Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message| ()  

Executives

Pamela Matthews – Director of Investor Relations

Michael F. Foust – Chief Executive Officer, Principal Executive Officer & Director

A. William Stein – Chief Financial Officer, Chief Investment Officer & Secretary

Analysts

Jordan Sadler – Keybanc Capital Markets

Jamie Feldman – Bank of America Merrill Lynch

Michael Bilerman – Citigroup

George Auerbach – ISI Group

Srinivas Anatha – Oppenheimer

Michael Knott – Green Street Advisors

William Marks – JMP Securities

Digital Realty Trust, Inc. (DLR) Q3 2009 Earnings Call October 29, 2009 1:00 PM ET

Pamela Matthews

By now you should all have received a copy of the Digital Realty Trust earnings press release. If you have not you can access one in the investor relations section of Digital’s website at www.DigitalRealtyTrust.com or you may call 415-738-6500 to request a copy. Before we begin I would like to remind everyone that the management of Digital Realty Trust may make forward-looking statements on this call that are based on current expectations, forecasts and assumptions that involve risks and uncertainties that could cause actual outcome and results to differ materially from expectations.

You can identify forward-looking statements by the use of forward-looking terminology such as believes, expects, may, will, should, pro forma or similar words or phrases. You can also identify forward-looking statements by discussions of strategies, plans, intentions, future events or trends or discussion that do not relate solely to historical matters including such statements that relate to demand, acquisitions, construction activities, cost savings to customers, investment opportunities, future contractual compliance, financing, liquidity, capital expenditures and the company’s expected financial results for 2009.

For a further discussion of the risks and uncertainties related to our business, view the company’s annual report on Form 10K for the year ended December 31, 2008 and subsequent filings with the SEC including the company’s quarterly reports on Form 10Q. The company disclaims any intention or obligation to update or revise any forward-looking statements whether as a result of new information, future events or otherwise.

Additionally, this call will contain non-GAAP financial information including funds from operations or FFO, adjusted funds from operations of AFFO, earnings before interest, taxes, depreciation and amortization or EBITDA, same store net operating income or NOI and same store cash NOI. Digital Realty Trust is providing this information as a supplement to information prepared in accordance with generally accepted accounting principles.

Explanations of such non-GAAP items and reconciliations to net income are contained in the company’s supplemental operating and financial data for the third quarter of 2009 furnished to the Securities & Exchange Commission and this information is available on our website at www.DigitalRealtyTrust.com.

Now, I would like to introduce Michael Foust, CEO and Bill Stein, CFO and Chief Investment Officer. Following managements’ brief remarks, we will open the call to your questions. To manage the call in a timely manner, please limit your questions to two per caller. If you have additional questions, feel free to return to the queue. I will now turn the call over to Mike.

Michael F. Foust

I’ll begin with a brief overview of Digital Retail Trust. Then, I’ll review the success of our portfolio operations during the quarter. Following my remarks Bill Stein will discuss our recent financing accomplishments, our third quarter financial performance and our 2009 revised guidance. Digital Retail Trust is the leading owner and manager of technology real estate. Our portfolio currently contains 78 properties now totaling 13.8 million rentable square feet and this excludes one property, the Westin Building in Seattle that’s held as an investment in an unconsolidated joint venture.

Our properties are located in 27 metro areas across North America and Europe. Our portfolio also includes approximately 1.9 million square feet of space held for redevelopment which continue to be a very important source of growth for the company. DLR provides a wide variety of datacenter facility solutions including our turnkey datacenter, our power based building and build-to-suit datacenters for domestic and international corporate customers.

Our properties serve a wide range of industry vertical markets including information technology, Internet enterprises, financial services, telecom network providers, energy companies and other Fortune 1000 firms. We are recognized as an industry leader in datacenter design and investment.

Moving on to our operating results for the third quarter, portfolio occupancy excluding space held for redevelopment increased slightly to 95.2% at quarter end compared to 94.8% at the end of the second quarter and 95.2% for the same period in 2008. The increase in occupancy is attributed to leases commencing during the quarter on new completed datacenter space entering the operating portfolio.

We completed three significant acquisitions during the quarter. In September we acquired a controlling joint venture interest in a very well located redevelopment project in suburban Dallas in Richardson Texas. Formerly known as Collins Technology Park, the new Digital Realty Data Center Park Dallas consists of seven very robust buildings totaling approximately 795,000 square feet of potential powered based building space. These buildings range in size from 15,000 feet to 250,000 square feet.

The 69 acre property also contains develop land sites for ground up build-to-suits and our own private utility substation with 40 megawatts of immediate power availability which is really expandable up to 125 megawatts. With this high capacity substation in place, we are supplied with power at rates generally 25% below most customers in the Dallas region. Combined with our industry leading datacenter construction costs, we offer tenants very lower cost of occupancy in the Dallas region.

