Digital Core REIT - DBS Research 2022-09-23: Delivers On Its Acquisition Promise

• Digital Core REIT (SGX:DCRU) announced their long-awaited maiden acquisition plans this morning. Similar to their guidance last quarter, Digital Core REIT aims to acquire 2 data centres (DCs) from its sponsor pipeline worth a collective total consideration of US$700m. The manager will be given 6 months to complete these acquisitions, and the size of the deal and way of funding the deal will be subject to overall cost of capital and market conditions.
• In Digital Core REIT's announcement, the manager provided
  1. a possible scenario of sourcing debt to fund a US$146m acquisition (25% stake in Frankfurt DC) or
  2. in the bull case scenario, acquire both DCs worth up to ~US$700m.
• Both scenarios have their merits, but we believe the later scenario, which will entail an equity-raising scenario, will be preferred if Digital Core REIT is able to raise equity at a unit price of at least US$0.83, subject to unitholders’ approval in an EGM to be called. The equity fundraising scenario is expected to generate a DPU accretion of ~3.1% – this could potentially be higher if the placement is done at a higher price. Every 1 US cent difference in the EFR price will drive accretion by +/- 20 basis points.

Scenario1 – Debt-funded scenario: 25.0% interest in Frankfurt DC

• Acquisition of a 25.0% interest in the Frankfurt DC for a total consideration of US$146m.
  • Estimated yield of ~4.5%.
• Will be fully funded by debt and gearing will increase to 33.0%.
  • New debt to be fully hedged to fixed rate, 64% of total borrowings will be fixed.
  • ~US$144m in new debt at an estimated borrowing cost of 3.5%.
• Occupancy of 91% with a WALE of 4.7 years.
• Estimated DPU accretion of ~2.0%.

Scenario2 – Equity fundraising scenario: 89.9% interest in Frankfurt DC, 90.0% interest in Dallas DC.

• Acquisition of ~90% interest in two DCs for a total consideration of US$700m.
  • Estimated yield of ~5.0% for Dallas DC.
  • Blended yield of ~4.7%.
• Funded by a mix of debt (59%), private placement (26%), and sponsor placement (14%).
  • ~US$416m in debt; estimated borrowing cost of 3.5%.
• ~US$180m in private placement at an illustrative price of US$0.83 per unit.
• ~US$97m in sponsor placement at an illustrative price of US$0.83.
• Gearing estimated to increase to 37.5%, with 62% of debt hedged to fixed rates.
• Dallas DC is 100% occupied with a WALE of 15.4 years.
• Built-in rental escalations of 1.6% for the acquisitions.
• Estimated DPU accretion of ~3.1%.
  • Every 1 US cent increase in the illustrative issue price will increase DPU accretion by ~20bps.

Our thoughts on Digital Core REIT's acquisitions

Multiple scenarios to work on; all scenarios are value-accretive to unitholders.

• Digital Core REIT will require unitholders’ approval, as this is a related party transaction, and we understand that if approval is granted at an EGM, management will have the discretion to decide on the best possible acquisition scenario for the REIT, subject to market conditions.
• As a base case, we believe that Digital Core REIT will embark on a debt-funded acquisition (scenario1), but it will also have the flexibility to acquire a larger interest in Frankfurt DC (up to 50% in our view, scenario3), through more debt. If market conditions are conducive, management will likely take on the acquisition of both properties, but that will require equity fundraising (scenario2). The total EFR quantum is US$280m (~30% of its current market cap).
• We take comfort in management’s reiteration that any EFR would ideally be done close to Digital Core REIT's NAV (net asset value), which affirms management’s view that they would not like to see any significant dilution of its NAV. We note that the accretion from the acquisition of both DCs implies that an EFR is done at ~US$0.83 (adjusted NAV assuming an EFR). As a sensitivity analysis, in scenario2, for every 1 US cent reduction in the issue unit price, DPU accretion is expected to decline by ~20bps.

Accretion levels are slightly below our estimates.

• We have priced in an acquisition in our estimates (US$250m, debt-funded acquisition), which equates to scenario 3. The pro-forma accretion is slightly lower, largely due to the higher cost of debt of ~3.5% (vs. 2.5% for EUR debt, in our assumptions).
• Given the expected completion is to be in end-November 2022 at the earliest, we believe there are near-term downside risks to our FY22 earnings estimates. We currently have a BUY recommendation on Digital Core REIT and target price of US$1.15, which assumes a debt-funded acquisition of ~US$250m (by September 2022).
• As the EGM is expected to only be held in end-November, we will update our projections once more details on the acquisition scenarios are confirmed. The earliest any acquisition can be concluded will be in early or mid-December, and the sponsor has given Digital Core REIT the flexibility to upsize the acquisition up to March 2023.