The former Chicago Sun Times printing facility into data center. (Photo: QTS)

The former Chicago Sun Times printing facility into data center. (Photo: QTS)

QTS Managing for Long-Term Growth, Expanding in Seven US Markets

QTS Realty Trust continues to pursue its so-far effective niche strategy targeting network, cloud, and enterprise customers who appreciate the flexibility offered by a one-stop data center shop.

According to statements by the data center REIT’s top management on its fourth-quarter earnings call Tuesday, it will stay the course, executing on its strategy of purchasing infrastructure-rich facilities at a low cost and repurposing them as state-of-the-art data centers.

Another QTS trademark has been to offer a full range of solutions, the one-stop-shop play it refers to as 3C’s: custom wholesale deployments, colocation, and cloud and managed services. Notably, the number of QTS customers who contract for more than one type of these services grew from 40 percent in 2014 to more than 50 percent in 2015.

Chicago Expansion to Impact a Key Metric

QTS management has consistently focused on allocating capital to generate a weighted average of 15 percent return on invested capital. During Q4 and full-year 2015, the company rang the bell at 15.8 percent ROIC.

QTS purchased the former Chicago Sun-Times press facility for $18 million in 2014. The 133,000-square foot data center under development sits on 30 acres close to downtown. The initial phase of 14,000 square feet is scheduled to be ready for occupancy in mid-2016.

Management said on the call that the company’s overall portfolio ROIC will dip below 15 percent later this year due to the amount of capital required to launch the Chicago facility. The QTS balance sheet will also carry a bit more leverage during 2016 than management’s targeted 5x net-debt to EBITDA.

The Chicago market does not have a large supply of modern purpose-built data center space available, compared with the size of the market. The QTS facility is located midway between the suburbs and downtown and is connected by fiber to the downtown carrier hotels.

Want to know how other data center REITs did in the fourth quarter? Curious about investing in data center REITs in general? Visit the Data Center Knowledge Investing section for everything you need to know about this high-performing sector.

Strong 2015 Results

QTS has been working through a backlog of large multi-megawatt contracts, where the deployments are phased over several quarters. This booked-not-billed backlog helps give it better earnings visibility and confidence to move forward with its current development plans.

QTS - 4Q'15 Earnings s5 2015 Overview

Source: QTS – Q4 2015 Earnings presentation

Notably, this backlog results in an uptick of larger wholesale deals being added to the revenue mix vs a more normalized leasing cadence. Additionally, QTS would be pleased to sign a wholesale tenant to anchor the new Chicago facility in a similar fashion to the way it kicked off its first site in the Dallas market in 2014.

Read more: Exclusive: How QTS Plans to Keep Momentum After Two Years of High Growth

Carpathia Acquisition “Pays Dividends”

Last year QTS closed on its $326 million acquisition of Carpathia Hosting, which added over 230 cloud and hosting customers.

The acquisition immediately increased revenues derived from cloud and managed hosting from 10 percent to 25 percent. It also bolstered the QTS security and compliance offerings, including its government offerings.

The Carpathia purchase, at 9.6x EBITDA, was immediately accretive to operating FFO and AFFO.

These are important REIT metrics which add back depreciation, amortizations and other non-cash adjustments to earnings. AFFO is also referred to as cash available for distribution (CAD) which supports the REIT dividend distribution.

Read more: Why QTS Dished Out $326M on Carpathia Hosting

Dividend Increase and 2016 Guidance

QTS announced a 12.5 percent increase in its quarterly distribution to $0.36 per share, up from $0.32 per share previously. The forward dividend yield on QTS shares based upon the most recent close of $43.62 per share is now 3.3 percent.

  • Adjusted EBITDA: 2016E of $177-$185 million, an increase of 29.3 percent vs 2015 at the midpoint
  • Operating FFO: 2016E of $125-$130 million, an increase of 22.6 percent vs 2015 at the midpoint
  • OFFO per share: 2016E of $2.54-$2.64, an increase of 13.1 percent vs 2015 at the midpoint

Management expects that core organic revenue growth for 2016 will be in the mid-teens. The Carpathia integration is six months ahead of schedule, and the expected $2 million in expense synergies is included in the forecast for this year.

QTS expects to bring 125,000 square feet online in 2016, including: 15,000 square feet in Richmond, Virginia, 20,000 square feet in the Atlanta Metro, 38,500 square feet in Dallas-Fort Worth, 19,000 square feet in the Atlanta suburbs, 3,250 square feet in Santa Clara, 15,000 square feet in New Jersey; and 14,000 square feet in Chicago.

Bottom Line

One of the reasons data center REITs like QTS and its rivals CyrusOne and CoreSite are able to deliver impressive mid-to-high teens ROIC is that they are building out new raised-floor space in existing powered shells. Additionally, they each can benefit from building out multiple data centers on campuses where they already own the land.

Currently, 91 percent of the space that QTS has built out and is available for lease is occupied. QTS is sacrificing a bit of short-term performance in order to open its Chicago facility and participate in the growth of this Tier I data center market.

This is a dilemma that CoreSite is now facing in some of its key markets, due to the strong customer demand, and recent leasing success.

Read more: CoreSite Reports Strong Q4 but Shell Capacity in Key Markets Short

Investor Takeaway

QTS’s mega-scale approach to infrastructure combined with flexibility for customers to expand in-place from colo to dedicated hosting or wholesale deployments helps set it apart from its peers.

I remain constructive on QTS shares for 2016. The analyst consensus target price is currently $49 per share. This implies a 12.3 percent upside for QTS from current levels and a 12 month total return of over 15.5 percent, including the dividend.

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About the Author

Bill Stoller is a financial writer/analyst, seated at Wall St. & Main St. where real estate intersects trends in: technology, retailing, office/industrial, residential, healthcare, energy infrastructure & green initiatives. He covers REITs, real estate and related technology, as well as fintech and real estate crowdfunding. He has written hundreds of investing articles which can be found on Seeking Alpha, Benzinga, Motley Fool, and Investopedia, Finviz and Yahoo! Finance. He often writes about data centers REITs -- a new and growing asset class -- attempting to bridge the gap between technology & traditional REIT investors. You can follow @REalBillStoller on Twitter, Seeking Alpha (http://seekingalpha.com/author/bill-stoller) articles, Tools4Investing (https://www.facebook.com/Tools4Investingcom) on FB, LinkedIn (https://www.linkedin.com/in/realbillstoller), and Google+ (https://plus.google.com/+BillStoller/posts). Bill is a real estate veteran with over 25 years of industry experience, including: general contracting, commercial, office and industrial development. He served as Vice President - Energy Services for Mechanical Services, Inc., a leading mechanical contractor in Central and Southwest Florida, and 1997 Contracting Business magazine Commercial HVAC Contractor of the Year. MSI is now a subsidiary of EMCOR Group, Inc. a Fortune 500® leader in mechanical and electrical construction, energy infrastructure and facilities services.

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