In addition, we acquired 444 Toyama Drive, a highly improved 42,000 square foot 100% leased datacenter located in Sunnyvale California. We also acquired the remaining non-controlling interest from our partner in 1525 Comstock Street. This is a fully leased 42,000 square foot property located in Santa Clara. The two stabilized investments yield an annual NOI of $5 million and were acquired for a total purchase price of approximately $43.9 million. The blended cash cap rate is consistent with our 2009 guidance of 10% to 12% given on the last call.

In terms of our leasing activities, for the quarter ended September 30, we commenced leases totaling approximately 101,000 square feet of space. This includes approximately 90,000 square feet of turnkey datacenter leased at an average annual GAAP rental rate of $187 per square foot and we leased approximately 11,000 square feet of non-technical space at an average GAAP rental rate of $25 per square foot.

Year-to-date we commenced over 666,000 square feet of datacenter. This includes 317,000 square feet of turnkey at an average GAAP rental rate of $178 per square foot and includes 174,000 square feet of powered based building at an average rental rate of $62 including conversion for foreign currencies. In addition, we commenced 176,000 square feet of non-technical space at an average GAAP rental rate of $16.

Lease commencements year-to-date as of September 30 are estimated to contribute approximately $54.2 million of incremental revenue recognized in 2009. Leases signed year-to-date totaled approximately 278,000 square feet of space. This includes 216,000 square feet of turnkey datacenter leased at an average annual GAAP rental rate of $176, 5,000 square feet of power based building leased at an average GAAP rental rate of $32 per square foot and approximately 57,000 square feet of non-technical space at an average GAAP rental rate of $20.

We continue to see longer sale cycles for lease approvals and signing often requiring customer board level approval because of the significant total capital commitment involved in these large IT deployments. In spite of the longer lead times we remain on track to meet our 2009 expectations and we see very positive leasing momentum heading in to 2010. As reflected in our year-to-date results the great majority of demand is for the turnkey product reflecting customer capital constraints also reflecting our extremely cost effective design and the very quick time to market delivered by DLR.

Currently our sales team is engaged with direct discussion with over a million gross square feet of new datacenter prospects in nine of our primary markets. This is consistent with the level of demand we are tracking over a year ago. Overall, we have identified approximately four million square feet of potential requirements requiring new datacenter space in our markets. We continued to achieve unlevered NOI returns on all costs of 12% to 15% for our new [inaudible] and turnkey construction.

Consistent with our last reporting period, the most active industry categories are IT service providers represented by Equinox, Telex and major network providers, system integrators such as IBM and financial services firms such as Nomura. Our lease renewal program is performing quite well with lease rents increasing on average and we continue to see a number of existing tenants choosing to renew their leases early.

During the quarter we signed 418,000 square feet of renewals bringing the year-to-date total after adjusting for short term extension to approximately one million square feet. Overall, we’ve renewed approximately 86% of eligible square footage, 111% cash rent and 112% of GAAP rent for those renewals. This includes approximately 27,000 square feet of turnkey space and an average GAAP rental rate of $146 reflecting an 8% increase on a GAAP basis and 4% cash basis over the previous rates.

These statistics also include 751,000 square feet of power based building data space and an average GAAP rental of $32 per square foot. This reflects a 30% increase on a GAAP basis and a 17% increase on a cash basis over the previous rates.

Turning to our redevelopment program, we are currently underway on construction projects on high demand projects in [inaudible] and Europe on approximately 143,000 square feet of turnkey datacenter space in several locations. 47% of that amount is leased. We’re underway on 135,000 square feet of new power based building at our Ashburn Virginia campus. During the quarter we delivered 59,000 square feet of turnkey space and 8,000 square feet of power based building all of which is 100% leased. We currently have approximately 66,600 feet of turnkey space that had been completed and is available for lease.

As a result of our strong balance sheet, operating platform and technical expertise, we continue to see attractive investment opportunities that have the potential to contribute to our earnings and the growth of our company. As discussed on our last call, we expect income producing acquisitions to take a larger role in our investment strategy complimenting our internal growth through leasing and the development program.

In addition, we have signed our first POD architecture services design and project management contract with an existing customer to develop its new corporate owned facility. As a turnkey customer already this major financial services firm has already experienced the benefits of our cost effective POD design and our operational capabilities. They will recognize additional savings of tens of millions of dollars in both construction and ongoing operating costs for this new project. We believe this is a powerful value proposition that when combined with leased spaced [inaudible] our own buildings will further deepen our relationships with the enterprise customers.

I would now like to turn the call over to our CFO Bill Stein.

A. William Stein

I will begin with a discussion of our liquidity position and then review our third quarter 2009 financial results and finally discuss our revised 2009 FFO guidance. Following my remarks we will open the call to your questions. In addition to the new $30 million commitment under our revolving credit facility that we discussed on our last call, we closed two important secured mortgage financings for properties in our European portfolio.

In mid October we closed a five year $23.8 million Pound loans secured by two properties located in the United Kingdom Cressex 1 in suburban London and Manchester Technopark in Manchester. The interest rate is 5.68%. The second is a five year $30 million Euro interest only secured mortgage financing for Clonshaugh Industrial Estate 2 located in Dublin Ireland. This loan is scheduled to fund in early December. Based on the current swap rate the all in interest rate is approximately 7.37%.

