Digital Realty Trust, Inc. (DLR) Earnings Call Transcript & Summary

We're tight on time today with only 35 minutes per session. So I'm going to try to get through as many questions as I can. Michael Funk, I cover the North American telecom data center and tower stocks at Bank of America. Really grateful to have Andy Power, Digital Realty President and CEO here again with us. So Andy, thank you.

Thanks for having me.

Yes. Absolutely. And we have Jordan down here as well, who heads the Investor Relations function. Hopefully, you guys all know both these guys.

So I'm going to try to rip through a bunch of these questions. And I do have some obligatory rapid fire questions, expect to ask at the end. So hopefully, I'll get those in as well. The big news last quarter, Andy, was, well, in my opinion, when you talk about extending double-digit core FFO growth per share into '27 and beyond, right? And that's a higher rate of growth maybe than you previously talked about. So can you walk the key assumptions underpinning that outlook and maybe the biggest variables also that investors should be looking for?

Sure. So it was certainly a milestone in the making. While we had the conviction to come public with it on the earnings call, I can't tell you, it all crystallized in the month of July right before that call. If you look at the milestones in each of our, call it, legs of business, the 3 pillars of growth, colo and enterprise, we capped off the second quarter with, I think, the third straight record in a row. We were doing $50 million of signings in that quarter for a long time and did eclipse the $100 million in the second quarter and basically had the first year on pace for over $200 million on the hyperscale development front, in roughly 6 months, we've taken our under development total projects from about $10 billion to $20 billion with roughly the same on pre-leasing and returns, call it, 11.5%. And lastly, well, it's strategic private capital/balance sheet activities. We started the year with an upsized closed-end fundraise. We had obviously gotten the balance sheet over time into a position from a leverage liquidity standpoint. We're making progress on the next legs of those, call it, strategic private capital raising. And I think all those things together is what brought us to a place where we see this flowing to the bottom line, not just this year, but next year and thereafter at that, call it, double digits 10-plus percent bottom line growth, and it helps to have a $2.3 billion backlog of revenue as well.

And I want to talk about the backlog and the bookings next. So last quarter, you had another really strong quarter of bookings, you hit the record backlog that you just mentioned. And then obviously, FFO growth ties into more development, right, which must express greater confidence and the durability of demand, right? So what are you seeing that's giving you confidence in the durability of demand? And I'll give you an example that another executive private company gave me a few weeks ago at lunch, maybe you can talk if you're seeing the same thing. What he said when asked the same question was that, he said, "Mike, we're delivering capacity today, basically, the usage of power is spiking immediately, much higher than it did historically, and customers also demanding full delivery capacity on day 1 when maybe in the past, they would have asked for x percent in year 1, y percent in year 2 more scaling the capacity." Those are the examples he gave. I don't know if you see similar indicators or if there are others that give you confidence.

Sure. I'll touch on the meat of your question in a second. What I will say, not only just have 3 pillars of growth or a triple threat there. If you unpack that bottom line algorithm, it's built off of a big piece of development, but other levers in that growth as well. If you look at our colo interconnection business, continually growing our platform, more customers, more locations, more cross-connects, ecosystem effects, cash mark-to-markets of 5-plus percent, our hyperscale estate that's already inked in all our expiration schedule has rates going down and has market rates going up. And we've had a great mark-to-market in that quarter and more to come on that front. And then you turn to the development where we've been able to -- in a world where costs have inflated, you can see we're building $20 billion on 1.4 gigawatts, still be able to push rates to keep those returns at, call it, 11.5%, that's about 63% leased. We had probably 5%, 7% of vacancy, which I'd call colo vacancy in the total development projects. And that 30% of vacancy, if you look at our track record, those buildings by the time we open those doors are full, right, especially the hyperscale buildings. And that's a product of our markets we chose to focus on are servicing robust and diverse demand, not just cloud or hyperscalers but also enterprise and other service providers, all hyperscalers, all the cloud availability zones, and AI landing in, be it AI inference because it's obviously a higher price point than where you can go anywhere for training workload. And the supply is being well outpaced by the demand. These customers have -- their end customers are real businesses that need to grow on their cloud in those markets. They need to grow with adjacency, right? So -- and I'm sure we'll talk about this a little bit more. The supply picture is not getting easier for anybody. So we see a lot of customers competing for the same capacity blocks. We see that on the enterprise side of our business, which is a new thing. We see that on the hyperscale business, which I would say, has been part of why us picking our spots and helping with customers where they need us most has allowed us to generate the output, the rate and the returns. But we've got tremendous conviction on that. And that [ 1.5 ] is a part of a 9 gigawatts of growth on the 3 gigawatt operating base today.

