May 9, 2017
Executives
Laura Chen - Head of IR William Huang - Founder, Chairman and CEO Dan Newman - CFO
Analysts
Operator
Hello ladies and gentlemen. Thank you for standing by for GDS Holdings Limited’s First Quarter 2017 Earnings Conference Call.
At this time, all participants are in listen-only mode. After management’s prepared remarks, there will be a question-and-answer session.
Today’s conference call is being recorded. I will now turn the call over to your host, Ms.
Laura Chen, Head of Investor Relations for the Company. Please go ahead, Laura.
Laura Chen
Hello everyone and welcome to the first quarter 2017 earnings conference call of GDS Holdings Limited. The Company’s results were issued via newswire services earlier today and are posted online.
A summary presentation, which we will refer to during this conference call, can be viewed and downloaded from our IR website at: investors.gds-services.com. Leading today’s call is Mr.
William Huang, GDS’s Founder, Chairman and Chief Executive Officer, who will provide an overview of the business. Mr.
Dan Newman, GDS’s Chief Financial Officer, will then review the financial and operating results. Before we continue, please note that today’s discussion will contain forward-looking statements made under the “safe harbor” provisions of the U.S.
Private Securities Litigation Reform Act of 1995. Forward-looking statements involve inherent risks and uncertainties.
As such, the Company’s results may be materially different from the views expressed today. Further information regarding these and other risks and uncertainties is included in the Company’s prospectus as filed with the U.S.
Securities and Exchange Commission. The Company does not assume any obligation to update any forward-looking statements except as required under applicable law.
Please also note that GDS’s earnings press release and this conference call include discussions of unaudited GAAP financial information as well as unaudited non-GAAP financial measures. GDS’s press release contains a reconciliation of the unaudited non-GAAP measures to the unaudited most directly comparable GAAP measures.
I will now turn the call over to GDS’s Founder, Chairman and Chief Executive Officer, William Huang. Please go ahead.
William Huang
Hello everyone. Thank you for joining today’s call.
In the first quarter of 2017 we continued to make meaningful progress across all aspects of our business and further strengthened our market leadership position. As you can see on Slide 3 we grew total revenue by over 60 percent and Adjusted EBITDA by over 130 percent year-on-year.
We invested over $50 million of CapEx to develop the capacity required by our customers. We raised nearly $80 million of debt to ensure that each new project is fully funded.
We maintained our strong sales growth momentum, signing up customers for over 7 thousand square meters (net) of new commitments, worth over $35 million in terms of annual recurring revenue. This includes full re-commitment of the area released by a churn customer.
I want to highlight that it is a rare case for any company to be able to reallocate such a large amount of area in such a short period. This further proves GDS’s high ability to execute and deliver, as well as the strong market demand.
As a result, our total area committed grew to over 68 thousand square meters, 85 percent higher than 1 year ago. We ended the quarter with commitment rates of 90 percent for area in service and 38 percent for area under construction.
We continued delivering the backlog, increasing our area utilized to nearly 38 thousand square meters, 58 percent higher than 1 year ago. On the resource side, we enhanced our supply pipeline with the Shenzhen acquisition we announced last quarter of a 10 thousand square meter project under construction.
Construction is ahead of schedule and the customer will be moving in Q3, faster than anticipated. In addition, I am pleased to announce today that we have secured a new data center project in Beijing.
It will add over 4 thousand square meters of capacity when completed in the first half of 2018. This is a big win for us.
Supply in Beijing is quite restricted. Our approval reflects the government’s acknowledgement of our unique industry leadership and deep experience.
Clearly, both of these new projects demonstrate our sourcing capabilities. Turning to Slide 4, our impressive sales achievement gives us high visibility to future growth.
Quarter after quarter, we continue to execute against our plan, delivering our backlog to customers, and driving revenue and operating income growth. I will leave it to Dan to elaborate on these numbers.
Moving on to Slide 5 Before I talk about our sales wins and resource development, I want to update you on what we see happening in the market. As we have said before, we believe China represents the biggest data center opportunity in the world.
