Company Overview - NEXTDC Limited (NEXTDC) is engaged in the development and operation of independent data centres in Australia. As a provider of Data-Centre-as-a-Service, it is focused on helping its customers efficiently manage their information technology (IT) infrastructure stored in its data centres. Through its data centre management portal, ONEDC, one can manage entire service with it, across multiple data centre facilities, in real-time, from any Web-enabled device. It is also available as an app for iPhone. ONEDC provides real-time information about each rack, including current power consumption against allocation; balance of power drawing against A and B feeds; rack temperature, and log of access history, including person, date and time. In December 2013, NEXTDC announced that the solar array on its M1 data center in Port Melbourne is operational.
 
Analysis – There is high demand for data centre capacity, due to exponential growth in internet traffic, data consumption and storage driven by cloud computing and the trend towards outsourcing. We believe there are first mover advantage benefits for NEXTDC in developing a national footprint and establishing broad relationships with telco carriers and system integrators in order to generate an ecosystem that allows for maximum interconnections with customers.


Red Room at NEXTDC's S1 Sydney Data Centre (Source - company Reports)

The high demand for data centre capacity has seen a number of scaled developers and operators of data centres with similar product offerings in competition with NEXTDC. The focus on Sydney and Melbourne has seen international players (Equinix, Fujitsu, Global Switch) and local players (Metronode and MacTel) open in recent years. NEXTDC’s national footprint is a key differentiator. NEXTDC’s data centre utilization rates (as % of total capacity) sits at 31%. The company’s largest facility, M1 has achieved 50% contracted utilization and the new S1 facility sits at 30% following the signing of a significant white space deal.  While NEXTDC does not own the land or building, initial rollout and fit out of sites is capital intensive with the supply of 1MW of IT load (power) to a data centre requiring an average investment of $8 -$10 million.


NEXTDC's Sydney Data Centre (Source - Company Reports)

Based on U.S colocation data centre peer experience (such as Equinix), mature data centres generate very strong cash flow and high operating margins as the initial capital requirements reduce. NEXTDC is now, to a large extent, reliant on new national agreements to build confidence that support further expansion. Although signing new agreements is naturally a slow process, new channel partner agreements should provide a meaningful catalyst in the near term. There is an increasing trend to outsource data centres driven by requirements for higher levels of data security, redundancy and disaster recovery, falling cost of data transit and increased focus on power, usage and cooling requirements. Now that all of NECXTDC’s data centres are fully operational it will be the only company able to offer its customers a truly national carrier-neutral and vendor neutral “next generation” data center footprint in each of Australia’s major cities.


Secure Access with biometric fingerprint reading at NEXTDC's M1 Melbourne Data Centre (Source - Company Reports)

There is strong demand for carrier neutral data centres in Australia such as NEXTDC’s as they may house the equipment of many different telco carrier and IT software/hardware providers (referred to as colocation), enabling customers to cross connect to multiple networks of their choosing and exchange traffic with each other. This should result in reduced network costs and improved performance and service levels. NEXTDC has already signed Master Service Agreements (MSAs) with major internet service providers and telcos ( such as Telstra, Optus, AAPT, NextGen, iiNet, M2, Amcom and Vocus). Channel partnership relationships (such as Telstra) offer another sales avenue to enterprise, government and business customers.


Rooftop Solar Energy at M1 (Source - Company Reports)

Data centres require substantial amounts of power and supply must be consistent to avoid any impacts from local fluctuations and network issues. This means data centres need to be located close to a substation with adequate capacity available for future requirements and connected to it at a high voltage level. Locations must also have access to multiple fibre networks and network operators to ensure that connectivity is robust and competitively priced. The significant upfront capital investment required and long lead times to achieve profitability also provide a barrier to entry. Revenue tends to be sticks once secured, based on other data centre peer experiences to date, given the high customer relocation costs, the need to minimize business disruption and contract terms also works to reduce customer churn.