Yes. It's a tremendous number. I want to pivot for a second to your comment about capacity. So I host the call at 11:00 today with Andy Lipman, who is my Washington, D.C. regulatory legislative expert on everything telecom and technology. And the theme of the call was data center regulation moratorium and executive orders, right? It's very topical, even more so after this weekend and AI even kind of raising -- rising to the topic kind of pushback or fear. One stat he gave us was that 75% of all voters now are opposed to data centers. They probably know what they are, but they're opposed to them, right? And 26 [indiscernible] candidates are now for moratoriums to some degree or another. And even Trump has told Republicans that they can go their own way on data centers as it means winning the races in their own space. And I don't believe moratoriums are terminal. They're temporary, right, because a permanent moratorium would be illegal, at least according to Andy Lipman, you can't have one. But it's certainly going to slow development. And kind of getting back around to the question and supply, can you just talk about the Digital Realty pipeline and what you have in place in terms of permitting, provision power and location that gives you confidence for meeting in-service dates relative to the fear affecting the broader landscape?

So a lot to unpack in there, and I'll get to the major emphasis of your question in a second. But, like, I think it's worth speaking to what everyone probably read over the last several days. Based on everything I'm seeing in the business, albeit new, this is not a pencils down moment on artificial intelligence and the infrastructure that is required to create this. So there may be forms of collaboration and pacing, but these are once-in-a-lifetime technological changes happening and economic drivers and capital behind these companies that -- and this infrastructure is needed, and they're on a race for profitability. There's also, we are at a place where we don't just do AI, we do digital transformation enterprises. We don't just do AI, we do cloud computing. Both of those 2, I believe, have been restrained by the focus on the fever around AI. And if AI, the piece that I think we are most exposed to, is the interaction, the inference, the private data, that is where the economics of this are going to unfold more than anywhere. So it's the piece that these companies, if they want to survive, they cannot go pencils down as an industry. So I look at what you're saying, and I agree with you. I will wear the scar tissue of being behind the 8 ball as an industry leader around this. But I will tell you, the ground game is a lot different than what you see in the national social media. And we have shown time and time again in markets where we operate for multiple decades, or markets where we're just going into that our track record, our expertise, our approach, we go in there, we educate them about who we are, what we're going to do. We make sure -- have you want -- would you like to tour a data center. Let me just tell you who our customers are, right? We find locations that are the right locations for this infrastructure. We educate them that -- I know you heard this thing on your TikTok or Facebook about data centers taking water. We have 300-plus data centers. We use less water than 18, 1-8 California golf courses. There are 16,000 golf courses in the United States. So if you have an issue with water, call the golf course companies. And the list goes on with electricity and other things as well. And to date, we've been very successful in navigating that as we've been scaling infrastructure like we've never seen before. So I don't think all folks are going to be as fortunate as us are going to have the experience that we've had and you hear the dustups and the bad actors and the updates happening. But I think our brand when it comes to this is a brand of trust, reliability, and benefit for all the community stakeholders. And I think that's going to win the day regardless of the political football around the asset class.

And another just kind of bank shot off of that, tighter supply market should enhance the value and even renewal rate that you're seeing in your existing portfolio, right? So I wanted to talk about that a little bit. And looking across your portfolio, which markets or market represent the best or most positive repricing opportunity?

Put aside the amazing Singapore market, which we are...

And I want to come to that in a minute talking about that market.

