Shares of giant data-center real estate investment trust (REIT) Digital Realty Trust (DLR 7.23%) have fallen as much as 10.9% this week, according to data from S&P Global Market Intelligence. By the start of trading on Friday, the stock had pared that loss to roughly 9%. The big news driving this decline came out on the first trading day of the new year.
After the close of trading on Jan. 3, Digital Realty announced that it had agreed to acquire a 55% stake in Teraco, valuing that company at $3.5 billion. The owners of the remaining 45% of the company will have the right to put their ownership interest to Digital Realty between 3 1/2 years and 5 1/2 years following the closing, with Digital Realty having the right to call that interest between 5 1/2 years and 6 1/2 years after the close of the deal. Teraco owns data centers in Africa, with the purchase instantly vaulting Digital Realty into the top echelon of such providers on that continent, according to the REIT.
That said, the transaction is expected to be 1% dilutive to Digital Realty's core funds from operations (FFO) in 2022 and neutral to core FFO in 2023. Teraco is expected to be accretive thereafter. In other words, this move is really about the long-term benefit of entering the African data center market as Digital Realty looks to expand its global reach.
The REIT noted a couple of key points on this front, including the fact that Africa is an underserved region where it expects to see rapid digital growth in the years ahead. Also of interest is Teraco's expansion opportunities, which include a 19-megawatt facility currently under construction and land in key markets that could support up to 93 megawatts of additional construction.
So there's a balancing act here between the short-term cost and long-term benefits of the deal. The thing is, the shares of companies that announce sizable mergers often sell off. So the stock drop in Digital Realty's shares isn't shocking, particularly in light of the slight dilution expected this year.
Digital Realty is clearly looking to its long-term future with the Teraco deal. That's a positive for investors, but it doesn't change the fact that making acquisitions is costly in the near term, and thus, investors often react by selling shares. That appears to be the backdrop for the share action this week.
If you are looking for a long-term play on the growing global demand for cloud services, though, it would make more sense to look at Digital Realty with a long-term view and not get too caught up in the very slight dilution expected over the next 12 months here. Indeed, given the growth opportunities at Teraco, this deal looks like it could be an important stepping-stone for the REIT for years to come.