Digital Core REIT:  Leadership changes from within the family

Key Summary Points

• Several changes within the Board of DCREIT as Mr Jeff Tapley takes on an expanded role within Digital Realty
• Mr Dan Tith will relinquish his role as CFO of DCREIT as he returns to the US to lead Global Finance for Digital Realty but will still be working closely with the REIT on its capital-raising and investment initiatives
• Mr Dave Craft who is a seasoned finance leader and investment specialist at Digital Realty will assume the role as CFO of DCREIT from 1 October 2023
• Leadership shuffle will be a welcome move as it creates more &ldquo links&rdquo for DCREIT, as pioneers remain within the Digital Realty group
• FTSE EPRA NAREIT Global Developed Index inclusion another catalyst for the REIT reiterate BUY with TP of US$0.90

 

DIGITAL Core real estate investment trust (Reit) : DCRU +1.8% announced on Monday (Sep 4) that it would be included in the FTSE EPRA Nareit Global Developed Index from market close on Sep 15.

 

The FTSE EPRA Nareit Global Real Estate Index Series is an international real estate investment index developed by the FTSE Group along with the European Public Real Estate Association and the National Association of Reits. The index series is designed to track the performance of listed real estate companies and Reits globally.  

 

John Stewart, chief executive of Digital Core Reit Management, said that the inclusion is a &ldquo significant milestone&rdquo that should enhance the Reit&rsquo s trading liquidity on the Singapore Exchange as well as its visibility to global institutional investors, while attracting new capital inflows from global index funds. 

 

Digital Core Reit also announced a slew of leadership changes in a separate announcement on Monday, in a bid to &ldquo provide additional depth to drive the next phase of its growth and build upon its commitment to deliver sustainable value for stakeholders&rdquo . 

 

David Lucey, who is currently a non-independent director, will become the chairman of the board of Digital Core Reit management. Lucey most recently served as interim managing director of Asia-Pacific, with responsibility for the sponsor&rsquo s operations across the region. 

 

He also previously served as senior vice-president of portfolio management for the Reit&rsquo s sponsor Digital Realty, and was responsible for leasing and financial management of the sponsor&rsquo s portfolio in North America. He replaces current chairman Jeff Tapley, who will take on an &ldquo expanded role &ldquo with the sponsor as Digital Realty&rsquo s chief commercial operations officer, and will step down from the board of the Reit&rsquo s manager. 

 

These changes will take effect from Oct 1. The Reit said that these changes are designed to &ldquo balance fresh thinking and new perspectives with experience and continuity&rdquo . 

 

Serene Nah, who joined Digital Realty in January this year as managing director and head of Asia-Pacific, will join the board of the manager as a non-independent director, effective Oct 1. Nah currently serves as an independent, non-executive director and a member of the audit committee and nomination committee for ESR Group. 

 

Her previous stints include roles as executive director and chief financial officer at Kerry Properties, head of Asia portfolio management for global technology private equity firm Silverlake Partners, and various roles spanning over a decade with General Electric. 

 

Dave Craft, who currently serves as vice-president of acquisitions for Digital Realty, will become the chief financial officer of the Reit&rsquo s manager from Oct 1. He will take charge of all financial functions of the manager, including financial reporting, capital markets, tax and investor relations as well as financial planning and analysis.

 

Craft succeeds Daniel Tith, who is returning to the US to lead global finance for Digital Realty. 

 

Stewart said that the new slate of industry veterans brings &ldquo strong leadership and investment experience that will be instrumental to driving the next phase&rdquo of the Reit&rsquo s growth. He added: &ldquo With these refreshments to our leadership, we look forward to continuing to capitalise on the favourable set of data-centre fundamentals along with our industry-leading acquisition pipeline to deliver sustainable value for our stakeholders.&rdquo

 

DIGITAL Core Reit&rsquo s distribution per unit sank 6.8 per cent to US$0.0192 for its first half-year ended June, from US$0.0206 the year before, as a result of lower rental income.

 

Two of its tenants filed for bankruptcy, which caused them to fall behind on rent payments. One of these customers has since vacated the data centre it was occupying in Toronto, Canada, and has been replaced by other tenants, the Reit manager said on Thursday (Jul 27) in a bourse filing. 

 

The other tenant, which The Business Times understands is Cyxtera, a Nasdaq-listed data centre operator, has remained current on rental obligations for July.

 

However, rent for June has not been paid due to administrative claim procedures, but is expected to be collected. 

 

Net property income fell 0.7 per cent to US$35.1 million on higher property taxes, while lower utilities expenses supported a 1.1 per cent increase in gross revenue for the first half of the year to US$53.4 million.

 

Income available for distribution declined 7.6 per cent to US$21.5 million, down from US$23.2 million previously, as finance and tax expenses for the first half of the year were higher than before due to a rise in interest rates in the United States since April 2022. 

 

The distribution will be paid on or before Sep 28, the manager said. 

