Fitch Rates Digital Stout Holding, LLC's 4.75% Sr. Unsecured Guaranteed Notes due 2023 'BBB'

NEW YORK--()--Fitch Ratings has assigned a credit rating of 'BBB' to Digital Stout Holding, LLC's GBP300 million aggregate principal amount of 4.75% senior unsecured guaranteed notes due 2023. Digital Stout Holding, LLC is a wholly-owned subsidiary of Digital Realty Trust, L.P., which is the operating partnership of Digital Realty Trust, Inc. (NYSE:DLR). The notes were priced at a spread of 215 basis points over the United Kingdom Gilt Treasury Stock due 2023.

The guaranteed notes are senior unsecured obligations of Digital Stout Holding, LLC and will be fully and unconditionally guaranteed by Digital Realty Trust, Inc. and Digital Realty Trust, L.P. The company intends to use the net proceeds from the offering totaling GBP296.4 million to temporarily repay borrowings under its global revolving credit facility, to acquire additional properties, to fund development opportunities, for general working capital purposes or a combination of the foregoing.

Fitch currently rates Digital Realty Trust, Inc., Digital Realty Trust, L.P., and Digital Stout Holding, LLC (collectively, Digital Realty) as follows:

Digital Realty Trust, Inc.

--Issuer Default Rating (IDR) 'BBB';

--$1 billion preferred stock 'BB+'.

Digital Realty Trust, L.P.

--IDR 'BBB';

--$2 billion unsecured revolving credit facility 'BBB';

--$1 billion senior unsecured term loan facility 'BBB';

--$1.6 billion senior unsecured notes 'BBB';

--$266.4 million senior unsecured exchangeable debentures 'BBB'.

Digital Stout Holding, LLC

--IDR 'BBB';

--GBP700 million unsecured guaranteed notes 'BBB'.

The Rating Outlook is Stable.

KEY RATING DRIVERS

Digital Realty's 'BBB' IDR takes into account the company's strong access to capital evidenced by increasing institutional acceptance of the company's data center portfolio, as well as adequate liquidity due to laddered debt maturities, moderate retained cash flow and a less aggressive development pipeline. Credit strengths also include a global platform and limited tenant concentration.

These strengths are balanced by an uncertain leasing environment following reduced occupancy rates and select rental rate roll downs; however, fixed-charge coverage should remain appropriate for the 'BBB' rating. Corporate leverage is low for the rating although unencumbered asset coverage is somewhat weak for the 'BBB' level as the company's unsecured debt incurrence has outpaced the growth of the unencumbered pool.

Uncertain Leasing Environment

Same-store cash net operating income (NOI) increased by 8.9% in 2013. However, same-store occupancy decreased to 91.2% as of Dec. 31, 2013 from 93.3% as of Dec. 31, 2012, principally due to a sizeable non-data center asset lease expiration. Cash rental rate roll downs on renewals were negative 0.4% for 2013. Further rental roll downs are possible in 2014 when 7.6% of rents expire as well as in 2015 when 8.5% of rents expire. Nevertheless, the company sees an opportunity to increase revenues from colocation (i.e., providing space, power, connectivity and outsourced IT solutions for corporate enterprises). Colocation provides an alternative vehicle for growth that would enhance DLR's revenue diversity to the benefit of unsecured bondholders.

Tenant retention was solid at 77% for 2013, indicating that only select tenants have chosen not to renew in favor of building their own data centers, which is a secular data center industry risk. In addition, the weighted average remaining lease term for the portfolio is approximately seven years, providing cash flow stability absent tenant bankruptcies or lease renegotiations during the term.

Solid Fixed-Charge Coverage

The company's fixed-charge coverage ratio was appropriate for the 'BBB' rating at 2.6x for 2013 pro forma for the series H preferred stock and 4.75% Guaranteed Notes offerings (3.0x actual in 2013), compared with 3.1x in 2012 and 2.9x in 2011. Fitch defines fixed-charge coverage as recurring operating EBITDA less recurring capital expenditures less straight-line rent adjustments divided by total cash interest incurred and preferred stock dividends.

Fitch anticipates that a backlog of leases signed but not yet commenced will offset potential further rent roll downs and increased capital expenditures associated with the lease-up of vacant space. Fixed-charge coverage should remain solid for the 'BBB' rating in the high 2.0x range. In a stress case not anticipated by Fitch in which rental rate roll downs result in low single digit same-store NOI declines, coverage could decline below 2.5x, which would be weak for a 'BBB' rating.

