Brokers Welcome NextDC’s New Expansion Phase

This story features NEXTDC LIMITED. For more info SHARE ANALYSIS: NXT

-Value in the longer term
-Competitive advantage
-Morgans cites positive research
 

By Eva Brocklehurst

Systems integrator and data centre provider NextDC ((NXT)) is on the threshold of building two new data centres in Melbourne and Brisbane. The company has finalised $220m in funding via $100m in unsecured notes, $70m in a rights issue and $50m in an institutional placement.

The initial investment phase in the projects will include obtaining land, building the centres and 3MW of installed capacity. Both centres should be commissioned in FY17. Management has confirmed its FY16 guidance at the announcement, with earnings of $25-28m and capex of $115-135m expected.

Obviously the large up-front investment and initial losses are not overly appealing, UBS acknowledges, but this is only from a short-term perspective. The broker believes investors should focus on the merits of the centres over the life of the investment. The net impact in the short term is a reduction in the broker's earnings per share forecast of 149% in FY16, 46% in FY17 and 24% in FY18. Still, UBS believes value is added over a longer-term analysis.

UBS estimates total costs, including building and fit-out, will be $432-457m. Longer term, the broker estimates that, under active 90% utilisation, the two centres will generate a combined $126m in earnings, with a blended margin of 75.5%.

The broker incorporates the two centres and the funding into its models. Assuming a 25-year life and no residual value UBS estimates a project internal rate of return of 13.8%, well in excess of estimated cost of capital. Allowing for the value of land and 40% replacement fit-out costs the return increases to 14.2%.

What this means, UBS maintains, is that the two centres create shareholder value and strengthen the company's competitive advantage. Hence, the broker has a Buy rating on the stock with a price target of $3.25, based on a 25-year valuation.

Ord Minnett, not one of the brokers monitored daily on the FNArena database, also believes near-term capex appears covered, although details such as location and possible anchor tenants have not been revealed. There is a change in strategy, the broker notes, with the company citing a benefit in owning the land and buildings, potentially lowering funding costs but with a trade off in terms of higher capital intensity and lower returns.

The broker notes the risk profile reverts back to the company's build and ramp phase but the scale of the proposed facilities are substantial compared with previously. Ord Minnett also suspects NextDC is signalling an intention to increasingly sell white space, which, given its lumpy nature, makes forecasting the ramp-up profile more challenging.

The broker is a strong supporter of cloud computing, and the company's Microsoft leverage, but is not particularly attracted to NextDC's free cash flow profile, which does not, on Ord Minnett's calculations, turn positive until FY20. Still, the broker upgrades to Hold from Lighten, given near-term capex is funded and there is modest upside to the target, revised to $2.80 from $2.33.

Citi is not troubled by another large capital raising and considers the prospect of the new data centres as an evolutionary step, positioning the company well for the years ahead as the leader in this industry.

Morgans, while not yet commenting on this particular announcement, conducted some research a month ago, given data centres are a relatively new asset class in Australia. The research was positive in that the financial metrics and reward were revealed to be even more positive than previously thought. Hence, Morgans believes the next build is a highly attractive proposition and the shares are undervalued.

FNArena's database has three Buy ratings for NextDC. The consensus target is $3.24, suggesting 40.7% upside to the last share price.
 

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