Year-to-date we have sourced $552 million of additional capital and are continuing our efforts to identify and selectively access capital when capital market conditions and pricing are favorable. Related to these efforts this morning, Moodys issued a press release announce it has rated DLR a BAA2 credit. We are currently awaiting ratings from the other agencies and plan to utilize our ratings to access the unsecured corporate bond market at the appropriate time. Access to the investment grade unsecured debt market will be an important component of our future funding strategy and will further differentiate us from our competitors.

Our total debt at quarter end was $1.6 billion and our ratio of debt to total market capitalization was 26.5% based on the September 30 stock price of $45.71. Based on yesterday’s closing stock price of $44.57 our ratio debt to total market value capitalization would be 26.9%. Our adjusted EBITDA to cash fixed charge coverage ratio was 2.9 times and our adjusted EBITDA to cash debt service coverage was 4.9 times for the quarter. Net debt to adjusted EBITDA multiple was four times for the quarter.

As of September 30th our weighted average cost of debt included interest rate swaps of 5.5% and the weighted average maturities was 4.6 years including debt extension options. A description of how we calculate these ratios and the other non-GAAP financial measures can be found in our supplemental offering and financial data report furnished to the SEC and available on our website.

Turning now to our liquidity, we have approximately $691 million of liquidity through short term investments, funds that can be drawn on our revolving credit facility and pro forma for the Cloonshaugh loan funding in early December. If this capacity were fully utilized our pro forma total debt to market capitalization would be approximately 34.5% based on yesterday’s closing stock price and pro forma our net debt to adjusted EBITDA would be 5.8 times. If we were to utilize the full $691 million we would remain in compliance with the covenants contained in our revolving credit facility, Prudential Shelf facility and outstanding secure debt.

Our remaining expected capital requirements for 2009 are between $210 million and $225 million and include $85 to $95 million of redevelopment cap ex, $25 million of portfolio level cap ex as well as $100 to $105 million for new acquisitions net of debt to be assumed. We have $3.2 million of ongoing principal amortization and no debt maturities for the remainder of 2009. Assuming that we fund all remaining cash needs through the end of the year on our revolver we’d have approximately $466 million to $481 million of liquidity without raising any additional capital.

In 2010 we have $50 million of principal amortization and no debt maturing. In 2011 we have approximately $233 million of ongoing principal amortization and debt maturities including $172.5 million for the 4 1/8ths exchangeable senior debentures which can be put to the company by the holders at 100% principal amount in mid 2011. Based on the conversion rate, the strike price is $32.22 per share. These debentures is currently trading at approximately 147% of principal amount.

Moving on to our dividend, yesterday we announced an increase of 25% or $0.09 to $0.45 per share per quarter for our common stock. This increase resulted from growth in taxable income and the need to meet our anticipated 2009 and 2010 REIT distribution requirements. Currently, we anticipate that a portion of the fourth quarter dividend payable in January 2010 will be pulled back to satisfy the 2009 distribution requirement. As we have previously stated, our policy is to distribute at least 100% of our taxable income to minimize the payment of federal income taxes by the REIT and we expect that future dividend increases will be based on such policy subject to our board of directors approval.

Now, I will turn to our third quarter 2009 financial results. The third quarter FFO per diluted share and unit was $0.74, up 4.2% from the second quarter 2009 FFO per share and unit of $0.71. Year-over-year, third quarter 2009 FFO per share and unit increased 8.8% over third quarter 2008 recorded FFO of $0.68 per diluted share and unit. As we stated in our press release this morning there were no material non-recurring items impacting FFO or net income in the quarters ended September 30th and June 30th 2009.

For the quarter ended September 30, 2008, the FFO of $0.68 per diluted share and unit included additional FFO from certain significant items that do not represent ongoing revenue streams primarily, lease termination fees. Without these non-recurring items FFO would have been $0.62 per diluted share and unit in the third quarter of 2008. After adjusting for these items our results represent and FFO increase of 19.4% over the third quarter of last year.

Adjusted funds from operations or FFO for the third quarter 2009 was $49.2 million or $0.59 per diluted share and unit. This compares to a second quarter 2009 AFFO of $41.8 million or $0.51 per diluted share and unit. The diluted FFO payout ratio for the third quarter of 2009 was 61% down slightly from the second quarter AFFO payout ratio.

EBITDA adjusted for preferred dividends and non-controlling interest was $97.3 million in the third quarter of 2009 up 4.4% from $93.2 million in the second quarter of 2009 and up 20.4% from $80 million in the third quarter of 2008. Same store NOI was $105.2 million in the third quarter 2009 up 5.2% from $100 million in the second quarter of 2009 and up 28.6% from $81.8 million in the third quarter of 2008. Same store adjusted for straight line rents and purchase accounting adjustments which we refer to as same store cash NOI was $92.1 million in the third quarter of 2009 up 5.4% from $87.4 million in the second quarter of 2009 and up 28.6% from $71.6 million in the third quarter 2008.