And we believe GDS is best positioned to capitalize on this growth. In our view, the data center market in China is growing at over 25 percent annually, with Cloud and Internet platform service providers driving around 70 percent of new demand, and cloud being key.
So, to understand the data center opportunity, we must first understand how the Cloud is developing in China. Joe Tsai, Executive Vice Chairman of Alibaba, stated that they see Cloud as a $30 billion market opportunity in China, assuming 20 percent of IT spending migrates to Cloud.
In 2016, the China market was worth around $1.5 billion. It is still early days, but Cloud adoption has clearly taken off.
Alibaba and Tencent reported that their Cloud customers and revenues increased by 2 to 3 times over the past year. Alibaba forecast that the market will grow by 4 times over the next two years.
This growth is largely coming from the three internet giants in China – Alibaba, Tencent, and Baidu. They see transformational opportunity in Cloud and related technologies.
Each of them has put the Cloud at the center of their strategic development. These three companies have huge influence over the digital economy in China.
They are able to leverage their dominant presence in different verticals to drive the development of their Cloud platforms in unique ways. Additionally, there are other giant companies, such as Huawei, which are allocating more and more resource to public Cloud development, and the global hyper-scale players –Microsoft, AWS, and IBM – which are significantly increasing their presence in the China Cloud market.
Cloud service providers aggregate demand for data center capacity, but they have different kinds of requirements which they fulfill in different ways. For their performance-sensitive data and applications, which need to be housed in edge data centers close to end-users in the Tier 1 markets, they look to outsource most of their requirement.
Why do they outsource? The first reason is because their business is highly dynamic and outsourcing allows them to accelerate their time to market.
Secondly, they want to focus their attention on the customer-facing products and services that are critical to their success -- and they recognize that sourcing, designing, building, and operating sophisticated data centers is very complex. Thirdly, their business models appreciate the flexibility of being able to access a secured supply of data center resource, with short lead-time, when they need it from a trusted provider.
Demand is running ahead of supply in the key markets. Hence, a lot of new capacity has to be built.
As the scale has increased – in terms of space and power – it has become more and more difficult to secure suitable industrial buildings for long-term lease and to obtain sufficient power capacity. Obviously, the market opportunity has attracted more carrier-neutral participants, but we do not see them having a material impact on competition.
They develop assets on a case-by-case basis and no competitor has a presence comparable to us across all the Tier 1 markets. No competitor has the combination of expertise, track record and comprehensive set of sustainable advantages that we do.
GDS is Best Positioned to Capture This Opportunity We recognized several years ago the strategic importance of capturing demand from Cloud service providers. First, because it represents a large part of the market opportunity and, by serving these high-volume customers, we gain scale advantages.
Second, because we believe that access to key Cloud infrastructure platforms located in our data centers is a unique value proposition that will drive the growth of our FSI and large enterprise franchise, and attract more Cloud players, such as SaaS providers. There are only a few hyper-scale Cloud infrastructure players, so there are only a few opportunities to make this a winning strategy.
How are we doing? We’ve had great success in capturing this demand.
As shown on Slide 6, from almost nothing 3 years ago, Cloud service providers now account for over 50 percent of our total area committed. In the last quarter, we obtained significant new commitments from three of the leading Cloud service providers in China, including a follow-on order from one of the major global players.
Our Top 2 customers are now each present in 6 - 8 of our self-developed data centers and in 4 - 5 different markets. We estimate that we house the majority of their incremental IT demand.
They consider us as partners in the development of their Cloud business. As we grow in market leadership, we are actively taking steps to deepen relationships with key customers and formalize our partnerships in different ways.
Why do we win with Cloud service providers? There are many reasons.
First, we have the right kind of data centers – meaning large-scale, high power density, and high efficiency facilities, and they are located in all the right places, so they map to the where our Cloud customers deploy their platforms. Second, we are able to offer them certainty of future supply as a result of our secured expansion pipeline and flexibility to take delivery when they need it.
