Digital Realty Trust Inc (DLR) — Q2 2016 Earnings Call Transcript

Thank you, Dan. The speakers on today’s call will be CEO, Bill Stein; CFO, Andy Power; Chief Investment Officer, Scott Peterson; Chief Operating Officer, Jarrett Appleby; and SVP of Sales and Marketing, Matt Miszewski are also on the call and will be available for Q&A. Management may make forward-looking statements related to future results, including 2016 guidance and the underlying assumptions. Forward-looking statements are based on current expectations that involve risks and uncertainties that could cause actual results to differ materially. For a further discussion of the risks and uncertainties related to our business, see our 2015 10-K and subsequent filings with the SEC. This call will contain non-GAAP financial information. Explanations and reconciliations to net income are included in the supplemental package furnished to the SEC and available on our website. And now, I’d like to turn the call over to Bill Stein.

Thanks, John. Good afternoon and thank you all for joining us. I’d like to begin today with the discussion on governance. We recently announced that Laurence Chapman has been named Vice Chairman of the Board of Directors in keeping with our commitment to sound corporate governance practices and longer-term succession planning. The Board expects to appoint Laurence as Chairman of the Board at its next Annual Meeting in May 2017. Many of you have had the opportunity to interact with Dennis Singleton, who has served as our Chairman since April 2012 when the Company’s founder resigned from the Board. Dennis led the Board during a period of significant transition, including a change in CEO as well as several other executives, a change in Board composition, and two strategic acquisitions that have meaningfully enhanced the Company’s growth profile and product mix. It is expected that Dennis will continue to serve on the Company’s Board of Directors after he steps down as Chairman. In addition, I’m pleased to announce that Mark Patterson has joined our Board effective yesterday. Many of you may also be familiar with Mark. He was formerly the Global Head of Real Estate Investment Banking at Merrill Lynch and prior to that he was the Global Head of Real Estate Investment Banking at Citigroup. He serves on the board of UDR as well as General Growth. We are absolutely delighted to welcome Mark to our Board. The governance principle behind these changes is balancing fresh thinking and new perspectives with experience and continuity. I would also like to remind you that we maintain a destaggered Board. The majority of our Directors' fees are paid in stock. Each of our Directors maintains a sizable investment in the Company. The Board and Senior Management are required to meet minimum stock ownership requirements. And finally, since 2014, 100% of the senior management team's long-term incentive compensation plan has been tied to relative total shareholder performance. We believe in eating our own cooking and we manage the business to maximize sustainable long-term value creation for all stakeholders. Along those lines, we announced several industry-leading sustainability initiatives earlier this month, including a long-term agreement to procure wind power offsetting 100% of our U.S. colocation and interconnection energy footprint. Let’s turn to Page 2 of our presentation to recap the guide posts of our strategic plan. Delivering superior risk-adjusted returns is our guiding principle. This entails emphasizing profitability over velocity and preserving the flexibility of our balance sheet. We are focused on the accretive deployment of capital and we are willing to turn down deals that do not provide a sufficiently positive spread above our cost of capital. We also execute when we can achieve the best long-term outcome for shareholders irrespective of short-term reporting requirements. In terms of capital allocation, the highlight of the second quarter was the agreement that we reached to acquire a portfolio of eight highly strategic data centers in London, Amsterdam, and Frankfurt, three of the most important interconnection hubs in Europe as shown here on Page 3. This transaction met all of our acquisition criteria. It was strategic and complimentary to our existing business, financially accretive, and prudently financed. These eight data centers are highly complementary to our European platform. The portfolio serves more than 650 customers predominantly concentrated in the network cloud and IT services, content and digital media, and financial services verticals. The concentration lines up very well with our target customer verticals and more than 80% of these customers are new relationships to Digital Realty. In addition, more than 80% of our traditional large footprint leasing activity has been repeat business with existing customers, underscoring the value of these new customer relationships. As you know, this sales process was dictated by the European Commission with the clear objective of standing up a business that would be immediately competitive in the marketplace. What you may not know is that this business came staffed with 130 employees, including 16 sales and marketing professionals. In contrast to the Telx acquisition, we have not underwritten any expense synergies in this acquisition. We are very pleased with the caliber of the personnel as well as the properties that we’ve acquired with this transaction and we welcome these new employees to the Digital Realty family. In terms of integration, it’s still early days, but we are actively working to ensure a smooth transition for the acquired business into the Digital Realty platform. And we are leveraging the lessons learned from the Telx integration to create a seamlessly repeatable process. Our teams are focused on communicating with our customers and employees, and we are executing on short-term objectives for the business, moving people, integrating processes, and standardizing reporting. Over the next quarter, we’ll finalize the plan to extend our colocation and interconnection platform and we will communicate it as appropriate. I should pause here for a moment to address the impact of Brexit. We did anticipate a potential Brexit scenario in our underwriting and we did hedge the purchase price, but we have not altered our global strategy. Fundamentally, we do not believe the EU referendum will materially impact global data center demand or our global portfolio as the secular demand drivers remain intact and the transatlantic cable landings have not moved. We believe our global platform is one of our key competitive advantages and we do not plan to exit either the UK or Continental Europe regardless of the outcome of the EU referendum.