I will now briefly review specific items in the statement of operations to provide additional detail on the results for the quarter. For the third quarter rental revenues increased to $130.9 million up 4.4% from $125.4 million in the previous quarter. The increase was primarily due to the commencement of leases signed in the previous quarters. G&A increased slightly during the quarter to $10.7 million compared to $10 million in the previous quarter. The increase was primarily due to our acquisition activities which now have to be expensed.

Consistent with what we have been reporting on our previous calls, our accounts receivable aging and delinquencies remain in line with historic norms and we believe we continue to maintain adequate bad debt reserves.

Turning now to our balance sheet; during the quarter we capitalized 8% or $2 million of interest related to construction projects which compares to 9% or $2.1 million in the second quarter 2009. We capitalized approximately 26% or $3.3 million in compensation expenses in the third quarter compared to 27% or $3.5 million in the second quarter 2009. Total construction work in progress in the third quarter was $210 million of which $159 million is construction costs and $51 million is allocated to acquisition costs. This compares to second quarter construction work in progress of $219 million.

As noted in our press release we are raising the lower end of our annual guidance range of FFO per diluted share and unit to $2.88. This revised guidance represents projected FFO growth of 11.2% to 12% over FFO per diluted share and unit of $2.59 for the year ended December 31, 2008. As discussed in our fourth quarter 2008 call FFO per diluted share and unit for the full year 2008 included additional FFO from certain significant items that do not represent ongoing revenue streams. After adjusting for those items our revised 2009 guidance represents projected FFO growth of 17.1% to 17.9%. Lastly we plan to provide 2010 guidance in November.

This concludes our formal remarks. We are now happy to take any questions that you might have.

Operator

Question-and-Answer Session

(Operator Instructions) Your first question comes from Jordan Sadler – Keybanc Capital Markets.

Jordan Sadler – Keybanc Capital Markets

Congratulations on the credit rating this morning. I just wanted to follow up on that and inquire what do you think the leverage capacity or debt capacity is in terms of sort of an unsecured bonds slug in your cap structure would be given sort of that rating?

A. William Stein

I think the initial bond issuance would be about $250 million. Moodys has said that in terms of their general sort of BAA2 ratings anything under six times debt to EBITDA is a BAA2 rating. I think that we can accommodate $250 million easily and still have full use of the credit facility. We wouldn’t take the credit facility up to the max just because that would not be prudent but we could comfortably do I’d say easily half of the capacity maybe a little bit more plus the $250.

Jordan Sadler – Keybanc Capital Markets

I guess based on that you probably have about $800 million in capacity if you were to keep it under six times but you’d do less than that?

A. William Stein

Yes, if we keep it under six times, that’s right. The indenture covenants might trip before that because indenture covenants tend to be booked based rather than EBTIDA based. Our EBTIDA relative to book value is quite robust as you know.

Jordan Sadler – Keybanc Capital Markets

Given the new found capacity it seems like your maintaining the 2009 guidance which included a slug of acquisitions that you plugged in there and some that you announced this quarter. Can you maybe give us an update on acquisitions prospectively, what you’re seeing in the market.

Michael F. Foust

We are seeing a handful of opportunities as we had discussed earlier. Someone off opportunities from funds where maybe these assets are outliers and they’re looking to sell income producing properties to redeploy capital elsewhere or redeploy back to investors. So, we have a couple more investments that we expect to close, actually three more that we expect to close by the end of the year and we’re looking at other opportunities as well for 2010. There will be definitely more deployment of capital on an ongoing basis to the income producing acquisitions to compliment our leasing and development program.

Jordan Sadler – Keybanc Capital Markets

In the 10% to 12% cap rate is still doable?

Michael F. Foust

On average, yes.

Jordan Sadler – Keybanc Capital Markets

Lastly, just on the leasing side, the signed leases as opposed to the commenced leases, signed leases year-to-date seem like they’re down on a dollar volume basis as opposed to space about 55% or so. Signed leases seem to be a better indicator of sort of the outlook if you will, or at least something of a leading indicator. Should we expect a seasonal uptick in the fourth quarter or are things just slowing down somewhat?

Michael F. Foust

We’re seeing more interest and more real opportunities, more real requirements in the market so that’s definitely ticking up. The approval time frames are longer than they use to be. We’re looking nine to 12 months now even in some cases. I think we’ll start to see an uptick in the fourth quarter and a little bit higher velocity in 2010 in terms of volumes overall.

Jordan Sadler – Keybanc Capital Markets

Higher volumes than 2009?

Michael F. Foust

Potentially in terms of signings, yes.

Operator

Your next question comes from Jamie Feldman – Bank of America Merrill Lynch.

Jamie Feldman – Bank of America Merrill Lynch

One quick accounting question, we noticed on the balance sheet that the deferred rent component is up. Can you just talk about what’s in there?

