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I prefer to research before buying and to monitor while holding. I have a background in tax/finance/accounting with a career focus in the real estate industry. My username has a personal meaning and has nothing to do with the metal.
  • Maintaining Digital Reality - A Comparison Of Recurring Property Costs At DLR & COR 6 comments
    Nov 19, 2013 3:38 AM | about stocks: DLR, COR

    This article is a follow on to my prior post on AFFO and payout ratios at DLR and Corsite (NYSE:COR).

    For this data analysis, the following concepts will be important to consider:

    1) Maintenance and Property Operating costs show up as expense on the income statement. Accordingly, they are reflected in both FFO and AFFO. For the Data Center REITs, in addition to maintenance/repairs costs, this income statement line item contains utilities expenses (electrical, water, trash, heating/cooling) paid by the property as well as network charges paid to third party providers. Electricity is the key item driving these costs and the Data Center's ability to pass-through electrical costs to customers has a significant impact on the profitability of the business model. Additionally, 2013 Maintenance and Property Operating costs for DLR have been adjusted to exclude the $10M straight line rent error (as that amount was included in that line item in Q3 2013) for comparative purposes.

    2) Real estate taxes and property insurance expenses appear on the income statement and thus in FFO and AFFO. A significant portion of these costs are passed through and collected as part of tenant reimbursements.

    3) Recurring Capex charges reflect costs that are necessary to upkeep and maintain the property on a recurring basis and would have been expensed as maintenance/property operating costs but for the fact that they extend the useful life of assets. This cost pool does not include "non-periodic enhancement and improvement capex" (i.e. upgrades). For DLR, in 2013, recurring capex includes approximately $2M of capitalized repairs under $10K as a result of their accounting method change earlier this year (IMO, a rather immaterial adjustment).

    4) Tenant reimbursements & Power revenue are gross revenue accounts on the income statement and reflect amounts collected from tenants for the previously stated cost items (maintenance and property operating expense, real estate taxes and property insurance expense, and recurring capital expenditures). As stated before, the most significant recurring cost to recover from tenants is electricity. For DLR electricity cost recoveries show up in the "tenant reimbursements" revenue account, whereas for Corsite, electricity is largely sub-metered ("breakered") to each tenant and collected as "power revenue".

    5) In order to compare the costs of delivering "Digital Reality" to the tenants on a recurring basis, I am netting these recurring costs with the tenant cost recovery accounts to come up with "net recurring property charges". I then convert these amounts for each company into a per diluted share amount to make comparisons possible.

    As an aside, although I don't include these amounts in the data analysis, non-periodic improvement and enhancement capex are costs incurred to upgrade the properties, but are not required to maintain/repair existing assets, so they are not considered part of AFFO. Enhancements and improvements are typically financed with debt and or equity, instead of operating cash. The important concept to consider with this pool of "non-periodic" costs is that in order to be a cutting-edge Data Center REIT, the business model requires constant injections of new capital to finance these non-periodic upgrades and enhancements.

    As stated in the prior post, as I only have 2013 data through Q3, I've used estimates based on guidance from each company for Q4 2013 where I could, and used the Q3 amount for Q4 where guidance did not have sufficient detail.

    Additionally, before getting to the data, I want to stress that I take no responsibility for your investment decisions and that you must perform your own due diligence. This data and any analysis are for informational purposes only and are intended to promote financial literacy.

    Sources are the same as the prior post on AFFO. Amounts (other than per share and %'s) are in '000's.

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    (click to enlarge)

    (click to enlarge)

    Take-aways:

    1) DLR's net recurring property charges have been growing significantly at 24% from 2011 to 2012 and then another 17.5% from 2012 to 2013, whereas COR's net charges have declined significantly at ~ -16% from 2011 to 2012 and have essentially remained constant at ~1% growth from 2012 to 2013.

    2) DLR's net recurring property charges have increased at a much faster pace than their overall FFO and AFFO growth. Whereas COR's net charges have essentially remained flat while overall FFO and AFFO have been growing at a relatively high pace.

    After thinking about these relationships in the context of each company's business, I've come to realize that DLR is paying for higher occupancy rates 91-92% by absorbing a lot of the costs that Corsite is passing through to tenants (Corsite's occupancy rate is 80-81%). However, higher occupancy is not necessarily more desirable from a shareholder perspective if the lower occupancy model is more profitable. For me, this relationship helps to explain DLR's decision to move into the middle market and compete for Corsite's bread and butter because COR's business seems to make a lot more sense financially (low recurring costs - high growth) than DLR's fully-loaded large-tenant model (high recurring costs - low growth).

