With five data centres built and operating, NEXT DC has moved away from construction risk, and is now fully operational – that means it can now leverage its infrastructure in place, to start to drive increasing returns.
It has taken a while, but data centre operator NEXT DC Limited (NXT) seems poised to finally print some black ink on its profit & loss statement in the current financial year. Still in loss, the company was at least able to tell the stock market that it expects to be earnings-positive in FY15. That will be good news to investors who have seen NEXT DC as a way to play the rise of cloud computing in Australia.
NEXT DC’s business slogan is that it is “where the cloud lives.” By that, it means that it runs data centres that offer secure co-location services to corporate, government and IT services companies. NEXT DC hosts critical IT infrastructure – such as servers – for its customers, and through it they and selectively source services: in the jargon of the IT industry, NEXT DC is a Data-Centre-as-a-Service (DCaaS) provider, which is independent of the big telcos or IT services providers like IBM.
NEXT DC operates five purpose-built date centres, in Melbourne, Brisbane, Sydney, Perth and Canberra. It has sold its data centres in to a real estate investment trust (REIT) called APDC Group (ASX code: AJD), and leases them from APDC on long-term leases. Not surprisingly, APDC Group is the only Australian listed REIT that owns data centre assets (NEXT DC does not own any of APDC Group’s equity.)
IT entrepreneur Bevan Slattery established the company in May 2010, to build and operate data centres in Australia and New Zealand. The business model was that the centres would be carrier- and vendor-neutral data. Slattery, who had previously sold his listed telco business Pipe Networks to TPG Telecom, invested $20 million into NEXT DC: subsequently, $40 million was raised in an initial public offering (IPO), with the company listing on the ASX in December 2010.
NEXT DC has yet to make a profit, but in FY14 it posted significant growth across all key operational and financial metrics and moved closer to generating positive cash flows. Total revenue rose by 33%, from $36.2 million in FY13 to $48.3 million. Data centre services revenue more than tripled, from $9 million in FY13 to $30.4 million in FY14.
At the earnings before interest, tax, depreciation and amortisation (EBITDA) level, the Sydney, Melbourne and Brisbane data centres were all positive contributors. The underlying EBITDA loss (adjusted for non-recurring items) improved from $20 million in FY13 to $16.1 million, but the statutory net loss after tax worsened from $2.2 million in FY13 to $22.9 million in FY14.
Annualised recurring revenue rose 36% to $41.7 million. In FY14, more than $160 million in cash and debt was raised to support NEXTDC’s capital investment program and the ongoing growth working capital needs of the business: the company had $70.8 million in cash and term deposits at 30 June.
With all five centres built and operating, NEXT DC has moved away from construction risk, and is now fully operational – that means it can now leverage its infrastructure in place, to start to drive increasing returns. In its result, the company described FY14 as a “pivotal year,” and foreshadowed the following outcomes over FY15:
• new sales of between 2.4MW and 3.0MW (FY14: 2.1MW);
• “substantial growth” in data centre services revenue to between $51.0 million and $55.0 million (FY14: $30.4 million); and
• “positive” earnings before interest, tax, depreciation and amortisation (EBITDA).
Subject to new sales continuing in line with current volume and price, the company said it expects to achieve EBITDA breakeven in the December half. That would mark a significant milestone in NEXT DC’s financial performance.
Broker Morgans – which acts as house broker to NEXT DC – says this guidance is conservative: it expects the company to be earnings-positive in FY15. Morgans says sales momentum continues to improve, and 75 cents of every $1 in new sales now contributes directly to earnings and cash flow.
Profitability at net level would be music to the ears of holders who have seen the stock come down from a peak of $2.82 in July 2013 to $1.69. Over the past 12 months, NXT has lost 35.7%; over three years, it has barely kept its head above water, returning 0.4% a year.
The key to investing in NEXT DC is to think of the way in which CEO Craig Scroggie describes the company: he says it is “at the heart of the digital economy.” In a world built on smart phones, tablets, “digital disruption,” and the “internet of Things” – let alone the now bog-standard internet – with all of the escalating data usage and associated storage needs that implies, NEXT DC should be able to make decent money. Eventually.
Morgans likes the stage that NEXT DC has reached, pointing out that, based on US experience, as initial capital spending requirements tail off, mature data centres start to generate very strong cash flow and high operating margins. Now that the data centres are built and fitted-out – a highly capital-intensive process – the only capital spending NEXT DC should have to do from here will be tailored to customer demand (and there is $70.8 million of cash on the balance sheet). However, investors do have to watch the major cost – electricity – which chewed up 13% of revenue in FY14.
The partnership with Telstra, which enables customers to move critical IT into the data centres, is crucial. Data centre utilisation is only at 30%, so NEXT DC has plenty of room to grow: the success of the sales function is critical. The company has probably been conservative in its guidance for new sales, preferring to under-promise and over-deliver. NEXT DC looks likely to be able to break through into the black this financial year, in which case current share price levels would appear cheap in hindsight.