Thank you, Bill. Let’s begin with our leasing activity on Page 8. We signed new leases totaling $15 million of annualized GAAP rent during the second quarter, including a $6 million colocation space and power contribution. Interconnection contributed an additional $8 million, and our total bookings for the second quarter were a little over $22 million of annualized GAAP revenue. While this is towards the lower end of our recent activity levels, we are taking a much more selective approach to landing the right mix of customers to maximize the long-term value of our global connected campus footprint. We are winning diverse demand across attractive verticals including cloud service providers both big and small along with other growing segments of the digital economy, IT service providers, and other large sophisticated users. You’ll note the appearance of a Fortune 50 hyper-scale cloud service provider on our top twenty customer list this quarter. At the same time, we also added more than forty new logos for the second consecutive quarter. Long story short, we are focused on landing demand from a diverse and growing customer set. Along those lines, I am pleased to report that during the month of July, we have already signed an additional $20 million of total bookings, including space, power, and interconnection. This activity has included significant signings across all three geographic regions including a healthy mix of large enterprise software cloud providers, hyper-scale cloud providers, IT service providers, and financial service customers. The total bookings figure includes $6 million of annualized colocation and interconnection bookings. In fact, the month of July has already been the best month for Telx since our acquisition. While we are not satisfied with the level of large footprint leasing during the second quarter, the pipeline for the second half is sizable and we are cautiously optimistic that we are back on track to return to normalized activity levels in the second half of the year.

Yes, Jordan, it’s Matt Miszewski. Thanks for the question. In keeping in alignment with what Andy has stated in his opening remarks and especially in our core markets but more broadly as well, we see stable to slightly improving rates, which also happen to be coupled with some of the great work that Jarrett’s team is involved in. We’ve been focused on cost containment in design and construction. So that we expect as the programs that we’re developing right now move forward to have even better performance from a pricing perspective. As our ecosystem development work that’s underway right now starts to take hold. The pre-leasing rates that in these markets similarly look good. Internationally in particular, rates look fairly strong. So strength in Chicago, in Ashburn, in Dallas, and in Singapore which is great given the new facility that we just launched.

Great question Jordan and really since before the acquisition of Telx but really with the acquisition of Telx and working closely with that team we’ve been focused on making sure that the funnel is not just full, but it’s full of the right opportunities in the right target accounts. Given our targeted focus on SMACC continuing, social, mobile, analytics, cloud and content, but especially inside that cloud and social verticals, our funnel has been slightly improving margins in it currently and I do say currently because it’s pipeline and we have to close, but we’re pretty happy that we’ve been able to slightly expand the margin inside the funnel as we start to work together with multiple products. In addition, we’ve been working together very, very closely with multiple clouds - large cloud service providers to make sure that we can match value for value going forward given their demand and given our capacity and given the pipeline, the pipeline margins this would give the pipeline margins for the rest of this fiscal year and moving into Q1 of 2017 potentially better outcome.