    Best of luck on your investments.

    Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in COR over the next 72 hours.

    Additional disclosure: I have no affiliation with either company and I wrote this post myself. I am long DLR-E preferred stock.

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Comments (6)
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  • montlakeal
    , contributor
    Comments (118) | Send Message
     
    That is indeed food for thought. I recently put DLR on my watch list so I appreciate your analysis. Now COR goes onto my watch list. I'm a bit leery of DLR's management.

     

    Thanks, Pall
    19 Nov 2013, 07:08 PM Reply Like
  • Palladium31
    , contributor
    Comments (444) | Send Message
     
    Author’s reply » You're very welcome mont. I strongly recommend reading the entire Q3 earnings transcript of COR as part of your due diligence before taking a position. COR's price is very much driven off AFFO growth expectations (its not an income stock like O). I think I'd start to get interested around $27 or less.

     

    For an income investment, I think DLR preferred shares look pretty good to me (I'm now long DLR-E to generate some cash flow for investment in my roth-IRA).

     

    Best of luck,

     

    P
    20 Nov 2013, 12:47 AM Reply Like
  • Qniform
    , contributor
    Comments (2506) | Send Message
     
    Occupancy rates are a key consideration as you said. As presented, I can't assess anything about comparable SF operating costs. I'm not sure we will be able to see any meaningful data here unless we can somehow compare DLR Colocation with COR. That is the only business segment which is comparable to COR's business. Similarly, PBB is the only business segment comparable to DFT triple net. Both of these segments together do not currently comprise a majority of DLR revenue, and it looks like PBB is getting smaller. Colocation may be a strategic target, but it is currently not much of a factor. IMO.

     

    My main take-away from the recent presentation was just how much service value added there is in the DLR model. If they can get paid appropriately, the level of service will translate to profits. At a minimum I think it will be a key discriminator for tenants and maintain higher occupancy rates. Another discriminator is the virtual city-wide VPNs they operate with owned fiber optics. This network is entirely under their control, unlike the cross connects and routings assembled from ISPs "time share" by their competitors. If it can be monetized, it may be bigger than expected. It sounded to me like backhaul might be a service that is not limited to just DLR tenants.

     

    Two last points: first, I know some investors have been upset by the quoted Foust comment "stuff happens." The remark was made specifically about two or three very large late stage lease negotiations that did not close as projected (worth more than .10 as I recall). It was NOT in reference to the fumbling PR over the past months.

     

    Second: we got a lot of new information on business metrics and presentations of how DLR does business. Their zeal and impulse toward openness should inspire confidence, and while I like the goal, the cynic in me sees that the information is another opportunity for some with ulterior motives to manipulate perception about the company. I hope it doesn't happen - it would be another self-inflicted wound.
    19 Nov 2013, 07:28 PM Reply Like
  • Palladium31
    , contributor
    Comments (444) | Send Message
     
    Author’s reply » Q - thank you very much for your comments.

     

    I agree with you that there is definitely a need to be fair and put management comments into their proper context. Personally, I'm not bothered too much by Faust's comments, the accounting method change on the under $10K repairs, the short attack by the Highfields, or the recent $10M straight line rent accounting error. Certainly these items can impact share price in the short term (i.e. the "yo-yo"), but what I'm primarily concerned about is operational performance which drives fundamental changes in share price (the stairs). Admittedly though, I too felt like counting my spoons when I saw their "peer" comparison charts and listened to the great expectations they are setting for the market going forward.

     

    As far as my analysis - I spent quite a bit of time reading the Ks/Qs, investor presentations and reading earnings call transcripts of both companies this weekend to be able to put this together. What I found is very similar to what you alluded to - it is very difficult to compare the two companies on a per square foot basis or line-of-business basis given the publicly available data. For example, COR has about 25% of its portfolio in light industrial/office buildings, and DLR has a wide mix of powered base, co-location, and now custom solutions tenant space in the mix. Moreover, neither company separately states maintenance costs, but instead includes these with "property operating costs" which contain utility (i.e. electrical) charges.

