A River (of cash) Runs Through It
On June 9 data center REITs Digital Realty Trust (DLR) and DuPont Fibros (DFT) announced their intention to merge in an all-stock transaction. Shareholders of DuPont Fibros will receive 0.545 shares of DLR for each share of DFT once the deal is approved by a majority of each company’s shareholders. The resultant entity would have a market capitalization of approximately $25 billion, making it the largest publicly-traded data center REIT in the United States.
This is good news for both companies. Shareholders of DFT enjoyed a 15% spike in the value of their stock the day the deal was announced, reflecting the premium DLR is paying to acquire its assets. However, shareholders of DLR have not suffered a decline in the value of their stock even though the company is paying a premium for DFT since this transaction will immediately be accretive to its net operating income, from which dividends are paid.
That’s because the economies of scale and customer benefits for a deal of this size are enormous. The very nature of cloud computing is to share data processing and storage capacity across a wide network of servers. The bigger the network, the greater its capacity to handle the massive amount of data used for the rapidly expanding VR/AR/MR (virtual reality/augmented reality/mixed reality) market.
It’s no accident this deal is taking place in advance of Apple’s release this fall of its new iPhone 8 model that is expected to offer a broad spectrum of AR/VR/MR apps that could greatly increase demand for data processing and storage across all platforms. “This strategic and complementary transaction significantly enhances Digital Realty’s ability to support the growth of hyper-scale users in the top U.S. data center metro areas”, said Digital Realty CEO A. William Stein in the press release announcing the transaction.
The only potential glitch is receiving regulatory approval for the merger since the new entity would be bigger than the next five data center REITs combined. But this is a rapidly consolidating market that is, similar to Telecomm, destined to become an oligopoly dominated by only a few huge companies so blocking this deal would only delay the inevitable. For that reason, I believe this deal will be approved by industry regulators after shareholders of both firms give it their stamp of approval.
Getting much more attention is Amazon.com‘s (AMZN) recently announced intention to acquire Whole Foods Market (WFM) in an all-cash transaction valued to $13.7 billion, or about half the size of this one. But Amazon is a much sexier company providing a service almost everyone has used, while Digital Realty Trust is a “boring” REIT that few investors understand. For that reason, investors can’t seem to pay enough for AMZN stock recently priced at 88 times forward earnings after spiking more than 10% in the wake of the Whole Foods announcement.
These two transactions announced within weeks of one another illustrate the disparity in investor psychology. Perhaps more so than any other company, Amazon represents the unbridled optimism fueling the stock market’s recent rise. It pays no dividend and is only marginally profitable, but enjoys enormous support based on the belief that one day its huge investment in product distribution will pay off for its shareholders.
Meanwhile, Digital Realty gets considerably less love despite increasing its dividend every year and having a profit margin ten times that of Amazon. Of course, it may never deliver groceries to your home like Amazon will soon be able to do, but I’m not sure that’s a good reason to value one business so much more than the other. What I do know is that Digital Realty’s acquisition of DuPont Fibros is a sure thing, while Amazon’s foray into the online grocery delivery business is at best a maybe.