Digital Realty Trust Inc (DLR) 2015 Q2 法說會逐字稿

Welcome to the Digital Realty second-quarter 2015 earnings conference call.

(Operator Instructions)

Please note this call is being recorded.

I would now like to turn the conference over to John Stewart, Senior Vice President of Investor Relations.

Mr. Stewart, please go ahead.

Thank you, Denise.

The speakers on today's call will be CEO, Bill Stein; Chief Investment Officer, Scott Peterson; SVP of Sales and Marketing, Matt Miszewski; and Chief Financial Officer, Andy Power.

Chief Operating Officer, Jarrett Appleby is on the call as well and will be available for Q&A.

We've posted a presentation to the Investors section of our website to accompany Management's prepared remarks.

You're welcome to download the presentation and follow along throughout the call.

Management may make forward-looking statements on this call.

Forward-looking statements are based on current expectations, forecasts and assumptions that involve risks and uncertainties that could cause actual results to differ materially.

Forward-looking statements include statements related to future financial and other results, including 2015 guidance and the underlying assumptions.

For a further issues related to our business, see form 10-K for the year ended December 31, 2014, and subsequent filings with the SEC.

This call will contain non-GAAP financial information.

Explanations and reconciliations to net income are included in the supplemental package furnished to the SEC and available on our website at www.digitalrealty.com.

Management's prepared remarks will be followed by a Q&A session.

Questions will be limited to one plus a follow-up.

And if you have additional questions, please feel free to jump back into the queue.

Now I'd like to turn the call over to Bill Stein.

Thanks John.

Good afternoon, and thank you all for joining us.

I'm happy to report that Digital just completed other solid quarter marked by strong execution against our core strategic objectives.

I'd like to begin, as usual, with the way forward slide on page 2 of our earnings deck.

We continued to make progress towards our top priority of driving improved return on invested capital.

And we achieved a 20 basis point pickup during the second quarter, building upon the 100 basis point improvement we delivered over the previous five quarters.

In terms of recycling capital we realized a $77 million gain from the sale of one core property and we are in act of negotiations on several others.

Scott Peterson will provide additional detail.

As you know, we've put a great deal of effort into stabilizing the business and derisking the development pipeline over the past year and a half.

With respect to inventory management, we have reduced our finished inventory by nearly half since our Investor Day in November 2013.

And our $630 million pipeline of active data center development projects is over 80% preleased at stabilized cash yields just below the high end of our 10% to 12% target range.

From the current position, we believe we are in solid footing to pivot towards the next phases of growth for Digital Realty, particularly with the recent addition of several key executive level hires, notably including Andy Power, Jarrett Appleby and Michael Henry.

I'm very pleased with the progress that the entire Digital team has made on each of the strategic objectives spelled out here.

But today, I'd like to focus and I'm sure most of you will too, on the red call-out box highlighting innovative product offerings, co-location and ecosystem initiatives.

As you are all aware, just two weeks ago we announced an agreement to acquire Telx, a leading, national provider of co-location and interconnection data center solutions for $1.9 billion.

We believe Telx fits squarely within the box in terms of our strategic priorities.

And that its product offerings and geographic footprint are highly complimentary to our current portfolio.

Page 3 really highlights the complimentary nature of the transaction.

Our existing business consists primarily of meeting the large footprint data center space and power requirements of credit-worthy customers.

Telx's co-location business is very similar, but in much smaller increments to a far greater number of customers.

Over time and in select environments, if a critical mass of customer concentration is achieved, an ecosystem may blossom which is the necessary precursor to the interconnection business, or the exchange of traffic within a data center.

As indicated by the bubbles on the right-hand column, interconnection represents nearly half of Telx's top line and has grown at a very healthy rate.

It is important to understand here that by combining our businesses we are creating an even more differentiated business model with a strong, large footprint business, and a solid, rapidly growing co-location business within a truly interconnected network.

In essence, we are widening and deepening the economic moat between ourselves and our competitors.

There are significant barriers to growing a portfolio of either a global large footprint platform or a co-location and interconnection business, but with all three under the same roof, we believe that the sum of the parts will truly be greater than the whole.

In addition, the properties that make up the physical infrastructure are almost entirely owned by Digital.

This makes future growth that much more significant, since we control our own real estate and the residual value from incremental growth opportunities accrues to us rather than a third party landlord.

In the long run, we believe this will further set us apart from our competitors in terms of products and services offered.

Now turning to slide 4, we have consistently stated that our key acquisition criteria focused on investments that are strategic and complimentary to our existing business and also financially accretive and prudently financed.

We believe Telx checks all of those boxes.

This deal makes strategic sense for several reasons.

First, Telx is a leading co-location and interconnection business that is extremely complimentary to our existing platform and is concentrated in top tier markets in the US.

In addition, this deal allows us to obtain a robust and extremely difficult to replicate interconnection ecosystem in one fell swoop.

The combination also sets the stage for future upside from cost synergies, significant revenue synergies and embedded growth potential from expanding Telx's offering across our global portfolio and leasing up Telx's underutilized properties in our own back yard on the West Coast.

And, finally, we expect to achieve these benefits while enhancing our standalone growth trajectory and funding the transaction in a manner consistent with our leveraged targets.

Our core competency remains providing space and power to our existing customer base.

This acquisition allows us to broaden the range of customers, even -- and provide even more choice on an open carrier-neutral platform.

The transaction will not fundamentally alter our relationship with our customers.

But what it will do is provide them a one-stop shop where they pick and choose from the entire range of data center solutions that best fit their needs.

That open platform is extremely compelling.

We are focused on serving the needs of our entire customer base, from enterprise customers to strategic channel partners and managed service providers, who sell through to corporate enterprise IT requirements.

We have a unique opportunity to provide an open environment that gives our customers a choice of varying levels of redundancy, footprint size, and connectivity options.

