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DuPont Fabros Technology (NYSE:DFT)

March 05, 2013 1:35 pm ET

Executives

Hossein Fateh - Co-Founder, Chief Executive Officer, President and Director

Jeffrey H. Foster - Chief Accounting Officer

Analysts

Emmanuel Korchman

Emmanuel Korchman

Welcome to the 1:35 p.m. session at Citi's 2013 Global Properties CEO Conference. This session is for investing clients only, and if media or other individuals are on the line, please disconnect now. We're pleased to have with us DuPont Fabros Technology and CEO Hossein Fateh. Hossein, I'll turn it over to you to introduce your management team, provide a couple of minutes of opening remarks, and then we'll go straight into Q&A.

Hossein Fateh

Great. Thank you, Manny. Again, my name is Hossein Fateh, I'm here with Jeff Foster, our Chief Accounting Officer, and Chris Warnke, Head of IR.

DuPont Fabros Technology is a data center REIT primarily in the wholesale business of data centers. We have approximately 218 megawatts of critical load, 90% of it is fully leased. Virginia is our biggest market. We lease space to the world's top technology companies and we are an alternative to having your own data center with the economies of scale of a very large data center. We lease space by the amount of available megawatts, more than square feet, because those terms are what the tenant really understands, whereby what they care about, is how many servers they can power up and as long as we have -- as long as we can cool them. And the buildings are all engineered to cool the power that the servers have because 1 kilowatt of energy equates to 1 kilowatt of heat, so it's a 1:1 ratio, and then we take off that heat.

The portfolio is mainly in the Washington DC area, but we are in 4 geographical locations. We are in New Jersey that primarily serves the financial industry. We are in Virginia, which is the, it's really the Silicon Valley of the East. Chicago serves the middle of the country, and Santa Clara, on the West Coast. The Ashburn Campus is now, in other 0.5 megawatt, is 100% leased. Chicago, we only have 1.3 megawatts left. And Santa Clara, we are 75% leased. New Jersey, the one market that has leased-up slightly slower than what we expected. But our guidance for this year shows -- our guidance for this year assumes no leasing at all in Jersey. So anything that we do in Jersey, we'll be additive to that. With that, Manny, I'll turn it over for questions.

Question-and-Answer Session

Emmanuel Korchman

Great. We're asking all the CEOs here the same starting question to get things of rolling. So what do you think is the most value-creating opportunity you currently have that the market is not attributing much value for?

Hossein Fateh

Well, currently, I think our stock is usually undervalued and we're buying back our own stocks. So it's a very pertinent question. Last -- about 10 days ago, we filed a form that showed that we have purchased, and it's about $20 million of our own stocks. We have a $80 million buy back in place, and since 10 days ago, we've bought another significant amount of stock. So at these prices, we think it's extremely attractive, our risk-adjusted return. I mean, I asked you just before the call, you have us trading approximately at a 9.5 cap at these prices, so risk-adjusted return is an unbelievable return. With the credit quality that we have, that is -- I mean, if you look at -- if you think about Facebook and Yahoo! being investment grade, we're 90% investment grade. Tenants locked in on triple net leases with average lease term running 7.1 years left.

Emmanuel Korchman

Maybe you can remind everyone how much you have left, obviously, after that performance value, so you bought back some more stocks. And how much more capacity do you have? And as a follow-up to that, any thoughts on increasing the size of the program?

Hossein Fateh

We are -- our intention is to go back to the Board once the $80 million is filled and ask for a second $80 million. We have some covenants in our line that restricts us right now, but we've talked to all the banks in our line to removing those covenants. So -- but we're going to be opportunistic with the buying. So, and we have plenty of capacity. Currently, even at these very low levels, we're at 23% debt-to-valuation. And we have -- we're trading at -- currently, our debt-to-EBITDA is 3.5, and our fixed coverage ratio is 2.4. So we have plenty of capacity balance sheet-wise to be able to buy more stock.

Emmanuel Korchman

So you don't think that the stock buy back is going to affect your other capital plans in any way, whether that be development or acquisition or whatnot?

Hossein Fateh

Well, I mean, if there were to be an acquisition that was available, we would be opportunistic about that, but we would marry that up. I mean, primarily, we'd use as much preferred as possible. Last night, the Citibank banker quoted me 6 3/8. It was a lot [ph] on our preferred so we would match any acquisition that was available with as much preferred as we can get. We can -- we have debt capacity to increase our debt. And then we would also match it with an accretive equity issuance if it was large enough, but we would not do an acquisition that is not accretive.