A. William Stein

It’s just new leasing with straight line rent.

Jamie Feldman – Bank of America Merrill Lynch

Is there more free rent component to leases now that there has been in the past?

A. William Stein

Not necessarily free rent it’s just when – if you do a 10 year lease with 3% bumps you’re going to have in straight line rent that’s booked at the beginning of the lease that will burn off over the course of the lease term.

Jamie Feldman – Bank of America Merrill Lynch

Then in terms of the fee business, can you talk a little bit about how you’re pricing it? It seems like you’ve had some successes but maybe the expectations for growth?

Michael F. Foust

The pricing is going to vary somewhat based on the nature of the nature of the assignment. In some cases we’re talking to folks in terms of a percentage of savings in terms of develop costs over and above certain expectations or certain budgeted amounts to give us a bit of incentive and in some cases it’s more on a fixed fee for design work. Then, the project management components or the technical operations components I should say, if we’re managing, would be based on more of a profit margin over costs.

Jamie Feldman – Bank of America Merrill Lynch

Then in terms of just growth prospects, what kind of successes you’re having?

Michael F. Foust

I think this is an initiative that could lead to maybe about $10 million to bottom line next year, maybe more. As importantly, probably more importantly it’s helping develop deeper relationships for broader basis of business especially in a build-to-suit opportunity where we might do build-to-suit and actually own the building so it ties in very nicely with a lot of our other niches both leasing turnkey space as well as some of the build-to-suit opportunities that we’re seeing.

Operator

Your next question comes from Michael Bilerman – Citigroup.

Michael Bilerman – Citigroup

I just wanted to first get your perspective on how you see the acquisition of Switch and Data by Equinox affecting your future business in particular and also I guess the overall datacenter landscape?

Michael F. Foust

I don’t think it has much of a direct impact. Equinox is our third largest customer and it further solidifies their position as kind of the preeminent interconnect and peering group out there. Switch and Data is a good customer of ours in several sites and I think it further enhances kind of our overall relationship with the combined entity. It seems to be a very positive event for them and I think it just shows a lot of the strength in the datacenter business and the kind of growth that folks are seeing overall.

Michael Bilerman – Citigroup

A couple of questions regarding your recent acquisitions regarding 444 Toyama and 1525 Comstock. I was wondering if the going in yields, I know you had previously guided the sort of 10% to 12% range as the goal, I’m wondering if that’s sort of commensurate with what actually occurred?

Michael F. Foust

If you look together the Toyama Drive property is a standalone datacenter facility fully leased, Comstock is also fully leased to two tenants. Comstock has been a joint venture with the [Apellio] Group here and we acquired their minority interest in the property. If you look at the yields that we were talking about earlier the two properties together yielded about a NOI of about $5 million and we acquired them for kind of total purchase price together $43.9 so over 11% NOI, cash NOI yield on those together.

Michael Bilerman – Citigroup

Then you also at the same time gave the 10% to 12% you mentioned that some of the potential deals that you were looking at had shorter lease terms and I was wondering if you could discuss what the lease roll looks like particularly on Toyama and some of the dynamics I guess that are occurring in your potential acquisition targets for potential lease roll windows when eventual mature lease maturities do occur.

Michael F. Foust

Sure, the Toyama Drive was actually a long term lease. I believe it’s like about ’20 or ’22 is the lease expiration on that and it has annual uplifts so it’s a very nice cash flow stream on that asset. Other properties we’re looking at that we do have under contract have shorter, shorter being around five to 5.5 years in a couple of cases but with very mission critical facilities that we’re very confident they’ll renew. It’s a little too early to say what the uplift might be over and above current but I think at least there will be some uplift.

Michael Bilerman – Citigroup

I just had a quick question, not to give him any credit at all but Jim Cramer comes out and said that the [inaudible] datacenter following this Equinox deal last week and I think there were a lot of inaccuracies in that reporting but I just wanted to give you sort of an opportunity just to talk about why that’s not the case. Obviously, you’re bullish in the datacenter business or you wouldn’t be in it. But, can you just talk a little bit about the dynamics that you see relative, and I’m sure you’ve seen it or gotten a transcript of it, what they were advocating.

Michael F. Foust

He was really way, way off the mark and it kind of shows a lack of understanding of what’s driving the growth of datacenter applications and the deployment. Whenever you increase computing power dramatically in the hardware that computer power gets taken advantage of if you will and gets absorbed in to the applications. That computer power is utilized because as we’ve seen over the last 50 years, there’s always more uses for computing power, for the various applications whether it’s trading or database, search, derivative pricing, what have you, risk management computational platforms.

The whole world can always use more computing power. The demand is going outstrip the availability of computing power if you will. On the other side, on the physical side, these pipes of multiprocessor chips and boards use a lot more power. Our business is all about leasing access to power. The square footage is almost secondary in some cases. Your power requirements are going to be staying pretty steady and continue to go up. I think Cramer kind of just missed the whole dynamic of the industry and the IT world no his comments.