While this acquisition expands our product offering, we will, of course, remain true to our real estate roots.

And we are keenly focused on maximizing the return on our existing asset base.

We expect to drive higher returns on every square foot, on every kilowatt in our portfolio, by augmenting our existing product offering with a wide array of size, power and redundancy requirements.

And by bringing core interconnection networking capabilities to our data center campus environments around the world.

In some instances this will mean partnering with customers to enable their managed services, thereby monetizing the tremendous value of our global footprint with minimal incremental costs.

Our ability to do so is unique among data center providers.

We will provide a full review of how we see Telx fitting into our strategy going forward at our Investor Day in Aspen now scheduled for October 6. I look forward to seeing you all there and now I'll pass the call over to our Chief Investment Officer, Scott Peterson, for a deeper dive on our underwriting of the Telx acquisition.

Thank you, Bill.

Picking up here on page 5, I'd like to first highlight the attractive growth profile of this business.

As you can see from the chart in the upper left quadrant, the top line has grown at over 20% compound annual growth rate and the interconnection business has grown even faster.

The drivers have been volume growth along with pricing power, as reflected in the charts on the bottom half of the page.

We view the interconnection business as high growth and highly desirable, with high barriers to entry.

Top line growth has also historically translated to growth in cash flow, as demonstrated by the core EBITDA time series in the upper right quadrant.

I'd like to pause for a moment to focus on the absolute numbers in this chart and to clarify a few points here.

For starters, I can tell you that we underwrote projected EBITDA of $148 million in 2016, which represents 11% growth from the $133 million run rate core EBITDA as of the end of the first quarter.

I'd like to point out core EBITDA excludes $22 million of non-cash deferred rent expense paid to third-party landlords in 2016.

The rent that Telx previously paid to Digital will be an intercompany elimination going forward.

We do intend to run Telx as a standalone line of business reporting to Jarrett Appleby.

We also underwrote $15 million of cost synergies, primarily redundant corporate overhead of which $10 million runs through the P&L and $5 million represents capitalized compensation costs.

It is important to note that our $148 million of projected 2016 EBITDA does not include any cost synergies.

We also have not factored any revenue synergies into our near term underwriting expectations, although we believe the longer term revenue synergies could be quite meaningful.

The EBITDA multiple is in the eye of the beholder but since the transaction is expected to close late this year, we view 2016 as the most appropriate time period.

And on that basis the transaction represents a multiple of a little less than 13 times.

Taking synergies into account, the EBITDA multiple would be right around 12 times.

The next slide on page 6 has received quite a bit of attention and I would like to clarify several points.

This is intended to be an illustration of the embedded growth potential from leasing existing built co-location inventory and improving utilization rates at underutilized properties.

It is not meant to tie to our 2016 EBITDA projection.

The concept behind this is simply raising the utilization rates for properties below 70%, up to 70%, and properties below 80% up to 80% utilized, while leaving those above constant.

The potential incremental revenue from reaching 70% and 80% utilization has been revised from $47 million and $75 million respectively to the $37 million and $65 million you see here on page 6. I would also like to point out the properties shown here represent a subset of the Telx portfolio.

If you tally up the number of properties shown in white at the bottom of the bars, you should arrive at 15 out of a total of 20.

The utilization rate for all 15 of these properties is less than 80%.

In fact, the average utilization for the 15 properties shown here is 57%.

Consequently, reaching 70% utilization would represent 1,300 basis points of lease-up on this subset and reaching 80% utilization would represent 2,300 basis points of lease-up.

In term of our underwriting, the $148 million of projected 2016 EBITDA we've been discussing contemplates lease-up of the overall portfolio utilization rate from a current 68% to a little less than 79%.

Of course, that includes the five properties that are above 80% utilized and represents approximately 37,000 square feet of new leasing.

The corresponding utilization rate on the subset of these 15 properties would be between 75% and 80% when excluding the impact of potential expansion at these facilities.

Said differently, our 2016 underwriting essentially contemplates that we will achieve some, but not all of the embedded growth potential represented on this slide.

I would also like to be clear about the corresponding capital investment, reaching 70% utilization requires a capital investment of approximately $15 million and reaching 80% would require an additional $25 million.

Our 2016 underwriting includes roughly $45 million of expansion capital which includes some CapEx to create additional inventory.

Separately, we have underwritten a little over $30 million of recurring capital spend in 2016 which we would deduct from FFO to arrive at AFFO, and which represents 20% of EBITDA.

I would like to point out that a significant portion represents capitalized leasing costs rather than physical maintenance CapEx.

The final point I'd like to make on this slide is to note that the empty sellable square footage within the Telx portfolio is somewhat analogous to a development pipeline in traditional real estate terms, and really represents their finished inventory.

If you zero in on 60 Hudson, you will see that it represents most of the lease-up opportunity in the table on the right and you can see from the bar chart it is currently 49% leased.

However, almost all of the vacancy at 60 Hudson reflects expansion space taken down in January of this year.

Prior to taking down that expansion space, 60 Hudson was 85% utilized.

Turning to the geographic overlap on page 7. Telx is headquartered in New York and has a very strong presence on the East Coast with leaseholds in three highly strategic internet gateway buildings in lower Manhattan.

Telx has a direct lease with the owner of 111-8 Avenue, the third largest building in Manhattan and one of the key internet hubs on the East Coast.

Digital also has a leasehold interest in 111-8 and Telx in turn sub leases a portion of this space from us.

In addition we recently moved out of the property management office we kept at 111-8, freeing up 3,000 square feet of prime inventory which we expect the Telx sales force will be eager to begin marketing upon closing.

Based on Telx pricing of 111-8, this represents a potential $3 million to $4 million of incremental EBITDA.

Just to be clear, however, this is not included in the $148 million of EBITDA we have projected in 2016, although to be fair neither is the $4 million of capital that would be required to build out this space.