And, third, as Cloud service providers increasingly penetrate the FSI and large enterprise verticals, they see value in co-locating with many of the best names in China who are our existing customers. These attributes are not easily copied and they distinguish GDS from all other carrier-neutral players.
Besides the Cloud service providers, in the last quarter we added over 20 new FSI and large enterprise customers, further diversifying our customer base. I would like to highlight a few.
First, we signed a large, multi-site order from the leading online securities and fund trading company. Second, we obtained an order for the settlement and clearing platform being established by the central bank to support digital payment service providers.
We already house the three leading e-payment platforms in China. We believe this new generation of FSI customers offers a long runway for future expansion.
And third, we just recently we won a bid with one of China’s largest online travel providers. Lastly, as we continue to build our ecosystem for both cloud and enterprise customers, we are in the process of obtaining the license and regulatory approval to provide cross connect services in China.
We will update the market when more details become available. Secured Resource Supply to Sustain Leadership.
In summary, our sales outlook is the strongest it has ever been. The market is growing faster than imagined and customers are looking to us to meet their requirements.
This is a golden opportunity for us and we are moving forward full-speed ahead. We have the strategic relationships and we are rapidly adding new customers.
Resource supply is the critical input for us to sustain this momentum. As shown on Slide 7 our area in service remains at around 61 thousand square meters, which is almost sold out.
With the Shenzhen 5 acquisition, our area under construction increased to just over 35 thousand square meters at quarter end. Out of this total, around 13 thousand square meters is pre-committed and around 21 thousand square meters is available to feed our current sales efforts.
The new data center project in Beijing (BJ3) will be included in area under construction in Q2. It is located next to BJ1, which is already 96 percent committed.
We are very confident about the marketability of BJ3. Including BJ3, we will have around 25 thousand square meters of area under construction which is not yet committed.
25 thousand square meters is equivalent to about 4 quarters of new bookings at our recent quarterly run rate. We intend supplementing these resources in order to support sales into 2018.
We have resource held for future development that we plan to activate, and we have promising prospects in all our markets that we aim to secure, in the next few quarters. Our data center portfolio is shown on Slide 8.
10 of those data centers are in service and 5 are under construction. Before handing over to Dan for the financial review, I would like to highlight the recently announced appointment of Mr.
Chang Sun as an Independent Director on our Board. Chang was formerly the Chairman of Warburg Pincus for Asia Pacific.
He is one of the most renowned and successful investors in China over the past 20 years. Real estate based businesses have been one of his focus areas.
He helped build highly successful businesses in the logistics, hotels, and retailing sectors. He also founded the China Real Estate Developers & Investors Association.
GDS is the first and only US public company directorship that he has accepted since moving on from Warburg Pincus. Chang brings a rich investment background and experience and we are delighted to have him join our Board.
With that I will now hand the call over to Dan.
Dan Newman
Thank you, William. In this section, I will focus on 4 main areas: first, revenue and operating leverage; secondly,CapEx; thirdly, funding; and then, fourthly, I will make some comments about delivery of the backlog and quarterly expectations for 2017.
Starting with the first quarter 2017 P&L analysis on Slide 10. On a GAAP basis, service revenue grew by 14.7% quarter-on-quarter to Rmb 343.7 million.
However, this includes a termination fee of Rmb 44.1 million, arising from the previously reported churn of 1,225 square meters at our Shanghai campus. The termination took effect a few days after the start of the quarter and the fee is now cash in the bank.
In 4Q16, we generated service revenue of Rmb 16.0 million from the churn area. The termination fee is therefore equivalent to nearly 9 months revenue.
On a Pro Forma basis, excluding the termination fee entirely from 1Q17, service revenue was Rmb 299.6 million, which is the same as for the prior quarter. In other words, even without the buffer of the termination fee, we were able to keep service revenue at the same level as before the churn event.
Turning to Slide 11, I will show you how we can better track the underlying trends in our financial results. On a non-GAAP basis, Adjusted NOI grew by 27.2% quarter-on-quarter to Rmb 179.4 million.
