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Fitch Affirms Digital Realty Trust's IDR at 'BBB'; Outlook Stable

^{Published on 2010-12-23 09:01:19 - Market Wire}
 

NEW YORK--([ BUSINESS WIRE ])--Fitch Ratings has affirmed the credit ratings of Digital Realty Trust, Inc. (NYSE:DLR) and its operating partnership, Digital Realty Trust, L.P. (collectively, Digital Realty Trust or the company) as follows:

Digital Realty Trust, Inc.
--Issuer Default Rating (IDR) at 'BBB';
--$502.5 million convertible preferred stock at 'BB+'.

Digital Realty Trust, L.P.
--IDR at 'BBB';
--$750 million senior unsecured revolving credit facility at 'BBB';
--$1.1 billion senior unsecured notes at 'BBB';
--$376.4 million senior unsecured exchangeable debentures at 'BBB'.

The Rating Outlook is Stable.

The affirmation of Digital Realty's IDR at 'BBB' reflects the company's consistent operating performance of its portfolio of datacenters and other technology properties, good unencumbered asset coverage of unsecured debt, and strong management team including technical staff. Offsetting factors incorporated into the existing ratings include a concentration in certain core markets, which stems from the fact that datacenters are niche assets that are typically located in major population centers with power availability, fiber routing infrastructure, and Internet exchange points. Digital Realty also has a degree of tenant concentration, although the company continues to become less concentrated via portfolio expansion. The company also has an active development and redevelopment platform that improves earnings power and the quality of the overall portfolio but also adversely impacts other near-term liquidity needs and is contingent upon access to capital.

Demand for datacenter space continues a positive trajectory due to a growing need for corporate applications, cloud computing (shared resources provided to Internet computing devices on demand), colocation space (multi-tenant datacenter product provided on the basis of individual racks or cages), telecommunication network services, and activities such as social networking. Digital Realty's portfolio includes turn-key datacenters that offer metered power to various customers, as well as powered-base building space that enables tenants to build out their own datacenter facilities. Therefore, the portfolio is positioned to take advantage of various demand drivers. According to Tier1 Research, LLC, demand for multi-tenant datacenters will grow 15% annually on average for 2011 through 2013, while supply will increase by only 7.5% annually on average, which should enable Digital Realty to increase rents upon renewal.

The company's fixed charge coverage ratio (defined as recurring operating EBITDA less recurring capital expenditures less straight-line rent adjustments divided by total cash interest incurred and preferred dividends) was 2.6 times (x) for the latest 12 months (LTM) ended Sept. 30, 2010, compared with 2.5x and 2.2x for full-year 2009 and 2008, respectively. The company has a weighted average remaining lease term of 6.9 years as of Sept. 30, 2010 and signed new leases at $104.70 per square foot in third quarter 2010 (3Q'10) compared with $29.49 on expiring rent per square foot as a result of meaningful leasing of turn-key space that carries substantially higher rents than other space.

While leases on space set to expire in the near term include turn-key datacenters as well as powered-base buildings and non-technical space, Fitch anticipates that the company's fixed charge coverage ratio will continue to be supported by long-term income that has further upside potential as additional leases expire. Fitch anticipates that mid-single-digit same-property net operating income (NOI) growth - driven by lease signings of existing customers and new leases - along with incremental cash flow from acquisitions and redevelopment and the recent redemption of series B preferred stock, will result in fixed charge coverage remaining in a range of 2.5x to 3.0x, which is strong for the 'BBB' IDR.

Digital Realty also has a high-quality portfolio of unencumbered datacenters that provide value to bondholders. Unencumbered asset coverage of unsecured debt - calculated as annualized 3Q'10 unencumbered property NOI per the company's bond covenants divided by a stressed capitalization rate of 10% to unsecured debt - is appropriate for the 'BBB' IDR at 2.4x. Unencumbered asset coverage would be 2.7x at a capitalization rate of 9%, which is generally consistent with pricing on the company's acquisition of the Rockwood Capital/365 Main Portfolio for $725 million in July 2010 and other recent acquisitions.

The ratings are further supported by Digital Realty's strong management team that is focused on maintaining consistent leverage. The company's net debt to LTM recurring operating EBITDA was 5.7x as of Sept. 30, 2010 compared with 4.5x and 4.4x as of Dec. 31, 2009 and Dec. 31, 2008, respectively. However, net debt to annualized 3Q'10 recurring operating EBITDA was 4.9x in 3Q'10 and is expected to remain in a range of 4.5x to 5.0x over the next 12-24 months, due principally to EBITDA growth via acquisitions and redevelopment coupled with the company's commitment to a 5.0x leverage ratio.

Management also has technical acumen, focused on providing operational efficiencies and reliability. For example, the company enters into volume contracts with equipment manufacturers and has experienced very limited downtime in any of its datacenters.