Finally, as you can see from the summary performance statistics on the left hand side of the page, the three West Coast properties are less than 50% leased.

We see significant embedded growth potential from these underutilized properties in our back yard on the West Coast.

In addition to the upside from lease-up, we see significant opportunity to roll out the Telx platform across our global portfolio, particularly in our campus environment.

As you can see from the overlapping logos at the top of page 8, Telx has an existing presence in our campuses in Chicago, Dallas, New York and Silicon Valley.

The overlap speaks to the complementary nature of the transaction, but the campus environments in Ashburn, London and Singapore where you don't see a Telx logo represent the most promising value proposition from the combination of the two platforms.

Turning to page 9, echoing Bill's points about our real estate roots and this deal being the best fit for Digital Realty.

As you know, Telx leases 11 of its 20 properties from us.

In addition, Telx owns the two properties pictured here on this page.

As a result, we will own outright over half of the real estate in this portfolio.

The mix of owned versus leased real estate compares quite favorably relatively to most other co-location businesses and the overlap of Telx's footprint within the envelope of our buildings should help mitigate integration risk, especially relative to the underwriting risk of the unknown in a typical arm's length transaction.

The customer data on the next page clearly demonstrate that Telx has effectively achieved a robust interconnection ecosystem within its portfolio.

Telx has a well diversified customer base, with over 1,250 customers of whom more than 80% are connectivity centric from within the telecom cloud and IT verticals.

In addition, while Telx's customer contracts tend to be shorter duration than our traditional lease terms, the stickiness of the customer base is highlighted by the average customer relationship of over nine years.

Page 11 underscores the strategic fit by demonstrating the impact of the transaction on our existing book of business.

We have publicly articulated a goal of doubling the top line contribution from our co-location business, and the Telx transaction accomplishes this objective.

The combination of Digital Realty's global, large foot data center, platform, with Telx's robust co-location business will open avenues of growth for well over 1,000 combined customers worldwide.

As outlined on page 12, the new combined entity will have enhanced scale, a diversified product mix and a stronger growth profile.

Pro forma enterprise value is expected to be approximately $17 billion, and the business mix will be a little over three-quarters large footprint data center, 14% co-location, and 9% interconnection.

Turning briefly to capital recycling, we closed on the previously announced sale of 833 Chestnut for $161 million or $228 per square foot.

At a 5.8% cap rate on 2015 budgeted cash NOI.

The sales generated net proceeds of approximately $150 million, and we recognized a $77 million gain in the second quarter.

We also brought a portfolio of five non-core data centers to market during the second quarter and we have recently begun fielding initial bids.

We are actively marketing an additional three assets for sale which are currently in various stages of negotiation.

We also signed a key long-term lease renewal with a single tenant in a non-core office building during the second quarter and we will likely begin marketing this property for sale at year-end if the tenant does not exercise its six-month purchase option.

We also acquired a redevelopment project in Singapore for $45 million.

Construction on the redevelopment project is already under way and we expect to deliver the first three Turn-key Flex data center suites by early next year.

Finally, we also acquired a small land parcel in Melbourne adjacent to our existing park, for approximately $2 million.

Although future development on this site will be subject to market conditions.

We continue to believe that minimizing speculative development risk translates to healthier data center fundamentals and better returns for our shareholders.

However, we are also mindful of our customers' growth needs and we are proactively investing to support their growth, particularly on our campus environments in core markets.

And now I would like to turn the call over to Matt Miszewski, to provide an update on the current data center leasing environment.

Thank you, Scott.

As shown on page 14, we signed new leases representing a little over $37 million of annualized GAAP rent during the second quarter.

Social, mobile, analytics, cloud and content accounted for over 80% of our second quarter lease signings.

Existing customers represented just over 90% of our second-quarter leasing activity, and we added 16 new logos in the quarter, bringing the full year total to 35.

Our co-location segment contributed $3.7 million, or 10% of our second-quarter leasing activity.

This was at the low end of the segment's recent quarterly run rate, largely reflecting the success we have had supporting the growth of existing co-location customers and to larger footprint requirements of greater than 300 kilowatts.

You may recall that earlier this year we revised our definition of co-location to less than 300 kilowatts.

To better align our sales force with our customers.

We haven't traditionally called out co-location re-leasing spreads in our earnings, but it is worth noting that the mark to market on colo renewal leases was up 10% on a cash basis during the quarter, and re-leasing spreads were positive on over 90% of the co-location deals we executed during the second quarter.

We commenced leases totaling $65 million of annualized GAAP rent during the second quarter, a record high for lease commencements.

The backlog came down by roughly $30 million as a result, from $104 million last quarter, to $73 million currently.

Which you can see reflected in the chart on the top half of page 15.

The weighted average lag between signings and commencements also reached a record during the second quarter, at 2.5 months.

As shown in the chart on the bottom half of the page.

Turning to page 16, cash releasing spreads were positive on turn-key as well as power-based building renewals during the second quarter.

We still have a few above market leases scattered throughout the portfolio, but the overall mark to market continues to steadily improve as market rents are on the upswing and we are gradually cycling through peak vintage lease expirations.

We leased a total of 21 megawatts during the second quarter, more than offsetting deliveries and expirations and generating 3 megawatts of positive net absorption within the finished inventory pool.

As Bill mentioned and as you can see from the chart on page 17, the finished inventory balance is down by nearly half since our last Investor Day in November 2013.

We remain keenly focused on maximizing the utilization of out existing asset base, but we are also taking steps to be in position to support our customers' future growth requirements, particularly on campus environments in core markets.

In addition to our land bank, our investment in shelf space enables us to move quickly in response to demand and meet our customers' needs.

Turning now to supply on page 18, the positive net absorption we have registered in our own portfolio has been mirrored in most major markets.