Michael Bilerman – Citigroup

Was there any sense of – one of the other things he talked about was corporate is now almost bringing datacenters back in house rather than the whole outsourcing model that they’ve been following the last few years. Have you seen any trend whatsoever on that?

Michael F. Foust

No. That’s pretty much the opposite of what folks in the IT services outsourcing – if you talk to EDS or IBM or Capgemini or Equinox or SAVIS, all their businesses are increasing very well.

Michael Bilerman – Citigroup

This last question, you’ve made some growth areas in terms of on the services side, where do you stand today in terms of generating potential income off of those initiatives as you think about where you are this year and heading in to 2010?

Michael F. Foust

On the POD architecture services, I think we’ll see conservatively about another $10 million to bottom line earnings from that next year. It could be more. As I mentioned before, the fact that the synergy of driving more business with our turnkey leasing in addition to the POD architecture services as well as the build-to-suits, I think it will drive a lot of the associated income as well.

Operator

Your next question comes from the line of George Auerbach – ISI Group.

George Auerbach – ISI Group

Just to go back to Jordan’s question, Bill where do you think you could price debt in the unsecured market today?

A. William Stein

Well, it depends on tenure and it depends on where S&P comes out and Fitch but assuming we’re a flat BBB with all the agencies, five year would be in the low sixes we think today, a seven would be around seven and a 10 year would be in the mid sevens.

George Auerbach – ISI Group

I guess how does that compare to the rate on secured debt? Also, if you could just comment on the availability of secured debt for datacenters in the US and Europe?

A. William Stein

It’s still challenging to obtain secured debt for datacenters both in the US and Europe. We were fortunate that we have closed these mortgages over in Europe. As I said, the UK deal is priced in the mid to high fives and the Irish deal is in the low sevens. We haven’t looked at doing a large mortgage for a little while because we’ve been in the middle of this rating agency process and clearly if we are successful in this regard as it appears we will be, that eliminates the need to rely on secured mortgage debt.

We were in the market I’d say six months ago and looking to do a sizeable deal which I would say between $100 to $150. There is a limited number of providers. They want to deal with the top tier sponsors and the rates at that time were eight or higher but I can’t comment on whether those rates have come in. Leverage would be about 50%.

George Auerbach – ISI Group

I guess final, yesterday on their conference call Boston Properties mentioned some pretty aggressive pricing in the convertible debt market. Is that an area you are looking at? Or, if you were to do unsecured you’d do just plain vanilla unsecured debt at this point?

A. William Stein

I didn’t hear the Boston Properties call but I would agree that the convertible market looks very attractive right now.

Operator

Your next question comes from Srinivas Anatha – Oppenheimer.

Srinivas Anatha – Oppenheimer

A couple of questions, Mike I think you mentioned in response to an earlier question that the pace of new lease signing should pick up as you go in to the end of the year and 2010. Is that based on the sales pipeline that you’re currently seeing? In the past you use to give a number, the total amount of square foot that you folks are currently tracking, if you could update that number that would be helpful.

Michael F. Foust

It is based on companies coming back in to the market for requirements especially now after Labor Day we’re seeing a good pickup in inquiries and searches in the market place. Right now we are tracking or in discussions and various levels of discussions with requirements totaling about one million square feet. We’re tracking potential requirements, folks that are in very early stages or corporates that we know that have their own requirements, that’s about four million. But, one million square feet that we’re engaged on in nine or 10 markets.

Srinivas Anatha – Oppenheimer

Mike, second question, I know you talked about going forward acquisitions would be a higher portion of your growth. I just want to make sure that you’re in no way implying that the internal growth rate of the company is slowing down here and hence you have to look at external acquisitions to keep the growth rate going forward?

Michael F. Foust

No, really it’s as we have always done. Our strategy as an investor is to look at where are the opportunities to achieve attractive risk adjusted returns and to the extent we can deploy capital in income producing properties and avoid the development and leasing risk that’s something that’s always been attractive to us and we really built our organization on. It’s more to augment and kind of diversify our deployment of capital where we see good opportunities.

Srinivas Anatha – Oppenheimer

Just one last question, Bill I know there’s been a lot of talk about cloud computing and what it means for datacenter demand going forward. In your conversations with large technology companies or the large IT companies, to what extent are you seeing demand that’s being driven because of these new cloud offerings that these companies are potentially going to launch a year from now or two years from now?

Michael F. Foust

It’s difficult to quantify but our experience has been that a number of the new space requirements that we have been satisfying for customers have been cloud or grid computing type requirements whether it’s directly with corporate enterprise such as financial services or with our customers like SAVIS who are providing grid computing, cloud computing applications. We’re seeing it as another growth driver for our business and for our customers’ business.

Operator

Your next question comes from Michael Knott – Green Street Advisors.

Michael Knott – Green Street Advisors

I think you had about 67,000 square feet or so of turnkey signings in the quarter. That was down a lot from 2Q and similar 1Q. Can you just speak to why those have been down so much, especially compared to last year and then is it possibly a reflection that you can get 11% type yields on buying now as opposed to only a little bit higher on building.

