Fitch Rates Digital Stout Holding, LLC's 4.25% Guaranteed Notes due 2025 'BBB'; Outlook Stable
Fitch Ratings has assigned an Issuer Default Rating of 'BBB' to Digital Stout Holding, LLC, a wholly-owned subsidiary of Digital Realty Trust, L.P., which is the operating partnership of Digital Realty Trust, Inc. (NYSE: DLR). In addition, Fitch assigned a credit rating of 'BBB' to Digital Stout Holding, LLC's private placement of GBP400 million aggregate principal amount of 4.25% Guaranteed Notes due 2025.
The Guaranteed Notes will be senior unsecured obligations of Digital Stout Holding, LLC and will be fully and unconditionally guaranteed by Digital Realty Trust, Inc. and Digital Realty Trust, L.P. The company intends to use the net proceeds from this offering to temporarily repay borrowings under the global revolving credit facility, to acquire additional properties, to fund development and redevelopment opportunities, for general working capital purposes or a combination of the foregoing.
Fitch currently rates Digital Realty Trust, Inc. and Digital Realty Trust, L.P. (collectively, Digital Realty) as follows:
Digital Realty Trust, Inc.
--Issuer Default Rating (IDR) 'BBB';
--$453.4 million redeemable preferred stock 'BB+';
--$123.3 million convertible preferred stock 'BB+'.
Digital Realty Trust, L.P.
--$1.8 billion unsecured revolving credit facility 'BBB';
--$750 million senior unsecured term loan 'BBB';
--$1.7 billion senior unsecured notes 'BBB';
--$266.4 million senior unsecured exchangeable notes 'BBB'.
The Rating Outlook is Stable.
GRADUAL SECURED LENDER ACCEPTANCE
The 'BBB' IDR reflects that broader institutional lender acceptance of datacenters as a niche property type has remained gradual. The inclusion of datacenter loans in select recent CMBS transactions indicates progress towards commercial property lenders' comfort with the asset class. That being the case, Digital Realty is committed to an unsecured funding profile and is less reliant on the secured debt markets to fund its business, predicated on the company's ability to access the unsecured bond, preferred stock and common stock markets on attractive terms.
The secured debt market for datacenters is not as deep as that for other property types, weakening the contingent liquidity provided by an unencumbered asset pool. Digital Realty's unencumbered assets (unencumbered NOI divided by a stressed capitalization rate of 10%) covered unsecured debt by 2.1x as of Sept. 30, 2012, which is adequate for the current rating.
STRONG CREDIT METRICS SUPPORT RATINGS
Digital Realty's credit strengths include a granular tenant roster that insulates the company against obsolescence risk, a geographically diverse portfolio in strategically important markets and a fixed-charge coverage ratio that Fitch anticipates will remain strong for the 'BBB' rating. Digital Realty also has a good liquidity position and strong access to capital. Leverage is consistent with the 'BBB' rating, though Fitch expects leverage to rise as the company continues to incur debt to fund acquisitions and development.
Digital Realty's properties span 32 markets across 10 countries and four continents, enabling economies of scale and facilitating the offering of Turn-Key Flex, Powered Base Building, or colocation space to both global and local customers. Top markets as of Sept. 30, 2012 were London (12.5% of rent), Silicon Valley (10.8%), Dallas (10.6%), Northern Virginia (9.3%) and New York (8.8%) as the company continues to focus on high barrier to entry markets with demand among colocation providers, corporate users and network/telecom companies.
The company continues its expansion globally as evidenced by the July 2012 acquisition of the three-property Sentrum portfolio in the greater London area for GBP 715.9 million and push into Singapore, Hong Kong and Australia. The company has the real estate and technical acumen to pursue such growth while maintaining credit metrics consistent with an investment grade rating. Tenant concentration continues to decline, which Fitch views favorably and which differentiates DLR from its major competitors, CoreSite Realty Corporation, DuPont Fabros Technology, Inc. and Global Switch Holdings Ltd. (Fitch IDR of 'BBB' with a Stable Outlook).
DIVERSE TENANT BASE
DLR's top tenants as of Sept. 30, 2012 were CenturyLink, Inc. (IDR of 'BBB-' with a Stable Outlook) at 9.5% of rent, Softlayer Technologies, Inc. at 3.8%, TelX Group, Inc. at 3.5%, Equinix Operating Company, Inc. at 3.4% and Facebook at 3.3%.
STABLE FIXED-CHARGE COVERAGE
Same-property NOI growth averaged 9.1% over the past nine quarters and was positive throughout the 2008-2009 financial crisis, driven principally by positive leasing spreads. Fitch expects same-property NOI growth to remain in the mid-to-high single-digit range over the next two years. Portfolio occupancy has been stable in the 94% to 95% range and was 94.2% as of Sept. 30, 2012.
The weighted average remaining lease term for the portfolio is approximately seven years, providing cash flow stability absent tenant bankruptcies -- technological obsolescence-related or otherwise. As of Sept. 30, 2012, lease expirations are laddered, with 2.4% of rent expiring in the fourth quarter of 2012 (4Q'12) followed by 5.9% in 2013 and 10.6% in 2014. Fitch anticipates that lease rollovers will continue to be positive due to high replacement costs that deter tenants from vacating and growth in data from devices such as tablets and from cloud-based services.