As you can see, Houston is the only major market that registered any meaningful uptick in new supply over the last 90 days.

As you may recall, we have limited exposure to Houston, at less than 2% of total NOI.

In contrast, Dallas and Phoenix, where we do have a more meaningful presence, both tightened noticeably during the second quarter.

Face rates have yet to register significant improvement, but the supply situation remains rational in virtually all major markets.

Data center demand remains robust.

Concession packages are firming and net effective leasing economics are continuing to trend in the landlord's direction.

With that I'd now like to turn the call over to Andy Power to take you through our financial results.

Thank you, Matt.

We reported 2Q 2015 core FFO per share of $1.30, $0.05 ahead of consensus estimates.

The outperformance during the quarter was driven by a combination of several factors, including $0.02 from successful property tax appeals in the central region and the reversal of a property tax accrual due to lapse of a statute of limitations in the west region.

$0.02 from the early commencing of several large leases upon completion of all landlord obligations and transfer to tenant control during the second quarter.

And roughly $0.01 from delayed timing of property operating expenses, asset sales, and a somewhat lighter foreign currency headwind.

As shown on the next page, however, FX represented roughly a 300 basis points drag on the year-over-year growth and our reported results from the top to the bottom line.

In terms of operating performance, portfolio occupancy improved 140 basis points sequentially to 93.5% and same capital occupancy ticked up 10 basis points sequentially to 94.8%.

As a reminder, we do expect portfolio occupancy to dip in the third quarter, due to a couple of known power-based building move-outs in the bay area, before bouncing back to finish up slightly by the end of the year.

As Matt noted in his remarks, cash re-leasing spreads were positive for both turn-key and power-based building renewals during the second quarter.

We have revised our full-year forecast from slightly negative to slightly positive and we are encouraged by the gradual improvement in the mark to market across our portfolio.

As shown on page 20, same capital, cash NOI was up 2.8% in the second quarter, squarely in the middle of our 2% to 4% guidance range.

However, it is worth pointing out that on a constant currency basis, same capital cash NOI would be up 5.5%.

For the full year, we now expect organic growth to trend toward the high end of our 2% to 4% guidance range on a constant currency basis, but toward the lower end of the range on an as reported basis.

I would point out that Net Data Centers, which filed for bankruptcy earlier this year, is a tenant at two of our properties in LA.

They remain current on all post-petition obligations and have until September 21 to accept or reject their leases with us, or to request an extension of this deadline.

While Net Data Centers is still in the process of evaluating its options and future operations, we remain comfortable with our position.

Turning now to the balance sheet on page 21, debt to EBITDA stood at 5 times at the end of the second quarter, unchanged from the prior quarter and roughly a half turn below our 5.5 times target.

As you know, we executed a forward equity offering the week before last to fund a portion of the Telx acquisition.

Upon fiscal settlement we expect to receive net proceeds of approximately $685 million.

I would like to take just a moment to discuss the forward sales agreements.

In the interests of time, I won't dwell on mechanics here, but I would like to point out that we have included a slide here on page 22 that does provide some detail on the mechanics for those who may be interested.

I would also like to reiterate that the public offering was executed by forward sales agreements for deal structure purposes, acquiring Telx at the REIT level rather than the operating partnership level was the most efficient structure, and we were able to facilitate that structure by selling Common Stock through forward sale agreements.

It is also worth noting that the public offering has occurred, that we locked in the pricing at $68 per share and net proceeds approximately $685 million, subject only to adjustments for interest and dividends paid and the forward structure does not represent an overhang on our stock.

Several of the underwriters borrowed the stock from securities lenders to sell to the equity offering participants.

And when the forward sale agreements are physically settled, those underwriters will simply deliver proceeds to the Company in exchange for newly issued shares.

To be clear, the newly issued shares will not be issued to the public.

The shares will be issued to the participating underwriters who will then return the shares to the securities lenders from whom they were borrowed, in connection with the public offering.

Before we open up the call for questions I would like to briefly address guidance as well as the financial impact of the Telx transaction, which we expect to close later this year.

As you may have seen from the press release, we are raising core FFO per share guidance by $0.02.

A portion of the beat during the quarter is essentially timing-related, particularly asset sales which we still expect to execute and property operating expenses which we still expect to incur.

Similarly, the property tax reversal during the second quarter were one time in nature.

In addition, G&A is trending higher than we previously expected.

We also upped the long-term debt issuance assumption in our guidance from roughly $300 million to $700 million, up to $500 million to $1 billion.

While we will incur additional capital carry costs which will depress earnings in the short run, we believe it is prudent to lock in long-term capital, particularly in a rising rate environment.

I would also like to point out that our guidance remains standalone for digital only and does not include any financial impact from Telx.

With regard to Telx, we tend to round our financing for the transaction with a combination of preferred equity and bonds.

We expect the Telx acquisition to be roughly 1% accretive to FFO per share in 2016 and roughly 3% accretive to AFFO per share.

We realise we have run long today, so we'll save Bill's closing remarks for the end of the call, and we will now open up the lines to take your questions.

Denise, will you please begin the Q&A session?

(Operator instructions)

Vance Edelson, Morgan Stanley.

Great, thanks.

So I guess as my first question, Bill, you mentioned the additional uptick in ROIC by 20 basis points after last quarter's more sizeable gain which means we're probably pushing double digits now.

How should we think about the upside going forward and do you think this metric might plateau a bit from here?

I think we're actually in the low 9s with that.

We were at 8 and I think we're now at -- if my math is right in my head about 9.2, 9.5.

John is giving me the 5 sign here.

Pushing 10.

Pushing 10.

That's right.

Obviously, we think that the Telx deal will be -- further improve ROIC for the long haul.

Okay.

And then as my follow-up, I think there was mention of cycling through the peak vintage expirations now.

