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Morningstar | Digital Realty Posts a Good 1Q While It Pursues Further Expansion and a Broadening Global Presence

Narrow-moat Digital Realty reported a good first quarter, with revenue, EBITDA, and funds from operations topping consensus. However, the more important facet of the company's quarterly report, in our view, was its glimpse to the future. The firm continues expanding its global presence and announced that it is now entering Chile, its 14th country. Digital is also due to finish construction on several data centers globally during the second half of 2019, which is crucial given recent capacity constraints. Management indicated it had virtually no available inventory in northern Virginia, its biggest market, so the completion of construction bodes well for the end of this year and 2020. Still, after a quarter that tracked the firm's full-year guidance and a consistent strategic vision that we expect the firm to execute on, we aren't making material changes to our long-term forecast. We expect to raise our $112 fair value estimate by $1, leaving shares fairly valued.

Revenue grew 9% year over year, slightly better than the 8% growth we project for the full year. But with most new supply not reaching the market until the third and fourth quarters, we don't expect to see a bigger pickup until 2020, when we project revenue growth to reach 10%. First-quarter bookings (excluding interconnection) were $50 million, a rebound from last quarter but still below all other quarters of 2018 and likely a harbinger of the slower revenue growth. We project quarterly 2019 bookings to stay around this level until more capacity becomes available, leaving full-year bookings below last year's $240 million. However, we expect the firm to eclipse 2018's bookings result in 2020.

Adjusted EBITDA margin was strong, exceeding 59%, but we don't project it to sustain that level throughout the year. While we think the margin can expand over time and ultimately exceed 60%, management was clear that in the near term, margin expansion will take a back seat to its pursuit of growth opportunities.

With Digital's acquisition of Ascenty complete and the joint venture (with Brookfield Infrastructure) that will operate it now settled, the firm is moving aggressively in South America, a new market for Digital. In moving beyond Brazil, which is Ascenty's home, the JV signed a 6.3 megawatt long-term contract to build a data center for a global cloud provider. Furthering its international expansion, Digital also signed a ground lease for three acres of land in Singapore that will support 40 megawatts and agreed to acquire five acres in Tokyo. With the U.S. and Europe currently accounting for over 95% of the firm's net rentable square feet, we expect the Asian and South American expansion will be fruitful. We think the firm's U.S.-based hyperscale tenants benefit by addressing their global needs with existing providers, so we believe demand exists. However, while we think these untapped markets are attractive opportunities for Digital, we think the potential exists for overbuilding in the industry as a whole. In our view, firms should be discerning in choosing where to build, and we think Digital would be well served to digest these recent moves before jumping in even deeper.