How 1 Executive Gave Digital Realty A Giant Boost

What a difference a year makes.

The search to find "the next leader to help guide Digital Realty to the next level and scale of operational sophistication" is over -- and the incumbent has earned the job.

Mr. Market had already cast its "vote" in favor of interim CEO Bill Stein's leadership of global data center operator Digital Realty Trust, Inc. DLR evidenced by the huge run up in its share price. Now, the board of trustees just made the vote official by removing the interim tag and officially promoting the long-time company CFO to the top spot.

Under Siege

The REIT sector as a whole had a weak second half of 2013 due to Federal Reserve comments sparking fears of a sharply rising interest rate environment.

However, Digital Realty was reeling from a negative Highfields Capital Management presentation in May 2013, compounded by poor communication on earnings calls regarding accounting adjustments.

An Abrupt Change

On March 17, 2013 Digital Realty announced that CEO Michael Faust, the man who had guided the company since its 2004 IPO, "had vacated that office effective immediately." CFO Bill Stein was appointed as interim-CEO to head the company.

Related Link: How These 3 Data Center Providers Stand Apart

Stein was quite candid during the Q1 earnings call addressing perceptions and refocusing the company efforts. "We cannot just offer them any color Model T they want as long as it's black," he said.

Historically, Digital had focused on larger "wholesale" data center customers, and was behind the curve when it came to marketing custom solutions and value added services.

Block & Tackle Approach

During his initial conference call, Stein emphasized that:

1. The No. 1 objective would be to "drive ROIC through the lease-up of existing inventory."

2. Digital will transition to a build-to-order inventory program to limit speculative development risks and meet return thresholds.

3. There will be a review of what properties constitute the core portfolio in order to prune underperforming and non-core assets.

Wash, Rinse, Repeat

REIT investors love their dividends. Digital Realty has a strong track-record and has not disappointed investors during this transition.

Mr. Market Is A Believer

Data center owners and operators have benefited from the explosive growth in data creation. Top performers besides Digital year-to-date include: DuPont Fabros DFT, QTS Realty Trust QTS and global interconnection leader Equinix, Inc. EQIX.

Meta-trends like cloud computing, solution outsourcing and exponential wireless data creation bode well for future growth in this high-tech REIT sector.

A Vote Of Confidence

Digital Chairman Dennis Singleton commented on the announcement, "As interim CEO, Bill has created impressive momentum in the business and made great strides in strengthening Digital Realty's operating and financial performance. His leadership capabilities are clearly evidenced by the improvement in return on invested capital since he took the helm as interim CEO in March 2014.

"Bill has a clear strategic vision for the company's future, a strong track record of sound financial stewardship and a big picture understanding of the future of our industry."

Challenges Moving Forward

One area where $9.4 billion cap Digital has an advantage over its smaller data center REIT rivals such as $2.5 billion DuPont Fabros and $970 million QTS Realty is global scale. Digital Realty has a network of 130 data centers serving over 600 customers on four continents.

However, $11.9 billion Equinix represents both a challenge and an opportunity for CEO Stein moving forward.

Equinix has strategic partnerships with large cloud providers such as Amazon Web Services, Google, Microsoft and Cisco. Equinix serves over 4,700 customers located in 101 IBX data centers worldwide. Currently, Equinix leases the majority of its IBX data center locations. Equinix is a large customer for Digital Realty, and the companies have recently agreed to several long-term lease extensions.

Equinix is expecting to receive formal REIT approval from the IRS shortly, and will be operating as a REIT as of Jan. 1, 2015. It remains to be seen if the Equinix lease/own equation will change moving forward.

Posted In: Bill SteinHighfields Capital ManagementLong IdeasREITTrading IdeasReal Estate