After excluding the termination fee and equipment profit which is non-core, underlying Adjusted NOI was 4.2% lower compared with the prior quarter. The main reason for this is that we booked a full quarter of operating costs for the 3 data centers, totaling over 12,000 square meters of space, which came in to service during 4Q16.
The contribution from these data centers will take several quarters to build up to breakeven. On a non-GAAP basis, Adjusted EBITDA grew by 34.7% quarter-on-quarter to Rmb 123.9 million.
After excluding termination fee, equipment profit and impact of foreign exchange changes, Underlying Adjusted EBITDA grew by 2.3% quarter-on-quarter. Underlying Adjusted EBITDA margin was slightly higher at 27.1% in 1Q17 compared with 26.5% in 4Q16.
Now let’s go further in to the key drivers of this growth on Slide 12. In 1Q17, there was an increase in area utilized of 816 square meters net of churn or 2,041 square meters gross.
Typically, the first quarter of the year in China is comparatively slow due to the New Year Holiday. The churn rate was 5.5% on a revenue basis or 3.2% on an area utilized basis.
Excluding the single customer churn event, the churn rate was 0.1% on a revenue basis. Retention rates are very high.
This was really just a one-off event. The average monthly service revenue or MSR per square meter was Rmb 2,708 in 1Q17 compared with Rmb 2,797 in 4Q16.
The lower MSR per square meter is mainly due to the churn area having an above average MSR per square meter as it was very high power density. On the right-hand side of Slide 13, we show a breakdown of our cost structure for 1Q17.
All these numbers are on a Pro Forma basis excluding the termination fee, equipment sales and cost, and foreign exchange changes. Starting at the data center level, Utility cost, which is mainly a variable cost, was 23.8% of Pro Forma service revenue in 1Q17, compared with 23.2% in 4Q16.
We had 3 new data centers entering service in the prior quarter which will take a while to reach optimal power usage efficiency. Other data center-level costs, which are mainly fixed, were 31.5% of Pro Forma service revenue in 1Q17, compared with 30.1% in 4Q16.
The increase was mainly due to booking a full quarter of costs related to the 3 new data centers. Underlying Adjusted NOI margin was 44.7% in 1Q17, compared with 46.7% in 4Q16.
Directionally, we do expect our NOI margin to trend up over time. To give you a better idea of the potential for margin improvement, we can point to our stabilized data centers (which for this purpose we define as data centers with a utilization rate of over 80%).
At the end of 1Q17, we had 18,155 square meters of area utilized in self-developed data centers which were stabilized. The Underlying Adjusted NOI margin for these data centers was 56.0% in aggregate.
At the same time, we had 12,859 square meters of area utilized in self-developed data centers which were still ramping up and therefore had not yet reached optimal levels of profitability. Moving on the corporate level, our SG&A (excluding D&A and stock-based compensation) was Rmb 7.7 million lower in 1Q17 and came out at 17.9% of pro forma service revenue, compared with 20.5% in 4Q16.
There were some year-end costs and professional fees which impacted the prior quarter. Turning to our investment activities as shown on Slide 14, we paid capex of Rmb 380.0 million in 1Q17, which was a step-up from the run rate over 2016.
Replacement capex accounted for 3.3% of this total. We incurred capex mainly on our CD1 (Phase 3) data center which is 100% pre-committed and due for delivery starting in mid-17 and on our BJ2 data center which, after the government imposed construction delay, we are completing as fast as possible.
As William mentioned, we obtained a significant follow-on order for BJ2 from a global cloud player which will roll out simultaneously in our Beijing and Shanghai data centers. SZ4 Phase 1 is close to completion.
We expect to obtain significant new commitments for this data center in the next couple of months. Those deals are far along in the contracting process.
SZ5, the project which we announced in March, is proceeding ahead of schedule. The customer which has pre-committed for 50% wants to start moving in during 3Q17.
Based on the pricing for the pre-commitment, we expect the NOI yield for this project on a stabilized basis to be in the mid-teens. SH4 is the 4th data center on our main Shanghai campus.