DRUPS at M1 Melbourne Data Centre (Source - Company Reports)

The main risks associated with this kind of business are: 1) Competitive Risk – There are a number of scaled developers and operators of data centres with similar product offerings in competition with NEXTDC. 2) Access to funding and Capital expenditure – The initial rollout is extremely capital intensive and ongoing growth is dependent on the acquisition and development of new data centres and purchase of new equipment. 3) Capacity Utilization Risk – The business model relies on gradual take up of space in data centres to generate return on capital. 4) Management Risk – NEXTDC is a newly established company with a short operational track record. The company is reliant on its key management personnel for delivery of earnings. 5) Planning/Development/Construction Risk – There may be un expected delays in opening new data centres and increased costs which impact on the company’s profitability. 6) Risk of Data Centre Failure – The company is exposed to risks of technology failure or security breaches which would impact demand for its services. 7) Utilities Risk – NEXTDC is reliant on a continuous and stable supply of utilities to its data centres.


NXT Daily Chart (Source - Company Reports)

NEXTDC develops and operates large carrier and systems integrator Neutral Data Centre facilities. It focuses on delivering secure, scalable and energy efficient facilities to house the IT infrastructure of medium to large corporations.  The company has worked to construct and develop five colocation data centres over the past 2 years. NEXTDC’s initial business model on listing the company in 2010 included owning the land and building of its data centre sites. However to free up capital the company recently moved to establish separate entity to own and manage the property investments on its behalf. In January 2013, Asia Pacific Data Centre (APDC), a data centre real estate investment trust (REIT) was established and listed on ASX. APDC independently owns and internally manages properties (land and buildings) that are operated or being developed as data centres. On listing, APDC contracted to acquire three of NEXTDC’s data centre properties (M1, S1 and P1) and NEXTDC became APDC’s largest initial shareholder with a holding of 23%. NEXTDC recognized $24.4m of data centre development revenue in FY13, after development costs of $18.2m which in resulted in a profit for the S1 and P1 buildings of $6.2m based on the proportion of P1 that was complete at 30 June 2013. In 1H14 $15.5m was recognized in respect to base building development revenue of P1 on $10.5m development expenditure. Overall P1 delivered total revenue of $23.8m on a total project cost of $16.7m. The property leases have 15 year terms with additional option periods totalling 25 years.

Fitting out a data centre is extremely capital intensive and requires significant expertise in design and project management. It can require more than twice the amount of investment compared to the combined value of land and building. As a result of significant customer signings in recent times, NEXTDC revealed plans to accelerate its data centre fit out for M1 Hall 4+5 and S1 Hall 2 as well as completing initial capacity at P1. Capex in FY 15 will be dependent on the demand profile of existing facilities and utilization  rates. Based on our expectations we believe it is likely that existing facilities will continue to expand towards their full MW capacity. In FY 15 we estimate a further $60m will be allocated towards expanding an additional 6 MW of capacity.

NEXTDC recapitalized its balance sheet in 1H14. Initiatives announced include: 1) In July 2013 announced the sale of its 26.45m stapled securities held in APDC for $28.1M. 2) In August 2013, secured a 3 year $30m corporate debt facility with ANZ bank. 3) In August 2013, moved to raise an additional $50m in new equity through a placement of new shares to institutional investors. NEXTDC ended 1H14 in a net cash position of $46.8m.

NEXTDC typically contracts with its customers under a Master Service Agreement (MSA) charging by a measure of space (per square metre, rack half rack, pod , cage or suite) and or a measure of power. Power usage costs are either fixed and included in the overall charge or passed directly through to the customer, subject to substantial escalations of price or volume of power consumed. Data centre pricing is influenced by factors including but not limited to geographic location, quality of facility, proximity to dense networks and availability of infrastructure. In order to attract larger telco and ISP customers ( which will drive maximum customers cross connects ) NEXTDC also offers what are known as whitespace deals which essentially offer blank floor space with no racks  and power is char2ged separately on  a consumption basis. Typical contract terms are 3-5 years and customers pay fixed monthly charged based on the leased square metre or rack space with a CPI inflator. NEXTDC will charge its customers to interconnect with other customers in the  data centre which is a very high margin source of revenue.

The free cashflow attributes of a highly utilized data centre are robust and underpin our BUY recommendation for the group when the current network is full, offering considerable potential upside from the current share price and within a favorable demand environment for quality data centre space. NXT is continuing to make steady progress across a number of fronts. We put a BUY recommendation on the stock at current price of $1.625.
 
 
 

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