Investors were surprised when Digital Core REIT (SGX: DCRU), or DCR, called for a trading halt on the first day of November.
The data centre REIT, which has a portfolio of 11 data centres worth US$1.6 billion as of 30 September 2023, was not having an easy time.
Back in June, its second-largest customer which took up 22.4% of the REIT’s annualised rental revenue filed for bankruptcy.
Since then, the REIT’s unit price has tumbled to US$0.50 before the trading halt, down nearly 9.1% year-to-date.
The REIT manager has unveiled a slew of announcements that address this customer bankruptcy and improve DCR’s portfolio metrics.
After the halt was lifted, the data centre REIT’s share price proceeded to shoot up 14% in two days.
Could this represent a potential buying opportunity, or is the REIT a value trap?
Resolving its customer bankruptcy issue
Source: Digital Core REIT Presentation Slides
The slide above summarises the series of transactions that DCR’s manager has undertaken.
These actions are divided into three parts to make them easier to understand.
The first batch of transactions involves the sale of two data centres in Silicon Valley to Brookfield Infrastructure Partners for US$160 million.
A third data centre in the same region had its lease assigned to Brookfield with no change to the existing lease agreement.
DCR also amended the leases on two Los Angeles data centres with the bankrupt customer as a tenant with an accelerated expiration date of 30 September 2024.
Over in Frankfurt where the customer leases 4% of a fully-fitted facility, the lease will be terminated and both DCR and its sponsor Digital Realty Trust (NYSE: DLR), or DRT, will re-lease the space at more favourable terms.
This set of transactions helps to resolve DCR’s customer bankruptcy issue.
With the sales proceeds from the divestment of its Silicon Valley data centres, DCR will procure an additional 20% stake in its Frankfurt data centre to recycle the capital into better-quality assets.
The REIT will also acquire a 10% interest in a Japanese data centre located in Osaka from Mitsubishi Corporation (TYO: 8058).
Improving overall portfolio metrics
With this series of transactions, DCR’s manager has not only resolved the lingering customer bankruptcy issue but also improved the REIT’s overall portfolio metrics.
This is an important move as it injects more confidence in investors with increased tenant diversification along with a slate of higher-quality customers.
The number of customers in DCR’s portfolio increased from 26 as of the third quarter of 2023 (3Q 2023) to more than 40.
Previously, 77% of DCT’s customers were investment-grade but this will increase to 85% after these transactions.
The proportion of hyperscale cloud providers within the portfolio is also slated to increase from 61% to 70%.
The manager is also diversifying DCR’s portfolio with international data centres making up 28% of the portfolio, double the 14% as of 3Q 2023.
Portfolio occupancy will stay fairly constant at 96% versus 97% as of 3Q 2023 but the weighted average lease expiry for the portfolio will decline from 3.6 years to 3.1 years.
Pro-forma distribution per unit (DPU) will be US$0.035 for the REIT with aggregate leverage projected to be 34.1%.
At a unit price of US$0.57, the projected DPU means the units will provide a forward distribution yield of 6.1%.
A solid sponsor
The REIT was able to pull off this chain of transactions partly because of its strong sponsor DRT.
DRT has enabled DCR to have access to strong partnerships in Brookfield and Mitsubishi that enabled these transactions to take place.
DRT also helped DCR with further growth by selling a portion of its Frankfurt data centre to help make up for the fall in DPU.
In addition, the DCR’s sponsor also has a pipeline of US$15 billion that can help to power its growth in the years to come.
Get Smart: The dawn of a new era
It is an interesting time for DCR as it rejigs its portfolio.
With the help of its sponsor DRT, it has settled the worries surrounding the bankruptcy of its second-largest tenant and helped to boost its portfolio metrics with choice acquisitions.
It is still early days but these improvements should help the REIT to better protect itself and place it on a better footing to grow.
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Disclosure: Royston Yang owns shares of Digital Core REIT.
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