Digital Realty Trust, Inc. (NYSE:DLR) Bank of America 2024 Global Real Estate Conference September 11, 2024 3:45 PM ET
Company Participants
Andrew Power – President & CEO
Jordan Sadler – IR
Conference Call Participants
David Barden – Bank of America
David Barden
So welcome, everyone. Thank you for joining us this afternoon. I’m Dave Barton. I head up, U.S. and Canada Telecom and Communications Infrastructure Research for Bank of America. Thank you for joining us. I’m really, really pleased to have with me, Jordan Sadler, Head of IR for Digital Realty. And then this guy, Andy Power, CEO, also important. And we’re going to talk a little bit about today, the data center industry. So thank you guys so much for joining us. Really appreciate it.
Andrew Power
Thanks for having us. Really appreciate it.
Question-and-Answer Session
Q – David Barden
So I guess I’d like to start, at a big, big picture level with maybe Andy, there’s a lot of uncertainty about the political climate. There’s a lot of uncertainty about the economic climate. There’s a lot of uncertainty about the rates climate. What does all that mean for Digital Realty sitting here at the end of 2024 thinking about how to plan for 2025 and what should we think, how should we think — you think about it?
Andrew Power
So, a few things. One, we’re a global company and we’re supporting 5,000 customers on six continents, 50 plus metropolitan areas. We’re a massively capital intensive company, so spending billions of dollars on new footprint infrastructure capacity. We are a real REIT, so we cannot retain our capital. So we’re a capital sensitive company, which go in the mix and bowls of economics and interest rates called fall-in. So all those things are obviously risks to the business that we have to operate within and execute.
I’d say, the fortunate piece of the equation is the demand side has proven over numerous economic cycles at numerous vintages or places in the telecommunication technology landscape from the dawn of the internet to mobile computing to cloud computing, now to gen AI that there’s just these secular tailwinds of growth that outgrow the broader macroeconomic backdrop. And I believe we are yet again seeing that play out with our customer base, many of whom, including some who just were on their earnings calls less than 24 hours ago, talking about great results, revenue growth, I think quoting the word data center 30 times, as an integral piece of infrastructure to the technology that they’re building out.
And that was just one example of many if you looked at the landscape of the, call it, hyperscale providers over the last several weeks or months. So they’re all towards — we are supporting things that are rising above the economic trends be it digital transformation, cloud computing, and gen AI.
David Barden
Yeah. I think that that’s a good kind of segmentation. So that there’s three big secular forces, digital transformation. I think the question might be, if the economy slows down, could that slow down or could it accelerate if the economy slows down because companies are going to be looking to save money, which of those two things you think is more important?
Andrew Power
What’s also unique about these components of demand is they’re all they’re unique at different phases of their growth or maturation, but they’re also very linked and coupled here, right? A digital transformation project for an enterprise customer, be it like Bank of America is going to have some place for data center and private workloads sitting inside of our four walls, probably in numerous parts around the world, moving off of on-prem locations or data centers they built and operated a long time ago.
It probably definitely has the use of many clouds, so numerous cloud computing, growth interwoven in that. And I don’t think anyone’s thinking about digital transformation or cloud computing and not also thinking about how Gen AI is going to be supporting it down the road. So, I don’t see these things as isolations that you would stop, and cut back on. And these are all pieces of business for an enterprise as the end customer that are improving their top line and their bottom line in terms of efficiencies at the same time.
And you kind of see it in the call it the CIO or the IT survey reports. The rank, the prioritization of everything that IT does from data centers, servers, to mobile devices and laptops, right? And AI, data center, data transformation are top of the list of our customers’ priorities.
David Barden
Yeah. I mean, I guess the way I’ve said it is, expansionary times people are looking to gain revenue by going digital and in contractionary times they’re trying to save money by going digital and they’re trying to do it. I’ve learned, being here at, Jeff Spector’s Global Real Estate Conference with Sara Cooper everybody that you guys are going to jump in at some point randomly. So if you guys are going to do that, just go ahead. This one over here, that guy right.
So the second thing I wanted to ask was just about the next big driver. This is a — it’s become weirdly controversial is the cloud which is that from the birth of the cloud, the idea was maybe that, well, who needs a data center if everything can live in the cloud. And then we kind of gave birth to this hybrid world where people want to keep a little bit to themselves, put a little bit in the cloud. But then more recently, in the last couple of years, we’ve had some regurgitation of these bare theories that the cloud is going to eat the data center marketplace. Could you kind of opine a little bit on where we live today?
