• S$960mn acquisition of 11 European data centres came four months earlier than anticipated, though below our S$1.5bn projection.
• Initial NPI yield of 6%, WALE of 4.6 years by GRI, portfolio occupancy of 97.9%. 58%/42% on triple net/colocation lease structures. 83% of leases have annual rental escalations of 1-3%.
• Acquisition deploys remaining 52.1% or S$612.5mn from S$1.2bn raised in November 2020, earmarked for this acquisition.
• Reiterate BUY. DDM TP (COE 6%) lowered from S$3.73 to S$3.64. We raise FY21e DPU by 0.3% to reflect sooner-than-expected acquisition but lower FY22-25e DPUs by 2.2-2.7% due to the smaller-than-projected portfolio size. AREIT remains our top pick in the sector for its scale and diversification.

What’s new?

Acquisition of 11 European data centres for S$960mn

Four of the assets are located in the UK, three in The Netherlands, three in France and one in Switzerland (Figure 1). Portfolio WALE is 4.6 years by GRI with high occupancy of 97.9%. About 83% of the leases have built-in annual rental escalations of 1-3%. More than half of the leases have 3% rental escalations. Some 58% are on triple net leases, while the remaining 42% are colocation assets. Valuation implies a 6% NPI yield. Cap rates of 5.6-6.5% are within the market’s 4-7%. The acquisition will be 63.8% funded by proceeds from its November 2020 fund-raising. Indicative cost of borrowing using longer-dated debt is about 2% p.a.

Nine or 93% of the assets are located in three of Europe’s four FLAP markets:  Frankfurt, London, Amsterdam and Paris. These are the four largest colocation markets in the continent. London, Amsterdam and Paris are ranked the first, third and fourth largest in Europe respectively, due to their large population centres, connectivity and infrastructure to support data-centre operations.

Demand for DC is strong, underpinned by companies embarking on digital transformation and increased cloud adoption. In 2020, take-up of 201 megawatts (MW) in colocation data centres in FLAP outstripped new supply of 174 MW. FLAP’s vacancy rate improved from 21% in 2019 to 19% in 2020, while market absorption – the number of years it would take for vacant supply to be fully let – fell from 3.0 years to 2.4. The 2021 outlook for FLAP is positive, with vacancy and market absorption expected to improve to 17% and 2.3 years respectively.

To mitigate execution risks and ensure a smooth transition while the sponsor builds up a European DC team, vendor, Digital Realty, has been engaged to provide property and facility management for 12 months to 17 March 2022. Given that most of the DCs are 10-20 years old, AREIT has also engaged two independent DC specialists to advise on marketing and capex requirements. We expect AREIT to set aside capex reserves for modernising the assets, upgrading machinery and equipment and/or repositioning and converting non-DC space to data halls.

What do we think?

We believe the acquisition will strengthen AREIT’s portfolio, by: 1) increasing its overseas diversification from 36% to 40% (Figure 2); 2) raising AREIT’s exposure to data centres from 4% to 10%; 3) increasing its proportion of freehold properties from 35.4% to 37.5%; and 4) improving its earnings visibility as a high 83% of the leases have 1-3% rental escalations. The acquisition is accretive as it is expected to lift DPUs by 1.3% on a proforma basis.

The acquisition was widely anticipated and will deploy the remaining 52.1% or S$612.5mn of equity funds out of the total S$1.2bn raised in November 2020. This portion was earmarked for its European DC acquisition. The rest of the proceeds have been used for two Class A office buildings in San Francisco and a suburban office in Sydney, Australia. These purchases were completed on 21 November 2020 and 13 January 2021 respectively.

Source: Phillip Capital Research - 23 Mar 2021