Emmanuel Korchman

Great. And then, Jeff, you mentioned with me that guys have some other capital markets activity that you can take advantage of at the end of 2013. Maybe you can walk through that?

Jeffrey H. Foster

Yes, our big opportunity this year comes at the end of the year. We have $550 million of bonds outstanding.

Hossein Fateh

I'm going to take that. I'll take that. We have $550 million of bonds outstanding. On December 15 of this year, we are able to buy it back at $104.25. So at $104.25, if you think about that, that's some $0.20 of FFO accretion, just that, and I think the market has somewhat missed that $0.20 of accretion. That's very real and we're certainly going to take advantage of it. And we'll probably upsize it from the $550 million to maybe $700 million, and any stock buyback would then be -- we can then pay down our line to 0.

Emmanuel Korchman

Any questions from the floor?

Unknown Analyst

I'm new to this space, so a lot of people may know this. But you talked about the tenants pricing off the megawatt.

Hossein Fateh

Yes.

Unknown Analyst

And when I look at your stock, it looks like it's trading around, call it, $8,000 a megawatt. And when I look at the deal you did in [indiscernible] Village, it seems like it's a pretty attractive cash flow yield on that. When I look at it as a real estate guy, it's $2,000 a foot. And so the immediate question I have is, are there -- in your leases, when you're creating them, in terms of the power capacity, are there things that depreciate as part of that lease? And so that part of the lease really reflects the kilowatts that they're buying, but part of it also reflects maybe other infrastructure that will depreciate during the lease term?

Hossein Fateh

No. In fact, if you -- that was the thought that some people have thinking that these buildings have a limited lifespan. But if you take the different components of the building and the way we maintain them, they really have a 30, 35-year lifespan. If you look at what does the building contain? It contains a diesel generator that runs 25 hours a year. What's the lifespan of a diesel generator that runs 25 hours a year? The rest of it is electrical wiring. What's the lifespan of electrical wire? The only piece of equipment we have that has a moving part to it is our UPS, the auxillary power supply. That has a flywheel. That flywheel gets overhauled every 4 years, but the overhaul is paid by the monthly maintenance contract that the tenants are on. The chilled water plant is pretty much steel -- stainless steel that's outside and water evaporates. What's the lifespan of a chilled water plant that is maintained to the nth degree? These are -- these buildings are maintained to such high standards that they really have a 30, 35-year lifespan. So there's nothing that depreciates.

Unknown Analyst

And so when you look at it compared to some of your competitors that have much lower enterprise values per kilowatt, is it -- how would you describe the differences between those?

Hossein Fateh

Well, I think our competitors, many of them don't look at the amount of total megawatt that they have. And some of their buildings are triple net leases, whereby Savvis or in Equinix as a tenant. And those buildings that are operated by the tenants, our competitor may not even know how many megawatts of capacity that building has because of the 15-year triple net lease where the tenant owns the infrastructure and the landlord owns the shell. So it's not really a fair comparison because it's not apples-to-apples.

Jeffrey H. Foster

Well, I think there's another thing, too. Some of our competitors report kilowatts in a different way than we do. We report available load that can go into the servers, but the load for our total building is much higher than available load. And other people might report the higher number.

Hossein Fateh

In another instance I read, this was like 3 years ago. One of our other competitors was quoting load at the substation, not even on the building. [ph] So it's really what -- in that instance, there was a building that I had sold them as a private guy. I was quoting that building at 5.2 megawatts. They were quoting the building at 25 megawatts. So...

Unknown Analyst

What are the requirements in terms of new developments for pre-leased and the discipline in terms of getting pre-leased?

Hossein Fateh

Well, obviously, we want to do as much pre-leasing as possible. We try and maximize as much pre-leasing as we can to reduce the risk. But what we've also been able to do, to follow-up on that question, is the ISO-parallel buildings we have produced the most redundancy that we've seen in the industry. Historically, we've only been able to build them in 18.2-megawatt increments. Now, on ACC6, we actually tested bringing on the live load in chunks, and now we have the ability, after having built 5 of them that are ISO-parallel, we have the ability to bring them on in smaller 4.55-megawatt increments. So going forward, the speculative risk that we're going to take on the buildings is going to be smaller, because we can bring them on in smaller chunks. So if we pre-leased 4.5 megawatts, we're only going to build 9-megawatt within 1 phase, and then add to it as the leasing goes along.