Reduced Development Pipeline

Fitch views favorably DLR's reduction in development activities in response to market conditions. DLR's future funding requirements for the total active development pipeline represented 4.9% of gross asset value as of Dec. 31, 2013, compared with 6% as of year-end 2012 and 6.9% as of year-end 2011. Among the in-service development inventory, approximately 17.3% of space is pre-leased as of Dec. 31, 2013, indicative of elevated lease-up risk going forward. However, approximately 79.4% of space was pre-leased across data centers under construction as of Dec. 31, 2013. Construction costs on a per-square foot basis are declining as well but remain high compared with other commercial property sectors.

Strong Access to Capital

The company continues to demonstrate strong access to multiple sources of capital on favorable terms, including the series H preferred stock and 4.75% guaranteed notes. In addition, the company refinanced its revolving credit facility in August 2013, increasing its total borrowing capacity to $2 billion from $1.8 billion and also refinanced its senior unsecured multi-currency term loan facility, increasing its total borrowing capacity to $1 billion from $750 million. In September 2013, DLR formed a joint venture with an investment fund managed by Prudential Real Estate Investors (PREI) and contributed nine Powered Base Building data centers valued at approximately $366.4 million. The PREI-managed fund took an 80% interest in the joint venture, and DLR retained a 20% interest. The company contributed another Powered Base Building data center to this venture in the first quarter of 2014 (1Q'14).

Adequate Liquidity

Liquidity coverage assuming no additional external capital raising, calculated as liquidity sources divided by uses, is 1.5x for the period Jan. 1, 2014 to Dec. 31, 2015. Sources of liquidity include unrestricted cash, availability under the company's global credit facility pro forma for the series H preferred stock and 4.75% guaranteed notes offerings, and projected retained cash flows from operating activities after dividends and distributions. Uses of liquidity include debt maturities, projected recurring capital expenditures and development costs. Assuming 80% of the company's secured debt is refinanced - an unlikely scenario as the company continues to unencumber the portfolio - liquidity coverage would be 1.8x.

Debt maturities are laddered in the coming years with 9% of debt maturing in 2014 followed by 10.4% in 2015. In addition, the company's adjusted funds from operations (AFFO) payout ratio was 83.9% in 2013 compared with 83.7% in 2012, reflective of good internally-generated liquidity of over $80 million annually based on the 2013 payout ratio.

Global Platform

Digital Realty offers Turn-Key Flex, Powered Base Building, and colocation space and its 131 properties span 33 markets across 10 countries and four continents. This significant market presence gives the company strong tenant relationships; approximately 58% of the company's customers occupy space in DLR data centers across multiple markets. Top markets as of Dec. 31, 2013 were London (12.6% of rent), Northern Virginia (10.2%), New York (9.5%), Dallas (9.3%), and Silicon Valley (8.4%).

Limited Tenant Concentration

Tenant concentration continues to decline, which Fitch views favorably and which differentiates DLR from its major competitors, CoreSite Realty Corporation, DuPont Fabros Technology, Inc. and Global Switch Holdings Ltd. (Fitch IDR of 'BBB' with a Stable Rating Outlook). DLR's top five tenants comprise 23.5% of total base rent, compared with 23.1% to 61% for its primary competitors.

DLR's top tenants as of Dec. 31, 2013 were CenturyLink, Inc. (IDR of 'BB+' with a Stable Rating Outlook) at 7.8% of rent, IBM (IDR of 'A+' with a Stable Rating Outlook) at 5.5%, TelX Group, Inc. at 4.3%, Equinix Operating Company, Inc. at 3.2% and Morgan Stanley (IDR of 'A' with a Stable Rating Outlook) at 2.7%.

Technical Team Focused on New Initiatives

The company offers customized solutions to its tenants; recent initiatives include the launch of EnVision, a comprehensive data center infrastructure management (DCIM) solution that provides increased visibility into data center operations, and the launch of Digital Open Internet Exchange (Digital Open-IX), a neutral and member-governed internet exchanges self-regulatory body in North America, similar to the system in Europe. The initial rollout for Digital Open-IX will take place in the New York metro area and Northern Virginia, followed by deployment in several other U.S. markets.

Low Corporate Leverage for 'BBB'

Leverage is low for the 'BBB' rating, with net debt as of Dec. 31, 2013 pro forma for the preferred stock and Guaranteed Notes offerings to 2013 recurring operating EBITDA at 5.3x, compared with 5.5x as of Dec. 31, 2012 and 4.7x as of Dec. 31, 2011. The incurrence of debt to fund a portion of acquisitions and development contributed towards the increased leverage trend from 2011 to 2012.

