Fitch Ratings has assigned a 'BB+' rating to the $225 million 5.875% Series G cumulative redeemable preferred stock issued by Digital Realty Trust, Inc. (NYSE: DLR). DLR intends to contribute the net proceeds of this offering to its operating partnership, Digital Realty Trust, L.P., which will subsequently use the net proceeds to temporarily repay borrowings under the global revolving credit facility, to acquire additional properties, to fund development opportunities, or for general corporate purposes.
Fitch currently rates Digital Realty Trust, Inc., Digital Realty Trust, L.P., and Digital Stout Holding, LLC (collectively, Digital Realty) as follows:
Digital Realty Trust, Inc.
--Issuer Default Rating (IDR) 'BBB';
--$678.4 million preferred stock 'BB+'.
Digital Realty Trust, L.P.
--$1.8 billion unsecured revolving credit facility 'BBB';
--$750 million senior unsecured term loan 'BBB';
--$1.7 billion senior unsecured notes 'BBB';
--$266.4 million senior unsecured exchangeable notes 'BBB'.
Digital Stout Holding, LLC
--GBP400 million unsecured guaranteed notes 'BBB'.
The Rating Outlook is Stable.
Key Rating Drivers
The 'BBB' IDR takes into account Digital Realty's credit strengths, including a granular tenant roster that insulates the company against technology obsolescence risk, a geographically diverse data center portfolio in strategically important markets and a fixed-charge coverage ratio that Fitch anticipates will remain strong for the 'BBB' rating. Digital Realty also has a good liquidity position and strong access to capital. Leverage is consistent with the 'BBB' rating, though Fitch expects leverage to rise as the company continues to incur debt to fund acquisitions and development.
The IDR also reflects that broader institutional lender acceptance of data centers as a niche property type has remained gradual. The inclusion of data center loans in select recent CMBS transactions indicates progress towards commercial property lenders' comfort with the asset class. However, Digital Realty is committed to an unsecured funding profile and is less reliant on the secured debt markets to fund its business, which is predicated on the company's ability to access the unsecured bond, preferred stock and common stock markets on attractive terms.
The secured debt market for data centers is not as deep as that for other property types, weakening the contingent liquidity provided by an unencumbered asset pool. Digital Realty's unencumbered assets (unencumbered NOI divided by a stressed capitalization rate of 10%) covered unsecured debt by 2.1x as of Dec. 31, 2012 pro forma for the Digital Stout Holding, LLC guaranteed notes offering and Series G preferred stock offering, which is adequate for the current rating.
Digital Realty's properties span 32 markets across 10 countries and four continents, enabling economies of scale and facilitating the offering of Turn-Key Flex, Powered Base Building, or colocation space to both global and local customers. Top markets as of Dec. 31, 2012 were London (11.8% of annualized rent), Dallas (10.4%), Silicon Valley (9.8%), Northern Virginia (9.2%) and New York (8.5%) as the company continues to focus on high barrier to entry markets with demand among colocation providers, corporate users and network/telecom companies.
The company continues its expansion globally as evidenced by the acquisition of a three-property data center portfolio in Paris in a sale/leaseback transaction with Bouygues Telecom in January 2013, purchase of a data center in Ontario, Canada in March 2013, and push into Singapore, Hong Kong and Australia. The company has the real estate and technical acumen to pursue such growth while maintaining credit metrics consistent with an investment grade rating.
Tenant concentration continues to decline, which Fitch views favorably and which differentiates DLR from its major competitors, CoreSite Realty Corporation, DuPont Fabros Technology, Inc. and Global Switch Holdings Ltd. (Fitch IDR of 'BBB' with a Stable Outlook).
Diverse Tenant Base
DLR's top tenants as of Dec. 31, 2012 were CenturyLink, Inc. (IDR of 'BB+' with a Stable Outlook) at 9.1% of annualized rent, Softlayer Technologies, Inc. at 4.0%, TelX Group, Inc. at 3.9%, Equinix Operating Company, Inc. at 3.3% and Facebook, Inc. at 3.1%.
Stable Fixed-Charge Coverage
Same-property NOI growth averaged 8.7% over the past eight quarters and was positive throughout the 2008 - 2009 financial crisis, driven principally by positive leasing spreads. Fitch expects same-property NOI growth to remain in the mid-to-high single-digit range over the next two years. Portfolio occupancy has been stable in the 94% to 95% range and was 94.4% as of Dec. 31, 2012.
The weighted average remaining lease term for the portfolio is approximately seven years, providing cash flow stability absent tenant bankruptcies -- technological obsolescence-related or otherwise.
As of Dec. 31, 2012, lease expirations are laddered, with 6.5% of annualized rent expiring in 2013 followed by 9.7% in 2014 and 9.1% in 2015. Fitch anticipates that rent spreads on lease rollovers will continue to be positive due to high replacement costs that deter tenants from vacating and growth in data from devices such as tablets and from cloud-based services.
