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This week’s deep dive is on NEXTDC (ASX:NXT). It is the biggest data centre stock on the ASX and the second biggest in Oceania after Equinix. It has had an unparalleled record of success in the last decade, growing its market cap from $80m to over $6bn!
But will NEXTDC’s run continue? We think there is potential, but it is by no means certain to happen and the company is no longer cheap. And we’re not just talking about the share price and multiples.
Who is NEXTDC?
NextDC was founded in 2010 by Bevan Slattery and has a portfolio of 17 data centres around Australia. Data centres are buildings hosting applications that store and share application and data. If you’ve used technology of any kind (whether computers or even mobile phones), you’ve likely been assisted by a data centre without even knowing it.
It listed in 2010, raising $40m at $1 per share in a deal valuing the company at $80m. But now, the share price is over $12. That is impressive enough, but doesn’t tell the full story.
With all the capital raisings the company has done over the years (taking its shares on issue from 80m to over 500m), those original shares are only worth 15c today, representing over 80x growth over 12 years.
NEXTDC listed early in its life because of the extreme amount of capital needed and difficulty of sourcing it from private markets back then. Some of it was funded by Slattery’s sale of Pipe Networks for $373m in 2010, but it needed further capital.
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It was clear data centres were going to be needed in the future, but it was only the major telcos that had them. The company betted that businesses and their customers needed and wanted even more capacity. Despite the upfront capex, data centres can generate revenue fast once operational.
Fast forward to today and NEXTDC expects $350-$360m in FY23 revenue and EBITDA is expected to be A$192-$196m, all from 17 data centres. Impressive considering it didn’t even have one data centre operational at its IPO.
For FY24, consensus estimates predict $418.2m in revenue (up 18%) and $214.3m in EBITDA (up 10%). Looking to FY25, analysts call for $486.6m in revenue (up 16%) and $267.4m in EBITDA (up 24%). Estimates for NEXTDC expand all the way to FY32 by which time the company is expected to have $1.8bn in revenue and $1.2bn in EBITDA, both way higher than today!
A COVID beneficiary that’s betting the benefits will continue
NEXTDC was in a good space during the pandemic due to the rise in remote working. So what? Well clearly you don’t just want all your data sitting in an office somewhere. And businesses have enough worries as it is without having to worry about infrastructure and whether or not it can operate. But the company is betting that the trend is not slowing down. Only a couple of months ago, it raised over $600m for new data centres in Auckland and Kuala Lumpur. This is the company’s first significant investment outside Australia and into the high-growth APAC region. And this deal now gives it liquidity of $2.6bn.
It has indicated plans for future data centres in Singapore and Japan. But considering the Kuala Lumpur and Auckland centres will not be open until the 1st half of FY26, it’ll be a while yet. In raising capital, the company also announced further contract wins and plans to expand capacity further. It reported contracted utilisation rose from 35.9MW (43%) to 120Mw in he first four months of CY23.
We think NEXTDC shareholders can take courage in the fact that shares rose after the deal despite it being done at a discount (at under $11 per share). So is more growth to come?
There are risks, but are they worth it?
We would note 3 things.
First, NEXTDC is not cheap. It trades 34.2x EV/EBITDA for FY24 and 27.4x for FY25. The first EPS positive year forecast is FY26 and the P/E for this year is a staggering 137x.
Second, the consensus price target is $13.60, from 17 estimates, which is just 8% ahead of where it is today. Granted, these vary from $18 at the highest and $5.37 at the lowest.
Third, there are a number of risks, including data centre interruption or outages, key customer contracts not continuing and the company’s ability to manage its debt. The latter is a key concern for us.
NEXTDC now has over $1bn in debt that will mature by FY28 and we think it will need to pay at least $200m per year. We estimate, in having modelled various scenarios using capex estimations the company has publicly provided and reasonable expectations that it will need to pay its debt, that it will likely need another capital raising in FY24 – we specifically think $500m as we outlined below.
Yes, NEXTDC could well take on more debt but this would be a clear cut case of short term gain and long term pain.
Although this call could come back to bite us, we wouldn’t invest in it right now. We know data centre demand is only going in one direction, but we are not so sure NEXTDC is the best way to pounce on this demand. Maybe Equinix is, but that’s a topic for another article.
We think NEXTDC is worth $15.19 – a ~20% premium to the current share price. This represents an Enterprise value of $8.15bn and an Equity value of $7.83bn. But we note 3 things.
First, ~90% of this is derived from terminal value, a figure given to growth after the projected life of the model. We estimate by FY32 it should have $877m in Free Cash Flow which is worth $388m today using the time value for money.
$807m is the sum of all free cash flows up to FY32, we estimate negative free cash flow until FY26 and only $64m in FY26. So what? Well, the predication the company is worth more assumes it achieves this high-growth without interruption and on-schedule.
Second, this is predicated on several factors, including future capital raisings, the cost of capital and future debt raisings. We assume the company will need $500m in fresh capital in FY24 – otherwise it’ll have a -/-$168m cash balance assuming FY24 capex is similar to FY23.
We have assumed this occurs by raising that capital at $13 per share and this hikes shares on issue to 581m and cuts the value today to just $13.49, which isn’t even a 10% premium.
We used a 9.53% WACC for our model derived from an 88-12% equity-debt weighting, a 4.4% pre-tax cost of debt and a 10.8% cost of equity. The latter figure is derived from a 3.6% risk-free rate of return, a 6% equity premium and a 1.2x beta (the industry average for Tech Hardware stocks).
Changing this figure substantially changes the valuation, as it would in any DCF model. For instance, if we changed the beta to 1.5x (normally the figure we use for unprofitable tech companies), the value falls below $10 per share.
And it is perfectly reasonable to argue that this WACC is too optimistic because the company is not profitable.
A big risk
The bottom line is that NEXTDC is undoubtedly in a good industry and has terrific prospects, but it is not profitable and will inevitably need future cash injections down the track to keep growing to scale and to capitalise on the opportunity it has. This being said, it is certainly a good trading opportunity as we enter a new financial year and is better positioned to capitalise on the demand for data centres than any of the penny stocks that only have one or two facilities (or perhaps even none).
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