Digital Realty Offers a Full Menu of Tenants’ Data Center Needs After Enhancing Connectivity Feature

Equity Analyst

Matthew Dolgin

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Digital Realty has transformed its business from one that merely provided large companies vast amounts of space and power (a typical wholesale data center that houses few tenants) to one that can offer customers of all sizes the full spectrum of space, power, and connection needs (historically called a co-location data center that has space for many tenants). We think this evolution—largely through acquisitions that focused on network-dense data centers—was critical for success in a modern environment where enterprises rely more on third-party cloud providers, and the constant use of data makes quick and easy access vital. With a sizable presence across nearly every continent, Digital also offers more value for multinational companies that want a fluid solution across their data center footprint. Along with Equinix, we think these qualities make Digital Realty one of only two data center providers that can offer this breadth and set itself apart from the rest of the pack in an industry with secular tailwinds stemming from the creation and use of more and more data.

We think Digital Realty’s ability to provide enough real estate for wholesale storage and computing needs along with a network-dense presence that facilitates interconnection in most of its geographies can make it a one-stop shop. Huge cloud providers drive the data center industry and need massive amounts of space and power, but they also need to connect to their customers, which happens via cloud on-ramps. Cloud providers locate on-ramps in data centers that have many networks connecting—allowing secure and convenient access for cloud customers that need to link their premises to the data center that houses the on-ramp. Digital Realty still trails Equinix by a wide margin in housing on-ramps of major cloud providers and the level of network density in its data center portfolio, but it has the more unique feature of being able to offer wholesale space and power across nearly its entire footprint. The shifting quality of Digital’s properties should translate to better returns on capital than a wholesale data center operator can generally provide and therefore a higher valuation multiple in the market.

Business Strategy & Outlook

We assign Digital Realty a narrow economic moat. Digital Realty’s roots are as a wholesale data center provider, meaning that it leased very large amounts of space and power to relatively few tenants per facility. Although its wholesale nature left it as a simple real estate operator in our view, the size of the portfolio it amassed has given it cost advantages, and its mature portfolio also benefits from switching costs. We think the firm’s acquisitions and resulting portfolio transformation in recent years have made its properties less commodity-like, but we don’t credit the firm as benefiting from a network effect—like we do for rival Equinix—because network-dense data centers don’t dominate Digital’s property portfolio like they do for Equinix.

We think switching costs provide Digital Realty's biggest competitive advantage, as there are numerous reasons tenants are unlikely to churn to a competitor, namely the significant monetary costs to deploy equipment and the risk in moving critical equipment. Digital Realty, citing statistics from Align Communications, estimates that a client deploying equipment to use 1.125 megawatts of power—a fairly large customer, but the type Digital Realty traditionally caters to—would spend $15 million-$30 million to set up its equipment. Migration of equipment from one facility to another would cost an additional $10 million-$20 million and bring with it a host of other challenges. Migrating to a new data center often requires the services of a company like Align, which specializes in it, and typically includes extensive planning, a multistep process, and involvement of many people within an organization. Migration risks include down time, which can be extremely harmful and expensive. Migrations thus typically include equipment mirroring, which is costly, to guard against down time. Given the monetary costs and business risks, we don't expect that tenants take a decision to move lightly, and we think they are effectively precluded from price-shopping once they are in a data center. Digital Realty claims most churn results from tenants merging or no longer needing a data center presence because of company-specific issues, such as their own business struggles.

Based on the number of data centers, square footage, and power, Digital Realty is the largest owner of data center space globally, and we think its cost advantages stem from its scale and property ownership. Digital Realty has said it is one of the largest consumers of generators and air conditioning equipment in the world, and it receives modest discounts on them as a result. It also has recently begun negotiating power needs on an aggregated basis within given metropolitan areas rather than for each campus individually, leading to even more favorable deals with electric utility companies. For example, the company has previously locked in power rates in Chicago at a 20% discount to the market and secured lower-than-market rates in Texas. 

We are convinced that the current environment results in a durable competitive advantage that makes it likely Digital Realty will earn excess returns over the next decade, but the evolving nature of technology keeps us from labeling Digital Realty a wide-moat firm. On balance, the advent of the cloud has been good for data center businesses, as the number of firms reducing their own data center needs has been much more than offset by those that increasingly move off-site for interconnection with cloud service providers for their hybrid cloud needs—the most common model for large enterprises. However, the speed with which technology changes and data centers' close connection to it leave us wary about making a 20-year assumption with any confidence. 