Could you add any granularity there around the vintage of leases rolling off these days, how many are from the recession era and how might that play into the mark to market pricing strength you expect going forward?

We would have to get back to you with that precise data.

We don't have that right at hand.

Jonathan Atkin, RBC Capital Markets.

Slide 18 gives an interesting overview of the supply dynamic, supply demand dynamic, and I wondered if you could qualitatively round out the picture of how you characterize Europe as well as Asia-Pac?

My follow up is related to the CapEx that you talked about associated with filling up the Telx inventory, the $15 million and the $25 million.

I didn't quite understand what that consists of.

Is that sales CapEx, meaning cadence, or were there other factors there?

So, thanks, Jonathan, for the question.

In terms of supply and demand dynamics in Europe and APAC, we're looking at supply and demand dynamics that are roughly equivalent to the report out that we gave last quarter in terms of the supply.

The supply characteristics in London remain in balance for us and we feel that we've got sufficient supply for us to hit the demand on both our Crawley campus in terms of land bank that we've got, as well as shell that we have got available to us in our Woking campus, as well.

We continue to have significant supply available to us in land bank in Amsterdam, in Europe.

And in Asia-Pacific, as Scott mentioned, we recently closed on an acquisition in Asia-Pacific, in Singapore, so we continue to have a considerable amount of supply to hit the needs for the demand in that region, as well.

And then on the CapEx side, Jonathan, yes, that consists of cabinets, cages, installation, expenses and commissions, success basis, those sorts of things.

John Peterson, Jefferies.

Great, thank you.

I wanted to ask about the development pipeline, the size of it is down about $100 million-ish from where it was last quarter.

Just curious about the conscious decision ahead of the Telx acquisition, just trying to save capital, or whether that's -- you guys being more conservative and there is just a lack of opportunities for new development?

John, this is Andy Power, I can speak to that a little bit.

I don't think this was anything about saving capital.

We looked at funding the Telx acquisition unto itself and have laid out now the equity done and will look to go to do preferred and bonds in the latter half of the year.

Sitting on the investment committee over the last three months as a new participant, I think it's just been very focused getting the timing of our investment as lined up as close to where we see demand.

I don't think there was a purpose preservation of capital there.

John, this is Matt, in terms of development pipeline that we've got, you'll notice that we've got about 80% pre-leased in terms of developments that are happening, and we've experienced a great amount of participation in terms of reacting to demand with our just-in-time development.

So we think that is working well in our favor.

Okay.

And then in terms of Telx, I'm curious about the mechanics of integrating that portfolio with some of your colocation properties, is what makes the most sense.

You could use maybe 365 Main as an example.

I assume you'll be taking the Telx brand and infrastructure into a facility like that.

The process of doing that and realizing the revenue synergies, is it just buying dark fiber between that and the Telx facility?

If you could just explain, how you go about integrating the Telx platform, if you can quantify what the revenue synergies might be?

First, great question.

First of all, we're treating it as a line of business, both as an asset or a campus, tethered into our campuses, taking their interconnection hub and connecting it to our data center campuses.

And because of the prior relationship, as they were a client of ours, we have that already set up in most of the markets out there.

So our first stage is connecting that.

The second is, we've looked at the assets as a combined entity, as a line of business for the product.

For colocation and interconnection products we want to integrate that, all our legacy colocation properties into the portfolio, and productize it.

And then we're going to leverage the product expertise they have in colocation and go to market around that and the interconnection and networking services.

So the first step is give them basically our capability, integrate it, and then we want to launch it, as we were saying, on a worldwide basis in the major markets where we can add colocation to their portfolio.

Jonathan Schildkraut, Evercore ISI.

All right.

Good evening, thanks for taking the questions and thanks for all of that additional disclosure on Telx in the presentation today.

It was very helpful.

I would like to ask about progress, really with your -- sort of your top customers, certainly noticed that the top-20 customer list moved quite a bit.

But really saw a lot of progress with some big names here, IBM, which has been a continued success story for you, but also LinkedIn and Oracle.

I wondering if you might provide some additional color as to what is going on with some of those big customers?

Thanks.

Yes, Jonathan, this is Matt.

Thanks so much for the question.

My team, in particular, looks at moving amongst those top 20 with great interest, as well.

We're thrilled to have IBM at the top of the list, and in particular, with regard to the work loads that we're landing with them.

I talked a little bit in my prepared statements about the continued persistence of the smack-oriented work loads, and the movement amongst the top 20 is really testament to the ability of Digital's great operational team to be able to provide solutions that match the needs of those smack work loads.

IBM is a great example of that.

A good deal of those work loads happen to be soft layer oriented public cloud.

Oracle also was very happy to break itself into the top 20, this quarter, with their public cloud offerings, as well.

And on a social side, we continue to expand our presence with LinkedIn.

What is great about these particular types of clients, Jonathan, is not that we get one-time wins with them, but they have a tendency to be repeat hitters and continue to grow with us, not just in one location, but in all of our portfolio assets throughout the world.

So it is a great win for Digital.

Great.

As a follow-up, I'd love for you to give us a little sense as to how we can connect some of the big cloud players you have in terms of the digital portfolio of customers into the Telx business.

One of the numbers that really jumped out was the very limited penetration Telx has to date in terms of the cloud vertical for their revenue base.

I think it was 8%.

So I would be interested to hear how you can match up the Telx asset and value proposition with some of the core customers you have in your base.

Yes, Jonathan, great.

It really was, again, a testament to the combination of these two organizations making a heck of a lot of sense.

Our ability to connect the cloud work loads that we've got in terms of IT core with Telx interconnectivity, is absolutely incredible.

So if you look at the number -- the number of customers that will now we'll be able to work together with, over 1,200 customers, to take from Telx's facilities, connect them into our cloud work load, it reminds folks of several of the things I've said on a number of the past earnings calls, which is the hybrid cloud environment and connecting those cloud instances with enterprises, is the magic that Digital can bring.

