Digital Realty’s Fundamentals Look Strong, but Margins Under Pressure Near-Term

Digital Realty’s DLR fourth-quarter revenue and adjusted EBITDA slightly beat FactSet consensus estimates, but multiple moving parts that cloud both metrics result in them meaning little. More importantly, we see very positive trends in Digital’s business and the transition it has made from a wholesale data center provider to one that can meet co-location and interconnection needs. We think this bodes very well for the firm’s long-term prospects, but in the near term, margins will be under significant pressure. We’re maintaining our $133 fair value estimate and think the stock is attractive.

Fourth-quarter revenue grew 11% year over year, but as is always the case with Digital Realty, there were many moving parts that management didn’t break out. Digital Realty frequently buys or sells data center properties, and some of the transactions that influenced fourth-quarter results included the acquisition of Teraco in Africa and the sale of a dozen data centers. Also influencing sales were foreign-currency fluctuations and power pass-through revenue, the latter of which added nearly 5 percentage points to year-over-year growth. Higher power costs also weighed on adjusted EBITDA margin, which contracted by 70 basis points from the same period last year. Apart from power, all of Digital’s operating costs in 2022 were well managed.

While we put little stock in the revenue number, we’re very encouraged by Digital’s underlying performance and management’s view of how it is positioned. Another good quarter of bookings, strong renewal pricing, interconnection momentum, and procurement of power in Virginia leave us thinking that Digital Realty will soon hit its stride and become a bigger challenger to Equinix as one of the only two data center providers that can offer global capacity, cloud access, and the ability to connect across data centers and geographies.