DCK Investor Edge is a weekly column about investment in the data center market, covering both publicly traded data center REITs and privately held players in the space. More about the column and its author here.
While it's early to break out the champagne, initial Q1 2018 leasing results are giving data center investors cause for optimism.
Last week, data center REITs QTS Realty, CoreSite Realty, and Digital Realty (DLR) all reported earnings for the quarter ended March 31, 2018.
Highlights from the QTS report are strong Q1 2018 leasing results and an agreement to transition 200 non-core cloud and managed services customers to an IT services channel partner. For CoreSite, it was another quarter managing through low inventory of available space in several key markets. Unsurprisingly, CoreSite’s bookings were below average, yet pricing on both new deals and lease renewals indicates that demand remains strong.
The strongest report of the week came from Digital, whose record leasing results appear to have boosted the entire data center REIT sector’s stock value.
Digital Realty reported a record $60.7 million in bookings for Q1 2018. The company’s never crossed the $60 million quarterly revenue threshold before.
There was strength across all product types, but the $42 million in wholesale bookings appears to have driven the outperformance.
Market sentiment toward data center REITs turned positive the day after Digital reported results. These REITs are still down compared to last year, implying that there could be plenty of runway left for share appreciation from here.
Digital Realty also signed $57 million in renewals during the first quarter. Rental rates on those deals rolled up 3.9 percent on a cash basis and 9.7 percent on a GAAP basis.
Strong bookings during the quarter also resulted in a record $126 million backlog. Digital’s management expects that $112 million of booked-not-billed leases will commence in 2018, with the remaining $6 million and $8 million to be booked in 2019 and 2020, respectively.
Digital Realty has raised its dividend for 13 consecutive years, rewarding shareholders in March with an annual increase of 9 percent. On the call, Digital CFO Andy Power told investors to expect double-digit AFFO/share growth for full-year 2018. This bodes well for another nice dividend raise next year.
QTS Executes on New Plan
After surprising Wall Street with a pivot away from in-house managed services last quarter, QTS Realty common shares have been in the penalty box, still down over 20 percent from 2017 highs. The QTS Strategic Growth Plan announced in February is focused on Hyperscale and Hybrid Colocation, with a simplified menu of in-house service offerings.
In March, the company pre-announced a 24MW hyperscale deal with an existing global SaaS customer, as well as 19MW of renewals with two anchor tenants in its Atlanta Metro data center, each with rent roll-ups. So, it was not surprising that Q1 2018 turned out to be a strong quarter for bookings.
In fact, the $21 million of "core" annualized leases signed was the second-largest quarter in QTS's history as a public company. Notably, the leases signed during last quarter were evenly split between Hyperscale and Hybrid Colocation -- not just driven by a few super-wholesale wins.
These signings resulted in a $54 million booked-not-billed backlog which will be realized over 2018, 2019, and 2020. QTS's previous four-quarter average bookings were in the range $10 million-$12 million range. During the Q&A on the earnings call, CFO Jeff Berson told analysts they could model $12 million-plus per quarter going forward.
In addition to reporting Q1 results, QTS Realty announced arrangements to transition 200 cloud and managed services customers to General Datatech (GDT), an existing IT services channel partner. This event was reported after the bell on April 24 and deemed important enough for QTS to move up its earnings call to early the next morning.
Berson estimated that in 2019 a 15-to-20 percent channel fee on revenue from those 200 customers GDT has agreed to pay QTS would generate about $5 million in high-margin income.
CoreSite’s Dearth of Inventory
CoreSite Realty did not have a blow-out quarter. The $7.1 million in bookings it reported was light compared with the trailing four-quarter average of $9.7 million. But this should not have come as a surprise, as the company’s lack of inventory was discussed in detail in the previous earnings call.
There does not appear to be any problem with CoreSite's connectivity-focused retail colocation business model. During the first quarter, signed leases averaged $239 per square foot, which was 14 percent higher than the trailing twelve-month average. Pricing on GAAP lease renewals was 9 percent higher, or 5.4 percent higher on a cash basis. CoreSite's development yields in Q1 were in the 19 percent range, at the high-end of data center REIT peers. CoreSite's portfolio utilization rate is simply "too high," which in a sense is a happy problem to have. This contributed to strong EBITDA margins of 56.2 percent.
The company is bringing some additional capacity online, which should allow for stronger bookings in the second half of the year:
The entire REIT sector has had a rough start to 2018 due to concerns about rising US budget deficits, price inflation, and rising interest rates.
Data center REITs, which outperformed the broader REIT sector in 2016 and 2017, have struggled this year due to specific industry concerns, including: supply/demand fundamentals, a flurry of expensive M&A deals, and well-financed new players competing for customers.
However, data center REITs have demonstrated the ability to consistently grow earnings at double-digit rates. In a rising-rate environment the ability to move the growth needle is crucial. Frankly, the pendulum of pessimism appears to have swung too far.
The next REIT to report earnings is CyrusOne, reporting this Thursday. The company generates most of its revenues from Northern Virginia, Chicago, Phoenix, Dallas, San Antonio, and Houston. It lacked powered-shell inventory to lease last quarter across its largest markets. However, CyrusOne’s "Massively Modular" building program allows it to construct large-scale data centers in a six-month time frame.
The strong wholesale leasing results Digital and QTS reported last week could bode well for CyrusOne results later this week.