QTS Realty Trust At The Intersection Of Real Estate And Technology

Data center REITs sit squarely at the intersection of real estate and technology.

On August 11, QTS Realty Trust Inc (NYSE: QTS) Chief Investment Officer Jeff Berson presented at the annual Oppenheimer Technology, Internet & Communications conference.

Berson explained how he believes a growing number of customers are now looking for hybrid data-center/cloud solutions, often driven by the need for data security and legal compliance.

This security and compliance shift also includes colocation, which QTS often refers to as "the engine which drives the business."

Tale Of The Tape - QTS vs Peers Since IPO

During the same period, the MSCI REIT Index (RMZ) gained 20.7 percent, which underscores the data center REIT sector outperformance vs. the broader REIT sector.

Related Link: Data Center REIT Digital Realty Explains How Telx M&A Will Add Value

Industry pioneer Digital Realty Trust, Inc. (NYSE: DLR) has recently shifted gears to beef up its colocation offerings, with its pending acquisition of Telx, and recent executive suite moves.

Business Model

QTS has a 3C product offering: C1 custom data center (wholesale); C2 colocation; and C3 cloud and managed services.

QTS significantly expanded both its cloud and managed services, and FedRamp efforts, with its recent Carpathia Hosting acquisition. In addition to Carpathia's pool of talent, QTS also picked up ~200 additional customers, plus an international presence in Toronto, Amsterdam, London, Singapore and Hong Kong.

Berson pointed out more than 40 percent of QTS customers utilize more than one product offering.

Notably, during 2Q15 QTS billed an average of $1,225 per square foot for C2/C3 products and services, including new and modified leases.

QTS Mega-Data Centers

If the 3C product offering has been the QTS recipe for success, its secret sauce has been the acquisition of strategically located, infrastructure rich, facilities for pennies on the dollar.

Berson explained that former semiconductor facilities have been repurposed in Atlanta, Richmond and Dallas; QTS is entering the Chicago market by converting the former 30 acre Chicago Sun Times press facility into a mega-data center campus.

The initial phase in Chicago, which is located just 1.5 miles from downtown, is expected to come on-line in mid-2016. Berson emphasized that Chicago had very favorable supply and demand characteristics, especially close to downtown.

QTS currently has 2.2 million SF of powered shell, with just 1.54 million of raised floor built out as of the end of 2Q15.

Record Booked-Not-Billed

As of June 30, QTS had just under $70 million of signed leases that are scheduled to commence between 2H15 through 2017 and beyond.

Berson explained that this helped to give QTS future earnings visibility, while expanding at existing facilities where costs are known, helps to de-risk this future growth.

Capex is reduced by just-in-time delivery, which helps to boost return on invested capital (ROIC).

Metrics That Matter To Investors

QTS reported a 2Q15 annualized unlevered return on invested capital of 15.8 percent, exceeding its stated goal of 15 percent.

Berson shared that the Carpathia acquisition was immediately accretive to earnings, and boosted QTS cloud and managed services revenues to the point where C1, C2 and C3 will each represent about one-third.

Notably, during the 2Q15 QTS earnings conference call, CFO Bill Schafer pointed out that next quarter he "expect[s] our margins to drop, as C3 typically contributes lower margins, while delivering significantly higher return on invested capital than C1 and C2."

How About Competition?

Berson was asked about competing as a smaller "niche player" for colocation with the much larger Digital/Telx combination. He replied that QTS has been providing these types of integrated services for the past 10 years, which gives them an incumbent advantage.

Berson explained there are costs to build the infrastructure for competitors attempting to move up the IT stack from wholesale to colocation and colocation to cloud services.

He felt that customers will be less likely to turn over crucial data and applications to a team that doesn't have a history of reliability and performance.

Investor Takeaway

In Berson's view, QTS has delivered on market leading growth, while maintaining market leading ROIC, despite the inherent difficulty.

He also suggested that the true value of the available QTS powered-shell space may not be reflected in the current EBITDA multiples used to value the shares.