It’s time to sell this stock

Digital Realty’s data-storage business model is moribund, consumed by the rise of cloud computing. Here's how you could short the shares, says Matthew Partridge.

One of the key developments in technology in recent years has been explosive growth in the amount of data produced worldwide. For instance, more photographs have been taken this year than during the entire history of film cameras. Similarly, an estimated 306.4 billion emails and 500 million tweets are sent every day.

While much of this digital information will go straight into the electronic equivalent of the recycling bin, a significant portion will be saved. No wonder, then, that demand for data storage has been booming. Over the past two decades, this has been good news for Digital Realty Trust (NYSE: DLR), a real-state investment trust (Reit). It builds large data centres, which it then leases to companies who want to store their data.

Big tech muscles in on Digital Realty’s business model

However, as short-seller Jim Chanos and others have pointed out, while this model has allowed Digital Realty to grow its share price nearly tenfold since it floated in 2004, the company is increasingly under threat from the rise of “cloud computing”, which allows firms to store the data over the internet in servers run by large tech companies such as Microsoft, Google and Amazon.

While these firms still need to build physical centres, the huge economies of scale associated with having the centres in one location, as well as the cash-rich tech giants’ ability to build and finance them more cheaply, represents an existential threat to Digital Realty’s business model.

There are signs that after years of growth, demand for traditional data centres is slowing, with Digital Realty starting to find it more difficult to find enough customers to fill its existing infrastructure. Occupancy rates have fallen from a peak of 93.5% in mid-2015 to 83%. Revenue, having grown by an annual 15% over the last two decades, is henceforth expected to expand by just 5%-7% a year.

Perhaps the most compelling reason to be bearish on Digital Realty, however, is that it still trades at 71 times 2023 earnings, a valuation you’d associate with a company growing much faster – not a mature one whose best years are behind it. While it still delivers a solid dividend yield of around 4.2%, this is only possible because it has been paying a dividend greater than its earnings, which is not sustainable in the long run. This relatively high payout has only been possible because the group has kept adding to its debt, an approach that is under threat from rising interest rates.

From a technical perspective, it looks as if the market has soured on the company. It has fallen by around a third from its 52-week high at the beginning of this year and is also trading well below its 50-day moving average. I therefore suggest shorting it at the current price of $118 at £20 per $1. I would cover the position at $167, giving a total downside of £980.

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