The New Criterion: the opportunities in - and pitfalls of - the data storage sector

Tim Boreham

Independent Investment Research

According to NextDC (NXT, $6.39) chief Craig Scroggie, in the next 18 months the world will create more data than that ever produced since mankind emerged from the primordial slime.

“This information explosion is forecast to accelerate exponentially as a result of further advances in cloud computing, the internet of things, 5G and artificial intelligence to name a few,” he told the company’s recent AGM.

Hani Iskander, a partner with the tech investment firm Cube Capital puts it another way: “we live in a world where nothing is deleted … I think there will never be too many data centres on planet Earth.”

Given the local cloud storage sector currently turns over more than $5 billion annually, the prospects should be rosy for the biggest home-grown shared data centre operator.

Yet NextDC is the eight-most ‘shorted’ stock on the ASX, with 12 per cent of the register punting on the shares going down rather than up (compared with 5 per cent a year ago).

In short – excuse the pun – these investors are worried about emerging competition and aren’t giving credence to the operator’s high-voltage expansion plans and the remorseless demand for ‘cloud’ data storage.

In the local market Equinix (the world’s biggest data centre operator), Digital Realty, Global Switch and Airtrunk all vie for a slice of the cyber action.

NextDC operates centres in Brisbane, Melbourne, Sydney, Perth and Canberra, with new facilities planned or being built in all but the latter.The centres are ‘vendor neutral’, which means that like shared offices any enterprise can rent space to house their servers.

The clients’ computers are housed – battery hen like – in endless rows of temperature controlled cages.

NextDC is an intriguing listed beast, combining the characteristics of a real estate play with a tech stock or an infrastructure stock.

Having previously rented its facilities, in October last year NextDC acquired the freehold for its initial Sydney, Melbourne and Perth buildings – self-explanatorily dubbed S1, M1 and P1 – for $163 million. This was done by acquiring the landlord, the listed Asia Pacific Data Centres from 360 Capital Group after a prolonged and unpleasant spat.

Data centre capacity is stated in megawatt terms rather than square metres because they use electricity at a rate that would put an alumina smelter to shame.

NextDC currently has 58 megawatts of capacity – 90 per cent utilised – and is increasing this to 146MW by rolling out the new centres at a capital cost of $430-470m. The company also has a development pipeline of 300MW –equivalent to the output of a small power station.

Despite the rosy outlook for data storage, heightened competition is expected to bite. Most notably, Singaporean group Airtrunk is building an 110MW ‘hyper scale’ centre in North Sydney, which will be open for business next year.

In the year to June 2019 NextDC recorded revenue of $179m, up 15 per cent with underlying earnings (ebitda) of $85m, up 13 per cent. The company also posted a statutory loss of $9.8m, “reflecting higher depreciation and interest costs after a record year of investment.”

Management projects $200-206m of revenue for the current year, with ebitda of $100-105m.

Even though NextDC shares have retracted around 20 per cent since peaking at $8 in June last year, the company is still valued at $2.25 billion.

As a guide to valuations, the last two local data centre transactions were done on fancy multiples: late last year Equinix acquired the local assets of the Canadian-owned Metronode for $1.3bn, a multiple of around 32 times earnings.

Early this year Brookfield bought DCI Data Centres from Blackrock on a multiple of around 20 times.

As with Afterpay – another high multiple wonder stock – NextDC is at an inflexion point as the market decides whether it’s all blue sky from here, or whether management has its head in the clouds and the ‘shorters’ are right.

5G Networks (5GN) 70c

As 5G chief Joe Demase readily acknowledges, the $50m market cap telco carrier isn’t exactly on the same scale as NextDC or Equinix.

But 5G offers what the others don’t: a seamless connection with the fibre optic cable networks and cloud services that it also installs.

5G in September paid $3.5 million for a data centre in Pyrmont, Sydney, owned by minnow Australian Pacific Data Centres (not to be confused with Asia Pacific Data Centres).

With 150 “racks” the Pyrmont centre takes 5G’s capacity to 600 racks, having acquired a Melbourne data centre in April.

The Pyrmont centre is operating at only 30 per cent capacity. But that’s enough to pay the costs, with every new customer beyond that representing incremental margin.

Demase says while plenty of parties are building data centres, there’s no hit of overcapacity because demand is growing even faster.

“We really can’t keep up with demand,” he says. “People are writing more applications, and recording more video content. 5G [the new mobile network] will only consume more.”

5G reported underlying earnings of $3.2m for the full year before acquisition costs, on an eightfold revenue increase to $51m. Depreciation and interest charges resulted in a $4.1m reported loss.

Data centres account for less than 10 per cent of 5G’s revenue, but we get the impression the business won’t be a bit player forever.

DXN Ltd (DXN) 5c

Despite its reputation for high margins, the data centre game is not as simple as building an edifice with an access to a decent power source.

After listing in April last year, Data Exchange Network (as it was then known) aspired to be the ‘next NextDC’ with plans to build facilities in Sydney, Melbourne and Perth.

But unlike NextDC or Equinix it has no plans to own the underlying property, opening the way for nimbler modular facilities.

After a bright start to its listed life, the company endured setbacks including cost blowouts and delayed planning approvals that stalled the opening of its Sydney centre at Olympic Park.

This flagship facility finally opened on September 13, with federal communication minister Paul Fletcher accorded the ribbon-cutting honours.

In the 2018-19 year the company reported a $7.3m loss on revenue of $2.78m.

DXN has also been an avid raiser of capital, tapping the market for $2.1m in a placement in December 2018 (at 15.5c a share).

It then raised $8.3m in a rights issue in March this year at 5c/sh, followed up by a $5m underwritten entitlement issue in October at 5.5c/sh – all a far cry from the 20c/sh listing price.

In February CEO Peter Christie stepped down citing personal reason and in August was replaced by Matthew Madden.

With a mere $23m market cap, DXN isn’t exactly priced as the “next NextDC”

Don’t write ‘em off: when NextDC listed in 2010 with a single leased building, the company was valued at $20m.

Meanwhile the $500m market cap Macquarie Telecom (MAQ, $22.90) is more known for business telephony, but it also operated data centres and web hosting.

The company is in the process of expanding its key facility in Sydney’s Macquarie Park from 10MW to 43MW, at a cost of $75-80m.

Tim Boreham edits The New Criterion

Disclaimer: The companies covered in this article (unless disclosed) are not current clients of Independent Investment Research (IIR). Under no circumstances have there been any inducements or like made by the company mentioned to either IIR or the author. The views here are independent and have no nexus to IIR’s core research offering. The views here are not recommendations and should not be considered as general advice in terms of stock recommendations in the ordinary sense.

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4 stocks mentioned

Tim Boreham
Tim Boreham
Editor of New Criterion
Independent Investment Research

Many readers will remember Boreham as author of the Criterion column in The Australian newspaper, for well over a decade. He also has more than three decades’ experience of business reporting across three major publications.

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