We aim to bring the data center in to service by the end of 2017. The previous phase, SH3, is now 89.3% committed.
All of our major Cloud customers are present on this campus as well as over 100 FSI and large enterprise customers. SH4 is already substantially pre-allocated on a soft basis.
We have also shown here the new Beijing project, BJ3, where construction starts in the current quarter. Its well-placed to serve the customers who are present in the adjacent BJ1 data center.
With the addition of BJ3, our total area under construction is 39,315 square meters across 7 sites, out of which 76.4% (i.e. 30,055 square meters) will enter service this year.
With regard to financing, as shown on Slide 15, during 1Q17, we re-paid a Rmb 199.6 million mezzanine loan, which had a high interest rate, and obtained Rmb 532.8 million of new debt facilities. Our blended financing cost was 7.1% in 1Q17 compared with 8.0% in 4Q16.
Excluding the convertible bond, the cost was 6.2% in 1Q17 versus 7.3% for the prior quarter. Almost all of our loans are floating rate, linked to the PBOC rate.
At the end of the quarter, our gross debt was Rmb 4.47 billion and our net debt was Rmb 2.94 billion. Net debt increased by Rmb 464 million since Y/E16.
The ratio of net debt to LQA Pro Forma Adjusted EBITDA was 9.2 times. Fully diluted for conversion of the CB, the multiple was 6.0 times.
So clearly conversion of the CB would make a significant difference. Because we are in a heavy investment phase, consolidated net debt / EBITDA ratios may not give a good indication of our financing structure.
On a pro forma basis, if we deduct the financing obligations related to data centers under construction, the net debt / EBITDA multiple falls to 7.5 times. If we further deduct the financing obligations of data centers which are still ramping up, the net debt / EBITDA multiple for the stabilized data centers which I referred to earlier would be 2.7 times.
The level of debt which we put on each project is designed to reach this kind of multiple once stabilized. As things stand, all of our data centers in service and under construction are fully funded, including the 2 latest projects, SZ5 and BJ3, where we are in the final stages of securing the debt financing.
The fact that we have very strong customers and many long-term contracts definitely helps us to access the debt finance which we need. Assuming a continuation of our current funding approach, we believe that we have sufficient capital to take on around 5 further projects, subject to size and timing.
Turning to Slide 16, I would like to make some comments to set appropriate expectations for the quarterly progression of our results this year. Our backlog grew to over 30,000 square meters at the end of 1Q17.
This provides high visibility to future revenue growth over a 1 – 2 year time horizon. On a near term basis, growth rates depend on how quickly customers move in and hence how quickly we can start billing them for the committed resource.
Around 56% of the backlog relates to area at data centers which are currently in service. For this part of the backlog, the move-in process is smooth and on-going.
The balance of 44% relates to area at data centers which are still under construction. For this part, the move-in process can only begin in the 3rd and 4th quarter of this year.
I mentioned on our last earnings call that we have a renewal this year for 4,365 square meters which relates to a single customer at a single data center. At the time of renewal, the customer will change out its IT platform and we will undertake some re-fit.
As part of the deal for a multi-year renewal, we have agreed not to bill the customer during the change out period which is expected to last 3 – 4 months. The change out will happen in phases over the next few quarters, but it will start to impact our revenue in the current quarter.
We took account of the move-in schedules and temporary billing interruption when we provided our FY17 revenue and Adjusted EBITDA guidance and we reaffirm those numbers. In terms of quarterly progression, taking 1Q17 Pro Forma as the base, we expect revenue in 2Q17 to grow in the high single digits in percentage terms quarter-on-quarter and then at higher growth rates in the 2nd half of the year.
We expect Adjusted EBITDA to follow a similar pattern. With that I will end the formal part of my presentation.
We would now like to open the call to questions. Operator.
Operator
Laura Chen
Thank you once again for joining us today. If you have further questions, please feel free to contact GDS’ investor relations through the contact information on our website or The Piacente Group Investor Relations.
Operator
This concludes this conference call. You may now disconnect your line.
Thank you. 1