 

Preserving the flexibility of its balance sheet, while prudently utilising debt headroom to execute upon accretive investment opportunities will be its key focus, it said. 

 

For the first half of 2023, aggregate leverage stood at 34.2 per cent while the weighted average debt maturity was approximately 3.4 years. 

 

As at Jun 30, Digital Core Reit&rsquo s portfolio is 97 per cent occupied with a weighted average lease expiry of approximately 3.9 years.

 

The manager said it intends to expand its asset base and diversify its customers.

According to a report by the International Data Corporation (IDC), AI is expected to increase data center demand by 66% by 2025. This is because AI-powered applications require a lot of computing power and storage space. For example, AI-powered facial recognition software requires a lot of data to train and operate. This data needs to be stored in data centers, which drives up demand for data center space.

In addition, AI-powered applications are often used in real-time applications, such as self-driving cars. This means that data centers need to be able to process large amounts of data quickly, which also drives up demand for data center space.

Overall, the increasing adoption of AI is expected to have a significant impact on data center demand. By 2025, AI is expected to account for more than 20% of all data center traffic. This will require data centers to be built or expanded to meet the growing demand for computing power and storage space.

Here are some specific examples of how AI is increasing data center demand:

• Virtual assistants: Virtual assistants like Amazon Alexa and Google Assistant require a lot of computing power to process voice commands. This demand is only going to increase as more and more people use virtual assistants.
• Self-driving cars: Self-driving cars require a lot of computing power to process data from sensors and make decisions in real time. This demand is only going to increase as self-driving cars become more widespread.
• Healthcare: AI is being used in healthcare to develop new drugs, diagnose diseases, and provide personalized treatment plans. This demand is only going to increase as AI-powered healthcare applications become more widespread.

As you can see, AI is having a major impact on data center demand. This trend is only going to continue in the years to come, as AI becomes more widespread and sophisticated.

 

The manager of Digital Core REIT has responded to the query by Singapore Exchange Securities Trading Limited (SGX-ST) stating that it was not aware of any information that may have caused the surge in its unit price.

 

The SGX-ST, on July 20, issued a query to the REIT after its unit price spiked to 57 US cents (75.5 cents), which was 14% higher than its last-closed price of 50 US cents apiece.

 

On further possible explanations for the &ldquo unusual price movements&rdquo , the REIT manager pointed out that it is &ldquo aware&rdquo that a brokerage firm has circulated a bulletin noting that the final bids for Cyxtera, the REIT&rsquo s second largest customer, were due to be submitted by July 19.

 

According to the media reports from the US, Cyxtera had received six letters of intent (LOI) to acquire its entire business.

 

DBS Group Research, on July 20, had issued a bulletin stating that Cyxtera is only seeking to reject two of its leases &ndash the one of a Serverfarm-owned data centre in Washington and a CyrusOne-owned facility in Amsterdam &ndash and is likely to affirm all the other leases with its landlords.

 

&ldquo [This is] positive news for the likes of Digital Core REIT, Mapletree Industrial Trust (MINT), and Keppel DC REIT as they had several properties leased to Cyxtera which were at risk of being vacated,&rdquo says DBS.

 

&ldquo Following the news that Cyxtera has filed for a Chapter 11 filing on June 6, Digital Core REIT which has [about] 23% of its revenue exposed, saw a steady increase in its trading unit price. Compared to the lows prior to that, Digital Core REIT&rsquo s share price is currently trading [some] 35% higher. Despite this, we believe the rally in Digital Core REIT&rsquo s share price is far from over as the continuation of all of Cyxtera&rsquo s leases in Digital Core REIT&rsquo s portfolio will reaffirm our earnings projections going forward,&rdquo it adds.

 

Further to its note, the brokerage noted that another catalyst in the REIT&rsquo s unit price could be the potential of an index inclusion to the FTSE NAREIT Developed Asia Index.

 

&ldquo Based on our estimates, Digital Core REIT will have to trade at a market cap of US$400 million to be considered for an inclusion by the cut-off date on Aug 21 (for the September review),&rdquo says DBS. &ldquo Digital Core REIT will have to trade at a price range of between 57 US cents to 58 US cents per unit to stand a good chance for the index inclusion. Following the price rally in the past few days, and the 10% increase [on July 20], we believe Digital Core REIT is on track for the index inclusion by the September review.&rdquo

 

&ldquo As we await for more news on the restructuring of Cyxtera and the affirmation/rejection of its leases, this is a case of &lsquo no news is good news&rsquo . Given that Cyxtera has not indicated their intentions to reject any other leases (other than the two already announced), we believe that there is a good chance they will affirm their leases at its other facilities. With this, it reaffirms our earnings projections for Digital Core REIT, implying a still very attractive forward dividend yield of more than 6.7% currently,&rdquo adds the brokerage.

 

The manager has also confirmed that it is in compliance with the SGX-ST listing rules.

