We’re in the throes of third-quarter earnings season for the digital infrastructure space, and watching results closely for trends in demand and pricing, as well as any shifts in the secular and cyclical themes playing out globally as we head into yearend.
As the data center industry behemoths, Digital Realty (DLR) and Equinix (EQX) are widely considered the bellwethers of the space, and watched closely each quarter. Digital Realty reported last Friday and Equinix will report tomorrow after close.
The OCOLO team is fortunate enough to have access to the research that the brilliant sell-side analysts Michael Elias of TD Securities Equity Research (TD Cowen) and Michael R. (Rollins) CFA of Citi Equity Research and their teams produce. We looked at their post-earnings conference call notes side-by-side to see where their views align and diverge.
Where they align
Strong demand driving record third quarter leasing results
- Both reports highlight the strength of DLR’s pipeline.
- Citi notes DLR’s management is predicting future record-breaking activity.
- TD Cowen describes DLR’s demand pipeline as being at or near record levels, with the possibility of another record leasing quarter in the next 12 months. They also note that DLR’s management considers the go-forward demand to be bullish.
- Citi sees expanding demand for Generative AI workloads as a contributing factor to hyperscale demand. They estimate that bookings from Generative AI workloads accounted for 50% of DLR’s leasing in the quarter.
- TD Cowen observes that DLR attributed approximately 50% of its record leasing to AI.
Hyperscale cranking but colocation no slouch, either
- Both reports mention strong hyperscale demand as a key driver of DLR’s success.
- Citi also notes that DLR’s retail-centric bookings at under 1 megawatt (MW) have accelerated. This segment comprises 80% of DLR’s total bookings and shows strong interconnection bookings.
- TD Cowen also highlights record 0-1 MW plus interconnection bookings for DLR, reaching $66 million, as well as a record number of new logos (149) and signings in the 0-500 kilowatt (kW) range ($40 million).
- Interestingly, they suggest this is more likely due to DLR’s investments in their enterprise go-to-market strategy than a significant change in underlying enterprise demand.
Greater pricing power than ever before
- Both analysts point to favorable pricing trends in the data center market.
- Citi mentions that pricing has increased, and DLR management expects this trend to continue across more markets.
- They specifically mention that DLR reported instances of 8 MW or higher blocks in Northern Virginia being offered at $175-$200+ per kW per month, a significant increase from the mid-$100 range previously observed.
- TD Cowen notes that DLR raised its 2024 renewal spread guidance and that new deal pricing for deals over 1 MW reached record highs.
- They observed that leasing for deals over 1 MW in the third quarter averaged $218 per kW per month on a GAAP basis, a substantial increase from the average price of $123 per kW per month for existing deals over 1 MW.
- TD Cowen also states that DLR has successfully renewed existing hyperscale deals with below-market rents early, allowing them to capitalize on current market pricing.
- They also indicate that DLR is now securing 4% fixed escalators on the majority of new leases, including hyperscale deals, which is a significant change in the market, as hyperscalers have historically been reluctant to accept escalators above 3%.
Future looks bright
- Citi is optimistic about DLR’s future growth, predicting improved annual core funds from operations (FFO) per share growth in 2025, reaching the mid-single-digit range.
- The team also anticipates further improvement to the mid-to-high single-digit range thereafter.
- TD Cowen expects potential for slight upside to the 5% core FFO per share growth that DLR’s management has projected for 2025.
- They also believe that the strong third-quarter performance increases DLR’s chances of achieving high single-digit core FFO per share growth in 2026 and beyond.
Where they diverge
Valuation – room to run vs. too rich for my blood
- The one area where the two analysts diverge is on valuation.
- Post-earnings, Citi raised their target price from $174 to $188 based on their expectations that the combination of core cloud demand, expanding demand for Gen-AI workloads, and supply limitations in certain markets (including near-term energy constraints) are supporting a stronger environment for data center demand across size requirements and markets.
- Meanwhile, TD Cowen came away convinced that, while the results and management commentary were highly encouraging, the positivity is already reflected in the stock price, as Digital Realty continues to trade at a premium to Equinix, despite demonstrating lower growth and returns.
- Acknowledging that near-term optimism surrounding AI might sustain this valuation dynamic for an extended period, they nudged their PT up from $120 to $128, but maintained a “Hold” rating on the stock.
Summary
- Both Citi and TD Cowen recognize DLR’s third-quarter earnings as positive for both the company and the industry. However, their outlooks on valuation differ widely.
- Citi is bullish, increasing their target price based on strong performance and a positive outlook for demand, pricing, and growth.
- TD Cowen acknowledges the growth potential for growth, but worries that growth is already baked into Digital Realty‘s valuation and maintains a “Hold” rating.
It will be interesting to see what Equinix has to say tomorrow when it reports Q3 2024 results. The OCOLO team will share analyst reactions to their performance as well.
As always, many thanks to the Citi Research team members who contributed to the note cited: Roberta Versiani, Michael R. (Rollins), CFA, Nick Joseph and Caitlyn Walsh, as well as the team at TD Securities Equity Research: Michael Elias, Cooper Belanger, Gregory Williams, CFA and Anton Rinnert.
