Tuesday, October 17, 2017

Anatomy of an unexpected $7.8bn data centre M&A

In-depth: An accretive acquisition that has created the US’s 8th largest publicly traded REIT which aims to be the “house of cloud” as hyperscale cloud CAPEX tops $25.3bn.

It was just after midday on Friday, June 9, 2017, when Digital Realty (DLR) surprised the data centre community with yet another multi-billion Dollar M&A.

Perhaps the surprise did not come from the $7.8bn invested or the fact that consolidation is continuing strong, but that the acquired entity was no other than DuPont Fabros Technology (DFT).

Across social media many showed their surprise, including Infrastructure Masons’ Dean Nelson who said on LinkedIn he “did not see this one coming”.

The blockbuster transaction, expected to close in H2 2017, is now a given fact and Digital Realty’s CEO William Stein, said in an investor call that the deal is consistent with the company’s strategy of offering a comprehensive set of data centre solutions, from single-cabinet colocation and interconnection, all the way up to multi-megawatt deployments.

“At the far end of the spectrum, this combination significantly expands our “hyper-scale” product offering and enhances our ability to meet the rapidly growing needs of the leading cloud service providers,” he said.

The company’s take to invest in the North American cloud market is in line with a growing industry. According to Statista, in North America alone, cloud revenues are expected to top $59.45bn by 2020, from $34.16bn in 2016. This year revenues are expected to reach $$39.33bn.


The transaction

The total transaction value associated to the DLR acquitision of DFT is approximately $7.6bn, including $5.8 billion of common equity issued by DLR, $200m of assumed preferred equity and $1.6bn of assumed debt, not including transaction costs.

Upon completion, Digital Realty shareholders are expected to own approximately 77% and DuPont Fabros shareholders approximately 23% of the combined company. There will be approximately 213.3 fully diluted shares outstanding based on assumed combined share count.

The anticipated annualised overheard synergies are expected to generate approximately $18m per year.

The Board will be comprised of the ten current Digital Realty directors, along with two directors from DuPont Fabros.

As of June 7, 2017, the combined entity’s equity market capitalisation was $25.18bn. This includes $5.83bn from DFT and $19.35bn from DLR.

DLR has gone from being the 12th largest publicly traded US REIT, to being the eighth, according to the MSCI US REIT Index.

The only other data centre REIT above DLR is Equinix, which is the third largest US REIT at $34.9bn. First and second places go to Simon Property Group ($55.8bn) and Public Storage ($36.8bn) respectively.

The total enterprise value for both DLR and DFT skyrocketed to $34.33bn (DFT: $7.59bn; DLR: $26.57bn).

Stein said: “The combined organisation will be the eighth largest REIT in the index with a total enterprise value of more than $3bn, and more than five times the size of the next largest data centre REIT.

“The benefits of this scale translate directly to operating efficiencies


Why now?

Following a 2015 and 2016 full of M&A activity, and a busy H1 2017, more consolidation was expected – as it still is – and Digital Realty’s desire to bulk up on its hyperscale vision comes as capital expenditure (CAPEX) in this segment booms.

In 2016, hyperscale cloud CAPEX topped $25.3bn, up from $21.1bn in 2015 and the same value in 2014. Back in 2010, CAPEX in this vertical ‘only’ amounted to $7.2bn.

Although many of the main public cloud providers usually build their own facilities, they are also large customers of colocation services – and not only with DLR but also other players such as Equinix.

As the cloud giants grow their environments, DLR’s acquisition of DFT places the percentage of cloud customers using its services at 26%, based on annualised base rents. This includes DLR’s current 23% and DFT’s 46% cloud customer base.

Having more than one-quarter of cloud customers in its data halls can prove a very profitable business. In Q1 2017 alone, the world’s five largest cloud providers reported combined revenues of $52.1bn, with Microsoft leading the pack at $15.2bn, followed by AWS ($14.6bn), IBM Cloud ($14bn), Oracle ($4.8bn) and SAP ($3.6bn).

In the combined entity, DLR’s main customer will be IBM, with a presence in 24 locations and representing 6.2% of all DLR customers.

This is followed by a not-named Fortune 50 software company in 15 locations (6% of customers).

Facebook, CenturyLink, Rackspace, Equinix and Oracle follow in order of largest occupancy.

Overall, the combined DLR customer base will be made of 26% cloud customers, 21% IT companies, 16% content businesses, 14% networks, 13% financial customers and 10% from enterprises.