And now Digital can bring it faster and better with combination of Telx.

Just a bit on two concrete examples of that.

If you take their network strength, Jonathan, in markets like Ashburn and Dallas, where we traditionally have folks connecting through other locations into our sites, we're going to go directly and offer that product directly into our sites, into the cloud compute engines.

So you get the power of what we have, in power and compute engines directly connecting into our sites.

Colby Synesael, Cowen and Company.

Great, thank you.

Like Jonathan, I really appreciate the information you provided on Telx, very helpful.

I guess to that point, it seems like there's a lot of low-hanging fruit to simply increase the utilization rate within Telx's current facilities and then perhaps leveraging off of some of DLR's facilities in the same markets.

When do you think you will be ready to actually expand the Telx presence internationally?

It seems like that's a really big opportunity when you can actually bring it in to some of the markets that you're already in, in areas like in Europe and Asia.

My second question, more to the guidance.

I was wondering if you could talk about pacing of speculative leasing?

I see that it obviously increased another $10 million in terms of what you were able write off in the second quarter, but how did that compare to what your expectations were going into this year?

Thanks.

Colby, I'll take the first one on global expansion.

We are looking to expand globally, really in early 2016.

Some of the markets that we outline there as Phase I, London and Singapore and Dublin are low-hanging fruit for us, and we're doing development projects in other markets.

In every single data center campus now, we're building our colocation and interconnection capabilities, so you'll see that expansion start in 2016.

And Colby, just really quick on your second one and I'll turn it over to Andy, too.

Recall that we raised guidance on leasing last quarter and we feel really good about the remainder of the year.

Not much more to add to that, Colby, we're on track.

Dave Rodgers, Baird.

To elaborate on the sales cycle, I think if I was reading through the release right, 2.5 months maybe was the average commencement time between signings and actual commencements, so I don't know if that was a mix issue or are you seeing greater demand coming through fast, any color would be helpful?

Yes, Dave, we've had a focus on reducing the gap from book-to-bill for some time and we certainly think we've gotten to a sweet spot.

I think that the 2.5 month gap is a little bit of the mix of customers in this particular quarter.

I wouldn't suggest that the 2.5 will stay that way ongoing, but we should be in a sweet spot in that 2.5 to 3 month range.

And maybe, Andy or Bill, maybe talk a little bit about leverage and the idea, I know you issued the equity but not taking leverage down a little further using the growth profile of Telx here as an excuse to de-lever and move a little faster on that side of the equation.

Thoughts about the asset sale plan and leverage overall would be helpful.

Sure, Dave, this is Andy speaking.

We feel quite comfortable now that we've got the $700 million approximately of equity off, pro forma for the Telx acquisition.

Which will likely close later in the year, we're below our 5.5 times target.

Based on some of the things we've already said, we do think we're buying a very attractive business with some embedded growth in it.

It spurs some of the EBITDA which will bring us down, as well.

But we think the balance sheet remains positioned for growth pro forma for the equity we just raised.

Vincent Chao, Deutsche Bank.

Good afternoon, everyone.

I want to go back to the accretion that you talked about for Telx, the 1% FFO, 3% for AFFO.

I just wanted to clarify, because you talked a lot about a lot of different ways you can extract value here, but do those numbers include any of the synergies you talked about on the cost side?

The $15 million, and presumably doesn't include the revenue synergies, but I just wanted to clarify on the cost side.

The synergies that we've underwritten, the 1% and 3%, to FFO and AFFO, respectively, they include roughly $15 million of expense synergies, of which only roughly $10 million flows through our P&L, the other $5 million is really the capitalized items.

They do not include any revenue synergies.

While we think the revenue synergies could be quite significant, as we've already discussed, we have not included them in our underwriting for 2016 financial impact.

Okay.

Thanks.

Just as a follow-up, in terms of the sales force at Telx there, I know there is going to be some folks leaving at the executive level, but since the deal has been announced, have you had discussions with some of the key sales guys there, and have any sense about what the turnover might look like as a result of the deal?

This is Jarrett, they are a highly qualified team.

They're very focused on their community; 95% of it is in five vertical segments.

Matt and I are totally aligned on going after and retaining the top talent, and they seem very interested.

We're going to give them a heck of a lot to sell.

It is going to be a global platform and leveraging the relationships of 1,250 customers now worldwide and also giving them capabilities that only Digital can bring in that community.

So I think the leverage of the two is very, very good.

And we've had a great relationship, as you know, with Telx as one of our major customers, and with the leadership over there being so ingrained with ours over here, we've had a great relationship in the past and we look forward to continuing that relationship a little more directly in the future.

Jordan Sadler, KeyBanc Capital Markets.

Thank you.

Bill, one for you on this deal being a sizeable M&A transaction, particularly the largest transaction you're overseeing since you're sitting in the CEO chair.

It is easy to see the success we're seeing in the colocation and interconnection business in particular, and how sort of layering that over the DLR platform would make sense intuitively.

But you're also buying from a private equity smart seller, if you will, and my question is really how do you mitigate the downside?

I want to straight-line the growth here up and to the right, like everybody else, but I also want to understand how do you mitigate the downside risk in the near to intermediate term?

Well that was obviously all part of the underwriting process.

One of the things we looked at was the churn that Telx had.

And it was -- their customers are incredibly sticky, at roughly 0.6%, and the average life of their customers is over nine years.

So while the contract duration is short compared to ours, their customers do stay with them and that was an important piece of our underwriting in terms of looking at potential downside.

We've also -- Matt mentioned that the re-leasing spreads on our colo business were up 10% this last quarter, and that gives us some encouragement as well in terms of how to underwrite the rents on this business.

