Digital Realty After Telx: Bigger With Lower Profitability

From major tenant and competitor to part of the portfolio, Telx was the third-largest tenant of Digital Realty Trust (NYSE: DLR), representing 4.1 percent of its annualized base rent. Of the twenty properties that Telx operates, twelve have been leased from Digital itself for interconnection and colocation data centers. Nothing is more convenient for due diligence than buying out a tenant with which one has had a relationship for nine years.

This is a huge transaction for Digital Realty. Telx will potentially add 1.3 million square feet to Digital’s data center space, which already covers 22 million square feet, and provide access to markets in which Digital decided to be so it can offer multiple customer solutions. It will strengthen its colocation and interconnection business. Telx, indeed, was founded as an interconnection data center in New York in 2000. Digital is expected to fund the acquisition through 62 percent debt and 38 percent equity and will issue an additional 10½ million shares, which represent about 8 percent of the total number of outstanding shares and units.

dlr telx

This Monday, Fitch Ratings issued an opinion regarding the transaction the day before it was formally announced, prompting some activity in the market and causing DLR to decrease one percent the same day, up by as much on Tuesday, and down two percent on Wednesday. Digital has already given the market a heads-up on the transaction, but a set of assumption disclosing Digital’s funding plans came as a surprise.

The positive thing about the above report is that the transaction will not affect Digital’s BBB investment grade rating. The caveats are that debt funding will exceed 50 percent; rental rates and same-property NOI will decline will decline as Telx’s EBITDA margins are lower; and leverage will increase from 5× to 5.4× (net debt to recurring operating EBITDA).

From a valuation viewpoint, DLR has had a good dividend yield at 5.0 percent and a fair entry point (price-to-FFO), but has not been so hot a stock as its smaller high-growth peers CyrusOne (NASDAQ:CONE), CoreSite Realty (NYSE:COR) and QTS Realty Trust (NYSE:QTS).

Link to Fitch Ratings Press Release

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Source: Digital Realty Trust, Telx, Fast Graphs


Written by Heli Brecailo

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