Coverage was 2.6x for 2012 pro forma, compared with 2.7x in 2011 and 2.4x in 2010. Organic growth and development-driven EBITDA led to improvements in coverage. Fitch defines fixed-charge coverage as recurring operating EBITDA less recurring capital expenditures less straight-line rent adjustments divided by total interest incurred and preferred stock dividends.
Under Fitch's base case, coverage would remain in the high 2x to low 3x range over the next 12-to-24 months, positively impacted by expected high single-digit same-store NOI growth and EBITDA from development, offset by increased fixed charges as the company continues to access the unsecured bond market and preferred stock market to fund acquisitions and development. Coverage sustaining above 3.0x would be strong for a 'BBB' rating.
In a stress case not anticipated by Fitch in which the company experiences tenant bankruptcies leading to low single-digit same-store NOI declines, coverage would decline to 2.5x, which would remain adequate for a 'BBB' rating.
Good Liquidity Position
Pro forma liquidity coverage assuming no additional capital raising, calculated as liquidity sources divided by uses, is 1.6x for the period from Jan. 1, 2013 to Dec. 31, 2014. Sources of liquidity include unrestricted cash, availability under the company's global unsecured credit facility pro forma for the Digital Stout Holding, LLC guaranteed notes offering and Series G preferred stock offering, and projected retained cash flows from operating activities after dividends and distributions. Uses of liquidity include debt maturities, projected recurring capital expenditures and development costs. Assuming 80% of the company's secured debt is refinanced with new secured debt--a scenario not likely as the company continues to unencumber the portfolio with corporate liquidity sources--liquidity coverage would be 2.1x.
Strong Capital Access
The company continues to demonstrate strong access to multiple sources of capital on favorable terms, and Fitch expects the company will continue to have good access to the capital markets as evidenced by the GBP400 million 4.25% guaranteed notes offering and $225 million Series G preferred stock offering. In addition, in September 2012, Digital Realty Trust, L.P. issued $300 million 3.625% senior unsecured notes due 2022 at a spread of 200 basis points over the benchmark rate and priced to yield 3.784%. In August 2012, the company expanded its global revolving credit facility to $1.8 billion from $1.5 billion pursuant to the accordion feature under the facility.
As of Dec. 31, 2012 pro forma, net debt to recurring operating EBITDA was 5.3x compared with 4.7x as of Dec. 31, 2011 and 5.5x as of Dec. 31, 2010. The incurrence of debt to fund a portion of acquisitions and development contributed towards the recent increase in leverage.
Fitch anticipates that the company will continue to manage leverage in the low-to-mid 5x range, which is appropriate for a 'BBB' rating. In a stress case not anticipated by Fitch in which the company experiences tenant bankruptcies leading to low single-digit same-store NOI declines, leverage could sustain above 6.0x, which would be more consistent with a 'BBB-' rating.
The Stable Outlook reflects Fitch's projection that fixed-charge coverage will remain in the high 2x to low 3x range, that leverage will remain in the low-to-mid 5x range, and that the company will continue its gradual tenant and asset diversification via acquisitions and development.
Preferred Stock Notching
The two-notch differential between Digital Realty's IDR and its preferred stock rating is consistent with Fitch's criteria for corporate entities with an IDR of 'BBB'. Based on Fitch's criteria report, 'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis,' dated Dec. 13, 2012, the company's preferred stock is deeply subordinated and has loss absorption elements that would likely result in poor recoveries in the event of a corporate default.
The following factors may have a positive impact on Digital Realty's ratings and/or Outlook:
--Increased mortgage lending activity in the datacenter sector;
--Fitch's expectation of fixed-charge coverage sustaining above 3.0x (pro forma fixed-charge coverage is 2.6x);
--Fitch's expectation of net debt to recurring operating EBITDA sustaining below 4.5x (pro forma leverage is 5.3x).
The following factors may have a negative impact on Digital Realty's ratings and/or Outlook:
--Fitch's expectation of fixed-charge coverage sustaining below 2.5x;
--Fitch's expectation of leverage sustaining above 6.0x;
--Base case liquidity coverage sustaining below 1.0x.
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
--'Criteria for Rating U.S. Equity REITs and REOCs' (Feb. 26, 2013);
--'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis' (Dec. 13, 2012);
--'Recovery Ratings and Notching Criteria for Equity REITs' (Nov. 12, 2012);
--'Corporate Rating Methodology' (Aug. 8, 2012);
--'Parent and Subsidiary Rating Linkage' (Aug. 8, 2012).
Applicable Criteria and Related Research
Criteria for Rating U.S. Equity REITs and REOCs
Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis
Recovery Ratings and Notching Criteria for Equity REITs
Corporate Rating Methodology
Parent and Subsidiary Rating Linkage