We didn't underwrite them as up 10%, I think we underwrote them, I'm looking at Scott here, probably flat.

He's nodding.

But the point is we're seeing a lot of demand in the colo business and pressure on rents.

I think I would add to that at a 68.5% utilization rate, all we have to do to protect the downside is maintain that.

We have a awful lot of potential growth if we just fill up the space that is already built and available.

Jordan, we see our customers coming to us with a multiplicity of demand and now we're able to hit them together.

And I know its been said before in M&A transactions, but the combination of Telx and Digital is better together.

We think the value we will be able to hit as one organization will increase the value to our customers and that we'll be able capture that value here at Digital.

And just as a follow-up to that, in terms of reporting structure, I think I heard that, Jarrett, you would be heading up the -- I don't know if it was the integration or just heading up the Telx within Digital, but does that include the sales effort or is that going to be managed by Matt?

That will include the sales effort.

Matt and I are coordinating how to support global accounts.

He's got some tremendous relationships.

We're working through that process right now.

But it is a line of business, and we want to build out the product, keep a focus on those clients and keep serving them, and I think bringing in additional assets into that portfolio capability.

Emmanuel Korchman, from Citigroup.

Scott, when we were going through the slide deck, you had mentioned that the numbers on page 6 had come down from when you had previously given them.

Was there a specific driver that would bring those potential incremental revenue numbers down?

No, nothing changed.

It was in the heat of pulling everything together quickly, there was an error in the sheet, and so it was just a mistake in the numbers.

Got it.

And then maybe more broadly on strategy, how do you manage the challenge of now offering an extremely similar product to what a lot of your customers are offering, sort of a different position than this Company has ever been in before?

Well, first, in terms of commitment, we are really focused on serving many of the same clients.

We're very focused on the service provider community and strategic channel partners.

What we didn't want to do is pivot our Company in a heavy enterprise-direct focus.

So we've aligned with Matt and the Telx team on really selling through and supporting their strategic channel partnerships.

Colocation is very complementary to support the ecosystem.

And folks need smaller footprints so we needed the product and service capability there.

But you won't see us getting in the line of business like others, moving into the managed service phase and competing with our customers.

Ross Nussbaum, UBS.

Hey, guys, good afternoon.

Is all of Telx's earnings going to be considered good REIT income, and are you planning on pursuing a private letter ruling to confirm what your beliefs are?

Hey, Ross, this is Andy.

So Telx has roughly 49%, or 47% from colocation, equal parts from interconnection, colocation is clear good REIT income, as is the interconnection, and we already have a private letter ruling for the interconnection.

There is a small percentage of income, really fees paid on the installations that represents a couple percentages of the revenue that we'll have housed in our TRS and offset by expenses at the TRS to minimize any tax leakage.

Okay.

And then as a follow-up, I just wanted to confirm the financing.

Your revised guidance in your supplemental talks about a $500 million to $1 billion unsecured debt deal in the second half of this year.

Is that independent of the additional, what, call it, upwards of $1 billion of bonds you're going to issue to help finance Telx?

Sure.

So the page in our supplemental, that far right column, that is Digital only.

It has no capital or operating assumptions related to Telx.

So essentially we decided to increase our guidance by roughly $250 million at the mid-point.

That incremental debt raised will be used to repay our revolver, and hence we'll have a lower revolver balance and a higher percentage of fixed-rate debt by the end of the year.

As it relates to Telx, separate from what's on the page, the plan is the same.

We've completed the roughly $700 million of equity that will close concurrent with the closing of the acquisition.

The remainder will be funded with a combination of preferred equity and investment grade bonds.

John Bejjani, Green Street Advisors.

Hi, guys.

I don't know if I missed this in any of the disclosure you've already released, but for 111 8th Ave, are you able to share the terms of Telx's lease or leases with Google?

How much remaining term do you have, how do you view your prospects of retaining that space long term?

I don't think we have that in the disclosure, but I believe, with extensions at 111 8th, it is roughly 10 years remaining.

Okay.

I mean, have you guys spoken to Google, even for your own space, do they seem amenable to renewing those leases, or is that a 10-year life there?

We haven't gone out and tried to extend it as part of this process.

We made sure we're good from an assumption basis.

As we move closer to that expiration, we'll obviously have to evaluate that with Google.

And I think Matt has something he wants to say.

John, we had had some conversations with Google when they had an interest in expanding their presence inside Manhattan.

They've done that in an alternative way, so they may be a little bit more open to the conversation than they were, say, about 1.5 years ago.

Stephen Douglas, Bank of America Merrill Lynch.

Thanks for taking the question.

Maybe follow up to previous question.

I'm interested in how you're thinking about the I guess the -- how leverageable the existing Telx sales force is, just when we think about expanding the focus to other digital markets and how we should think about any sort of incremental sales investments there?

Second, maybe for Matt, I'm wondering if you could just talk about what the initial customer response has been to the Telx announcement and any kind of initial impact that's had on the pipeline so far, if at all?

Happy to answer both of those, Stephen, and if Jarrett's got some extra color, he would be happy to add that as well.

Interesting, inside the sales force at Telx, while they have been primarily a domestic organization right now, they do have an awful lot of sellers with international experience, so we're excited about that because our intention is to take the incredible assets that Telx has and expand them, expand them internationally.

And so it's good to have some more talent.

The second thing is that their vertically oriented sales force is not only a regionally experienced sales force, so we'll be able to take that vertical experience and apply it across multiple regions, both in North America as well as world wide.

Customer reaction has been fantastic.

In fact, we're trying hard to keep everyone calm as we're getting towards the actual closing of the deal, because people are interested in having lots and lots of conversations that we're not having until the deal closes, but I can tell you that the customer response has been fantastic.

Emmanuel Korchman, Citi.

Bill, maybe we can follow up on the ROIC question from earlier.

