NextDC Entangled In Push On Data Centre

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Brokers are concerned that data centre operator NextDC may be distracted by the recent corporate activity that is besetting data centre owner, Asia-Pacific Data Centre.

-Strategic stake to be used to vote against 360 Capital resolution to install its own nominee
-360 Capital wants to pursue other avenues in the data centre space and distribute additional capital, raising debt levels
-Demand for data centre services seen dominated by large cloud-computing providers with substantial bargaining power
 

By Eva Brocklehurst

What is happening with Asia Pacific Data Centre ((AJD))? Brokers suspect the management of NextDC ((NXT)) may now be distracted by recent corporate activity involving AJD and 360 Capital ((TGP)).

NextDC has made a strategic investment in Asia Pacific Data Centre, to be used to vote against a resolution by 360 Capital to remove the responsible entity and install its own nominee.

NextDC believes retaining the existing structure and an independent board is in the best interests of security holders. The company acquired a 14.1% stake in Asia-Pacific Data Centre for $29m and has stated it does not intend to control the data centre, or acquire the underlying assets, but will review its strategy if required.

360 Capital requires 50.1% of the vote at the extraordinary general meeting next week to successfully remove the current responsible entity. Macquarie notes proxy advisory group ISS has told AJD investors to reject the 360 Capital proposal, citing corporate governance concerns.

Asia-Pacific Data Centre is NextDC's landlord for three data centres, Sydney, Melbourne and Perth, and 360 Capital acquired a 19.8% stake on May 2 for $36m, requesting a seat on the board which was rejected.

NextDC's reasoning regarding the acquisition will be crucial to its ability to win over the remaining eligible shareholders at the vote, Moelis contends. Should NextDC be unable to block 360 Capital's change of management and responsible entity, the next move to protect its strategic interest will be anxiously awaited, as NextDC is the sole tenant of the data centres.

In Deutsche Bank's view the strategic investment is an attempt to preserve the current landlord/tenant relationship and prevent a more aggressive entrant into the Australian data centre industry, which may compete for assets in the future.

The investment underscores a potential risk to the company's longer-dated returns profile, the broker believes, given the capital that is looking to enter the industry. Deutsche Bank envisages limited financial risk with the strategic stake and an aggressive response to a potentially less rational competitor could reduce the threat of new data centre entrants going forward.

Citi suspects the reasons behind the acquisition are to ensure that the landlord of the company's three assets is aligned with NextDC's best interests. The broker envisages limited upside from deploying this capital to acquire a non-blocking stake and does not rule out a move to acquire the underlying assets of Asia-Pacific Data Centre.

An activist external manager, were 360 Capital to be successful, raises corporate governance issues, in Macquarie's opinion. This is underscored by the stated intention of 360 Capital to distribute additional capital to security holders by increasing debt levels and pursuing other opportunities in the data centre space.

Macquarie envisages the latter could reduce the quality of the asset portfolio but believes the risk to the leases is relatively low, and any share price weakness in NextDC is a buying opportunity.

UBS notes Asia-Pacific Data Centre's board has had confidential approaches from third parties expressing interest. The board is progressing the discussions to determine whether a proposal will be put to shareholders. The broker points out that NextDC has right of first refusal over the data centres.

The initial lease agreement between NextDC and Asia Pacific Data Centre was 15 years, starting in December 2012, with two 10-year option periods followed by 15-year option period. Rent is adjusted annually for CPI and a market rent review is conducted every five years determined in agreement between the two parties.

Asia-Pacific Data Centre assets was spun out of NextDC in 2013, with the group's sole assets being the first Melbourne Sydney and Perth data centres in which NextDC is the single tenant.

FY18 Outlook

CLSA suspects, if NextDC decides to acquire the assets, that it will likely be funded by an equity raising. At present, the company has minimal debt capacity and the broker believes it unlikely it will tap the debt markets again. CLSA, not one of the eight stockbrokers monitored daily on the database, has a price target of $4.25 and downgrades the stock to Underperform from Buy.

Moelis reduces its rating to Hold with a $4.85 target. The broker, also not one of the eight, is cautious about FY18 estimates and the uncertainty regarding the acquisition of the stake.

The caution around FY18 consensus estimates stems from the potential for negative operating earnings (EBITDA) contributions from the three new centres that are ramping up, as well as higher electricity prices affecting the second half of FY18.

Moelis believes in the NextDC investment proposition over the medium term and considers the business on track to becoming a materially larger company, with excellent data centre locations and generating attractive returns on capital.

Demand for data centre services remain strong but CLSA suspects it will be dominated by hyper-scale cloud computing providers that have substantial bargaining power. The company is building three new data centres in Brisbane, Melbourne and Sydney and the broker believes these second-generation centres will now be ready later than previously anticipated.

The broker was quite discouraged by a recent visit to the Melbourne site, given the progress. Annualised revenue per megawatt is reduced by -1-2% per annum relative to the broker's previous forecasts.

While demand is not considered an issue the average revenue per megawatt of capacity is likely to come down, CLSA believes. In addition, competition is increasing with AirTrunk coming online in August/September and Equinix and Metronode both expanding existing facilities.

There are six Buy ratings on the FNArena database. The consensus target is $4.83, suggesting 15.0% upside to the last share price.
 

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