Andrew Power
So the terminology cloud, given that we’re in a very physical oriented conference here, it was probably not a great description because it gives someone the illusion that means the data just floats out to the ether and appears on our devices when it is happening in a physical infrastructure in a data center many of our 300 data centers. And I think you’re right, there has been a different vintages or views on cloud. Is it — are we going to have a one cloud world?
Will AWS rule the world, right? And then move to — I think that view has kind of been shelved to provide even the biggest proposers of cloud saying multi-cloud take the best of all the different cloud providers. And at the same time, private cloud and hybrid IT infrastructure inside customer owned servers in a facility purpose built like ours as part of the architecture as well.
And you’ve also had, like you mentioned, customers that were born in the cloud, pop out of the cloud due to efficiency and scaling and some pop back into the cloud for some of their workloads at the same time. So I look at this as — we at digital are supporting 5,000 customers. So corporate enterprises like Bank of America to the hyperscale cloud customers, of which those customers we’re supporting in 30, 40, 50, 60 different locations around the world. And we’re a physical trusted infrastructure partner for both those customers, trying to be that one-stop shop for space power and connectivity.
Jordan Sadler
And I would layer on there, right, in terms of IT architecture, the argument is, it’s just not well struck or thought out relative to what happens across IT [Technical Difficulty] over time, right? So as Andy indicated, people are moving into the cloud and some very significant portions of which actually the large majority of large enterprises today actually expect to pull workloads off of the cloud in the near future, right, based on the same survey work that he was referencing.
So we see people repatriating potentially at a bigger rate over time. Certainly, the cloud players would — and these hyperscalers would like everybody moving into the cloud, and they will, and there are some great use cases especially for different applications. But when you look at overall architecture, there’s lots of use cases that make the case for, hey, we should have some of our own compute.
David Barden
Right. There’s a proprietary and there’s elements of proprietariness. There’s regulatory reasons. There’s also the nature of the cloud, which is a variable cost for an institution. And so if you’re going to be using things maybe in a bursty way, it’s very helpful. But in terms of regular compute load, there might be owners economics to having your own facilities in a data center environment.
So just before we move on from that kind of conversation, you mentioned you have 5,000 customers, but you’ve got some incredibly large important customers. And some of these large and important customers are subject of certain governmental scrutiny, if you will. I’m speaking specifically of TikTok and what could happen if they disappeared. How you — how do we as a group think that you think about that?
Andrew Power
So what we’re obviously very confidential on our customers unless they give us their blessing to use them as an advertisement of the great quality service with given the day-in and day-out. So I’m not going to comment on any specific customer name, but you can imagine as a global company that’s been in business for now north of 20 years, we come into situations like this and have to think about. We’re making substantial investments in each of these markets that long-lived infrastructure and the counterparty risk is another way of saying that.
Will that counterparty disappear for whatever reason, could be the things you illustrated there could be credit risk or bankruptcy on the other bookend. So my handicapping the facts and circumstances, and I have no inside baseball on, call it, the geopolitical or regulatory framework we have here. I’d say, any customer that is with us in 10, 20, 30, 40, these big customers, hyperscale you talked about. They didn’t start in 2023 or ’24 to be our customer when we had this massive inflection in the rates for our product.
So they really very likely have contracts in place with us that are very attractive to them, less attractive of what we would have signed if they would have showed up our doorstep this year. So most of the coding scenarios, you could possibly imagine vacancy in our portfolio caused by draconian events what obviously be potentially post the downtime from releasing, very economic windfalls to our bottom line, given the rates that those type of customers pay on their installed base to what we’re signing in the market today.
I’m definitely not routing for that for any customer and I don’t think my wildness dreams have that all come up showing up at our doorstep like that. I believe there’s a long road of jousting and regulatory things that could happen. And I also would say, unlike our B2B customers, Azure, AWS, Google Cloud, Oracle Cloud type of customer that has locational sensitivity and sovereign sensitivity, GDPR, they’re in certain of our European countries for European data.
B2C type customers than using their apps just consumer do not have that. And many of the B2C type customers put a substantial amount of infrastructure in the United States, but have most of their users outside the United States, right? So banning a B2C customer per se doesn’t necessarily mean that infrastructure leaves our shore 100% at the same time. So that’s a long-winded way of saying, I think our diversification below market rents, and I think a pretty low likelihood that, that benefit shows up back to us. I don’t think I’ll be reporting that out anytime soon.