Unknown Analyst

A follow-up on that, if you just look at your 4 markets on the areas where you have oversupply, and how long it will take for that to move?

Hossein Fateh

Well, I think, there's only really one area that we have supply in. In Northern Virginia, where the Ashburn campus is 100% leased. In Chicago, we were 100%. One tenant had an option to give back 2 parts, they elected to and we gave one of them back. So we only have 1.3 megawatts. I wish I had 5 megawatts available in Chicago right now, but that's not going to be so. In Santa Clara, we're now 75% leased and it's going exactly as planned. So the only real vacancy we have is in the New Jersey market. And for the good part, we are almost the entire vacancy of the market. So anything that we can get will be additive to that. We haven't -- our guidance, as I said, shows that we do no leasing in Jersey. Obviously, I'm cautiously optimistic that we'll do better than 0, so anything will be additive.

Unknown Analyst

I see. And I think everyone in the room sort of realizes that New Jersey is kind of not in guidance at this point and it's taking a while for you to get leasing there. But what people continue to struggle with is the idea of 2 competitors -- major competitors, building new facilities there or doing redevelopments there, however you want to look at it. Can you help give us some confidence in the -- either the structure of the asset itself or maybe what you're seeing in terms of walk-in demand that could come? And sort of, how do you internally get confident that it's not -- it hasn't gotten stale and not -- that it's just going to go anywhere at this point?

Hossein Fateh

Well, I think, look, it is 39% leased, right? So a couple of more leases and we'll be 50% leased. So we're more than -- and we're on our way there. So it's the fact of this, that market is typically for what works well just like an insurance company, or a smaller investment banks that would not make sense to have their own data center. If it is not necessarily revenue-driven, but it's not one of a big software company saying that, "Look, my cloud product is not going to grow as fast if I don't have the data center space." Because more where -- it's a company that had 2 data centers in New York, one of them was flooded and underwater, now they need a new data center, or their data centers were old, and now, if they can delay the decision for another year, they'll delay it and then lease data center space next year. As far as our competitors are concerned, I think, well, there are 2 of them, right? So let's be open. The CoreSite, I believe, they're going after the network-centric market, and that's what they're trying to build, and hopefully, they'll be successful. As far as our other competitor, they're typically bringing on 1 or 2-megawatt chunks. So I think, eventually, we'll get there, and we have a handful of deals right now that we're talking to, and hopefully, some of them can get signed.

Unknown Analyst

What kind of chunks are those deals in?

Hossein Fateh

They're smaller. Typically, New Jersey market is 0.5 megawatt to 1 megawatt-type of customer.

Emmanuel Korchman

Any other questions out there? Is it -- maybe going back to the question we had from the audience earlier on pre-leasing. Sort of when do you get to a point that you start developing quicker? So right now, we're looking over of your portfolio, you've got potentially Chicago and Virginia coming on as the next sort of things that you're building. When do you do more than 1 or 2 small projects?

Hossein Fateh

Well, I think when you look at what we have on our plate right now, in the second quarter of this year, we'll probably start ACC7. We're super excited about that product. We've been working on it for many years, what we termed as our Version 3.0. It will be more efficient to build and more efficient to operate in terms of PUE, in terms of construction cost. And in terms of redundancy, it will be the best data center that we've ever built. So we're excited about that on the second quarter of this year. And again, depending on the amount of pre-releasing, we'll determine how much space we'll put out. The other one that's, again, not in our guidance, but could happen depending on preleasing is the second phase of Santa Clara, because right now, we're at 75% leased and we're making very good progress there on the leasing.

Emmanuel Korchman

I'm going to take advantage of that to segue to answer our next question, which was CoreSite's built-to-suit deal in Santa Clara. Did you have conversations with the same tenant and sort of what your Santa Clara project there and space available in Phase 2 right around the corner, why did they chose to go CoreSite rather than you?

Hossein Fateh

I'm not sure which deal it was that CoreSite did, so...

Emmanuel Korchman

CoreSite announced the built-to-suit deal in Santa Clara. I don't have it even. Ask the audience? But there was a built-to-suit deal that they announced with their fourth quarter results.