The company is focused on areas with high demand for datacenter space including Silicon Valley (13.7% of rent in 3Q'10), San Francisco (10.3%), New York/New Jersey (10.2%), Chicago (9.9%), and Northern Virginia (9.8%). Technology firms and larger enterprises continue to drive space for datacenters in Silicon Valley and San Francisco, while Internet enterprises, hosting firms, and various industry verticals bolster demand in the greater New York, Chicago, and Northern Virginia areas. Digital Realty's presence in higher-barrier-to-entry markets offsets the nominal geographical focus of the portfolio. Furthermore, Digital Realty recently expanded its footprint beyond North America and Europe into Singapore and is expected to further grow its presence across the Asia-Pacific rim, including Hong Kong and Sydney.

The 'BBB' IDR takes into account credit weaknesses including Digital Realty's exposure to certain tenants, although the tenant roster continues to become less concentrated via portfolio expansion. Top tenants as of Sept. 30, 2010 were Savvis Communications (8.0% of annualized rent), Equinix Operating Company, Inc. (4.3%) and Facebook, Inc. (3.8%). Rent from the company's top three tenants comprised 16.1% of total rent as of Sept. 30, 2010, compared with 18.9% and 20.7% as of Dec. 31, 2009 and 2008, respectively, when top tenants were Savvis, Equinix and Qwest Communications International, Inc. (Fitch IDR of 'BB-', on Rating Watch Positive ).

The company's base case liquidity coverage ratio assuming no additional capital raises (unrestricted cash, availability under the company's unsecured revolving credit facility, and projected retained cash flows from operating activities after dividends and distributions, divided by debt maturities and projected recurring capital expenditures) was 1.5x for Oct. 1, 2010 to Dec. 31, 2012, and 3.4x if the company refinances 90% of upcoming secured debt. However, liquidity coverage would be 1.0x if the company incurs $487.5 million of development and redevelopment capital expenditures (the midpoint of the company's guidance of $450 million to $525 million). In addition to having adequate liquidity, Digital Realty has covenants related to its unsecured credit facility and senior unsecured notes that do not limit its financial flexibility.

The two-notch difference between Digital Realty's IDR and preferred stock rating is consistent with Fitch's criteria for corporate entities with an IDR of 'BBB'. Based on the criteria report, 'Equity Credit for Hybrids & Other Capital Securities,' Digital Realty's preferred stock is 75% equity-like and 25% debt-like, since it is perpetual and has no covenants but has a cumulative deferral option. Net debt plus 25% of preferred stock to recurring operating EBITDA for the LTM ended Sept. 30, 2010 was 6.0x and 5.2x in 3Q'10 compared with 5.0x and 4.9x as of Dec. 31, 2009 and 2008, respectively.

The Stable Outlook reflects that while Digital Realty's credit metrics are strong for the 'BBB' IDR and demand for datacenter space continues to solidify the company's strong market position in a niche real estate sector, it has yet to steer through various cycles. In addition, while the company has strong proven access to equity and debt capital, the depth of the secured debt financing market as a source of contingent liquidity for datacenter REITs has been borne out by only limited years of history and may be subject to disruption given the uncertainties of technology demand.

The following factors may have a positive impact on Digital Realty's ratings and/or Outlook:

--Fixed charge coverage sustaining above 3.0x (fixed charge coverage ratio was 2.6x for the LTM ended Sept. 30, 2010 and is expected to remain in a range between 2.5x and 3.0x);
--Net debt to recurring operating EBITDA sustaining below 4.5x (leverage was 4.9x in 3Q'10 and 5.7x for the LTM ended Sept. 30, 2010 but is expected to remain in a range of 4.5x to 5.0x);
-- Broader tenant and asset diversification.

The following factors may have a negative impact on Digital Realty's ratings and/or Outlook:

--Fixed charge coverage sustaining below 2.5x;
--Net debt to recurring operating EBITDA sustaining above 6.0x;
--Liquidity coverage below 1.0x.

Digital Realty is an equity real estate investment trust (REIT) with $5.8 billion in undepreciated book assets and a total market capitalization of $9.2 billion as of Sept. 30, 2010. As of Sept. 30, 2010, Digital Realty's portfolio consisted of 95 properties, excluding two properties held as investments in unconsolidated joint ventures, of which 81 are located throughout North America and 14 are located in Europe. The company's properties are located in major markets where corporate datacenter and technology tenants are concentrated, including the Boston, Chicago, Dallas, Los Angeles, New York Metro, Northern Virginia, Phoenix, San Francisco and Silicon Valley metropolitan areas in the U.S., and the Amsterdam, Dublin, London and Paris markets in Europe, and Singapore.

Additional information is available at [ www.fitchratings.com ].

Applicable Criteria and Related Research:
--Corporate Rating Methodology, Aug. 16, 2010;
--Criteria for Rating U.S. Equity REITs and REOCs, April 16, 2010;
--Equity Credit for Hybrids & Other Capital Securities - Amended, Dec. 29, 2009;
--Rating Hybrid Securities, Dec. 29, 2009;
--Recovery Rating and Notching Criteria for REITs, Dec. 23, 2009.

Applicable Criteria and Related Research:
Corporate Rating Methodology
[ http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=546646 ]
Recovery Rating and Notching Criteria for REITs
[ http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=492828 ]
Rating Hybrid Securities
[ http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=493086 ]
Equity Credit for Hybrids & Other Capital Securities - Amended
[ http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=493112 ]
Criteria for Rating U.S. Equity REITs and REOCs
[ http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=510465 ]

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