David Barden
So let’s talk a little bit about how business is doing. So first quarter record leasing, I think you said — and this is the third leg of the kind of secular demands tool (ph) roughly half was AI-related. We’ve gone 14 minutes, and we haven’t mentioned AI yet. So I might as well go ahead and bring it up. Talk to us about the opportunity that Digital Realty faces and why Digital Realty is positioned to benefit from it?
Andrew Power
So just to recap your accolades, which I appreciate, record first quarter, record first half, first half of this year, double the pace in the prior year. We did call out a 50% contribution for AI in the first quarter, 25% in the second quarter. I think it’s important to understand how we are attacking the opportunity. We are not chasing this opportunity to unproven markets just because a customer asked us to build in a data center.
We’re sticking to our 50 plus metropolitan areas where we see robust and diverse customer demand that is not just AI trading model demand. Numerous cloud computing companies compute, network, enterprise demand markets that we truly believe in the locational or latency sensitivity of the applications living in those markets like Northern Virginia, Frankfurt, Singapore, etc.
David Barden
And could you just talk a little bit — you’ve said something interesting about how demand is actually concentrating as opposed to diversifying?
Andrew Power
When it comes to AI, which AI is also a multifaceted piece of demand, we’re seeing the preponderance of large capacity blocks from hyperscale cloud companies one in three things. One, they want large contiguous capacity blocks begin together. Two, they want it right now, like they’re running to the Bodega to pick up something they forgot.
Jordan Sadler
A megawatt of capacity.
Andrew Power
Yeah, exactly. 50 or 100 megawatts. Exactly. And three, their preference is fungible markets or markets I’m referring to, where if they get their AI demands wrong at that very minute, they can put their cloud compute in that same very data center.
The third leg of the stool is, it’s not a must have, hence, in these core markets, they can get that third leg because the core markets have had the great supply constraints. So it’s spilling over to some second-tier markets as well. The power due to power transmission generation and other trends like that.
So we’re doing that on the bigger, larger capacity blocks. I think on the first quarter record, we announced a big supporting Oracle and a big GPU cluster for their enterprise, AI cloud customers. We’ve also been supporting on the more enterprise piece of AI. We had a win with the Novo Nordisk Foundation, where we and NVIDIA building the largest supercomputer in the Nordisk, that is not a 50-megawatt type of deployment. More enterprise-oriented use cases.
And I think we’re both — both of those segments are growing, but I’d say the big deals are probably taking up the most — getting the most spotlight. And I think we’re — a, we’re still getting started. Trading in my opinion is not done. Two, when we know the next leg of this is the inference. Think of the users of the applications with AI devices, be it people or technology, clearing the models, which we understand, one, be a multiple of size of the addressable market that we’re already experiencing in a large and fast-moving training market and could come into capacity blocks that are not near — do not need to have that continuous requirement.
And we hope, we don’t know definitively that, that blends itself back to our corporate in campuses where we had infrastructure where we’re hosting cloud computing and private AI or private compute for our enterprise customers.
David Barden
So I think that the question then is, first, there’s been so much money put into the data center industry that we’ve all heard about from the private guys, from others. So our team estimates that the top five, just the top five hyperscale guys are going to spend $240 billion in CapEx this year and $280 billion in CapEx next year. And you’re going to spend how much?
Andrew Power
Just a couple of billion.
David Barden
So it’s not like you need all the market share, right? You — there’s a lot of runway that you’ve built. And it kind of just happens that you were building a runway for digital transformation then you added cloud to that and you put land and you put power and you put capabilities and common sense together. And it so happens that now when the hyperscale guys hit the panic button, go to the Bodega. Bodega, right?
Andrew Power
We were supporting them for their traditional needs in many, many markets for a long time. We were repositioning when we saw a few things going back several years. One, we tell this business is going global, right? We are a largely a U.S. company, call it, 10 years ago. Now we’re across six continents, right? 30 metropolitan area, 50 metropolitans and 30 countries. Two, we saw everything was just starting to get bigger. Scale mattered, right? Because that the data halls, the buildings, the campuses, the runways for growth.
We’ve been — we had this work future proof of customers’ growth and their future just kept getting better and brighter and we need to be prepositioned and ready for it. And we also lastly saw that being the full spectrum from the enterprise to the hyperscaler and everything in between was value-add to our platform. Because we’re driving cloud consumption by our enterprise customers, cross connecting to the public compute. And I imagine the AI workload will follow a similar virtuous cycle as well. So that’s how we have thought about this.