Michael F. Foust

I think the level of signing is reflective of the fact that we did have such a slowdown in inquiries and companies having the inclination to pull the trigger on new facilities at the end of last year and beginning of this year. I think it’s just kind of a general slowdown and the longer time frames for the approvals. I think it will start catching up now as we go in to the next six months and new requirements are coming on the table and some of the requirements that we started working on earlier in the year will come to fruition and come to approvals. So, I think it’s more kind of the cycle catching up with itself over the next six months.

In terms of the kind of our [spy] versus investment and income producing versus leasing, as I mentioned it’s purely on where can we get the most attractive risk adjusted returns and looking that way. But, I don’t think that reflects on tenant demand for datacenter space because we’re looking as an investor as opposed to a customer who’s looking for deployment of applications. If I understand your question.

Michael Knott – Green Street Advisors

Then just a follow up to that, what do you feel like the right spread is between buying income producing and building turnkey? It sounds like it is anywhere from 300 to 500 basis points, is that about the right spread?

Michael F. Foust

It might be somewhat tighter than that depending on tenant credit and location.

Michael Knott – Green Street Advisors

Any comment on the appropriateness of that spread?

Michael F. Foust

It’s going to vary quite a bit. I mean it could be, like I said it depends on credit. It could be 200 basis points but it’s just going to vary – and the size of the space and so on and so forth. It’s going to be a pretty broad range.

Operator

Your next question comes from William Marks – JMP Securities.

William Marks – JMP Securities

A couple of questions, one on that Equinox acquisition, would REIT rules have prevented you from making that type of purchase or could you actually consider it?

Michael F. Foust

Well, it’s a little different business, I mean Switch and Data I believe leases virtually all their facilities in their 20 some markets so they’re not an owner of real estate. Their business is clearly in the co-location, peering, interconnection and they’re very strong in those areas which is very different from our more wholesale real estate based business. So, as a customer obviously they have been a very good customer but I think their type of business being in more the co-location interconnection fee based business is sufficiently different from ours that it would be an investment for us.

William Marks – JMP Securities

Second, I believe in yesterday’s Wall Street Journal the Toronto datacenter that sold, did you look at that property, is that something you’d be interested in?

Michael F. Foust

We did look at it back about a year ago and it’s a very good facility. At that time the pricing seemed to be higher than we were willing to pay at the time but it’s a good project.

Operator

Your next question comes from Jordan Sadler – Keybanc Capital Markets.

Jordan Sadler – Keybanc Capital Markets

Bill, I didn’t get the backlog from you, could you hook us up?

A. William Stein

Would you prefer I put that in the remarks or do you like asking the question?

Jordan Sadler – Keybanc Capital Markets

I like asking the question.

A. William Stein

There’s obviously not much but the signings will be recognized in the fourth quarter just because of where we are in the quarter. Roughly 75% would be recognized in the first quarter next year and 25% in the second quarter.

Jordan Sadler – Keybanc Capital Markets

What was the dollar volume?

A. William Stein

Dollar volume for next year revenue recognition is about $7.5, $5.5 in the first quarter and $2 in the second.

Jordan Sadler – Keybanc Capital Markets

Those are the full year contributions?

A. William Stein

Yes, that’s right.

Jordan Sadler – Keybanc Capital Markets

My other questions is just on the acquisition front. There was a portfolio kicking around last year, a west coast portfolio that I recall that I never saw cross and I was just curious if that’s still kicking around and if that would still be of interest to you?

Michael F. Foust

I’m guessing you’re referring to the Rockwood Capital 365 Main portfolio. That one has three properties in the west coast and properties on Phoenix and Virginia. They’re looking at various financing opportunities so they have not traded.

Jordan Sadler – Keybanc Capital Markets

Would that be of interest to you, that portfolio, at the right price?

Michael F. Foust

Conceptually yes. I mean, it does have a very big component of co-location which is not our core business at all which we could execute and continue to manage as its been managed but it’s very different from the real estate business in their San Francisco facility, different valuation metrics.

Jordan Sadler – Keybanc Capital Markets

I had a question, just following up on one of your comments on the cycle catching up to itself a little bit over the course of the next six months, are you guys a little bit victims of your own success meaning things are so good and the profits been so good that capital has become somewhat available to good opportunities like your sector? It seems to be that despite the environment we’re in there continue to be folks who expand their datacenter business plans. Is that squeezing out some of the profit a little bit or the opportunity a little bit?

Michael F. Foust

You mean in terms of companies doing it themselves versus looking for an outsource?

Jordan Sadler – Keybanc Capital Markets

Not as much. I was thinking like the telcos actually getting in to the business a little bit more and maybe, I know the private guys aren’t as well capitalized but there are some that do have a little bit of access.

Michael F. Foust

Hopefully those kind of demands we can take advantage of. A good example, both with NTT and ATT, for their enterprise services solutions, we’re playing an important role as landlord of those facilities. We’ve seen this play out that it will lead towards more demand for our facilities as a landlord and facility provider.