I'll preempt you on that. We're 6% of the portfolio. We're delighted to have just been awarded a precious 50 megawatt block of IT. Talked about NIMBYism, I'm copying Jordan, NIMBYism at its best is when the country literally says, you get a megawatt, you get a megawatt, and you get a megawatt, nobody else, like that market, our rates of returns are off the charts. Put that one aside for a second. Let's talk the U.S. for a second. Northern Virginia has been our workhorse and has now eclipsed rates that Santa Clara, which is clearly higher cost of occupancy market put up in my time at Digital. So -- and what you're seeing is, it's not just a one strong market phenomenon. You're seeing a coalescing of all prices because demand is robust. Its diversity is growing, right? There's more companies that are direct users of data center capacity today than there were a year ago, 3 years ago, and the list is growing with this technology, right? SpaceX is a small customer, but they're investment-grade customer overnight, right? And I think that list is going to expand, creating more competition for the traditional hyperscalers. Supply is wind away and is metered out by physical power infrastructure that takes years, not months. The NIMBYism or the political football makes it harder to do to invest, right? Having conviction around this, the stakes of entering into power contracts, the bar is getting raised dramatically. We can put $0.5 billion of letters of credit or security deposits for power that may not arrive for several years. You can't do that if you're subscale. So all these things are -- as well as an inflationary backdrop to build costs because everyone is building are pushing rates higher and higher and higher. So luckily, we're supporting something that are the most profitable companies on the planet, right? So they can bear this occupancy cost because just like our workloads are mission-critical, this infrastructure is mission-critical to their futures.

And you mentioned a few things in there, right? So rates are going up, right? Development...

I didn't say rates. Interest rates are so...

No, I mean pricing per kW, that you were talking about. That's what you meant. I should have been more specific. Pricing per KW is going up occupancy side. Development costs are also higher, we're seeing higher borrowing costs. I presume or expect you're probably seeing higher development yields. But are your development spreads also expanding because of those factors in there, which are just kind of build cost movement maybe relative to projected higher borrowing costs. Are you seeing better development spreads?

We've been able to keep our development yields firmly in the double digits for a while, and I think they're going to continue there. And the -- we are beyond just a pure spread investing being. We are -- based on our strategy when it comes to hyperscale, not alone put aside our enterprise business, we basically picked our spots and just don't just go after market share. We try to find places where we can really help these hyperscale customers, and that generates alpha and extra rates -- higher rates and, but those workloads need to be there, and there's numerous customers competing for that capacity.

Yes. And that leads to the next question, Andy. I think 80% of your development is currently in the U.S. Is that right, Jordan, 80% roughly? Okay. So should we expect the next leg of development to remain U.S.-centric? Or those higher returns, more opportunity where customers want to go, is that going to be outside of the U.S.?

It's not a great answer, the answer is both. Like we have a global platform. We have global customers. They're growing in all regions. The U.S. pre-AI was the laggard in the growth rates. The U.S. has now become the leader in the growth rates for infrastructure. And I think it will continue to be that way. But you're going to see a global catch-up phenomenon. You already saw it in our first half of the year where markets like Tokyo and Brazil in first quarter or second quarter were call it top of the list in terms of contribution. So you continue to see us scaling our business, both inside the U.S. and outside the U.S. In addition to adding -- we've got 7, 8 new markets on the enterprise colo side, including an announcement at the beginning of this week with our entry into Turkey.

Yes. And I want to come back to the enterprise market in a minute because we probably had too much focus or overemphasis on AI-related demand, maybe on that, too. But -- so the inorganic growth, though, right, you acquired the full stake in the Blackstone JV in Northern Virginia. You had the Columbia Capital transaction. Teraco investment, they all broadened your portfolio and profile. So how should we think about future M&A focus and scale?

So this goes back to what I said at the outset. We are really trying to drive the 3 pillars of growth, triple threat. So making sure all this growth then flows through our bottom line, but not be single threaded in any opportunity. And that's because we think that these businesses go better together. Our hyperscale customers are offering the destinations, the on-ramps, the ecosystem that our enterprises consume. Our networks obviously monetize those connection points and that the production facility for the compute and the AI inference goes back to those same 4 walls we're building or expansive campuses. Those 3 transactions you mentioned hit each one of those sleeves. Teraco, the most highly connected destination I was going to say Africa, but you could say worldwide, it's a top 10 location here. We were able to pick up our stake pursuant to the contractual agreements we had and do so in an accretive fashion to our bottom line. That is one market where we actually have a higher growth in our Teraco business than we have with the mothership Digital Realty. Part of that's due to sizing and timing of capacity coming online. But that was a win in terms of taking about 77% ownership. Kansas City was -- and I'll give you 2-for-1 on hyperscale. Kansas City was a new market where we are not only getting a 2-gigawatt campus, but 600 megawatts in 2028. My view is Kansas City is going to be a top 7, top 5 hyperscale market in the next several years. I believe when it comes to digital infrastructure in the United States, a lot of that West is moving east due to it's very challenging due to regulation, political climate and environment to build on Western parts of the country. And Kansas City is smack in the middle with tremendous fiber optics, expansive runway of growth. We've had a great partnership with the energy company there. And I think you're going to see some exciting things with what we're doing in that market shortly. Our Blackstone transaction somewhat straddles hyperscale and also private capital. We are able to work with a great partner to basically take on balance sheet what I believe are probably the best assets built in the last several years in terms of markets, still below market rates, 15-year contracts, triple net lease structures, strong investment-grade rated, AA average rating roughly at an attractive valuation and make it accretive to our bottom line and also create a pipeline of product for the incremental private capital we're building and scaling as we speak. And Columbia Capital was a way to essentially further accelerate our push into private capital with a partner that we believe could keep us ahead of the game on the AI ecosystem, but also brings a amazing track record for numerous decades, $9 billion of assets under management at the forefront of Cologix, partnered with us on Teraco, partners with us in other businesses, major investor in one of the largest power land bankers in the U.S. So all 3 of these things, call it, hit each one of those legs of growth we're operating under.

