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Is Digital Realty Trust About to Spend $2 Billion in a Consolidation Race?

By Eric Volkman – Jul 8, 2015 at 6:15PM

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The data center REIT is apparently bidding for a privately-held peer, Telx.

For Digital Realty Trust (DLR 5.18%), it seems to be "acquire or get left behind" time. Last month Reuters reported that the real estate investment trust, which specializes in data centers, is making a bid of over $2 billion in an auction for privately held peer Telx. Neither firm has commented on the matter.

The target company is an excellent fit for the REIT, but purchasing it may be a catch-up play, rather than a great deal for a complementary asset.

The REIT price?
Either way, if Digital Realty buys Telx, it'll take a real hit to its wallet. That $2 billion well exceeds the $1.6 billion in revenue the REIT booked last year and is lightyears ahead of the $49 million in cash it had in its coffers at the end of Q1.

Further, Digital Realty is apparently not the only suitor participating in the auction. The Reuters story, citing "people familiar with the matter," said that the REIT "is one of several U.S. and international bidders" for Telx.

Because Telx is a privately held company that doesn't release its financials, it's impossible to say whether that $2 billion-plus price tag is appropriate.

What we can assume is that Digital Realty has a pretty good idea of what it could buy: For almost a decade the two companies have been business partners, with Telx owning and managing interconnection data centers in several of Digital Realty's buildings.

Deals for data
It's interesting that as far as we know, across that stretch of time Digital Realty made no bid for Telx, nor was it offered a chance to purchase the data center specialist.

Rather, the two might be getting pushed together by outside forces. So far this year there's been a wave of consolidation in the data center business, which follows a pattern: smaller, privately held operator is snapped up by bigger, publicly traded operator.

The most notable such acquisition occurred in late May, when Equinix grabbed Britain's Telecity for around $3.6 billion in cash and stock. On a smaller scale, QTS Realty Trust bought Carpathia Hosting for $326 million last month, not long after CyrusOne spent $400 million to acquire Cervalis.

On top of that, Telx is controlled by two private equity companies, Berkshire Partners and ABRY Partners, which bought their stakes in 2011. Such investors are after the highest gains in relatively short time frames, and they don't like exiting an investment without making a chunky profit. No doubt the two will squeeze out the highest price possible for their asset.

Pay to play
Expensive as it may end up being, such an acquisition could still be worthwhile for Digital Realty.

Even though Digital Realty's most recent quarter wasn't particularly inspiring, the REIT has a fine track record of producing above-average returns with its assets. It's also operating in a market that will continue to grow as the healthy rise in Internet traffic drives higher demand for data.

But that kind of potential intensifies competition. The landscape is getting more concentrated and challenging. Digital Realty seems to be doing its best to stay competitive, but investors need to realize that won't come easy -- or cheap.

Eric Volkman has no position in any stocks mentioned. The Motley Fool recommends Equinix. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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