In terms of remaining milestones, I would say unifying the brand under one brand across the company is a big one, one global sales force is another big one that is going on, both of those going on really right now. Remaining milestones other than, obviously, meeting or exceeding our underwriting targets probably be more back of the house oriented in terms of accounting systems that will eventually be fully united and kind of HRIS systems. I think in terms of facing the customer and driving more revenue, the two that we mentioned on this call are the biggest that are kind of nearing the end zone.

I would agree we’re focused on integration. We want to be good stewards of our shareholder capital. I think one of the great aspects of these two acquisitions is these platforms give us a lot of flexibility. We can grow the platforms organically. We could grow through M&A, but we have a lot of flexibility and that allows us to remain disciplined in our future M&A activity.

Yes, Jordan, it’s Matt Miszewski. Thanks for the question. In keeping in alignment with what Andy have stated in his opening remarks and especially in our core markets but more broadly as well we see stable to slightly improving rates, which also happen to be coupled with some of the great work that Jarrett’s team is involved. We’ve been focused on cost containment in design and construction. So that we expect as the programs that we’re developing right now move forward to have even better performance from a pricing perspective.

Sorry about that. So I was interested in the remaining milestones that you have perhaps on the operations side. You talked about integrating the sales force and retiring the brand, but what remains to be done with the Telx integration as well as what would be some of the initial milestones as you look at the European assets that you just acquired?

In terms of the European portfolio acquisition, quite frankly, it’s early days, we are delighted to receive approval from the commission and ultimately closing the acquisition what is I guess a handful of days or weeks ago. We think we got a really talented team along with some very attractive assets coming on board. We have onboarded some consulting help to kind of help us stimulate the 130 team members and assets with our existing franchise in Europe. So we probably have more to post you on that integration coming next earnings call, but just a handful of weeks of post closings, so far so good.

Great. Thank you. I wanted to start with the leasing numbers, the $15 million in the quarter. Would you characterize that more a function, and it being lower than what you’ve been doing, which you characterize that more a function of you’re not chasing the deals that are out there because you think that the returns don’t meet your criteria? Did you not necessarily have capacity in the markets where some of the bigger deals were being won this particular quarter? Or is it that you actually are bidding and you’re losing out perhaps to others?

It may have not flowed through to our supplemental because until a commencement happens on a lease, it won’t show up in a utilization stat and some of those buildings are kind of portions of our building, so you can’t always see it transparently. We have seen some traction increase not on the East Coast, but also the West Coast. I’m not sure that’s kind of coastal specific, I think it’s more a testament to onboarding more QBRs and we have several on-ramp that newly joined the Company. And they’ve, quite frankly, the new QBRs have driven a lot of new logos and customers, which is what I would say attributed to Telx’s success in the quarter which was certainly backend loaded more towards June and the beginning of the quarter and then that success is certainly spilled over in the month of July.

Great, thank you. I just wanted to follow-up on a clarification. Given the Equinix asset probably is a little bit lower margin than the core business and it’s staying in guidance, what gave you the confidence to raise up the guidance range for adjusted EBITDA to 56 to 58?

Even with the absorption of - you’re correct, lower margin than existing digital. Based on the outperformance we’ve seen on the EBITDA side or expense side year-to-date and what we’re trending for the remainder of the year. We think we’re going to be able to absorb that portfolio and continue to maintain - I should say deliver slightly higher than previously disclosed EBITDA margin.

In summary, at the one year mark since the Telx acquisition announcement we’re on track to meet or exceed our underwriting targets and complete the integration process. Thank you all for joining us and have a great summer.