NextDC Needs New Major Customers

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Data centre builder and operator NextDC did not add any major customers during the second half of FY18, which has triggered concerns from several brokers.

-Revenue in FY18 robust and ahead of most estimates except for cash flow
-Management emphasises demand growth is not linear but substantial
-Large contracts across the Sydney, Melbourne markets required for brokers to be more confident
 

By Eva Brocklehurst

NextDC ((NXT)) has troubled and puzzled brokers because of the addition of only 1MW in contracted acquisitions in the second half of FY18, amid the absence of major contract announcements. UBS poses the question: are tenders still live, or have they been won by others?

All metrics were strong in FY18 except operating cash flow, although this has now been addressed via the company's billing system. Revenue was up 38% and ahead of most estimates while underlying operating earnings (EBITDA) of $62.6m was up 28%.

Morgan Stanley reiterates an Overweight rating and liked the result, as it reinforces views around the structural support in the industry and the strengthening of co-location networks. The main positives include contracted utilisation, up 28%, and customer gains, up 26%.

The broker also points to the fact that capital expenditure is notoriously lumpy. Capital expenditure is expected to be materially higher in FY19 as the company brings forward some capacity because of increased customer demand. Still, UBS requires further assurance of the value of expenditure on this front.

Morgans expects a strong FY19, because of the $500m in capital expenditure which is being deployed. The company will upgrade the existing footprint and a key plank of the strategy is the ability to offer dual zones of capacity, such as M2 and M3 and/or S2 and S3.

Morgans does not doubt that customer demand is strong and accelerating, particularly at the larger end of cloud service providers, but believes, from an equity investor perspective, this is already factored into the share price. A failure of this growth to materialise represents downside risk to the share price.

Deutsche Bank does not believe the company is capturing the acceleration in data centre demand alluded to by management. The broker continues to envisage elevated risks in the deteriorating cash flow, increased exposure to hyperscale pricing and elevated levels of capital expenditure.

The stock requires patient investors, Citi asserts. The broker does not side with those that argue the company is finding it difficult to obtain sales traction because of the lack of contracted utilisation growth.

The company has provided qualitative indications of demand and has signalled that growth will not be linear although demand for high-quality centres has been growing quickly. Sydney's first centre took more than 2.5 years to build but it is expected to only take one year to build the second. This is what makes Citi excited about the growth trajectory.

Citi points out the second Sydney centre (S2), due to open in the first half of FY19, will have 8MW of additional capacity brought forward and this is a leading indicator of considerable demand. Still, the broker agrees significantly more customers need to be obtained to fill this facilities in the similar timeframe to the previous roll-out in order to create the next leg of share price growth.

But Where Are The Contracts?

Management has indicated substantial demand and brokers believe winning hyper-scale contracts will be critical to fill the substantial upgrade of the footprint in a healthy timeframe. Morgans asserts that substantially more customers are needed to fill Sydney and Melbourne facilities in a similar timeframe to the previous roll-out, to create the next leg of share price growth.

CLSA blames complexity in negotiating with large cloud providers for the lack of major contracts in the second half. NextDC is differentiated from competitors in that it has good locations and an ecosystem that allows for a premium in an otherwise commoditised market. The broker, not one of the eight monitored daily on the FNArena database, has a Buy rating and $8.73 target.

The lack of a major contract win was the major surprise for Macquarie but the company is considered well-positioned to capitalise on the high demand for data centre capacity. Still, until a major contract is announced the stock is expected to be subject to nervousness, particularly given bullish commentary at the capital raising in April.

Macquarie needs more contracts across the key Sydney and Melbourne markets to become more positive on the stock. The broker considers the rate of customer acquisition from the enterprise segment was solid, although there were no large-scale deals and also emphasises a need for hyper-scale and channel sales to accelerate materially to fill the second and third generation facilities in under 10 years.

FNArena's database shows four Buy ratings, two Hold and one Sell (Deutsche Bank). The consensus target is $7.89, suggesting 14.3% upside to the last share price. Targets range from $6.30 (Deutsche Bank) to $9.20 (Morgan Stanley).

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