • Development commitments: Approximately 1.37 million square feet was under construction or development projects at year-end. The filing reports $244.3 million of open construction-contract commitments and an expected total delivery cost of approximately $1.624 billion for the identified projects, including related acquisition and capitalized costs.
  • Lease and tenant exposure: Leases covering 11.2% of portfolio square footage were scheduled to expire through 2014, and 5.6% of net rentable space was available. CenturyLink subsidiaries represented 9.1% of annualized rent; the 20 largest tenants represented 46.8%. Data-center specialization, competition, technological change, tenant credit and access to power are key business risks.
  • Financing and international risks: Significant debt, refinancing needs, unhedged variable-rate exposure and dependence on external capital could constrain growth or distributions. Foreign operations add currency and regulatory exposure; England represented 22.3% of long-lived assets at year-end, though no foreign country exceeded 10% of operating revenue.
  • Contingencies and subsequent events: The Sentrum acquisition included contingent seller consideration valued at $90.7 million at year-end, subject to remeasurement. No material legal proceedings were reported. After year-end, a subsidiary issued £400 million (approximately $634.8 million) of 4.25% guaranteed notes due 2025, and the company completed additional acquisitions. Series D preferred shares converted into common shares effective February 26, 2013.
  • Reporting and controls: The independent auditor gave unqualified opinions on the financial statements and internal control over financial reporting; management concluded controls were effective. No impairment losses were recognized through 2012.

Most important facts for investors to verify

  • Whether acquisition-led revenue and FFO growth translate into sustained same-property performance, and how occupancy and renewal rents develop.
  • Delivery timing, leasing and actual costs for the development pipeline, including the 2013 capital expenditure plan and construction commitments.
  • Debt maturities and refinancing requirements, available revolver capacity, covenant headroom, and the impact of the unhedged variable-rate debt.
  • Tenant concentration, CenturyLink lease exposure, and the near-term expirations and available space that must be renewed or leased.
  • The ultimate amount and timing of Sentrum contingent consideration, and the effect of foreign exchange and foreign-property concentration on cash flows and asset values.
  • Whether operating cash flow continues to support dividends and distributions alongside capital spending; the filing states that future dividends are subject to board discretion.