Hyperscale Data Center Deals Drive Record Bookings for Digital Realty

DCK Investor Edge

Data center REITs kicked off the year with uncharacteristically poor price performance. But share prices started steadily improving in May, boosting returns for investors – especially ones who understood industry fundamentals and added to positions when shares were falling.

With the exception of Switch, all publicly traded data center REITs (there are five of them) reported a strong second quarter. Among them stood out Digital Realty Trust, which reported record $94 million in bookings – markedly off the charts, considering its $67.3 million trailing four-quarter average.

One Market Stands Out

Much of Digital’s success during the quarter is attributed to the continuing data center leasing frenzy by hyperscale cloud platforms in Northern Virginia, where the San Francisco-based REIT is the biggest player, following its $7.6 billion acquisition of DuPont Fabros Technology last year.

Digital reported a 25MW hyperscale deal in Northern Virginia closed during last quarter. Signings in the region contributed to a record $142 million backlog for the REIT.

Digital reported $76 million in customer renewals in Northern Virginia for the quarter at 3.4 percent positive cash yield on average.

The company recently purchased 62 acres of land in Manassas, which is about 20 miles south of the Northern Virginia market’s epicenter in Ashburn. The alternative location gives hyperscale customers an option that’s remote from Ashburn but close enough to deploy additional availability zones. Cloud providers often deploy in two or three locations within a metro for greater availability.

Digital currently operates 370MW of critical load in Northern Virginia and has 63MW in the development pipeline, which is already 87 percent pre-leased.

Changing Role of the CFO

Digital Realty CFO Andy Power took over in 2015 from Bill Stein, who was elevated to CEO, replacing founder Michael Foust. But Power had prior history with the company, having worked on its 2004 IPO as an investment banker with Bank of America Merrill Lynch. 

This May Digital Realty announced departure of its CIO Scott Peterson and senior VP of global sales and marketing Dan Papes. In the announcement, the company said Papes’ replacement would report to Powers, which is a departure from the norm. Top sales execs typically report to CEOs.

That change reflects the increasingly important role of the CFO in hyperscale data center deals. Besides managing the REIT’s balance sheet and capital-markets activity, Powers is now often directly involved in these leases. That’s because the deals have grown exponentially larger over the past two years, both in size and length, with the initial weighted-average lease term often extending to ten years and beyond.

In Digital’s case, large cloud deals in Europe and Asia Pacific often require hedging foreign exchange by floating debt in local currency as part of the underwriting, for example.

Retail Colo, Connectivity Business Healthy

Meanwhile, Digital continues to deliver about $7 million quarterly growth from interconnection revenue and close to that in retail colocation signings. Digital executives told DCK that there are now more than 76,000 customer cross-connects in the company’s facilities, up from 50,000 just a few months ago.

Digital’s ability to provide customers with global connectivity through partnerships with virtual cross-connect providers like Megaport and PacketFabric has helped level the playing field in competition with the interconnection powerhouse Equinix.

Investor Edge

In a world where hyperscale customers have become a key segment for third-party data center landlords like Digital Realty, relationships, operating history, existing contracts, and C-suite involvement are more important than ever.

Digital’s rival QTS Realty recently elevated chief investment officer Jeff Berson to CFO. Like Power, Berson comes from a Wall Street investment banking background.

That move can be viewed as another example of the increasingly important role of the CFO in landing some of the largest customers on the planet. The financial structure that underpins each hyperscale deal plays a decisive role in securing acceptable returns on invested capital.

Equinix’s recently announced hyperscale unit is also dealing with complex financial calculations, expecting to finance the deals “off balance sheet” in joint ventures with financial partners to get more leverage and turbocharge returns.

Evaluating quality of management has always been key for savvy investors. It is now more important than ever.