So you're running around, let's call it 9% for ease in numbers, you're buying Telx at a 12 or 13 times multiple.

I think your comment was that ROIC would actually go up on that?

Maybe I'm confused somewhere, but it doesn't seem like the math works.

Manny, this is Andy.

I can jump in and help on this.

We're at 9.3% our NOI, our cash NOI over our total gross investment, book value, at first quarter, 9.5% at the second quarter.

That is NOI, not EBITDA.

When you look at our underwritten EBITDA, which we've kind of put out there, of $148 million and you add back the G&A, which you can get from looking at the pro forma that was in our filed 8-K, we see that investment closer to, I think -- definitely north of where that 9.5%, so we see it slightly accretive to our existing return on investment.

But, again, the other piece of it is we're not buying the stabilized portfolio as well, like when we deliver a development at 10 to 12, and it's pretty much fully leased.

We're buying a business which still will have embedded growth and additional cash upside to continue to grow that return on investment from the initial 20 assets in the portfolio.

Thanks, Andy.

Make sense?

It does.

Matt, just a quick question for you on the backlog.

It looks like you've had the numbers in 2016 and 2017 come down.

Were those just commencing earlier?

Why would the backlog numbers, especially in 2017, come down at this point in time?

Manny, this is Andy, again, I'm getting lots of pointed hand off to me today.

Maybe because it is my first call.

We had some -- we had some early commencements.

I think two tenants, we completed the space, finished all our work and we handed over the space and they took over possession early.

But I still love you, Manny.

Will Clayton, Macquarie.

Hi, guys, thanks for the question.

I was wondering if you could run us through the puts and takes of the Telx EBITDA margin and where you see the most incremental cost synergies being unlocked, and how we can think about that margin as you subsequently scale the business?

And then I have one more after that.

Sure.

This is Andy.

So I think the best place to start, you can look at our pro forma that has the incremental EBITDA, or you can take the core EBITDA from the 8-K and divide it by the revenue to start, obviously on paper, the margin is going to look better because part of leases associated with their space to us get eliminated upon the transaction closing.

I think we have to think about increments to it.

First piece is the underwriting expense synergies, 10 of the 15 will flow through the P&L, so that will obviously be incremental margin enhancement off the bat.

We're underwriting to deliver those for a full-year 2016 impact, so we'll work through our execution on achieving that through the end of the year and have that in place for a full year by, come December.

And then, on top of that, I think there will be pretty high flow-through revenue contribution as we lease up, what we see as an underutilized portfolio that has a significant amount of recently delivered space.

And also, as we put to work some of the Digital talented team assisting on some of the West Coast assets, as well.

I don't have a number for you right there because we haven't in our underwriting didn't put a firm revenue synergy, but I think that will have a contribution to the margin, as well.

Thank you for that color, and my second question is can you provide some commentary surrounding the pace and the success of the capital recycling program to date?

And more specifically, how we should think about the impact of capital recycling in the second half of 2015 versus 2016?

So I think the pace has been on target.

It has been a little slower in some areas because we've pursued some value-add opportunities and a number of these projects which are now coming to fruition, we've seen a lot of benefit on that.

The Decatur Road building that we leased up 100% is a good example of that.

The lease extension that we just signed for the single-tenant office building is another great example of that.

So it is taking a little longer but I think the benefit to our shareholders has been very significant.

I think what you'll probably see is that the remainder of the assets will largely be executed by the end of the year from the sales perspective.

John Bejjani, Green Street Advisors.

Great, thanks.

To the extent that you guys looked at Telx on an asset-by-asset basis, are you able to share what kind of cap rate or EBITDA multiple you assigned to the portfolio's key assets, specifically 56 Marietta, 60 Hudson and 111 8th?

Yes, we didn't really look at it.

We do look at it on an asset-by-asset basis, but we don't really do a full evaluation on an asset-by-asset basis.

We do projections, roll-ups for every asset in terms of generating our revenue and EBITDA projections, but we didn't really do a full analysis on each one.

I will tell you on Marietta though, we did spend a little time thinking of what the potential value of that asset might be, and you can get an very interesting array of outcomes on that, and some of which are quite impressive to be honest with you.

John, by the way, I want to get back to you on the 111 8th lease for Telx, it has an expiration date of 2022, with two five-year renewal options on it.

So that takes you out to 2032, there.

This will conclude our question-and-answer session.

I would like to hand the conference back over to Bill Stein for his closing remarks.

Thanks, Denise.

I'd like to wrap up our prepared remarks by recapping our second-quarter 2015 highlights, as highlighted on page 23 of the deck.

First and foremost, we picked up another 20 basis points of sequential improvement in our return on invested capital, following the 100 basis points we have delivered over the past five quarters.

We tightened the commencement lag from 3.7 months in the first quarter to an exceptional 2.5 months.

The balance sheet remains positioned for growth, with debt to EBITDA at 5 times.

We beat the second-quarter consensus estimates by $0.05, and we raised 2015 core FFO per share guidance from $5.03 to $5.13 range, to $5.05 to $5.15.

Finally, we made the made the exciting announcement entering into an agreement to acquire Telx, a leading provider of colocation, interconnection and cloud-enabling services

In short, we continue to consistently execute on our top priorities that we set forth early last year and have since updated as the way forward for our Company in 2015.

We believe we have a unique and competitive footprint that can be leveraged further to the benefit of our shareholders.

I would like to thank the incredibly talented team of Digital Realty employees around the world who were responsible for delivering yet another solid quarter.

Once again, I'd like to remind all of you to mark October 6 on your calendars for our upcoming Investor Day.

Thank you all for taking the time to participate in today's call.

That concludes our second-quarter 2015 earnings conference call.

Thank you for joining us.

Ladies and gentlemen, the conference is now concluded.

We thank you for attending today's presentation.

You may now disconnect your lines.