Digital Core REIT - To Buyback Or Not To Buyback?
- At its EGM held on 18 Nov 2022 morning, Digital Core REIT (SGX:DCRU) received overwhelming support for the proposed acquisition of a 25% stake in the Frankfurt DC. See Digital Core REIT's announcements.
- The resolutions to issue new units has also been approved and we understand that management has committed to only carrying out an equity fund raising (EFR) if it can be done close to NAV.
What next for Digital Core REIT?
- At the current Digital Core REIT's share price of US$0.585 (~31% discount to NAV), it seems unlikely that Digital Core REIT will be able to carry out an EFR in the near term. However, Digital Core REIT will still have ample debt headroom to upsize its acquisition of the Frankfurt DC.
- Based on the proposed debt-funded acquisition of a 25% stake in the Frankfurt DC, Digital Core REIT’s gearing will go up to ~33.5%. If Digital Core REIT were to double its acquisition stake of the Frankfurt DC (upsize its take to 50%), its gearing would only go up to ~39.5%, still within Management’s long-term gearing target of less than 40%. This could potentially double the DPU accretion from ~2.0% to ~4.0%.
How else to drive DPU accretion?
- We are reminded that Digital Core REIT currently has the mandate to carry out a share buyback to repurchase up to 10% of the units in issue. Based on this, we look at the possible scenarios of share buybacks, and the potential DPU and NAV accretion.
- From the scenario analysis, Digital Core REIT has the debt headroom to carry out the share buyback up to a maximum of 10% of its outstanding units, and gearing will still only go up to ~39%. Based on the various amounts of share buybacks, DPU accretion could range anywhere from 0.4% - 2.0%, and NAV accretion could be anywhere between 0.6% - 3.4%.
- It is, however, important to note that the above scenarios are based on assumptions that Digital Core REIT’s financing cost for the share buyback exercise is ~5.0%, and the shares are bought at ~US$0.60 per unit. For example, if financing costs are 100 bps lower, DPU accretion would almost double to between 0.7% - 3.9%.
Can it be done?
- Theoretically, the share buyback is definitely an option that Digital Core REIT can consider, especially at a time now where cap rates of data centres remain stubbornly compressed and making accretive acquisitions are looking more challenging. If Digital Core REIT has no plans to optimise its gearing for other uses, the share buyback will definitely be an avenue for management to support its share price and create accretion for unitholders.
- Moreover, this is a temporary measure, and Digital Core REIT can always sell these shares in the open market once its share price recovers, and recognise a tidy gain in the meantime.
- There are other aspects that Digital Core REIT will have to consider before carrying out the share buyback:
- Trading liquidity: Based on Digital Core REIT’s average three-month trading volume, ~48.3m units are traded monthly. For Digital Core REIT to do a share buyback of up to 5% of its outstanding units, it will take them much longer than one month to acquire the ~57.3m units. Moreover, if Digital Core REIT has to carrying out the buyback at a higher price than our assumed US$0.60, the accretion to DPU will be lower.
- Cost of financing: In our previous scenario analysis, we have assumed that Digital Core REIT’s cost of borrowing averages at 5.0%. Given the current volatility in interest rates, Digital Core REIT’s cost of borrowings could swing significantly in either direction. Moreover, it depends on Digital Core REIT’s plans for the units that it buys back and if it makes sense to hedge the new debt to fixed rates. (i.e. if management sees the share buyback as a short-term initiative, it may not make sense to hedge the loans taken to fixed rates as it may be even more costly to unwind these hedges; conversely if it does not hedge the new loans to fixed rates, Digital Core REIT could be exposed to further interest rate fluctuations).
- Other uses for its debt headroom: Although the share buyback will be DPU and NAV accretive, it could potentially utilise the remaining debt headroom Digital Core REIT has. And depending on their intentions for the units bought, their funds could be “locked” up and Digital Core REIT will not be able to be as nimble to pounce on opportunities in the market.
- The ability to carry out a share buyback to generate DPU and NAV accretion provides Digital Core REIT with an alternative option to create value for unitholders. Moreover, the current environment makes it challenging and provides limited options for Digital Core REIT to embark on further accretive acquisitions. With ample debt headroom, a share buyback will be immediately accretive for unitholders and beyond the financial metrics, it also signifies the Manager’s commitment to its unitholders and belief that its shares should be trading at a higher price.
- However, if Digital Core REIT has the option to upsize its stake in the Frankfurt DC (up to a 50% stake), we would much rather they utilise their debt headroom for the acquisition. Over the longer term, given the continued structural growth of the data centres sector, a larger acquisition will be more beneficial for the REIT and for their earnings.
- Although Digital Core REIT could embark on a smaller value in share buybacks (less than 2% of outstanding units), it may not be feasible as the accretion could potentially be too marginal.
- We will be maintaining our BUY recommendation with a target price of US$0.90 on Digital Core REIT.
Above is the excerpt from report by DBS Group Research.
Clients of DBS may access the full report in PDF @ https://www.dbs.com/insightsdirect/.
Dale LAI DBS Group Research | Derek TAN DBS Research | https://www.dbs.com/insightsdirect/ 2022-11-21 2022-11-21
Previous report by DBS:
2022-10-27 Digital Core REIT - Acquisition Of Frankfurt Data Centre On The Horizon.