Digital Core Real Estate Investment Trust (DigiCore Reit) : DCRU -1.03% bought back 520,000 units for a total consideration of US$213,002.75 over the period.

 

The units were repurchased to be cancelled.

 

On Jun 6, the Reit manager bought back 500,000 units at US$0.4081 each for a total consideration of US$204,292.42.

 

On Jun 7, it repurchased another 20,000 units at US$0.435 each for a total consideration of US$8,710.33.

 

The buybacks came after the manager warned on Jun 5 that the Reit&rsquo s annual distribution per unit (DPU) could be reduced by about US$0.02 if the annual revenue from its second-largest tenant is completely eliminated.

 

The tenant, a global co-location and interconnection provider, filed for Chapter 11 bankruptcy protection on Jun 4.

 

The Reit manager did not name the tenant, but The Business Times understands it to be Cyxtera. The Nasdaq-listed data centre operator had been struggling under a significant debt load for months.

 

According to the Reit manager, the tenant in question represents about US$16.3 million, or 22.4 per cent, of the Reit&rsquo s annual rental revenue.

 

Units of DigiCore Reit closed at US$0.48 on Friday (Jun 9), up 17 per cent over the course of the week. The counter is down 12.7 per cent this year.

 

ANALYSTS have lowered their target prices for Digital Core Reit : DCRU +4.88% after its manager on Monday (Jun 5) warned that the real estate investment trust&rsquo s (Reit) distribution per unit (DPU) could fall by US$0.02.

 

This is assuming the elimination of annual revenue from its second-largest tenant, Cyxtera, which filed for bankruptcy protection over the weekend.

 

UOB Kay Hian slashed its target price for Digital Core to US$0.67, from US$0.78 previously. Citi Research also reduced its target price by 18 per cent to US$0.67 from US$0.82.

 

Cyxtera currently occupies 100 per cent of five shell and core facilities in Silicon Valley and Los Angeles, and 4 per cent of a fully-fitted facility in Frankfurt.

 

The tenant, which represents about US$16.3 million or 22.4 per cent of the Reit&rsquo s annual rental revenue, has 120 days to decide which leases to resume and reject.

 

On Tuesday, UOBKH analyst Jonathan Koh said he expects Cyxtera to reject the two leases for data centres in Los Angeles as occupancy there is low, at 57 per cent.

 

Similarly, Citi analyst Brandon Lee said that the data centres in Los Angeles and Frankfurt are &ldquo poised for a downtime&rdquo due to lower customer occupancy.

 

Both research teams reduced their FY2023 to FY2025 DPU estimates for Digital Core.

 

Koh from UOBKH reduced his DPU forecast for FY2024 by 15 per cent to US$0.035. Citi&rsquo s Lee cut his DPU estimates by 5.7 per cent to US$0.0374 for FY2023, by 12.8 per cent to US$0.0357 for FY2024, and by 0.9 per cent to US$0.0422 for FY2025.

 

Meanwhile, DBS Group Research said that &ldquo all negatives have already been priced in&rdquo .

 

&ldquo We believe that the worst-case scenario &ndash fully vacating all properties and impacting about 35 per cent of DPU &ndash are unlikely to happen,&rdquo it said.

 

This is because the market occupancies at the Silicon Valley and Frankfurt properties are &ldquo relatively healthy&rdquo at 95 per cent and 70 per cent, respectively, it added. But it noted that risks are &ldquo probably concentrated&rdquo on the two assets in Los Angeles.

 

DBS Group Research said it is maintaining its target price of US$0.90 and its &ldquo buy&rdquo call on the counter until there is &ldquo more clarity&rdquo on the leases with Cyxtera.

 

Both Citi Research and UOBKH are keeping their &ldquo buy&rdquo calls on the counter as well.

 

Lee said that Digital Core Reit can continue to receive rents until Sep 23 as the tenant has secured debtor-in-possession financing with a 120-day ceiling.

 

The Reit said on Monday that its tenant obtained a commitment for up to US$200 million of debtor-in-possession financing, and it intends to pay vendors and suppliers in full for goods and services provided on, or after, the filing date.

 

&ldquo It has up to 120 days to determine which leases to assume and reject, and post-petition rent must be paid until lease rejection occurs,&rdquo Lee said.

 

He also said that Silicon Valley occupancy is &ldquo likely to hold&rdquo given the &ldquo solid supply and demand dynamics and limited power until 2028&rdquo .

 

Supply constraints can drive higher rents, noted UOBKH&rsquo s Koh. &ldquo Rising rents and tightening vacancies augur well for Digital Core Reit&rsquo s efforts to backfill the vacant data centre space.&rdquo

 

He added that the Reit&rsquo s estimated in-place passing rents are 15 per cent to 40 per cent below market at Northern California and 5 per cent to 15 per cent below market at Los Angeles.

 

Koh also said that the Reit is well-positioned to deal directly with Cyxtera&rsquo s existing end-user co-location customers.