In addition, on March 17, 2014, Digital Realty announced its intention to redeem all its outstanding 5.5% senior unsecured exchangeable debentures. The exchange of all of these debentures for common stock would further reduce leverage to approximately 5.0x.

Fitch's base case anticipates that the company's same-property NOI will be flat over the next 12-to-24 months, which will result in leverage in the low-to-mid 5x range. In a stress case not anticipated by Fitch in which the company experiences low single digit same-store NOI declines, leverage would approach 6.0x, which would be weak for a 'BBB' rating.

Separately, in October 2013, DLR's board of directors authorized a $500 million share repurchase program, although the company has yet to utilize the program. Fitch does not expect the company to access this program actively; should the company do so, it would weaken the position of unsecured bondholders and could result in negative rating actions, depending on the magnitude of the buyback.

Slightly Weak Unencumbered Asset Coverage

Digital Realty is committed to an unsecured funding profile. However, the company's unsecured debt incurrence has outpaced the growth of the unencumbered pool. Unencumbered assets (unencumbered NOI pro forma for redevelopment and development NOI divided by a stressed capitalization rate of 10%) covered pro forma net unsecured debt by 1.8x.

Executive Leadership Announcement

On March 17, 2014, the company announced that Michael F. Foust departed as Chief Executive Officer. Digital Realty's Board of Directors appointed A. William Stein, Chief Financial Officer and Chief Investment Officer, to serve as Interim Chief Executive Officer. Stein joined the company's predecessor private equity fund in April 2004 and, having overseen the company's growth and achievement of investment-grade credit ratings, is well-positioned to serve in this role.

Preferred Stock Notching

The two-notch differential between the company's IDR and preferred stock rating is consistent with Fitch's criteria for corporate entities with an IDR of 'BBB'. Based on Fitch research titled 'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis', available on Fitch's web site at 'www.fitchratings.com', these preferred securities are deeply subordinated and have loss absorption elements that would likely result in poor recoveries in the event of a corporate default.

Stable Outlook

The Stable Outlook reflects Fitch's projection that fixed charge coverage will remain in the high 2x to low 3x range, that leverage will remain in the low-to-mid 5x range, and that the company will continue its gradual tenant and asset diversification via acquisitions and development.

RATING SENSITIVITIES

The following factors may result in positive momentum in the rating and/or Outlook:

--Increased mortgage lending activity in the datacenter sector;

--Fitch's expectation of fixed-charge coverage sustaining above 3.0x (pro forma fixed-charge coverage is 2.6x);

--Fitch's expectation of net debt to recurring operating EBITDA sustaining below 4.5x (pro forma leverage is 5.3x).

The following factors may result in negative momentum in the rating and/or Outlook:

--Sustained declines in rental rates and same-property NOI;

--Fitch's expectation of fixed-charge coverage sustaining below 2.5x;

--Fitch's expectation of leverage sustaining above 6.0x;

--Base case liquidity coverage sustaining below 1.0x.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Rating U.S. Equity REITs and REOCs: Sector Credit Factors,' (Feb. 26, 2014);

--'Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit Analysis' (Dec. 23, 2013);

--'Recovery Ratings and Notching Criteria for Equity REITs' (Nov. 19, 2013);

--'Corporate Rating Methodology' (Aug. 5, 2013).

Applicable Criteria and Related Research:

Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=715139

Criteria for Rating U.S. Equity REITs and REOCs

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=700091

Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit Analysis

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=726863

Recovery Ratings and Notching Criteria for Equity REITs

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=722363

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=825524

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Contacts

Fitch Ratings
Primary Analyst:
Sean Pattap, +1-212-908-0642
Senior Director
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst:
Steven Marks, +1-212-908-9161
Managing Director
or
Committee Chairperson:
John Culver, CFA, +1-312-368-3216
Senior Director
or
Media Relations:
Sandro Scenga, New York, +1-212-908-0278
sandro.scenga@fitchratings.com

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Contacts

Fitch Ratings
Primary Analyst:
Sean Pattap, +1-212-908-0642
Senior Director
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst:
Steven Marks, +1-212-908-9161
Managing Director
or
Committee Chairperson:
John Culver, CFA, +1-312-368-3216
Senior Director
or
Media Relations:
Sandro Scenga, New York, +1-212-908-0278
sandro.scenga@fitchratings.com