A Tech Play for Grounded Investors

03/23/2012 3:38 pm EST

Focus: REITS

Jim Jubak

Founder and Editor, JubakPicks.com

This firm has exposure to all the fast-growing tech names, but in a refreshingly low-tech way, writes MoneyShow’s Jim Jubak, also of Jubak’s Picks.

In my March 16 post on investing in the technology sector—even after it has rallied so strongly at the beginning of 2012—I said don’t forget about companies that enable bigger technology trends.

To this end, I mentioned very briefly Digital Realty Trust (DLR) a company that owns a portfolio of 102 data centers in 31 markets serving clients that include Facebook, AT&T (T), and Morgan Stanley (MS). Organized as a REIT (real estate investment trust), I noted, Digital Realty pays a 3.8% dividend.

Let me dig a little further into this REIT, because I think it’s a very interesting way to get some technology exposure for even a risk-averse portfolio.

The company makes its money from leasing space in its data centers. This could be anything from a turn-key operation to build-to-suit, for operations that range from a company’s computing center, to a telecommunications network, to an Internet enterprise such as Amazon.com (AMZN) or Salesforce.com (CRM).

The bulk of its business (90%) comes from North America, but Digital Realty Trust has been building out its capacity in Europe (Dublin, Paris, and London), Singapore, and Australia.

A typical deal might start with Digital Realty buying a building from a technology company looking to lower its debt load by getting paid to convert an owned asset into a lease. Digital Realty then installs the basic infrastructure in the building, but passes on the cost of things such as fully redundant electric systems to tenants.

That helps lock in clients—the company saw a 92% retention rate in 2011. On average, tenants sign a lease for 14 years with built-in 3% increases in annual rent. Tenants also pay for maintenance, real-estate taxes, and insurance.

Even though it’s selling facility management and space to technology companies, instead of apartments or retail space, Digital Realty works like a standard REIT. The company pays out 100% of taxable income to unitholders and raises money on the public debt markets to invest in building new facilities. In other words, business is pretty good when money is cheap.

As long as, that is, demand for data center space is growing. In the company’s most recent survey of North American demand, the company found that 92% of companies responding to its survey said that they would definitely or probably expand in 2012. That’s the highest percentage in the six years that Digital Realty has sponsored this survey.

In 2011, EBITDA (earnings before interest, taxes, depreciation, and amortization) climbed to $623 million, from $512 million in 2010. That’s a 21.7% increase from 2010.

The company has raised its annual payout to $2.92 in 2012, from $2.72 in 2011 (a 7.4% increase), and from $2.02 in 2010. That’s a 4.07% yield at the March 22 close of $71.67. (Digital Realty paid its most recent quarterly dividend to shareholders of record on March 15.)

As of March 23, I’d adding units of Digital Realty Trust to Jubak’s Picks with a 12-month target price of $78 a share for Digital Realty. With the units trading on March 22 at $71.67, near their 52-week high of $73.73, that would give an investor a 9% gain—plus a 4% yield, for a 13% return in a year.

With a beta of just 1.04, suggesting that this REIT is not significantly more volatile than the stock market as a whole (the market’s beta is one by definition) that seems a solid potential return. Of course, you might do better. In 2011, the units gained 34.6%.

Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund, may or may not now own positions in any stock mentioned in this post. The fund did own shares of Polypore International as of the end of September. For a full list of the stocks in the fund as of the end of September see the fund’s portfolio here.

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