We’ve got north of 3 gigawatts of land on our balance sheet, that was underwritten and mostly acquired before they were talking about GPUs, so this is obviously well positioned us to capture this well faster than we initially underwrote pull forward a lot of that capacity, and that’s what we’re doing right now.
David Barden
So I guess I want to ask my big question, which is that you had a record first half in terms of new leasing in the first half of 2024 can we beat it? So this is record a better half in the second half. What do you want to know about a quarter. Just give you the number…
Jordan Sadler
As I said on unlike my typical disposition on the first quarter call in conjunction with the record similar question may have been view. He was asked about, will there be another record and I’d said, listen, you don’t usually call it put — in this size of business we’re talking about, you don’t usually see records upon records that consecutively to that quickly, right? Because we don’t build this in a modular fashion, right? We don’t go speculative all these shelves or suites and so we’re derisking our capital outflows. And hence, we don’t have shelves lined with product to sell out the store and set records traditionally.
That being said, in my commentary was, one, we’re in an era where everything is in the XXXL size category is the most popular, right, the biggest capacity blocks. Two, our shelves were not bearing in that category. We’ve still had some very attractive, and I think that being carried into the second quarter, where Dallas led the way in terms of our signings contribution, not a record quarter, but a very respectively high quarter. And we still look back at markets like Northern Virginia and others, where we have large continuous capacity blocks, an opportunity to put up a record.
And then last I said, I said I got three more shots, three more bites of the Apple, so I won’t rule it out. Now that has changed. I got two more bites of the apple. I’m probably less convicted on that than I was with three shots at it, but I wouldn’t roll it out still.
Unidentified Participant
[indiscernible]
Andrew Power
So the question was of the hyperscale CapEx numbers that our Internet guys put together, do we have a breakdown of the $240 million to $280 billion this year and next year, that’s specifically related to data centers, we don’t. We know that the vast majority of it is going to be the chips and the servers and all the bits and pieces that go into the data centers, but they’re absolutely self-provisioning a portion of this, We could probably double-click into that a little bit more and figure out their numbers.
But I think the message I was trying to communicate was like that when you think about Equinix and Digital Realty being the two largest data centers on the planet, their spending is a small part of this huge opportunity and there’s a lot to go take advantage of.
Jordan Sadler
I can maybe lend a little bit of a hand there. I think in our experience, we see fit out so data center fit out by these hyperscale customers buy the megawatt, right? We build for we call it 10 million a megawatt keep-it-round numbers. We see them investing in that same space at a rate of about $40 million to $50 million a megawatt in servers, racking, stacking and cabling. So per megawatt. And our — the telecom and technology.
Unidentified Participant
20%, that’s the spend is on the data center. To you guys [Multiple Speakers]
Andrew Power
They actually pay us $1 million of rent, right.
Unidentified Participant
[indiscernible]
David Barden
Can you repeat the question?
Andrew Power
Yeah. Sure. I think Jordan’s asked about to characterize the — how the conversations with the big customers in the current environment. What we’re seeing is a continued urgency for these large capacity blocks with the nearest term delivery with certainty around power, and it’s from the same group that were the top buyers of cloud computing. But slightly expanded because some of those we’re doing more self-build themselves historically, less now. We’re doing deals where they did Shell deals and built inside the data centers themselves less now.
And there are some new names around the trough to hyperscale today like big buyers as well, all in the backdrop where supply constraints due to power generation, transmission, substation components, switch clear sustainability concerns, moratoriums, nimbyism are called intersecting the market in many fashions, so our value add being prepositioned with all those attributes and be able to — be able to operate is extra appreciated right now. on that backdrop.
Unidentified Participant
[indiscernible]
Andrew Power
Correct.
Unidentified Participant
[indiscernible]
David Barden
How do you see pricing across the marketplace?
Andrew Power
So the hyperscale business has shown proven to be the most volatile in pricing. Part of that is just, it went from earliest innings and matured as an asset class, that happened in a time period when interest rates were only going down and there — it happened broadly in markets that didn’t have supply constraints, right? And so rates for a market like in Northern Virginia got probably pushed down to the 70s. And now, call it, popped up well north of 150, and we have the potential to be, call it, printing close 200 in terms of rates as an example.
That phenomenon, I don’t see playing out in our enterprise colocation business as much. Hyperscale is, call it, longer-term contracts. The colo (ph) contract format is usually a shorter-term contract. There is, I’d say, a greater stickiness or less churn in the colo and we’ve just had more regular pricing power in terms of escalation of those contracts. So you have less of dislocation or really massive supply constraints in the colocation market like hyperscale.
