NextDC: Building A Generative AI Future 

This story features NEXTDC LIMITED, and other companies. For more info SHARE ANALYSIS: NXT

Valuing a major infrastructure developer and operator with a growth tilt to generative artificial intelligence has caused some speed, or value humps for investors. What matters when it comes to assessing the case for a burgeoning data centre behemoth.

-Breaking down the NextDC business model
-Why dividends and PE ratios don’t matter
-Demand versus supply
-Laying foundations for growth

By Danielle Ecuyer

What is the NextDC business model?

Around 2017 I attended an investor presentation by FNArena’s editor where an audience member raised a question along the lines of ‘how could anyone buy NextDC ((NXT))?’ on the grounds the stock was loss-making, expensive and shareholders don’t receive a dividend.

At the time, NextDC’s share price traded between three to four dollars, compared to current levels around $16.50 and a recent high of over $18.

Many investors have stumbled over the question of how to value NextDC and what are the driving factors behind the company’s performance, when traditional valuation metrics don’t cut the mustard. 

Equally, unlike capital light software and software-as-service models, NextDC’s raison d’etre is based around, as Macquarie formulates it, “build it and they will come”.

‘It’ being the infrastructure – data centres and ‘they’ are the customers – enterprises, hyperscalers, and information/communication telecommunication companies (ICT).

Wilsons describes NextDC as the builder, operator of independent co-location facilities, which supply power, cooling, security and IT systems to support cloud infrastructure. Earnings revenue is generated from rental on racks and cages located inside the data centres with long term contracts – anything from five years up to 10-15 years for hyperscale customers.

Unlike REITs which depict asset capacity in terms of metres squared, the capacity of NextDC’s portfolio of assets is defined by power in terms of Megawatts (MWs).

In the latest research update from Wilsons, the broker sliced up NextDC into five categories to simplify the business for investors, as follows:

–Total power planned: total planned power across the entire data centre portfolio

–Contracted utilisation: the amount of power that NextDC’s customers have agreed to use over time, usually next 5 years, but hyperscalers like Microsoft work on 10-15-year contracts

–Built capacity: the amount of power currently available to use in its data centres

–Billing capacity: amount of power currently being used by customers and charged for

–Forward order book: the difference between what customers have agreed over time (contracted utilisation) less what are already paying for (billing utilisation)

The definitions are applied to the company’s business model to add further clarity and context about what is important for investors to focus on.

-Post the FY24 results contracted utilisation stood at 173MWs which is around two times greater than the 86MWs being billed to customers.

-Contracted capacity (173MWs) is above the existing total built capacity of 165MWs.

These observations highlight NextDC has contracted demand which will underwrite a doubling of revenue over time and more capacity needs to be built to fulfill the contracts.

In other observations, Wilson’s points to the ongoing investment spend which allows NextDC to showcase future capacity to customers, particularly for what the analyst refers to as non-linear demand in AI related capacity and services (AI factories).

-NextDC’s capital expenditure rose 54% or $700m for FY24 and is forecast to rise a similar amount in FY25 to around $2bn ($1bn in each fiscal year) against a combined spend of $1.3bn for FY22/FY23.

-Wilsons expect the company’s forward order book to grow 87MWs in 2024 and to 106MWs in FY27, inferring a faster forward order book requires more investment as the gap between contracted and billed capacity declines.

For NextDC it is all about lowering costs and building out the infrastructure with the optimisation of hardware and software for customer needs.

NextDC’s case study at FY24 earnings

In its FY24 results presentation, the company offered the Victoria model as a case study. 

Starting in 1H13, M1 went live, generating $14.5m in revenue with an EBITDA margin of 48% in FY14. 

By FY16, M2 acquired a 40MW site at which point M1 was generating $38.9m in revenue with a 79% EBITDA margin. 

M2 went live in FY18, and land was added to 60MW in FY20. 

In FY21, M3 saw 150MW acquired land and M2 land was increased to 100MW in FY22 and to 120MW in FY24. 

