DuPont Fabros: A Bet on Internet Growth

Data center real estate is a fast-growing but specialized business requiring large amounts of capital and engineering experience, according to Hossein Fateh, the President and CEO of DuPont Fabros Technology (DFT). Fateh offered his insights into the data center industry last month in a presentation to investors at the 35th Annual UBS Annual Global Media and Communications Conference.

DuPont Fabros, which had its IPO in October, was among a presenter list filled with some of the world's largest media companies, such as Viacom, News Corp., Walt Disney and NBC Universal. UBS analyst Omotayo Okusanya said DuPont Fabros is positioned to benefit as media content moves online.

"We are very, very bullish on the data center real estate space," said Okusanya, a director and equity analyst on UBS team tracking the REIT sector. "We believe owners and operators of data center space have done very well over the past two years due to strong fundamentals. We expect the fundamentals to remain very strong for the next few years, which will create a supply and demand imbalance that should be to the benefit of companies like DuPont Fabros."

"This is a real estate bet on the growth of the Internet," said Fateh. "We see growth much faster than that of a typical real estate companies. The product we rent and sell is really power, cooling and the security for the front door. As the Internet has exploded, so has demand for this space. At every iteration, there are new business models that come up."

Microsoft and Yahoo represent more than 60 percent of DFT's leasing revenue, but the company's customer base is diversifying. "If you told me two years ago that social networking sites would be important to our business, I wouldn't have believed it," said Fateh. "Today they are a very large part of our business," as Facebook and MySpace both lease space in the company's data centers. Fateh said he expects online video to become a large part of DuPont Fabros' business, along with online delivery of medical records.

Fateh emphasized his belief that it will be difficult for new players to capture share in data center real estate. "There are enormous barriers to entry in this market," he said. "For a typical real estate investor to build one of these facilities, it would have to buy a 20 acres of land and then spend $3 million on design alone. Then you have to order $50 million of pre-purchased data center equipment. We're not going to see a Larry Silverstein trying to get into this asset class. This is an asset class that takes enormous know-how, and unless you've had some experience in this asset class, it's difficult to get into."

Long-Term View

Private equity firms have been active players in the web hosting and domain name space, and have the resources to compete in the data center space. But Fateh said that leasing issues make data center real estate a tough market for new investors focused on short-term gains. "The tenants want to know who the operator of the building is," he said. "If a private equity investor came in, they'd want to flip the building two years from now. The tenants want to know that their mission-critical space is being handled by someone who will be in this space for the long-term, not someone who's going to come in, make a quick buck and leave. The tenants would prefer to be with an experienced operator who has done this before."

Fateh said 3 to 4 percent annual increases are built into most leases, but the sector is "a good story on new construction, rather than raising rents on existing tenants. In the last three years, everything we have built has leased up 100 percent." DuPont Fabros plans to build data centers in Chicago, Ashburn, Santa Clara, Calif. and Piscataway, N.J. in the next two years, bringing 735,000 square feet of space online. The company has also considered sites in new markets including San Antonio, Texas and overseas expansion in Switzerland or Singapore, but has made no decisions yet.

Fateh says DuPont Fabros has the resources to forge ahead with its construction plans, even in a tight credit environment for commercial real estate. "We have the money to develop the sites without needing to go back to the markets," Fateh said. "We could build up to $2 billion of construction and not go out for new money."