David Barden
So let’s — we’re going to run out of time here really quick. So let’s kind of rewind a little bit and maybe close out that conversation. A couple of years ago, one of the challenges that Digital Realty faced was negative releasing spreads. And that was because the customers that you had signed a decade earlier became these behemoths, and they came back and they asked you for a lot better pricing at the 10th year anniversary and you had to give it to them. Are we starting a new cycle where it feels good today, but we might have a problem in the future.
Andrew Power
I mean there’s always — the volatility in the business always has the potential just to resurrect. I think the way we’re pursuing our strategy around hyperscale, when you think about what we’re doing today, we are obviously signing at better rates than we had in any priority of recent times. We’re locking in the longest contracts we’ve ever had 15 years. We’re also pushing on the escalations. I think last quarter, our biggest deal on a 3.5% rent bump, we could potentially do better than that in the coming quarters.
David Barden
The domestic 3.5%?
Andrew Power
Yes. And I think the — what you have is the overall market saturation in 15 years’ time, the locational sensitivity, there’s going to be less places for these customers to build the cloud out. So I think that combination with also there’s been inflation in build costs, right? There’s no question that the per megawatt cost we would quote were certainly single digits for many markets years ago. We’ve been now throwing around 10 as a more rough swag average a day.
These camps are getting bigger. It’s going to take longer to build out. So the impact of inflation and the build cost could continue as well. So I don’t see — and I also believe the pain points on new capacity, yes, they may get solved, but I don’t see quick solves with permanence. Yes, the southern line may come in and relieve power needs for — no star. But they’re going to need to do a Northern line after that. That’s going to take a series of years, not months and other markets are going to — that we’re butting up against other, call it, uses too.
When Northern just started, it was corn fields, right? And we were welcomed as an asset class. Now we got to be very good neighbors. And I think Digital Realty stands out in that in terms of where we locate our data centers next to the airport, not next to the battlefield and things like that. And I think this — I’m picking on one particular market, but of our 50 markets, preponderance of these types of supply constraints and more thoughtful elongated development time lines. I think these are features of the business that are going to be here for some time.
David Barden
Yeah. I would just point out — so thank you for that. So I would point out that today, the telco tech industrials group put out a report called who makes the data center. So if you want to know about who builds what that goes in the data center, that’s a big part of it. And earlier this year, the industrials group, Andrew Obin and his team put out something that talked about the grid demand and that data centers are not the only thing that’s putting attacks on the grid, it’s EV, electric vehicles and also the onshoring of manufacturing, which is a big deal.
I want to maybe wrap it up, Andy, by talking about something that kind of dovetails from the prior question, which was that a couple of years ago, it was negative re-leasing spreads. It was dilution from acquisitions. Last year, it was trying to fix the balance sheet in a rising interest rate environment. The AFFO per share growth guidance for this year is 0% to 1%. There’s a target to get to mid-single digits and I think an aspiration to get better than that. Walk us through how Digital Realty gets from where it is now on a bottom line growth given all these great top line things that are happening to better bottom line growth.
Andrew Power
So we basically came out at the beginning of this year and next year 2025, net of headwinds from the deleveraging that took place over 2020 this year, that mid-single digits is the goal. And thereafter, that is not the goal of that is the floor and we would do better than that. And our path to that is through, obviously, execution on the pricing lever, our cash mark to markets on the installed base. Leasing up our vacancy, delivering on our capacity coming online, blocking and tackling.
But thereafter post the headwinds from the deleveraging, we’re really — we think there’s a path where we are essentially taking this demand is AI demand and clock-out demand and turn it into long 15 year contracts with 3, 3.5 maybe even higher escalations and building record backlogs to have a long runway of growth that we want to drive to the bottom line. And the M&A dilution is behind us.
And the only thing that puts headwinds are things that we think are long-term goods, be it contributing to private capital sources, stabilized assets and attractive valuations or how much development we share with partners. So we’re not happy with five even though that’s the goal for next year. We think there’s better ahead. And we want to build a long runway of comp consistently compounding the per share bottom growth as the top priority for our company for several years in the future.
David Barden
I think that’s a great place to leave it. Thank you so much, Andy. Thank you. Appreciate it.
Andrew Power
Thank you, everybody. Appreciate it.
Jordan Sadler
Thank you.
