Analysts from DBS Group Research and UOB Kay Hian (UOBKH) have maintained their “buy” calls for Digital Core REIT (DC REIT) after the REIT announced, on Sept 9, that it would exercise its option to acquire an additional interest of between 0.2% and 40% in a Frankfurt data centre. The acquisition will be fully funded by a Euro-denominated term loan at an all-in cost of 3.6%. The REIT had previously completed the acquisition of another 24.9% stake in the same data centre in April.
The additional interest is priced at an “attractive” discount of 17.8% to the facility’s valuation and the REIT’s net property income (NPI) yield of 5.7% in 1HFY2024 ended June 30, notes UOBKH analyst Jonathan Koh.
In the analyst’s view, DC REIT will likely acquire an additional interest of 10% given current market conditions, bringing its aggregate interest to 59.9%. The 10% acquisition will provide a distribution per unit (DPU) accretion of 1.7%. DC REIT’s net asset value (NAV) per unit would increase by 4.5% to 70 US cents (90 cents), notes UOBKH analyst Jonathan Koh. However, should market conditions improve, the REIT may acquire a 40% stake in the data centre, which will drive its DPU accretion to 7% and NAV up to 71 US cents, he adds. The REIT manager has up to 90 days to conclude the deal, which means it has up to early December this year to decide on the size of its acquisition. DC REIT will also need to hold an extraordinary general meeting (EGM) to seek unitholders’ approval.
According to UOBKH’s Koh, the further acquisition of an additional 10% stake in the Frankfurt data centre would reduce reliance on North America from 66% to 63%, while data centres in Germany and Japan have expanded by three percentage points (ppts) to 37% of annualised rent.
UOBKH’s Koh cites operational improvements as a reason for higher valuations. The Frankfurt data centre is linked via dark fibre to Hanauer Landstraße campus, a “leading connectivity hub”, Koh notes. The data centre is fuelled by renewable energy and two anchor tenants have renewed their leases for five years at positive cash rental reversion of 2% in 1Q2024, according to Koh. Furthermore, occupancy in the Frankfurt data centre has improved by 6.3 ppts q-o-q to 98.5% in 2Q2024 after the signing of multiple new leases, with growth potential to lease up the remaining vacant space.
At present, DC REIT provides an FY2025 distribution yield of 6.1% based on Koh’s estimates.
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To him, the merits of DC REIT’s acquisition has been overlooked by the market so far. As at Koh’s report dated Sept 18, DC REIT’s unit price stood at 59.5 US cents.
“DC REIT has been a laggard in the recent rally for data centre REITs, which benefits from increased demand from [the] adoption of generative artificial intelligence (AI),” Koh writes. “We expect the sizeable discount of 17.8% to the refreshed valuation and lucrative NPI yield of 5.7% for the impending acquisition to be a catalyst for DC REIT to catch up with peers in terms of share price performance.”
With the impending acquisition, Koh has raised his DPU estimate for FY2025 by 2% to 3.6 US cents. The added stake is expected to start contributing in 1QFY2025.
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Koh has also raised his target price to 88 US cents from 86 US cents previously.
Meanwhile, DBS analysts Dale Lai and Derek Tan have kept their target price unchanged at 75 US cents.
To them, the option to acquire a further stake of up to 40% in the Frankfurt facility is “too good an opportunity to miss”.
Beyond the price discount, the analysts note that the data centre’s occupancy rate rose to 98.5% from 92.0% since December 2023. Additionally, underlying rents have risen significantly after DCREIT terminated the Cyxtera lease (which accounted for [around] 4% of the property) and replaced it with new leases at substantially higher rental rates, the analysts note.
Furthermore, the property’s valuation has increased by over 20%, rising from EUR470 million ($677.8 million) in December 2023 to EUR571.5 million, which is the average of two valuations as of Sept 7.
“Under the terms of the option, DC REIT can acquire the additional stake at the previously agreed valuation of EUR470 million, representing a discount of more than 20% compared to the latest valuation,” write Lai and Tan.
Overall, the DBS analysts like DC REIT’s prospects, noting that the pure-play data centre REIT is currently riding on structural tailwinds.
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“Demand for data centres in key markets remains robust with the lack of available capacity. DC REIT’s presence in some of these key markets throughout the US, Canada, Europe, and Japan means it continues to benefit from such robust demand,” they write.
“Moreover, the long weighted average lease expiry (WALE) for its assets ensures income stability in the foreseeable future,” they add. “In the event of any vacancy, DC REIT should be able to quickly backfill the space, given the healthy demand dynamics in those markets.”
Furthermore, the REIT enjoys a right of first refusal (ROFR) for the pipeline of assets from its sponsor valued at US$15 billion ($19.36 billion). This means that the REIT has the potential to become the biggest pure-play data centre Singapore REIT (S-REIT).
Given its healthy debt headroom, DCREIT has the financial flexibility to continue with acquisitions, allowing DCREIT to continue growing, Lai and Tan add.
Units in Digital Core REIT closed 2.5 US cents higher or 4.17% up at 62.5 US cents on Sept 19.
