Why NextDC never suited Coolabah's portfolios

Since 2014, NextDC has tapped public debt markets seven times. Coolabah Capital Investments has not participated in any of those deals, which have been popular in Aussie credit markets. This week’s guidance downgrade, and the brutal repricing of the data centre operator’s bonds that followed, illustrates why.

This is not a verdict on the quality of NextDC’s assets or on long-run demand for compute. It is a judgment about what belongs in a high-grade, daily liquidity fixed-income portfolio.

What happened

On 19 October, NextDC entered a trading halt pending an assessment of power supply delays at its M3 site in Melbourne’s inner west. Two days later it slashed FY27 guidance after Jemena, the distributor that supplies M3, suspended parts of the 66kV network augmentation works needed to lift grid capacity.

Jemena cited safety concerns, community opposition, restricted access to work sites and the absence of local council consent. It does not expect to restart before February 2027, so the next increase in supply now lands in FY28. The Victorian government’s planning decision on M3 Stages 6 and 7 will not come until after the 28 November state election.

NextDC removed the affected contracts from guidance, stripping roughly $140 million from both net revenue and underlying EBITDA. Revenue guidance fell from $615 million to $640 million to a range of $475 million to $500 million.

EBITDA guidance dropped from $385 million to $410 million to between $245 million and $265 million, a 36 per cent cut at the midpoint, with service-level credits a further downside risk. While revised FY27 net revenue guidance of $475 million to $500 million still implies growth of 17 to 23 per cent over FY26, EBITDA is expected to remain broadly flat, highlighting the earnings impact of delayed capacity delivery. Capital expenditure guidance was trimmed by $750 million to $4.5 billion to $5 billion, and uncontracted projects and land acquisitions were paused. The shares plunged almost 42 per cent in a day.

The bonds

NextDC’s $750 million unrated, unsecured subordinated notes, issued in April at 350 basis points over the bank bill swap rate (BBSW) and maturing in April 2030, had been changing hands at $102. They sank as low as $92 and Bloomberg now shows them near $94.50. In credit spread terms, the margin above BBSW has gapped out from about 285 basis points to roughly 625 basis points at the trough, and sits around 535 basis points today. That is a near doubling of the risk premium on a four-year instrument in a matter of days.

The convertible is uglier. In September NextDC sold $1.1 billion of 1.75 per cent subordinated convertible notes maturing in September 2031, with a conversion price of $16.70, a 32.5 per cent premium to the $12.60 reference share price. They settled on 17 September.

Barely five weeks later they are quoted near $70.80, a paper loss of about 29 per cent of face value for anyone who bought at issue, including a drop of around 17 per cent on the day of the downgrade alone.

With the shares at $5.75, barely a third of the conversion price, the equity option is so far out of the money that these securities now trade as what they really are: deeply subordinated, unrated corporate debt. At current prices they imply a yield of roughly 14 per cent to the investor put in September 2029. Not a single dollar of default has occurred. This is purely mark-to-market pain, and it is exactly the kind a daily liquid fund cannot normally absorb.

Illiquidity

NextDC reported $8.675 billion of liquidity at 30 September, comprising $1.275 billion of cash and $7.4 billion of undrawn debt and hybrid facilities. The company itself cautioned that its ability to draw all $6.7 billion of undrawn senior facilities while staying covenant-compliant would depend on drawdown timing and future customer billing profiles. Headline liquidity that hinges on power arriving on schedule is a very different animal to cash in the bank.

Management expects to pass the December covenant test. But the interest cover covenant excludes subordinated and hybrid interest, and permits the inclusion of prospective EBITDA from contracted capacity expected to start billing within 24 months. Both features can flatter current debt-servicing capacity. Even Macquarie, which retains an outperform rating, puts interest cover at only 1.67 times in its bear case, against a 1.5 times covenant floor.

Senior lenders, with priority over assets and cash flows, are well placed. Subordinated, convertible and hybrid holders, whose interest is ignored by the covenant, sit behind them and wear the consequences of delayed cash flows, rising leverage and refinancing pressure. Land sales and a potential joint venture over the S4 Sydney site offer some flexibility, but they are options, not certainties.

Other risks

Revenue has grown impressively over the last decade. Operating costs have grown broadly in lockstep. NextDC reported a statutory pre-tax profit of $28 million in FY26, but that included a $128.8 million non-cash fair-value gain on investment property. Strip it out and the business lost about $101 million before tax.

Gross debt almost tripled in FY26 to $3.3 billion, taking gross leverage to 13.2 times and net leverage to 9.6 times. Those multiples were struck before this week’s EBITDA downgrade. NextDC carries no public credit rating, and its leverage and thin underlying profitability point to a sub-investment-grade profile. Some $7 billion of further capex is needed to deliver the forward order book, and the funding mix is shifting towards costlier subordinated and hybrid capital.

Universe restrictions

Coolabah’s portfolios are typically A to AA rated and daily liquid. We focus on assets that carry strong liquidity and credit profiles, and we hedge out interest rate and currency risk. To enter our universe, an issuer generally should be either government guaranteed, or a monopoly or oligopoly that is too big to fail, with no or negligible risk of default or a gap event.

NextDC fails several of these tests. The first is default risk. A single-site delay caused by a third party’s power lines just removed more than a third of a year’s EBITDA guidance. A business that exposed to events outside its control, running double-digit leverage, cannot be described as carrying negligible default or gap risk. We are maniacally focused on avoiding precisely that exposure.

The second, and equally important, is liquidity. We have never regarded NextDC’s bonds as particularly liquid, or as belonging in a daily liquidity fixed-income portfolio. These are modestly sized, unrated issues: $750 million of subordinated notes and $1.1 billion of convertibles, the latter listed on a Vienna multilateral trading facility rather than the ASX. When the news turns, dealer balance sheets shrink, bid-ask spreads explode and prices gap.

Our liquidity requirement has to hold in all market conditions, not just benign ones. The absence of a rating is, on its own, enough to exclude these bonds from most Coolabah portfolios.

Sector-wide concerns

Many of these vulnerabilities are shared across data centre operators. Customer bases are often concentrated among a handful of hyperscalers, whose bargaining power, shifting capex plans and ability to build in-house create pricing, renewal and utilisation risk. Projects face construction delays, cost overruns, equipment shortages and slow grid connections. Rapid capacity growth could eventually outstrip demand, while advances in chip density demand constant reinvestment in power and cooling. Operators are exposed to outages, cyber incidents and physical damage, as well as electricity and water constraints whose costs cannot always be passed on. Planning restrictions and community opposition can stall or kill expansion.

M3 is a textbook case. The constraint did not arise from NextDC’s own construction programme. It came from local resistance and approval delays affecting someone else’s infrastructure, a risk no amount of operational excellence can fully control.

Outlook

NextDC is working with Jemena and its customer on alternatives, including squeezing more power through existing connections and alternative network routes, and will update the market at its AGM on 20 November. Demand for capacity remains robust, and some equity analysts point to the stock’s valuation relative to book and its sizeable contracted pipeline. Shareholders may well be rewarded from here.

Bondholders face a starker asymmetry. Their upside is capped at par plus coupons. Their downside, when leverage, funding constraints and execution delays collide, can be substantial, and in a daily liquid fund it arrives immediately, in the unit price. That is a trade we have declined seven times.