Will Digital Realty Trust and QTS Realty Trust Continue to Benefit From The Big Data Boom?

"Data center operators providing solely wholesale or colocation only are a thing of the past." -- "January 2014 Report: 2013 Year in Review," from Avison Young Data Center Practice

The recent explosion of data is just staggering. According to an industry expert, 90% of the data that exists today has been created in the past two years.

Data center REITs such as Digital Realty Trust (NYSE: DLR  ) and QTS Realty Trust (NYSE: QTS  ) offer customers a way to have their cake and eat it too. These high-tech landlords can provide a wide range of choices for CIO's to evaluate, while concurrently reducing their need for capital expenditures.

DLR Year to Date Total Returns Chart

Helping customers generate revenue
Data center REITs sit squarely in the middle of the intersection of real estate and technology.

In the past, it was fine for a business to just store its data. Today, many companies are using cloud applications to monetize this data in real time. When time is of the essence for deploying a new application, often solutions such as Infrastructure as a Service, or IaaS, combined with other service offerings can be an optimal choice.

Mr. Market has recently rewarded two very different approaches
Industry giant Digital Realty Trust has a global footprint and sports a market cap of $8 billion. Wholesale data center space leased by large users has historically been Digital Realty's bread and butter.

By almost any measure, Digital is larger than the rest of the data center REIT sector combined. Digital owns 131 properties in 11 countries containing over 24.5 million square feet. This portfolio is ideally suited to service large multi-site customers.

Why is Digital Realty changing gears in midstream?
The short answer is that on March 17, 2014 Digital Realty announced that long time CEO Michael Foust had vacated that office effective immediately. Mr. Foust had been at the helm of Digital Realty since its 2004 IPO. The competitive landscape is very different in 2014, as data center REITs must quickly adapt to customers evolving needs for hybrid solutions.

Back in 2012, Avison Young noted in its industry newsletter that "in November 2010, there were only five national wholesale developers; now there are 14 that are offering wholesale space in multiple states."

Charting a new path forward
Digital's long tenured CFO Bill Stein is currently steering the ship as interim CEO until the board hires "the next leader to help guide Digital Realty to the next level and scale of operational sophistication." 

Wall Street has reacted positively so far to acting CEO/CFO Bill Stein's mea culpa during the latest earnings call discussing results of the quarter ended March 31, 3014: "We cannot just offer them any color Model T they want as long as it's black." Digital Realty admittedly was behind the curve when it came to marketing custom solutions and value added services.

Digital near term focus on reducing vacant space
On the conference call, interim CEO Stein emphasized that:

·       The No. 1 objective would be to "drive ROIC through the lease-up of existing inventory."

·       Digital will transition to a build-to-order inventory program to limit speculative development risks and meet return thresholds.

·       There will be a review of what properties constitute the core portfolio in order to prune underperforming and non-core assets.

Digital reported just under 20 million SF, or 92.1% of net rentable space being leased as of the end of March 2014. That leaves ~ 1.6 million SF of vacant space to lease-up, in addition to: 1.3 million SF of space under active development, and 1.4 million SF held for future development.

QTS seems to have found the sweet spot
Meanwhile, much smaller $850 million market cap QTS Realty Trust continues to hit on all cylinders. Results for the quarter ended March 31, 2014 compared to the same time period in 2013 included:

·       Operating FFO of $17.3 million, a 102% increase.

·       NOI of $31.5 million, an increase of 21%.

·       Adjusted EBITDA of $21.6 million, an increase of 29%.

QTS has a C3, or three-pronged approach, to co-creating solutions with customers. The majority of revenue is currently coming from Colocation, or C2, and Cloud and Managed Services, or C3. The balance of revenue generation comes from Custom Data Centers, or C1.

QTS has a stated goal of obtaining at least 15% ROIC, or return on invested capital. This is the key metric that management has selected to measure performance:

Investor takeaway
Digital Realty is trying to change direction to better compete with smaller rivals for mid-market size customers, while simultaneously managing significant annual lease expirations of wholesale data center space. Nonetheless, the board of directors hitting the reset button has resulted in renewed investor confidence.

QTS Realty has racked up another quarter of excellent results. However, investors should keep in mind that QTS is a newly minted public company. That said, QTS appears to be well positioned to benefit from the growth of cloud computing moving forward.

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Bill Stoller

Sipping a latte at the corner of Wall Street & Main Street -- where real estate often intersects with trends in: technology, retailing, office/industrial, residential, healthcare, energy infrastructure & green initiatives.

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