A small cap embedded in a multi-year growth opportunity

Roger Montgomery

Montgomery Investment Management

Macquarie Telecom (ASX:MAQ) is a data centre owner/operator with facilities in Sydney’s CBD, Macquarie Park in Sydney’s north, and Canberra. MAQ’s cloud services generated 46 per cent of the company’s revenues in FY21, while telecom services, in which it competes with Telstra, Optus, TPG and Vocus, and includes data, voice, mobile and colocation generated 47 per cent of revenues. The remaining revenue (6- 7 per cent) comes from data centre services for wholesale customers.

MAQ can safely claim to be part of a global megatrend and a multi-year growth opportunity – enterprises migrating to the cloud. Of course, ‘The Cloud’ has to live somewhere and that place is data centres.

MAQ was a first-day investment for our Montgomery Small Companies Fund and it remains a top five holding today. 

We’ve promoted the company’s story and outlined the investment opportunity since about $25 per share, and we think it is worth far more than that today. We also believe considerable upside remains from its current price of $76.

Up 40% since mid-July

The basics of the 2021 result are thus; revenue increased 7.1 per cent to $266.2 million, EBITDA rose 13 per cent to $73.8 million and NPAT (net profit after tax) at $12.5 million was 7.4 per cent lower than the year prior. Capital expenditure increased to $139.1 million compared to $64.1 million in FY20. Notably EBITDA has grown at 15.6 per cent compounded for the last three years and the company has now increased EBITDA annually for seven years.

There’s little really to be garnered however from a helicopter view of the FY21 results. Perhaps of more interest is the 40 per cent share price increase since mid-July when MAQ announced plans to significantly expand capacity at its Macquarie Park Data Centre Campus in Sydney.

It’s a journey taking sellable capacity there from approximately 6MW to 50MW of IT Load, with a huge impact on the profit potential for the group.

MAQ will deliver this huge uplift in capacity in stages, the first of which, IC3E, adds an incremental 11MW of capacity, of which 10MW was immediately sold in a mega deal by Australian standards and announced by the company in November 2020.

Normally it would take many years to fill such capacity, but this first phase expansion was almost sold out before construction had completed. Macquarie Park is prime real estate from a data centre market perspective. Only hyperscalers such as Amazon, Microsoft and Alphabet are assumed to be able to procure capacity in 10MW blocks. And they are hungry it appears for capacity in prime DC locations to fuel the rapid growth of their online and cloud empire’s here in Australia.

Additionally, MAQ has a business enabling the digitalisation of the Australian Government, and its many departments and agencies. Intellicentre 5 (IC5) – a secure facility with the highest level of security compliance - in Canberra was completed on time and on budget and officially unveiled by the Minister of Defence in June 2021. 

MAQ builds secure clouds for Government agencies, and while smaller in scale than facilities for Hyperscaler, the value add here is profound and a long term differentiator for the economics of MAQ’s DC expansion.

The DC expansion transforms the profit pool available to MAQ. For example, the recent 10MW hyperscaler sale we estimate will add roughly $25 million to the annual EBITDA run rate of the business when full billing commences in December 21/January 22. It also cements MAQ’s reputation as a quality provider capable of satisfying the demands of the big hyperscale customers, which will come in handy for phase two of the expansion of its Macquarie Park Data Centre campus in Sydney – IC Super West.

The State Significant Development of Super West adds 32 MW of IT Load to the portfolio, as well as adding an extra 1MW of sellable capacity to IC3, and it takes the Macquarie Park Data Centre Campus to 50MW IT Load over time. There is the potential for three times the profit pool of the IC3 deal, from the Super West capacity expansion.

And there’s more...

An important aspect of MAQ’s business model is that large capacity sales to hyperscalers are much lower revenue opportunities compared to, for example Cloud Services & Government’s Hybrid IT managed services, which can deliver 10 times revenue per MW compared to colocation sales. There is an economic-v-time-to-fill trade off here. The hyperscalers take huge blocks of capacity quickly, and while building private secure cloud platforms for Governments takes much longer, there’s a much higher value add, and superior unit economics per MW.

For example, if 90 per cent of a datacentre’s MW IT Load is sold at X to hyperscalers, the 10x revenue opportunity from selling the remaining 10 per cent of capacity, doubles the revenue and profit of the entire facility over time versus a hyperscale only facility. 

We think this point is less well understood by many in the market who may also see the very low trading liquidity as a hurdle to investing.

Where's the value today?

At F21 MAQ had $110 million net debt. Working roughly, if we add an assumed $700 million of capital expenditure, to complete the development of both IC3E and Super West out to 2025, and assume the company produces around $400 million of pre-capex, post tax, cash flows in that period, MAQ would have around $400 million of debt. Add that to the current market capitalisation of $1.65 billion derives an EV of $2.05 billion. Our modelling suggests the company could produce something like a run rate of $170 million of EBITDA in FY25 (a more than doubling of FY21’s $73.8 million in just four years). This puts the company on an EV/EBITDA multiple of 12x with structural growth tailwinds that we believe will produce low double-digit EBITDA growth from 2025 onwards - from that longer to fill but higher value add cloud services, cybersecurity and Hybrid IT managed services business.

And keep in mind the 30-year useful life of a data centre. The sticky highly visible annuity style income produced by full-tenanted data centre may just be of interest to an income hungry pension or super fund.

For all of these reasons, we think an equivalent EV/EBITDA multiple higher than 12 for this critical digital infrastructure is appropriate, in which case a valuation of more than $100 appears reasonable.

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Roger Montgomery
Founder and Chairman
Montgomery Investment Management

Roger Montgomery founded Montgomery Investment Management in 2010. Roger has more than three decades of experience in investing, financial markets and analysis. Roger also authored the best-selling investment book, Value.able.

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