Hossein Fateh

Yes, I'm not sure which deal it was, so I can't comment on it.

Unknown Analyst

The other thing that CoreSite said in theirs was that they have had a lot of prompts in Facebook and the other super wholesale tenants because they're sophisticated guys with big balance sheets that could [indiscernible] driving them to leave their projects if they didn't lower rent. Obviously, one of the great things about you is you've got the greatest tenant roster, but they're also smart guys that all have big balance sheets. How do you price your product to make sure that you're competitive now and just do it themselves?

Hossein Fateh

Well, in the last 6 months, Facebook just signed another video [ph] with us. So obviously, we're pricing it correctly, because they just signed another 8 megawatts with us. And it seems to have -- it's worked certainly very well for us because we're able to aggregate even these larger tenants on that project, ACC6 Phase 2. We were able to get a 12% un-levered return even at those super wholesale rates, which when we went public 12 years -- 5 years ago, we only predicted doing 12% on all our deals. So that's remained consistent, except for a while, we were doing 15% in Virginia. But a 12% yield when we can get our preferred money at 6 3/8, that's a home run all day long.

Unknown Analyst

Just a couple of questions. First one was, with respect to -- just a follow-up on the larger tenants that you have. What is the risk that the tenants come to you 2 or 3 years before their contract is up and renegotiate in that kind of a time span? Because if they're going to build their own alternative, they have to have a couple of years lead time with that. And so what is the risk that you have to keep signing new deals, maybe lowering the initial price and you could get an escalator from there with the idea that you never realized the full initial contract value that you'd signed?

Hossein Fateh

There is no risk on that, and I'll explain why. Even on the 1 tenant that we renewed at a lower rent, their lease goes on to the end of the contract and then it resets at the end of the contract. So we've never done a deal where you've renegotiated and cut the lease up. That has never happened and we would never do that. And I think to go onto second part of it, that risk is also minimal because when you look at the 4 larger tenants that we have, the Microsoft, Rackspace, Yahoo! and Facebook, the Microsoft deal, the 2 deals are already redundant. At the Rackspace, where the majority of those leases are 15-year leases, that they're already at the lower rent. So it leaves 2 of those. The last Facebook deals we did were already at the lower rent, so I would say 2/3 of Facebook remains at risk, but that's more than 6 or 7 years out. And the only other one is Yahoo! and frankly, with Yahoo!, we have one deal coming up in 2015, and I'm not sure what they're going to do. I recently had another tenant that wanted to into that space, and I called them and I said, "Would you give me back half of your space, and I can release it back up?" And their response was, "No, we absolutely need it. We can't move." So -- but I think Yahoo!'s whole strategy right now is uncertain to some point.

Unknown Analyst

The second question was as you think about the future of data center builds, let's say, you get through to some of these occupancy opportunities in Jersey and fill out the rest of your portfolio, how do you think about the next leg of growth? How would you position the build cycle? Would you build the same kind of facilities on this large-scale basis? Would you take a different approach? How do you think about that next leg of data center growth?

Hossein Fateh

Well, I think you certainly want to eventually end up with a same-size data center, but build it in smaller increments. The size makes an enormous difference to our operating costs, and that's really the real value proposition here. It is not just the cost of capital for these tenants. If you look at that our -- typically, our rent may be $110 per kilowatt, the operating cost in the ACC-type of buildings are about $25 a kilowatt. If you're a 1-megawatt tenant and you have your own little data center in the basement of your office building, your operating cost is going to be $75, $80 a kilowatt on a 1-megawatt deal. So I don't care what cost of capital they have, it's the operating cost that's going to kill them. And that's really the real value proposition when you go into a much larger data center that you can spread your cost over a much bigger base. So I think more and more of the tenants realize that, and we've had, actually, tenants come to us and say, "We'll -- " -- we've had discussion and they're not signed, so please don't write anything like that, Manny. But we've had discussions where our tenant comes to us and says, "We're looking at this geographical area. We want to be in a 36-megawatt building, but -- and we'll commit to taking 8 megawatts of it." Because they know, by cooling their assets with other tenants, they'll be able to lower significantly the operating cost. And when you look at that versus PUE -- if you look at the PUE discussions that has had so much press, the -- at $0.06 a kilowatt, if the power cost -- if you're running 1 megawatt, your power is going to be approximately $35 a kilowatt, if you're using 80% of your load. So you're cooling at -- in one of our buildings, it would cost you approximately $8 a kilowatt, right? $8 a kilowatt even if you double the -- improve your cooling, that'll go to $4 a kilowatt, so your savings is $4. But if you screw up your operating expenses, you're going to be hit with $50 per kilowatt. So that's really the value proposition.

