DLR: Data Centers Not Discretionary Spending

Why would companies continue to invest heavily in data centers in the midst of a global credit crunch and steep losses in the stock market? It doesn't always make sense. And yet they do. 

The quarter ending Sept. 30 was the best quarter ever for new leasing at Digital Realty Trust (DLR), the world's largest owner of data center properties. Last week the company announced new leases of data center space with IBM, Equinix, Starwood Hotels and the Children's Medical Center of Dallas.      

"We are not seeing a reduction in demand, even with the consolidation in the financial sector," said Chris Crosby, Senior VIce President of Digital Realty Trust. "These are really not discretionary expenses for these companies. You definitely have a longer decision-making process, and decisions are moving higher up in the customer organization.

"But these (data center-based) applications are driving significant revenues for these companies," Crosby added. "Some of the highest margin businesses these companies have are coming out of the data center. As long as you are in the bucket where you're driving revenue or supporting the business, you're in good shape."

The factors supporting continued data center demand can be counterintuitive. Crosby describes them as "contrarian drivers" of market activity. "In financial services, you have a lot of turmoil," said Crosby. "That volatility in the stock market means the volume of trading is way up. Commissions on trades are a huge revenue driver for financial services companies. Computers do all this stuff." Electronic trades represented 22 percent of volume in 2007, and have almost certainly trended higher this year.

Crosby said that some of the mergers and makeovers could actually increase demand for specific data center services for the financial sector. One example is Goldman Sachs and Morgan Stanley shifting from investment banks to bank holding companies. Crosby said the change could actually stimulate data center demand at those companies, because their regulatory burden will be different and will likely require them to save and store a greater volume of documents for compliance purposes.

As we noted last week, Merrill Lynch was acquired by Bank of America but is moving ahead with its purchase of iDataPlex servers from IBM so it can “build and evaluate new risk-analysis programs."

Digital Realty is better positioned to fare well through a downturn due to its size and the geographic breadth of its portfolio, which is an advantage in working with multi-national companies. Crosby said that Digital Realty is not alone in seeing continuing demand, but is also on the lookout for any signs that the market may be turning.

"We are very cautious in keeping a keen eye on all sectors to make sure we're not too long in any one area," said Crosby. "That means doing an analysis by geography as well as by sector. Right now, we're not seeing any indicators of a slowdown, other than longer decisions. I think we're only seeing about a quarter of delay on most deals."

While cloud computing may be disruptive in some sectors of the hosting and IT infrastructure industry, Digital Realty believes its position as a developer of "wholesale" data center space allows it to benefit from cloud providers' growth. While Crosby wouldn't confirm any specific tenants, Amazon (AMZN) is known to lease at least one large facility owned by Digital Realty. “We look at (cloud computing) as an opportunity," said Crosby.

The credit crunch has one clear benefit for Digitial Realty and other experienced data center developers. The lack of credit makes for a high barrier to entry in the data center business, which has always been capital-intensive. "On the supply side, this environment is favorable for the folks that have supply and can bring in online quickly," said Crosby.