Analysts from Citi Research, UOB Kay Hian and DBS Group Research have each maintained their “buy” rating for Digital Core REIT DCRU , after its second-largest customer filed for bankruptcyon June 4.
However, with the exception of DBS, which kept its target price unchanged at 90 US cents ($1.22), Citi Research’s Brandon Lee has reduced his target price to 67 US cents from 82 US cents previously. UOB Kay Hian’s Jonathan Koh also lowered his target price 67 US cents from 78 US cents before.
According to Digital Core REIT’s announcement on June 5, Cyxtera Technologies intends to pay its vendors and suppliers in full for goods and services provided on or after the filing date.
In conjunction with its bankruptcy filing, Cyxtera announced separately that it has obtained a commitment for up to US$200 million of debtor-in-possession financing “to support ongoing operations and continue meeting customer demand for global data centre platforms”.
However, were all of Cyxtera’s annual revenue contribution to be eliminated, Digital Core REIT estimates that its distribution per unit (DPU) would be reduced by approximately 2.0 US cents.
The REIT’s total asset value would be reduced by approximately US$85 million or an estimated 6%, while net asset value (NAV) per unit would be reduced by some 9% from 81 US cents to 74 US cents.
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Meanwhile, aggregate leverage would increase by around 200 basis points, from 34.4% to 36.5%.
Notwithstanding, the REIT says it expects to be able to minimise any potential DPU impact and maintain or enhance long-term value and returns for unitholders given below-market rents in top-tier markets with favourable fundamentals.
Lee of Citi says that his base case assumption is Digital Core REIT can still receive rents until September due to debtor-in-possession financing and the 120-day ceiling.
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He expects Cyxtera’s occupancy in Silicon Valley to hold given solid supply and demand dynamics and limited power until 2028, but for its Los Angeles and Frankfurt facilities to see some “downtime” due to lower customer occupancy rates at present.
As such, Lee has cut his FY2023, FY2024 and FY2025 DPU estimates by 5.7%, 12.8% and 0.9% to 3.74 US cents, 3.57 US cents and 4.22 US cents, respectively.
Along with a lower growth rate of 1% and a higher discount rate of 9.3%, his target price has fallen by 18% to 67 US cents implying a total return of 73%.
Although Koh of UOB Kay Hian says that Cyxtera’s bankruptcy has crystallised his “worst fear”, he notes that Digital Core REIT is still well-positioned to deal directly with Cyxtera’s existing end-user colocation customers.
According to him, the in-place passing rents for the affected data centres are below market, while vacancy rates are in the low- to mid-single-digit range across all three markets.
Koh’s research shows that market rents rose 40% to 60% in Northern California — where Silicon Valley is located — and 25% to 50% in Los Angeles over the past two years.
Digital Core REIT has estimated that its in-place passing rents are 15% to 40% below market in Northern California and 5% to 15% below market in Los Angeles. “Rising rents and tightening vacancies augur well for Digital Core REIT’s efforts to backfill the vacant data centre space,” says Koh.
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He notes that the facilities are 95% occupied in Silicon Valley, 57% occupied in Los Angeles and 70% occupied in Frankfurt, adding that the three data centres in Silicon Valley accounted for two thirds of annualised rent from the six affected data centres.
“Cyxtera has 120 days to decide which leases to resume or reject. We expect Cyxtera to reject the two leases for data centres in Los Angeles as occupancy is low at 57%,” Koh predicts.
He has cut his FY2024 DPU forecast and target price for Digital Core REIT by 15% and 22% respectively to 3.5 US cents and 67 US cents, assuming the REIT backfills half of the data centre spaces vacated by Cyxtera.
Emphasising that the rental rates that Cyxtera is paying for its leases with Digital Core REIT in Silicon Valley and Los Angeles are significantly below market rates, DBS analysts believe this implies that Cyxtera or its potential acquirer will want to continue with their leases at most of these properties on such favourable rents.
Digital Core REIT could also benefit from some potential uplift in the event they have to lease out the properties to other tenants, they add.
“Although this latest development with Cyxtera is a negative for Digital Core REIT and for Mapletree Industrial Trust (MINT) ME8U and Keppel DC REIT (KDCREIT) AJBU to a lesser extent, we believe that this should provide some clarity on the issue that has been ongoing for the past few months,” say the DBS analysts.
Based on DBS’s estimates, the impact to Digital Core REIT’s DPU in the worst case scenario would be around 35% if Cyxtera does indeed vacate all their leases immediately.
However, the analysts believe that this is an unlikely scenario as the market occupancies at their properties in Silicon Valley and Frankfurt are relatively healthy at 95% and 70% respectively. “The only market that we would be a little more cautious on will be in Los Angeles, where market occupancies are around 57%,” they add.
Assuming that Cyxtera chooses to only reject its leases at the two properties in Los Angeles, the DBS analysts say they could potentially see around an 11% downside to their FY2023 DPU estimates.
“Despite the negative connotations, we believe that current valuation on Digital Core REIT has already fully priced in the worst case scenario of Cyxtera vacating all of its leases. However, if we only account for the income void from the LA properties, current valuations implies a potential forward yield of around 8.0% at its current trading price,” they say.
At this point, they believe the worst case scenario is “unlikely” to play out, and could potentially look to Digital Core REIT's sponsor stepping in to provide some form of support again for the REIT.
As at 2.44pm, units in Digital Core REIT were trading 0.5 US cents or 1.22% down at 40.5 cents.
