DigitalBridge: The Asset-Light Investment Model Differentiator

Last time, we covered DigitalBridge (New York Stock Exchange: DBRG) In April, I was optimistic that the company would acquire data center service provider Switch, instead of Equinix (EQIX) or 5G, which operate in the same industry. Infrastructure company American Tower (AMT).

This has proven to be accurate, and as part of the $11 billion acquisition, DigitalBridge is partnering with investment services provider IFM Investors.

But as the green chart below shows, investors punished the company’s stock last year more than others operating in the real estate sector, including Crown Castle (CCI).

Now, my purpose in this paper is to understand the reasons for this downturn. We will also use this opportunity to assess whether we can create value in a highly competitive ecosystem as the macro economy deteriorates and customers facing high inflation are readjusting their methods. You can also. They spend on information technology.

First, we provide insight into DigitalBridge’s focus areas and growth strategy.

Digital infrastructure as an asset class

First, it is a real estate services company focused on digital infrastructure such as towers, fiber networks and data centers. It was born in June 2021 when Colony Capital sold its non-digital assets and rebranded it under its current name. Specifically, it consists of DataBank, Scala data centers, Landmark Dividend LLC, and PCCW data centers. It also includes significant holdings in Vantage Data Centers and AtlasEdge, and AMP Capital’s global infrastructure equity investment management business. As such, it has a global footprint.

Second, benefiting from the Covid-driven digital transformation, growing both organically and through acquisitions, with themes such as cloud migration, 5G and edge computing leading to 200% year-on-year revenue growth from March 2021 onwards. Earnings soared as it surged by more than 10%.

This is shown in the table below.After the return in earnings seen in 2020, the 976% growth enjoyed in the June quarter 2021 is expected to continue as digital infrastructure becomes a separate segment on a par with residential and commercial. It shows the company’s bet that it could emerge as an asset class.

Additionally, in the third quarter of 2022, Switch achieved $174 million in sales compared to DigitalBridge’s $244.3 million (table above). Therefore, we expect the deal to close in Q4, so when we add up our earnings for the quarter ending in December (Q4 2022), we are poised to see growth spike again. In this regard, Switch earned his $161.4 million in the fourth quarter of 2021. Adding this amount to DigitalBridge’s $189.9 million (table above) would imply 85% (161.4 & 189.9) growth in Q4 2022, which is an even number. When ignoring the organic growth of both companies.

So, after growth of less than 20% in the first three quarters of 2022, growth of at least 85% in the fourth quarter of 2022 could break the wall of pessimism that has hampered the stock’s performance this year. . In this case, powered by Switch, his GD Towers of Deutsche Telekom (OTCQX: DTEGY), and other acquisitions, the company expects to increase his AUM (assets under management) to his $50 billion in Q3-4. We need to raise it from $ to $65 billion. Expand business scale by 30%.

Equity volatility amid rising interest rates

Digging deeper into its operating model, the company initially began diversifying from residential and commercial real estate to a tower business leased to telecom companies under inflation-adjusted contracts. It has since expanded into data centers, fiber and small cells. This brings to mind companies like AMT, which bought CoreSite and entered the data center edge space, and Crown Castle, which has an extensive fiber network and small cells for his 5G transmission.

And in contrast to Switch, which was an IT company, all of these companies are real estate companies that, in the words of DataBridge CEO Marc Ganzi about 11 months ago, perform better when interest rates are persistently low. Now, almost a year later, the situation is very different. The days of cheap money companies have gotten used to as the Federal Reserve raised interest rates by 75 basis points on the recent occasion and plans to continue tightening monetary policy, albeit at a more moderate pace. . It is rapidly coming to an end.

In this situation, a rising interest rate environment is characterized by a higher cost of capital, and the dividend yields offered by real estate companies typically move in tandem with risk-free interest rates such as US 10-year Treasury bonds. Now that government bond yields are rising, investors expect the risk premium (the difference over government bonds) to remain the same. So, according to the table below, AMT, Equinix, and CCI are all increasing their dividend payouts.

This is not the case with DigitalBridge, which suffers from high volatility as a result. The company now rewards shareholders through his $50 million share buyback, which translates directly into higher EPS as about 2.4% of outstanding shares have been retired. However, given investors’ appetite for dividends in a rising interest rate environment, this did little to stop the downtrend. It is also a company that was previously structured as a REIT (real estate investment trust), which could also explain why the company’s stock has suffered more from volatility than its peers.

However, for those ready to look beyond dividends to invest in building, owning and operating digital real estate, an asset-light investment approach makes sense.

Description and evaluation of asset-light investment models

Today, whether by paying dividends or executing share repurchases, companies need to generate predictable FCF (free cash flow). This needs to be done without increasing debt levels, especially when the cost of capital is rising. In this regard, when compared to AMT, Equinix and Crown Castle, DBRG’s quarterly FCF has been very stable with significantly lower debt levels as shown in the dark blue graph below. . This contrasts with peers, which have increased long-term debt. I specifically chose to start charting in his 2019. That year, the company took its first steps towards becoming a major player in digital real estate infrastructure.

This feat of achieving exponential growth and delivering incremental free cash flow of 12.14% as of 2019 is attributed to its ‘asset-light investment management model’ without increasing the debt burden. According to Ernst and Young’s research, this model involves the transfer of functions (people, processes, and technology) to owners with the goal of moving from a fixed cost structure to a variable cost structure.

Going further, being asset-light proved to be a key differentiator for DigitalBridge. This has allowed the company to grow rapidly at his CAGR of 64%, outperforming digital infrastructure peers such as Digital Realty Trust (DLR) and SBA Communications (SBAC) as shown. in the figure below.

Comparing the above six companies’ ratings in the table below, we can draw two main conclusions.

First, DigitalBridge’s higher price for multiple book reservations compared to Digital Reality is justified given the former’s higher AUM. Second, DigitalBridge’s low price versus cash flow is not normal. Especially when compared to AMT, whose quarterly free cash flow has declined by more than 50% over the last three years, as shown in the chart above. Adjusting the price/cash flow multiple moderately and considering it as 10x (but 1/3 of AMT) gives us a target of $16.4 (10/7.43 x 12.2) based on the current stock price . $12.20.

Conclusion

After the stock price crashed in such a way, it is not surprising that the valuation fell despite the company showing some excellent financial metrics. seemingly unaware of asset-light investment models that excel at generating

Investors, on the other hand, seem to be focusing on dividends. While management is focused on “returning profits to shareholders,” the company is also profitable as it has been operating at a loss for the past four quarters. Therefore, in an environment of rising interest rates, volatility should persist and investors should continue to focus on value strategies.

Finally, if you’re looking to invest in digital real estate through stocks that can increase its value (“AUM”) in an unconventional and exponential way, but don’t recognize REIT-style dividends, choose DigitalBridge. recommended. And while switch-led growth should see the stock skyrocket when Q4 results are announced in February, volatility will dominate in the meantime.