Data center maintenance may not seem like a sexy topic for Wall Street. But during this earnings season, maintenance costs have been a key discussion item during the earnings calls for three of the industry’s largest data center operators.
Why the sudden focus on maintenance? The attention has been driven by a headline-making May presentation in which hedge fund Highfields Capital Management asserted that investors should short shares of Digital Realty Trust, saying the huge data center developer was understating the future investment in facilities that would be required to support its enterprise customers. Digital Realty responded publicly, saying Highfields was “mischaracterizing and drawing inaccurate conclusions” from its disclosures.
Nonetheless, Digital Realty (DLR) appears to want to put the controversy behind it. In its quarterly conference call with analysts Friday, the company said it would not be accounting for maintenance costs below $10,000 as capital expenditures, rather than operating expenses, as had previously been the case. Digital Realty Chief Financial Officer William Stein said the change would be more in line with GAAP accounting practices. The company also will make additional documentation of its CapEx spending available in its quarterly reporting, Stein said.
“Today, we are capitalizing what’s appropriate to capitalize down to any amount, which is really consistent with GAAP,” said Stein. “The $10,000 and lower policy was a holdover from our IPO days when we had limited resources and there was a question of our ability to track, from a capitalization standpoint, expenditures of $10,000 or less.”
Shortly after the completion of the call, shares of Digital Realty slipped more than 6 percent.
On its earnings call Thursday, DuPont Fabros (DFT) President and CEO Hossein Fateh described maintenance expenses as a “topic of major interest in our industry” and emphasized how the company’s lease structure protects it against unexpected maintenance costs over the long run.
“Since we’re a ground-up developer, we have not acquired any properties with existing leases,” Fateh said. “Every lease that we have signed is with a lease that we have written. All our leases are triple-net. This allows us to recover all our operating expenses. Should these expenses go up, we’ll be reimbursed by our tenants.”
Under a triple net lease, tenants pay for property taxes, insurance and maintenance costs, insulating the landlord from these costs. An example: DuPont Fabros recently had to do maintenance on batteries to support backup systems for its VA4 data center inA shburn, Virginia. “We replaced the batteries for the building, and we’re able to pass this replacement cost through to our tenants over the useful life of the batteries, which is 12 years,” said Fateh.
Fateh said tenants are willing to pay these maintenance expenses because “it’s in their best interest. Our customers do not want us to be financially incentivized to cut corners on maintenance. They want us to consistently maintain and renew our assets. This assures them maximum efficiency and uninterrupted service.”
Equinix (EQIX), the largest player in the colocation industry, included an extra slide in its earnings presentation to address questions from investors, according to CFO Keith Taylor.
“It’s fair to say the economic life of our IBXes (data centers) and these critical assets will likely extend to 30 years or greater, given the level of spend in both our predicted and preventive maintenance programs,” said Taylor. “Overall, our maintenance capital was approximately 2% of our revenues, consistent with our expectation, but there should be no meaningful reinvestment requirement in our IBXes.”