     

    That being said, DLR clearly considers COR to be a competitor (as they labeled them a "peer" comparable in their investor presentation), and there is ample evidence that they are going after the mid-market/co-location business rather aggressively (based on their signal to hire 33% more sales people per the Q3 call transcript and continued messaging in this regard at the investor presentation). Thus, the angle I felt that I could compare between the two companies given the publicly available information was the change in net recurring property-level costs for the two firms over time and compare these with the changes in overall distributable cash flow over the same period.

     

    As stated in the blog, DLR's experience of the past three years has been slow growth in distributable cash flow ~3%/year while recurring property charges have increased at a much faster pace (24% YoY from 2011 to 2012, and 17.5% YoY from 2012 to 2013). COR on the other hand has faced the opposite experience: rapidly growing distributable cash flow at 29% YoY from 2011 to 2012 and 22% YoY from 2012 to 2013, while recurring property charges have decreased by ~16% from 2011 to 2012 and remained essentially flat at a 1% change from 2012 to 2013.

     

    If nothing else, this data helps to explain the divergence between COR's share price performance these past two years (up over 80%) versus DLR's (down ~25%). Incidentally, for COR's first year as a publicly traded REIT, its share price performance appears to have moved in tandem with DLR (I believe because of lack of data) until late 2011/early 2012 when full year 2011 earnings were released.

     

    In any event, past performance does not guarantee future results... for either company.

     

    Best regards,
    P
    20 Nov 2013, 01:55 AM Reply Like
  • Aurora Research
    , contributor
    Comments (36) | Send Message
     
    This is very interesting work, and as someone who does analysis, I appreciate the attention to details very much.
    One quick comment, which I believe, is of importance.
    At the end of the day (and for the purpose of the comment i'm assuming that all the figures you end up with are accurate as well as the follow up conclusions), there should be a connect between the fundamental based data/conclusions and the market price of that equity (DLR/COR in this case).
    Currently, COR is much more expensive than DLR (trading at an FFO multiple of nearly 17, relative to DLRs 10).
    So again, assuming your findings are correct, does that (in addition to other factors) warrant a relatively high multiple of 17 to COR ? Does that warrant a relatively low multiple of 10 to DLR ?
    In other words - even if your findings are accurate - it could be that COR is overpriced and DLR is under priced..
    Not sure that's my view - but nevertheless - there's no mention to market price in your analysis, and although the most difficult part, I believe it's at the end of the day, the most important question for the investor.
    It's a question I always end up with in my work.Specifically with regards to DLR, which is a lot in the news lately, is the future so grey as to warrant current price ?
    Best regards,
    AIR
    20 Nov 2013, 09:17 AM Reply Like
  • Palladium31
    , contributor
    Comments (444) | Send Message
     
    Author’s reply » Hi AIR,

     

    That is a very good suggestion. I suppose I had a false premise that those reading this blog already were familiar with my other comments on the matter, and I can see that it would certainly be more effective if I added those thoughts to the blog so it could work as a stand alone piece.

     

    The narrative over the past six months on most of the Seeking Alpha articles on DLR has been that it's any number of things causing the share price to fall: un-trust worthy management, the accounting method change on the under $10K repairs, the short attack by the Highfields, the "taper-tantrum", or the recent $10M straight line rent accounting error. IMO, these "unfortunate events" have had an affect on the share price but do not explain why COR is up 80% over the past two years, while DLR is down 25% over the same time period. With that said, I find myself going back to Tom Lewis's man with a yo-yo walking on a flight of stairs analogy. In my opinion, the narrative explanations are simply describing the "yo-yo".

     

    When you look at the fundamental data (i.e. the "stairs"), it starts to become clear that DLR has transitioned over the past two years into a slow growth income stock and deserves a lower valuation than COR whose fundamental performance over that same time period clearly reflects the activity of a growth stock.

     

    While I am not certain that such a divergence (DLR at 10, COR at 17) is necessarily sustainable, I leave it to the readers to perform their own due diligence before making an investment. Some useful questions to consider are what is COR worth if it maintains its 20%+ distributable cash flow growth? What if they only achieve 10% distributable cash flow growth? What is COR worth if it takes on more equity or debt and raises their payout ratio? What is COR worth if they lose future deals/releasing opportunities to DLR or any of the other Data Center competition?
    
    Hope that helps.

     

    Best,
    P
    20 Nov 2013, 11:17 AM Reply Like
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