Emmanuel Korchman

Hossein, if we can go back to the example you just gave of a tenant coming to you and saying, "We'll do 8 megawatts of a 36-megawatt total building." You can now build 9 megawatts of it in sort of the first stage. So obviously, you'd have the build type bigger than that because you wouldn't probably just hand it to a single tenant. Is that enough comfort for you to go into a new market?

Hossein Fateh

I think, if we're -- if we had 8 megawatts of it pre-leased and we would probably put out another 3 or 4 megawatts, yes, it would be.

Emmanuel Korchman

I think there's a question.

Unknown Analyst

[indiscernible] talking about [indiscernible] structure and the amount of [indiscernible].

Hossein Fateh

I think...

Emmanuel Korchman

Just to repeat the question, it was is there a sort of a limit as to, in your mind, on preferreds. And you obviously like that as a source of capital, but from a fixed cost coverage or fixed cost side of things, it's no different than that.

Hossein Fateh

Well, I think, on a fixed charge coverage, is what you're talking about, right now, we're at a 2.4x or 2.5x. I'd be comfortable with that coming down to about a 2x. So we have some room there. Does that answer your question?

Unknown Analyst

Yes, and [indiscernible]

Hossein Fateh

I think we -- Yes, I think we want to -- yes, I think we are a -- well, if I could answer that. I think, how -- we have risks in development, we have risks in leasing, we have the unusual asset class. If we can eliminate the maturity risk, it's very comforting. But I agree with you that we would balance it, like I said earlier. We would, probably at the end of the year, upsize our debt as well.

Unknown Analyst

And are there any other sources of capital that you've thought about in terms of potentially selling assets?

Hossein Fateh

We have, actually. And funny, you should ask that because we have thought about, now, some of the single tenant buildings may make sense, especially now that many of them are leased all the way through to 2026. They're very bankable, and we could easily sell them with great credit. I mean, it was disclosed in our IPO that the ACC3, for example, was leased to Microsoft. And so if you go back and look at that to have Microsoft leased through 2026, that's a very much of a bankable deal. We haven't approached the tenants about it, but that's really -- I mean, if and when we need equity, that would certainly be an option as well.

Unknown Analyst

Who would be a buyer for something like that?

Hossein Fateh

The most obvious one would be the tenant. But I haven't approached them and so...

Emmanuel Korchman

Great. Well, I think we'll wrap up with our 3 rapid fire questions. The first one is what will same-store NOI growth be for your property sector, so all data centers in 2014?

Jeffrey H. Foster

[indiscernible] same store NOIs for all data centers. We only have 2 leases up for renewal ourselves, so we haven't -- we know for ourselves, it's not an issue. I haven't focused on the other groups. Do you think they're same -- they're renewals would go up or down or -- for the other CoreSite [indiscernible].

Hossein Fateh

I think it depends. I mean, you have to look at it. It was disclosed in CoreSite's S-11 that their Facebook deal was the -- was at a high rate in Santa Clara. So I think the network part of their business is very valuable. I think they have other sorts of businesses not necessarily as valuable. But I think the whole industry is going to do well. Certainly, the cloud is growing and it'll help both us, CoreSite, Digital and CyrusOne. All of us will do well with the growth of the cloud.

Emmanuel Korchman

10% cloud or 2% cloud? Do you want ...

Hossein Fateh

I'll say 3%.

Emmanuel Korchman

If you had to, what property sector, other than your own, would you personally invest in right now?

Hossein Fateh

I would personally invest in stick building apartments, if I could.

Emmanuel Korchman

And maybe this is a given...

Hossein Fateh

To be built.

Emmanuel Korchman

To be built. All right. Do you expect to see more or less public data center companies 1 year from today?

Hossein Fateh

That's the easy one. I think, probably, maybe, there may be 1 or 2 more.

Emmanuel Korchman

Thank you.

Hossein Fateh

Thanks, Manny.

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Source: DuPont Fabros Technology, Inc. Presents at 2013 Citi Global Property CEO Conference, Mar-05-2013 01:35 PM

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