Yes. I know it's early days with Columbia. But to your point, I mean, it's adding intelligence, expertise, knowledge, maybe initial visibility. What have you learned so far that might affect strategic decision-making at Digital Realty?

We just literally closed very recently. But what we learned, I think our thesis has grown conviction around it based on we're seeing the synergies of where we work of late. This is something we learned -- they learned from this investment in this type of company that Digital Realty would never invest in, right, not a data center, but it may be an adjunct to AI, an adjunct to cloud, an adjunct to networking, places where I think we can collaborate and invest together as well, opportunities where maybe we don't, Digital Realty, want to invest that much investment because it's a longer buildup to return, but Columbia is in a more total return-oriented private capital vehicle and on the LP front. So they've got hundreds of sophisticated institutional investors that we've already stepped into the RIA, registered investment adviser, status. So I think it's already made us a more attractive provider to the private capital world.

Okay. That's really helpful. And I don't know if I caught it in there or not, but then your thought process on incremental M&A and size?

We've been -- if you look at our story over the last several years, it's been a lot about operationalizing. It's a lot of been about executing when it comes to our colocation enterprise interconnection. It's been a lot about scaling development and capital. But at the same time, we've been making moves that have not been the biggest splashiest deal, and I would call them versions of M&A where we've entered through that pursuit, Indonesia, Malaysia, Lisbon, organically Barcelona, Rome, Crete, Bulgaria, just now Turkey. So we've expanded our addressable market of our platform now, I think, 57, 58 markets where enterprises need their infrastructure to be. That's been a big piece of that. We've not done any M&A just to get bigger. We don't want to get bigger. We want to get our bottom line growing faster and our stock price higher, right? That's sort of how we operate.

Very, very deliberate. I think you also made the argument that your global portfolio is particularly well suited for AI inference. And there's been a lot of debate over the years where AI inference is actually going to live. And we project inference will go from, call it, 25% demand to 45% demand over the next several years. So a very meaningful component. I'd love to hear more details on why your portfolio is so well suited to attract and to capture inference demand.

So I just look at the options of what this is going to be used for and how it's going to be physically deployed and what I hear from our customers. And things I hear are important, power densities, how you cool it, form factors, footprint sizes, connectivity, proximity to data points, all IoT things around that. And when I look at our global portfolio of 57 markets, 6,000 customers, and I know where the cloud, actually, compute lives, I know where the networks are homed, I know where the enterprises want to put their infrastructure. I know where we were doing liquid cooling years before people were talking about GPUs. When we were talking about AI, investor days -- 3 investor days ago, whatever it was years ago, where we came at this business from higher power densities, from larger footprints, from serving the most technologically savvy customers out there, I think we have the sweet spot for inference by service providers, inference by hyperscalers, inference by enterprises and whatever vector around this AI ecosystem to come. Now I'm not going to tell you this is going to all show up on our doorstep tomorrow. This is going to be a long build. But we are -- when we're operating 3 gigawatts and we have 9 gigawatts runway for growth, and it all fits that. It's not 9 gigawatts on the moon or in the middle of nowhere, right? Maybe I shouldn't said the...

Are you making a reference?

I was not intentionally making a reference to anyone.

I think my X is blowing up now.

9 gigawatts in the right markets where the enterprise lives, where the cloud lives, where the networks live, where compute lives, I think we are extremely well positioned for this.