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TheStreet Open House

I'm Trusting Management and Buying Digital Realty on the Weakness

NEW YORK (TheStreet) -- Digital Realty (DLR) saw Funds From Operations (or FFO) come in at $147.4 million ($1.10 per share), down slightly from $148.9 million ($1.13 per share) in the year-ago quarter. The company said the third-quarter results included a non-cash, straight-line rent expense adjustment of 7 cents per share related to the company's leasehold interest at 111 Eighth Ave. in New York City.

This onetime adjustment was related to accounting for a ground lease and Digital states that the change (in accounting) should have been made at the time of a lease extension in fall 2010 (three years ago). Effectively, the straight-line adjustment should have resulted in greater accounting charges for the past three years.

Clearly, Digital was transparent by admitting the mistake. However, the impact to credibility hit the shares hard as this is not the first time that Digital has gotten clobbered by an earnings miss. More important than the severity of the earnings hiccup is the shattering of investors' erstwhile growth dreams -- the more enticing the dream reflected by the lower valuation (P/FFO) ... the larger the disappointment the greater the wake-up call.

But considering the earnings miss this week, should Digital Realty still be a Buy? The volatility has rocked the boat and the big question is will Digital return to the glory days when the "first mover" in data storage held a glamorous lead noted for robust tenant demand, low supply, and compelling capital allocation. We all know that Digital enjoyed a virtuous cycle of strong earnings performance and total returns with an enviable dividend record:

I will be the first to tell you that I'm very frustrated with the earnings miss and the latest accounting mess. If it weren't for the fact that Digital recently invested in a very sharp and highly skilled IR executive (John Stewart), I would be moving on to bigger and better opportunities. However, my continued optimism is based on positive documented developments, like improved leasing volume and strong development demand.

Stewart has only been at Digital for a few weeks and I believe that he will be able to enhance the company's visibility and credibility in capital markets. Enhanced credibility of managers as straight shooters is a key position and I believe that building trust will be a major issue that will play a significant role in moving Digital's stock price. It stands to reason that profitable companies with higher market values can better afford advanced IR functions -- I just wish Stewart had been there a year ago.

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