While we see the possibility that enterprises will have less need for data centers if they use infrastructure as a service to a greater extent, our bigger concern is that companies will be able to satisfy their data center needs with less space and power. Hardware with more capacity in a smaller physical size and virtualization could each reduce the need for space over the long term even as enterprises use data centers for an increasing amount of data. Also, as cloud service providers become even more dominant, we expect they will have increasing control over data centers' fortunes. While they seem to be great customers now, we will not bank on that considering the leverage that they hold.

Narrow

Economic Moat

Digital Realty Trust

Digital Realty Trust, Inc. operates as a real estate investment trust, which engages in the provision of data center, colocation and interconnection solutions. It serves the following industries: artificial intelligence (AI), networks, cloud, digital media, mobile, financial services, healthcare, and gaming. The company was founded on March 9, 2004, and is headquartered in Austin, TX.

Earnings data Q1 2024

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Investors may want to tread carefully as the data center REIT battles macroeconomic challenges.

Is Now the Right Time to Buy Digital Realty Trust?

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Dividends received in February totaled $244.23. Forward dividend income grew by $71.65, translating to M/M growth of 1.27%.

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To capitalize on the rising demand for data centers, Digital Realty (DLR) enables access to an Oracle Cloud Infrastructure FastConnect PoP in the newly launched Oracle Cloud Chicago Region.

Digital Realty (DLR) Offers Access to Oracle Cloud FastConnect

Digital Realty recently capped off a strong year and has a robust backlog. It's set to benefit from continued client migration to the cloud and from the emergence of AI.

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Access to the new Oracle Cloud Chicago Region will enable customers to manage their data more efficiently on a consistent, secure network with lower latency and increased reliability AUSTIN, Texas , Feb. 28, 2023 /PRNewswire/ -- Digital Realty (NYSE: DLR), the largest global provider of cloud- and carrier-neutral data center, colocation, and interconnection solutions, and member of Oracle PartnerNetwork (OPN) today announced it will offer connectivity to an Oracle Cloud Infrastructure (OCI) FastConnect point-of-presence (PoP) within the newly launched Oracle Cloud Chicago Region. The new connectivity deployment located at Digital Realty's 350 E.

Digital Realty Announces Access to Oracle Cloud Via FastConnect

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Risks Of 'No Landing'

On our last coverage, we had just suggested that the risks for Digital Realty were rising and we did not want to be involved with even the preferred shares. Digital Realty reported Q4-2022 and guided down for 2023.

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Digital Realty's (DLR) Q4 performance reflects growth in revenues, though rising expenses act as a spoilsport.

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While the top- and bottom-line numbers for Digital Realty Trust (DLR) give a sense of how the business performed in the quarter ended December 2022, it could be worth looking at how some of its key metrics compare to Wall Street estimates and year-ago values.

Here's What Key Metrics Tell Us About Digital Realty Trust (DLR) Q4 Earnings

Digital Realty Trust, Inc. (NYSE:DLR.PK ) Q4 2022 Earnings Conference Call February 16, 2023 5:00 PM ET Company Participants Jordan Sadler - Investor Relations Andy Power - President and Chief Executive Officer Matt Mercier - Chief Financial Officer Greg Wright - Chief Investment Officer Chris Sharp - Chief Technology Officer Corey Dyer - Chief Revenue Officer Conference Call Participants Ari Klein - BMO Capital Markets Eric Luebchow - Wells Fargo Jon Atkin - RBC Capital Markets Michael Elias - Cowen & Co Michael Rollins - Citi Matt Niknam - Deutsche Bank Frank Louthan - Raymond James Operator Good afternoon and welcome to the Digital Realty Fourth Quarter 2022 Earnings Call. Please note this event is being recorded.

Digital Realty Trust, Inc. (DLR) Q4 2022 Earnings Call Transcript

Digital Realty Trust (DLR) delivered FFO and revenue surprises of -1.79% and 1.69%, respectively, for the quarter ended December 2022. Do the numbers hold clues to what lies ahead for the stock?

Digital Realty Trust (DLR) Q4 FFO Lag Estimates

AUSTIN, Texas , Feb. 16, 2023 /PRNewswire/ -- Digital Realty (NYSE: DLR), the largest global provider of cloud- and carrier-neutral data center, colocation and interconnection solutions, announced today financial results for the fourth quarter of 2022.  All per share results are presented on a fully diluted basis.

Digital Realty Reports Fourth Quarter 2022 Results

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Digital Realty Trust (DLR) is seeing favorable earnings estimate revision activity and has a positive Zacks Earnings ESP heading into earnings season.

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Digital Realty Offers A Good Combination Of Yield And Growth

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News for Digital Realty Trust Stock (DLR)