Surging Demand Sets NextDC On Course For S2

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Data centre owner operator NextDC has altered tack, bringing forward its plans to build a second Sydney data centre after a large contract win.

-Company now targeting three new data centres to be built in three cities over 12 months
-Demand surging on the back of a proliferation in devices and content storage needs
-Capex requirements high but operational risk considered limited

By Eva Brocklehurst

Data centre owner and operator NextDC ((NXT)) is being nimble, changing tack to capture the strengthening winds that are driving demand for data storage. The company was expected to deploy most of its cash balance in FY17 on the building of new data centres in Brisbane (B2) and Melbourne (M2). However, an existing international customer has purchased a further slice of the Sydney data centre (S1), pushing up contracted capacity to 82%.

This has necessitated the company bringing plans for a second Sydney centre (S2) into play. NextDC will now be developing the three facilities concurrently. The company has undertaken a capital raising to fund the investment with a $50m placement completed at $4.06 a share, and a 1-for-9.1 accelerated non renounceable entitlement offer, at $3.74 a share, to raise $100m.

The decision was sparked by a contract with a major customer for over 1.5MW capacity at S1. The company is sourcing the land, which it will own, with initial capacity envisaged at 2MW rising to 30MW, making S2 almost twice the size of S1. The cost of the land, building and first 2MW is expected to be around $140-150m.

Credit Suisse notes that while the announcement removes one uncertainty about the timing of the next Sydney centre, development risk is heightened. The company is targeting building times of 12 months but previous facilities have taken 18-24 months. There is also enhanced competition risk. NextDC will have 55MW of capacity to sell in both S2 and M2, with a newcomer potentially entering these markets. Should the new entrant proceed the broker expects pricing is likely to come under pressure.

Nevertheless, in its pre-sales announcement, the company was confident about the potential across the three new centres and Credit Suisse also notes NextDC is able to refinance $160m in senior notes every six months from December. The valuation remains attractive to the broker and, whilst a discount may be necessary given lower occupancy and a weaker capital structure, Credit Suisse believes this cautious view is overdone.

Citi envisages global industry demand in this industry is a consistent set of waves, with growth driven by the proliferation of the number of devices on which to consume data, and the vast amount of content being created both personally and professionally. The transition to the cloud, which NextDC is enabling via its co-location and carrier-neutral data centres, should continue to support the business.

FY17 is expected to show the company flexing its operating leverage across its main 42MW footprint while profitability should mature at these assets. The maintenance of M2 and B2 time frames is encouraging for the broker, as is the S2 development, notwithstanding competitor Equinix formally opened its 26MW asset on August 21.

The broker believes there is room for more than one professional data centre provider and NextDC captured sufficient demand to fully fit out the S1 centre's 14MW within three years of opening despite Equinix being up and running. In observing Equinix' operations, Citi notes that solid returns can still be generated from assets that have reached an operationally viable maximum. In Equinix's case its mature data centres were still growing revenue at over 7% and gross profit at over 8% with rent increases, uptake of inter-connection and increased power density.

Timing of the new facility means the cost base will, in the short term, step up more than revenue until utilisation reaches a tipping point from which strong returns should emanate, Morgans asserts. With the exception of B2, the broker's forecasts do not currently include any large up-front deals and this means initial costs of new centres will be worn by NextDC, but securing enough up-front customers could change the dynamics quite quickly.

Morgans observes the S2 is well funded and, while the capital intensity of building data centres is very high, there should be limited operational risk. The main risk to the share price, in the broker's view, relates to the rate of sales and whether this plateaus, slows or accelerates. Morgans reduces forecasts for the short term but upgrades these meaningfully over the longer term. A Hold rating is maintained for now but the broker recommends investors participate in the entitlement offer.

There are five Buy ratings and one Hold on FNArena's database. The consensus target is $4.60, suggesting 12.2% upside to the last share price. This compares with $4.29 ahead of the announcement. Targets range from $4.30 to $4.90.

See also, NextDC Ramping Up Developments on August 24 2016.
 

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