By FY23 when M3 went live, the facilities were generating revenue of $96m and $105.2m in FY24 with an 88% EBITDA margin.

Layering a similar development model across the company’s nine Australian state facilities as well as expansion into NZ, Malaysia and Japan, reveals the build out in infrastructure and accompanying growth in revenues.

The future strategic moves for NextDC

Currently NextDC has 1500 enterprise relationships, Morgans notes, with the broker forecasting the Australian data centre industry to grow from the current 1000MW capacity to 1500MWs by 2030.

While management envisages a long growth runway for enterprises with 70% still on premise, the recently announced certified partnership in the Nvidia DGX-Ready Data Centre program will enable NextDC to support advanced AI infrastructure.

The in-house business model has been reconfigured into the establishment of separate divisions for enterprise, hyperscale and international.

Macquarie observes the partnership with Nvidia and the supply of its GB200 chips in AI factories will increase output for the same power input, compared to Nvidia H100 chips currently used.

NextDC is reported by the broker as employing a new strategy to reduce capex for MW which will in turn enhance the opportunity to secure large hyperscale contracts. Management flagged advanced discussions in over 100MW contract opportunities at the FY24 results.

According to Morgans, the negotiations can take years but the analyst expects some news in the next 12-18 months.

As described in the earnings report case study, M2 Part 3 is a hyperscale site at 120MWs.

Macquarie also assessed in the latest results a structural shift in how NextDC is managing two key areas. As a non-core business activity, physical security is being outsourced, while the data centre legacy IT management OneDC system is moving to cloud based on demand IT systems. The transfer turns a capital cost into an operating cost and leverages third-party software.

Morgans believes these changes are part of managements aim to transition and scale the business while also meeting domestic compliance requirements.

The shift in reporting to net revenue per MW is also believed to be a major positive by the analyst at Macquarie. This metric increases insights into profitability and underlying trends of the business. In other words, the metric wraps a structure around profitability of capacity.

Looking through the updated development spend, Macquarie asserts additional site acquisitions might be likely, particularly with the potential for utilities to implement power restrictions. While land banking costs money and depresses margins in the short term, the broker emphasises the near-term hiccup to earnings “pales into insignificance” compared to the alternative of not securing sites for growth.

Shareholders are now well acquainted with the “drill” the analyst highlights, referring to the potential for a rights issue, even though the company recently bagged $1.32bn in a 1-for-6 issue at $15.40. Since 2020 the company has raised $2bn from shareholders.

While brokers have been cutting earnings forecasts to account for the increased ramp up in development spending, most present a united front on what drives share price performance.

Macquarie states it is contract wins and the “incremental capex dollars spent relative to the weighted average cost of capital.”

NextDC is a valued using a discounted cash flow model, not a price to earnings or even price to sales model. 

Morgans describes the company as “laying the foundations for platform growth” and Wilsons “FY25 & FY26 the ‘Dig’, FY27 ‘the Spike’ “ referring to cashflow and earnings generation.

Macquarie is almost poetic “The Field of Dreams: Build it and they will come”

The FNArena daily monitored brokers have an average price of $19.975, all Buy equivalents with Macquarie the highest at $21.20. Not part of this group, Wilsons is Overweight with an $18.50 target.

As this wraps, Blackstone was announced as the successful bidder for AirTrunk from a private consortium including Macquarie Asset Management ((MQG)) for $23.5bn with 1000MWs across 11 data centres in Australia, Hong Kong, Japan, Malaysia and Singapore.

For more information on Next DC check out the recent article:

https://fnarena.com/index.php/2024/03/06/nextdc-and-the-ai-boom/

Find out why FNArena subscribers like the service so much: “Your Feedback (Thank You)” – Warning this story contains unashamedly positive feedback on the service provided.

FNArena is proud about its track record and past achievements: Ten Years On

Click to view our Glossary of Financial Terms