US Digital Core REIT- Worst Maybe Over With Unraveling of Stalking Horse Bid by 16 July 2023.

The worst maybe over for Digital Core REIT ("DCR") with regard to the default risk from their 2nd largest tenant, Cyxtera, which is under chapter 11 bankruptcy proceedings. US Media has reported that 37 parties had expressed their keen interest in taking over some or all of Cyxtera's assets- out of these, 6 entities have submitted their non-binding Letter of Intent. Moreover, DCR management has stopped their daily Share Buy Back as at 27 June 2023 and the market price of DCR has been surprisingly resilient at US$0.470 to US$0.480 per unit range for the past few trading days in early July 2023. 

1. Cyxtera Expected to Reject Two Data Centres in Amsterdam and Moses to Save US$114Mil

The rather intriguing US Chapter 11 process allows DCR to reject any ongoing contract or unexpired lease with court approval which are underutilised. DCR is widely expected to be rejecting the above data centres to save operating expenses of US$114Mil. To address the elephant in the room, these 2 as aforesaid data centres do not belong to DCR. 

2. Revelation of Stalking Horse Bid by 16 July 2023

A stalking horse bid is an initial bid on the assets of a bankrupt company. The bankrupt company will choose an entity from a pool of bidders who will make the first bid on the firm’s remaining assets. The stalking horse sets the low-end bidding bar so that other bidders can’t underbid the purchase price.

Cyxtera is expected to reveal their chosen stalking horse by 16 July 2023. This should accelerate the recapitalisation and restructuring of the business with a new business owner. Personally, I thought that the probability of the 2nd largest tenant of DCR defaulting on their rental payment has just gone down significantly.

3. Bad Point In That the Market Rental Rate Is Higher Than What Cyxtera is Paying to DCR

If Cyxtera survives the chapter 11 restructuring, this may not be necessary good for DCR. It has been reported that the market rental rate at these properties occupied by Cyxtera is way higher than what they are currently contracted. DCR would have missed out on the opportunity to market out the space to get higher rental reversion as well as to reduce concentration risk of a major tenant.

Parting Thoughts

I have re-allocated my capital with additional S$12K invested into DCR this week as I think that its bearish unit price has bottomed out and I think that many investors on the sideline will re-rate DCR upon confirmation that the bidders for the assets of Cyxtera are real (and not a fragment of one's imagination) on 16 July 2023. Anyway, investment is all about managing the risk & reward and I maybe wrong- DCR may turn into a value trap as disgruntled investors demand a huge risk premium to cushion against future similar "mishap" which has been happening rather frequently since DCR's IPO debut. 

(Note: It is interesting that DBS analyst is extremely optimistic on DCR and has a price target of US$0.90 per unit as at 23 June 2023.)