Jordan Sadler – Keybanc Capital Markets

So more sort of a base building?

Michael F. Foust

Both base building and turnkey. But, we’re happy to accommodate either way.

Jordan Sadler – Keybanc Capital Markets

You did say that you think turnkey is going to be sort of the way of the future near term?

Michael F. Foust

Well, certainly this year turnkey is the great, great majority. I think this year it’s over 90% so far by revenue of new business.

Jordan Sadler – Keybanc Capital Markets

And you think that will continue, that dynamic?

Michael F. Foust

I think so, I think it will moderate a little bit especially with a couple of products we’ll be bringing on line in the next year but I think it will still be the great majority of new leasing will be the turnkey by revenue.

Jordan Sadler – Keybanc Capital Markets

Did I miss anything on the markets? Any changes, positives or negatives?

Michael F. Foust

No, what we’re seeing is our IT service provider customer vertical, you know SAVIS, Equinox, Telex, IBM, system integrators as well included in there, their businesses are going quite well and demand from that customer base is very good. We’re seeing financial services continue to grow their applications.

Jordan Sadler – Keybanc Capital Markets

Geographically that’s sort of silicon valley, DC and New Jersey?

Michael F. Foust

New Jersey, Dallas, Chicago, London, Paris would be I think our top activity centers.

Operator

Your next question comes from Srinivas Anatha – Oppenheimer.

Srinivas Anatha – Oppenheimer

Mike, on the last call you mentioned going forward we should expect some consultancy related revenue because of the hiring of [Michael Manners]. Was there any contribution this quarter or is that something we should expect more in 2010?

Michael F. Foust

I don’t recall exactly from the quarter but we’ve had ongoing assignments with a couple of customers that are contributing revenues currently. I think in this year it will be $3 to $4 million of revenue from consultant services, POD architecture services this year I believe.

Srinivas Anatha – Oppenheimer

Bill, in the guidance on the last call you guys gave from acquisitions it should be to $122 to $200 million. Looking at your acquisitions year-to-date the guidance is well above that. Does that guidance still hold good? Should we expect more on the lower end, mid range or higher end, what do you think going in to 4Q just with a few months left here?

A. William Stein

As is said it’s going to be between $100 to $105 with a few months left and that’s net of debt that’s going to be assumed on one deal.

Operator

Your next question comes from Michael Knott – Green Street Advisors.

Michael Knott – Green Street Advisors

Could you give an estimate of where you think your overall portfolio in terms of your mark-to-market is today in terms of your average in place rent per foot compared to where that would be at market?

Michael F. Foust

I think to be a little more accurate I would say on renewals we’ll continue to see and uptick of 10% to 15% on average I believe and I think that’s probably not a bad indicator on an average basis.

Michael Knott – Green Street Advisors

Bill, in the context of obtaining the rating from Moodys can you guys give us an update of what your target capital structure would be in terms of equity, preferred, unsecured debt, convertible, etc.

A. William Stein

I think we’ll probably keep our debt to EBTIDA to sort of under 5.5 maybe under 5 and fixed charge coverage ratio I would expect to remain pretty much where it is in the mid twos. Obviously, it’s been a little higher recently and it could go a little lower. But, perpetual preferred market really isn’t open right now so that’s not an option and convertible preferred is really not open either except I saw that Grubb & Ellis did a small deal the other day but I don’t think that’s open meaningfully. As I said we’ll target based on fixed charge coverage and debt to EBITDA multiples.

Michael Knott – Green Street Advisors

But the intent of accessing the unsecured market at some point is more broadening your capital sources not a move towards less conservative financial structure that you’ve employed during your time as a public company.

A. William Stein

No. In fact, the Moodys rating, one of the criteria is, you’ll see this in the Moodys release is the fact that we have had conservative financial policies. If we were to lever up that would work against us in terms of ratings.

Michael Knott – Green Street Advisors

Lastly, I’m just curious how you view your cost of equity here today given that the real estate cap rates for your portfolio seem like they are fairly high and the public market is appropriately given you plenty of value for your platform etc., above and beyond the real estate value. How do you view your cost of equity today? Any thought about raising additional equity?

A. William Stein

We consistently view our long term cost of equity in the low double digits. We think that’s an appropriate measurement over the long term. Obviously, if you look at the cost of equity on the basis of FFO yield leader this year or next it’s a lot less than that. But, that’s not how we prefer to look at it.

Operator

There are no further questions at this time if you’d like to continue with any further remarks.

Michael F. Foust

Thank you everyone for joining the call. I appreciate the tracking us and I want to thank our management and our overall operating team here at DLR for another very good quarter. It’s much appreciated. Thank you very much.

Operator

Ladies and gentlemen that does conclude our conference for today. Thank you for your participation and for using ATT Teleconferencing. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Digital Realty Trust, Inc. Q3 2009 Earnings Call Transcript
This Transcript
All Transcripts