At yesterday’s Ira Sohn Conference in New York, Highfields Capital LP’s founder Jonathon Jacobson put out a short case on DLR, stating that “pricing is going lower, competition is increasing, and the company is tapping into capital markets as aggressively as they can,” and stating that the fair value of Digital Realty is about $20/share. Beyond the comments above, Highfields’ thesis appears predicated on Digital Realty Trust, Inc. (NYSE:DLR)’s high recurring capital needs and it stated that the rate of expenditures was materially higher than what the company represents and that items portrayed as non-recurring were actually understated maintenance capex. Citi rebuts Highfields’ claim in a report today which we highlight below:
Highfields Capital LP Presents Digital Realty Trust, Inc. (NYSE:DLR) Short Thesis at Ira Sohn Conference
While there has always been some concern on the high levels of capital expenditures necessary in the data center space and the potential for pricing to come down as the space matures, we believe that the comments and case presented today were overly aggressive. We have not yet spoken to or seen Highfields’ analysis behind their case. That being said, Citi believes, and financial statements prove, that capital that has been invested over the past several years has actually driven significant NOI growth with ROIC in the low double digits, rather than be value destructive, as claimed. It should also be noted that DLR puts a significant amount of their maintenance expenditures through their operating expense line item.
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Digital Realty Trust, Inc. (NYSE:DLR) Neutral Ratings
We continue to believe that Digital Realty Trust, Inc. (NYSE:DLR) presents a fair value and maintain our Neutral rating.
Not all Space is Created Equal — Digital Realty Trust, Inc. (NYSE:DLR)’s business model is centered on providing space across distinct asset classes: powered-base-building, turn-key flex space, custom solutions, and colocation. Each has distinct capital needs and resulting returns. We believe that some of the volatility in DLR’s capital expenditures is due to these different spaces and investments and that to compare to more homogenous portfolios is incorrect. Leasing commissions across the portfolio have been reasonable historically, in our view, and likely continue to be in the $25-45 range. Management has also run into some hurdles recently with the disclosure of expiring leases across the asset types including non-technical space – with a recent reclassification of Digital Realty Trust, Inc. (NYSE:DLR)’s own office space within the assets driving a “jump” in non-technical space.
Best-in-Class — The DLR management team has worked together for a long time and has built a best-in-class portfolio of data center assets; Digital Realty Trust, Inc. (NYSE:DLR) has grown into a fairly large public company. Over the last 8 years the company has earned a reputation for honesty and we do not question their reporting.
Short Interest Has Always Been High — Short interest in Digital Realty Trust, Inc. (NYSE:DLR) shares has always been high due in part to the company’s outstanding converts. Others have shorted the company on the business model which is non-traditional compared to other REITs and IS capital intensive. That said, the recent pop in short interest (see Figure 1) is likely overblown and a sell-off on this news could see some short covering.