Crunch Time: The Incumbent Advantage
March 4th, 2008 By: Rich Miller
This is part two of a five-day series examining supply and demand in the data center market, and how it may be affected by the credit crunch and economic slowdown. See the introduction and part one for more.
“Significant competitive advantage.” That was the key phrase Digital Realty Trust (DLR) used last week in discussing its financial strength and access to capital.
As the commercial real estate industry is gripped by a credit crunch, Digital Realty and other veteran data center developers have raised funding through stock sales, bank credit line expansions and asset sales, building up financial warchests to enable them to complete their building programs. At a time when the Wall Street Journal describes the real estate credit market as being in a “state of near-paralysis,” many of the leading names in the data center market say they are fully funded. Executives of these companies say this will allow their construction projects to move ahead smoothly while new market entrants contend with financing challenges.
Digital Realty expanded its borrowing power in September, boosting the limit on its senior unsecured revolving credit facility from $500 million to $650 million. “Since the beginning of 2007, we have raised over $1 billion from our increased revolving credit facility, mortgage financings and refinancings, as well as equity offerings at very favorable terms,” said William Stein, Chief Financial Officer of Digital Realty Trust, who described the environment for raising capital for real estate companies as “severely constrained.”
“A guy who is trying to build his first data center, I think he’s in a lot of trouble,” said Tony Wanger, Senior Managing Director of i/o Data Centers. “I think what you’re going to see is that this will separate (veteran data center builders from new ones). I think it is really going to clear the brush of the new entrants.”
Digital Realty is one of two publicly-held REITs specializing in data center real estate. The other is DuPont Fabros (DFT), which raised more than $640 million with its October IPO, allowing it to repay existing debt.
DuPont Fabros (DFT) plans to build four huge data centers in the next two years, bringing 735,000 square feet of space online in premium markets of Chicago, Ashburn, Santa Clara, Calif. and Piscataway, N.J. “We have the money to develop the sites without needing to go back to the markets,” company CEO Hossein Fateh told investors in a recent presentation. “We could build up to $2 billion of construction and not go out for new money.”
Equinix (EQIX) said its aggressive building plan is also fully-funded, and that its cash flow and existing debt agreements will allow it to finish 2008 with between $175 million and $200 million in cash. The company could complete its projects with an even larger cash cushion “if we had to batten down the hatches,” CFO Keith Taylor said last week. Equinix has active construction projects in Chicago, Los Angeles, Santa Clara, northern Virginia, Paris and Sydney and just announced additional expansions in Hong Kong and Singapore.
Other Funding Deals
In June Terremark Worldwide (TMRK) arranged for $250 million in financing to fund its expansion projects in Culpeper, Virginia and Santa Clara, Calif. Savvis Inc. (SVVS) has positioned itself for expansion through asset sales, raising $200 million with the sale of two data center leases to Microsoft and another $135 million by additional data centers in Boston, Chicago, London and Singapore. In late June the company paid down $342 million in debt.
Several of the privately-held data center specialists have deep pockets and may be able to proceed with expansion plans. CRG West is a holding of The Carlyle Group, the huge international private equity firm. i/o Data Centers is backed by i/o Capital, consisting of investors who previously backed the 120 East Van Buren carrier hotel in Phoenix.
It remains to be seen whether lenders will view data center projects as risky in a tight credit market. Some may have long memories of failed projects from earlier in the decades. But data center REITs have fared considerably better than the broader market. Digital Realty Trust shares gained 15 percent in 2007, while the average REIT had a loss of 15.7 percent, according to the National Association of Real Estate Investment Trusts. On Monday JMP Securities raised its price target for Digitial Realty to $48 a share (it’s currently at $36.62) and said the company “deserves a premium multiple to its peers” – which suggests that data centers are expected to perform better than other major REIT asset classes.
Incumbents See Benefits
Fateh said the shifting plans of large data center customers may help them fill their data centers. “With the slowing economy, the 2-megawatt to 10-megawatt customers may find that it makes more sense to outsource their infrastructure,” said Fateh. “It may be good for us.”
Digital Realty’s Chris Crosby also said changing credit conditions work in favor of the specialists. “There are a lot of folks who want to get into the data center business and then wait for that magic client to arrive,” Crosby said. “It’s a lot harder to build a new data center when you can’t get a construction loan.”
Stein, Digital’s CFO, sees access to funding as a differentiator. “Digital Realty Trust is in a capital intensive business and capital is essential to our ability to continue to acquire and redevelop properties,” said Stein. “We believe that our track record of accessing well-priced debt and equity capital from several different sources, particularly in difficult markets, is a powerful competitive advantage.”
I think the credit crunch will be healthy for the data center industry. Tightening up the supply of capital will reduce the risk of overbuilding and help keep the supply and demand in balance.
Who knows? Back in the day, a good credit crunch could have kept the .com boom from going bust!