QTS Realty Trust Inc Could Become an 800lb Gorilla

While it is much too early in the game to crown QTS Realty Trust (NYSE: QTS  ) as king of the data center REITs, this newly listed company has a growth game plan proving profitable right out of the gate. One week after the its IPO on Oct. 9, 2013, I wrote a Motley Fool article highlighting the fact that this company has far more customer density than its rivals. This strategy is beginning to pay dividends.

DLR Total Return Price Chart

I am sure that Digital Realty  (NYSE: DLR  ) , DuPont Fabros  (NYSE: DFT  ) , CoreSite Realty  (NYSE: COR  ) , and CyrusOne  (NASDAQ: CONE  )  realize that QTS is serious competition when it comes to snagging both data center and co-location customers. Here is what investors need to know.

QTS secret syrup
QTS is an acronym for Quality Technology Services. At first glance it seems to be a strange name for a company with real estate operations sufficient to be granted REIT status by the IRS. However -- similar to fried chicken and waffles -- it actually is a perfect recipe. Combining the real estate ingredients with cloud service offerings makes QTS more than just another data center landlord. It makes them a hybrid solutions provider.

QTS has three different platforms, or the 3C's, in its business model: Custom data centers, Co-location, and finally Cloud and managed services. Approximately 60% of revenues are generated from the latter two platforms -- on average, pricing for these leases has increased over 16% in the past four quarters.

Already this year, QTS has announced a number of big developments:

  • Federal Cloud Solution: an infrastructure as a service, or IaaS, solution exclusively for federal agencies and government contractors to meet performance, security and compliance requirements. The QTS 1.3 million square foot campus in Richmond, VA and 900,000 square foot megadata center in Atlanta, GA are the sites for this program.
  • Enterprise Cloud Solution: an IaaS solution to be housed in QTS' Atlanta-Suwanee and Santa Clara data centers. Customers can operate virtual data centers where QTS provides all: compute, storage, network and security needs – as well as support for a hybrid environment.
  • A target date of July 2014 for the initial 25,000 square feet of C1 space at its new Dallas campus. QTS is repurposing a 700,000 square foot former chip plant which is located on 40 acres. This site has the potential of housing over 1.4 million square feet of data center construction.

QTS secret sauce
Sporting a market cap of only $565 million, QTS owns 10 U.S. data centers totaling 3.8 million square feet. QTS currently has just over 1.2 million square available for active development and 2 million square feet held for future development. By way of comparison, $7 billion sector giant Digital Realty owns 131 properties totaling 24.5 million square feet in 33 markets throughout North America, Europe, Asia, and Australia. 

During the Feb. 21, 2014 QTS earnings conference call, QTS founder and CEO Chad Williams shared this key aspect of his strategy:

"Going forward, we will continue to look for opportunities to acquire assets at low cost that are infrastructure-rich in strategic new markets. This can be accomplished either by buying or repurposing non-data center facilities, or acquiring enterprise-owned data centers that are under-utilized by their current enterprise owners."

Show me the money
QTS Dividend Yield (TTM) Chart

QTS paid shareholders a prorated $0.24 per share dividend for the quarter ending Dec. 31, 2013 and announced a 20% dividend increase to $0.29 per share for 2014, putting its yield already in line with peers.

Funds from operations, or FFO, is a REIT metric similar to free cash flow. Year over year, QTS grew their funds from operation over 90% in 2013. Based on the current estimate $75 million in FFO, the company looks to be trading at just 12.6x FFO -- a low valuation for such huge growth.

Investor takeaway
The QTS strategy of buying large strategically located facilities coupled with the huge opportunity in cloud-based services seems like a great plan. QTS targets a 15% return on invested capital and reported achieving 15.5% for 2013. Although QTS real estate allows it to compete as a low cost provider, leveraging the growth of cloud computing to provide unique hybrid solutions is driving higher margins and faster growth.

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