Stein said: “We envision the combined organization really will be the “home to the cloud,” as demonstrated on page eight.

“The cloud and “cloud-like” customers represent a very significant proportion of DuPont Fabros’ rent roll, which will further expand Digital Realty’s cloud concentration.

“We believe we are still in the early innings of cloud adoption, and supporting the explosive growth of this customer base will represent a tremendous opportunity over the next several years.

“The credit quality of DuPont Fabros’ “cloud and cloud-like” customer base is exceptional, and will further enhance the credit quality of Digital Realty’s existing customer base.”


Digital Realty’s updated global footprint.


The new Digital Realty

A transaction of this magnitude changes any company, and Digital Realty is set to grow from it, becoming one of the few operators in the world with more than 150 facilities.

The combined entity will amount to 157 data centres, in 12 countries across 33 metropolitan areas. In total, the operator will manage 26 million sqf of rentable data centre floor, one of the largest footprints on Earth.

Altogether, the ‘new DLR’ will own 88% of its real estate based on the number of properties, a value that increases to 92% when looked from a net operating income.

In comparison, Core Site owns 70% of its real estate based on number of data centres, CyrusOne 65%, QTS Realty Trust 48% and Equinix 31% (including the Verizon assets acquired in May).

On a more local basis, DFT will be giving DLR 12 facilities across three US markets including Northern Virginia, Chicago and Silicon Valley. Combined, the data centres have 302MW of IT load and stand at a 98% occupancy rate.

On a market level, this will take DLR’s fleet in Northern Virginia alone from 17 data centres, 2.2 million sqf of space, 90MW of power and a 97% occupancy rate to 26 data centres, 4.4 million sqf, 292MW. Occupancy rate remains unchanged.

In Chicado, DLR’s footprint of five data centres, 1.7 million sqf, 52MW and 91% occupancy will go to seven data centres, 2.5 million sqf, 116MW and 94% occupancy.

Lastly, in Silicon Valley, DLR is to add one facility to its existing 15. Today, the company runs 1.7 million sqf in this market and a 47MW IT load at a 96% occupancy rate. This will grow to 2.1 million sqf and 84MW with occupancy levels to remain unchanged.

CEO Stein said: “The merger will benefit Digital Realty by bolstering its presence in these top-tier metro areas, while DuPont Fabros will realise significant benefits of diversification from the combination with Digital Realty’s existing footprint in 145 properties across 33 global metropolitan areas.

“Both companies have traditionally pursued similar campus strategies in the major data centre metros, as you can see from the clusters on the aerial maps here on page seven.

“These campus environments enable both companies to achieve operational efficiencies, and we expect the combined portfolio should benefit from additional economies of scale, given the complementary campus footprints.”


Future of expansion

Just like other M&As in the data centre space, DLR’s acquisition of DFT brings with it a range of expansions, some already under way, others in the pipeline.

Stein said: ”DuPont Fabros has six development projects currently underway as well as significant capacity and land held for future development, as shown here on page twelve.

“These six active development projects are 48% pre-leased and represent a total expected investment of approximately $750m.

“They are also located in metro areas where Digital Realty has an existing presence, and they are expected to be delivered over the next 12 months, representing a solid pipeline of future growth potential.”

The six DFT under construction projects above mentioned by Stein are located in Ashburn, Chicago, Santa Clara (Silicon Valley) and Toronto (Canada).

Northern Virginia is to add 702,000 sqf and 68MW of IT load. Chicago is adding 305,000 sqf and 27MW. In Toronto, DLR will see 711,000 sqf and 35MW delivered in the coming year.

In addition, DFT owns land holdings in Ashburn and Oregon, which will support the future delivery of up to 163 megawatts of incremental capacity, along with 56 acres of land recently acquired in Phoenix.

The Phoenix site in Oregon is expected to deliver 1.5 million sqf of net rentable sqf and 96MW of powers.

Stein concluded: “We are very excited with this strategic transaction which will enhance our ability to serve our customers – and hyper-scale cloud customers in particular – in the top data centre metro areas across the US.

“It will be immediately accretive to earnings and cash flow, and strengthens our balance sheet.  The complementary nature of the two footprints, customer bases and product offerings provide mirror image diversification and enhancement benefits and enhance our ability to create significant long-term value for both sets of shareholders.”

Note: All graphics courtesy of Digital Realty