According to the Financial Times, short seller Jim Chanos believes that data centres in REITs and that are not owned by Alphabet, Microsoft and Amazon are going to be behind the curve so to speak. The web service arms of the trio, Google Cloud, Amazon Web Services and Microsoft Azure have their cloud services housed in their own leading edge data centres. For instance Google has a state-of-the-art data centre in Jurong.
Chanos is quoted to have said the cloud is growing but “the cloud is their (the REITs’) enemy, not their business. Value is accruing to the cloud companies, not the bricks-and-mortar legacy data centres.”
In fact, Alphabet, Amazon and Microsoft are likely to be the REITs’ biggest competitors, not their biggest customers. When your biggest competitors are the three most vicious competitors in the world you have a problem, Chanos is reported to have said.
Data centres owned by groups such as Digital Realty Trust and Equinix are vast warehouses of servers that power large swathes of the internet, the FT explains. The growth in demand for data centres has been a big theme for institutional investors, who are seeking to tap into the global expansion of cloud computing, the FT adds.
As an example, investors in the Asian timezone bought into Digital Core REIT, whose sponsor is Digital Realty Trust, at 88 US cents back in December 2021 during its IPO. As at June 29, 2022, its unit price is at 82 US cents. In fact, Digital Core REIT is down almost 29% since the start of the year.
The reasons for Digital Core REIT’s performance could be threefold. The main reason, is of course, interest rates. In addition to an impact on Digital Core REIT’s unit price, its capital management leaves a lot to be desired. In its business updates in 1Q2022, the REIT manager started the year without any fixed rate debt. Moreover, all the debt taken on at IPO is not staggered and expires at the same time.
See also: CICT's manager proposes to acquire ION Orchard at $1.85 billion, subject to EGM
On April 21, the manager announced that it had established a minimum target of 50% fixed rate debt, and entered into a US$175 million interest rate swap to mitigate interest rate risk. The REIT has some US$500 million of debt, of which US$350 million has been drawn down, and the remaining US$200 million is undrawn. The amount that is on fixed rates is just US$175 million. Cost of debt is 2.1%.
The cost of debt includes the pro forma cost for US$175 million interest rate swap, assuming the swap was outstanding for the entire 1Q2022 period. The actual average cost of debt for the 1Q2022 period was 1.2%, the manager says. This implies that cost of debt in 2Q2022 is likely to be a lot higher, as cost of debt is likely to rise from hereon.
Secondly, the REIT’s manager announced this: “In April 2022, Digital Core REIT’s fifth-largest customer, a privately held IT service provider occupying 2.7 MW of capacity in Toronto, filed for bankruptcy protection.”
See also: CICT's manager proposes to acquire ION Orchard at $1.85 billion, subject to EGM
Finally, Digital Core REIT’s manager promoted its US$15 billion pipeline from sponsor Digital Realy Trust as a growth story.
Based on Chanos’ world view, this may not be the growth story it was first promoted as. Chano reckons that Google Cloud, Microsoft Azure and Amazon Web Services, the so-called trio of “hyperscalers” prefer to build data centres to their own design rather than moving into existing ones. When they do outsource, they typically offer low returns to their development partners, the FT points out. Chanos also said he believes that these REITs are overvalued and are in for a period of declining revenue and earnings growth.
Chanos' thesis may also mean the Digital Realty Trust will be incentivised to divest its data centres to Digital Core REIT. Whether this is good for the latter will be up to its unitholders to decide.
