Data centers got some attention as pandemic investments last year, with people all over the world encouraged to stay home and live as much of their lives as possible online. But the longer-term growth story predates the pandemic and should last for years. And while investors haven't focused too much on COVID-19 plays in recent months, that doesn't mean those businesses have been forgotten.
One such company is data center real estate investment trust (REIT) QTS Realty Trust (QTS), which this month agreed to be taken private by private equity giant Blackstone Group (NYSE: BX). Blackstone sees a future in this segment of the market -- should you?
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Data proliferation is a long-term growth story
QTS Realty Trust owns 28 data centers, which provide data storage, connectivity, and co-location services. Blackstone has bid $78 per share for the REIT, or about $10 billion when assumed debt is included. The transaction will be subject to a QTS shareholder vote and is expected to close in the second half of 2021. But Blackstone has given QTS a "go-shop" period during which it will be permitted to solicit alternative bids. QTS will now run a sale process and see if another data REIT or a different private equity firm might want to present a better offer.
Greg Blank, senior managing director at Blackstone, described the rationale for the proposed transaction this way: "QTS aligns with one of Blackstone's highest conviction themes -- data proliferation -- and the required investment makes it well suited as a long-term holding for our perpetual capital vehicles." The fact that Blackstone is putting QTS in a perpetual capital vehicle (in other words, a fund with no maturity date) means that it views data as a long-term growth story.
Data proliferation refers to the ever-increasing amounts of data that businesses and governments are generating -- everything from customer data to communications and virtual meetings. In late 2018, market research company IDC estimated that by 2025, the collective amount of data used worldwide would increase from 33 zettabytes that year to 175 zettabytes, a compound annual growth rate of 61% (1 zettabyte is equal to 1 trillion gigabytes).
Blackstone is not overpaying for QTS Realty Trust
Blackstone's bid amounts to a little more than 28 times QTS's funds from operations (FFO) for the trailing 12 months. REIT investors tend to focus on FFO instead of net income because it is a more accurate description of this type of company's cash flow. A look at where some of QTS's competitors are trading makes it clear that Blackstone is definitely not overpaying. Data REIT giant Equinix trades around 32 times adjusted FFO per share at Wednesday's prices, while Digital Realty Trust, after a recent pullback, is trading around 27 times FFO per share. QTS has lower margins than its peers, which is why it is attractive to a private equity buyer. Private equity funds look for ways to improve corporate performance, and that is probably Blackstone's game plan here. Private equity funds have historically sought underperforming companies, taken them private, fixed them up, and then reoffered them to the public.
As a general rule, REITs tend to have high dividend yields, unless they are investing heavily in their businesses. A lower payout ratio (the annual dividend divided by FFO per share) indicates that the company expects higher growth. QTS pays an annual dividend of $2.00 per share, which gives it a payout ratio of 61%.
Will QTS find another suitor? It certainly is possible, given its FFO multiple. A competitor could top Blackstone's cash offer with a stock offer and still have the deal be accretive to its FFO per share -- even before synergies are taken into account. Usually, it's wise for investors to sell into a merger. However, in this case, it might make more sense for shareholders to stick around until the go-shop period expires in mid-July.