Coverage was 2.8x for the trailing 12 months (TTM) ended Sept. 30, 2012, compared with 2.7x in 2011 and 2.4x in 2010. Organic growth and development-driven EBITDA led to improvements in coverage. Fitch defines fixed-charge coverage as recurring operating EBITDA less recurring capital expenditures less straight-line rent adjustments divided by total interest incurred and preferred stock dividends.
Under Fitch's base case, coverage would remain in the high 2x to low 3x range over the next 12-to-24 months, positively impacted by expected high single-digit same-store NOI growth and EBITDA from development, offset by increased fixed charges as the company continues to access the unsecured bond market and preferred stock market to fund acquisitions and development. Coverage sustaining above 3.0x would be strong for a 'BBB' rating.
In a stress case not anticipated by Fitch in which the company experiences tenant bankruptcies leading to low single-digit same-store NOI declines, coverage would decline to 2.5x, which would remain adequate for a 'BBB' rating.
GOOD LIQUIDITY POSITION
Liquidity coverage assuming no additional capital raising, calculated as liquidity sources divided by uses, is 1.3x for the period from Oct. 1, 2012 to Dec. 31, 2014. Sources of liquidity include unrestricted cash, availability under the company's global unsecured credit facility, and projected retained cash flows from operating activities after dividends and distributions. Uses of liquidity include debt maturities, projected recurring capital expenditures and development costs. Assuming 80% of the company's secured debt is refinanced with new secured debt--a scenario not likely as the company continues to unencumber the portfolio with corporate liquidity sources--liquidity coverage would be 1.8x.
STRONG CAPITAL ACCESS
The company continues to demonstrate strong access to multiple sources of capital on favorable terms, and Fitch expects the company will continue to have good access to the capital markets as evidenced by the 4.25% Guaranteed Notes offering. In addition, in September 2012, Digital Realty Trust, L.P. issued $300 million 3.625% senior unsecured notes due 2022 at a spread of 200 basis points over the benchmark rate and priced to yield 3.784%. In August 2012, the company expanded its global revolving credit facility to $1.8 billion from $1.5 billion pursuant to the accordion feature under the facility. Other recent transactions include the issuance of $830.9 million of follow-on common equity to fund a portion of the Sentrum acquisition in July 2012, the issuance of $182.5 million 6.625% series F preferred stock in April 2012 and the closing of a $750 million senior unsecured multi-currency term loan also in April 2012.
Net debt as of Sept. 30, 2012 to latest 12 months (LTM) annualized recurring operating EBITDA was 5.6x compared with 4.7x as of Dec. 31, 2011 and 5.5x as of Dec. 31, 2010. The incurrence of debt to fund a portion of acquisitions and development contributed towards the recent increase in leverage.
Fitch anticipates that the company will continue to manage leverage in the low-to-mid 5x range, which is appropriate for a 'BBB' rating. In a stress case not anticipated by Fitch in which the company experiences tenant bankruptcies leading to low single-digit same-store NOI declines, leverage could sustain above 6.0x, which would be more consistent with a 'BBB-' rating.
The Stable Outlook reflects Fitch's projection that fixed-charge coverage will remain in the high 2x to low 3x range, that leverage will remain in the low-to-mid 5x range, and that the company will continue its gradual tenant and asset diversification via acquisitions and development.
The two-notch differential between Digital Realty's IDR and its preferred stock rating is consistent with Fitch's criteria for corporate entities with an IDR of 'BBB'. Based on Fitch's criteria report, 'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis,' dated Dec. 13, 2012, the company's preferred stock is deeply subordinated and has loss absorption elements that would likely result in poor recoveries in the event of a corporate default.
WHAT COULD TRIGGER A RATING ACTION
The following factors may have a positive impact on Digital Realty's ratings and/or Outlook:
-- Increased mortgage lending activity in the datacenter sector;
-- Fitch's expectation of fixed-charge coverage sustaining above 3.0x (fixed-charge coverage was 2.8x for the TTM ended Sept. 30, 2012);
-- Fitch's expectation of net debt to recurring operating EBITDA sustaining below 4.5x (leverage was 5.6x for the TTM ended Sept. 30, 2012).
The following factors may have a negative impact on Digital Realty's ratings and/or Outlook:
-- Fitch's expectation of fixed-charge coverage sustaining below 2.5x;
-- Fitch's expectation of leverage sustaining above 6.0x;
-- Base case liquidity coverage sustaining below 1.0x.
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
--'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis' (Dec. 13, 2012);
--'Recovery Ratings and Notching Criteria for Equity REITs' (Nov. 12, 2012);
--'Corporate Rating Methodology' (Aug. 8, 2012);
--'Parent and Subsidiary Rating Linkage' (Aug. 8, 2012);
--'Criteria for Rating U.S. Equity REITs and REOCs' (Feb. 27, 2012).
Applicable Criteria and Related Research:
Recovery Ratings and Notching Criteria for Equity REITs
Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis
Corporate Rating Methodology
Parent and Subsidiary Rating Linkage
Criteria for Rating U.S. Equity REITs and REOCs
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New York, NY 10004
Philip Zahn, CFA