Equity Research Report: GDS Holdings
Rocketing demand for data storage services and high capital cost entry barriers will protect the company's dominant position in China; market competition will intensify.
Nowadays, China is transforming its economy into a more digitalized one. The change has in part been forced by the country's slowing economic growth, which made its leaders seek new development sources in the technology space. This overwhelming process implies massive opportunities for emerging businesses in data-related sectors.
However, China's 5G and cloud adoption are still in the early stages. Specifically, few companies are using the new-gen networks at the moment. But the present commercial frenzy around the concept heralds booming data consumption in the future.
Helping businesses shift to the cloud is vital for China's tech giants, such as Alibaba (BABA:NYSE, 09988:HK), Tencent (00700:HK) and Huawei, in the next decade, as their vast ecosystems are mushrooming in terms of both scope and scale.
Data center service providers represent the very upstream of the aforementioned two sectors – telecommunication and cloud computing. Offering computing power and data storage, they free telcos and cloud service providers from most hardware concerns and let them focus on their core products. They permit an outsourced IT infrastructure while lowering the initial costs, providing fast scalability, professional operation and maintenance.
GDS Holdings (GDS:NASDAQ, 09698:HK) is the biggest (by revenue in 2019) third-party data center brand in China. It provides neutral colocation and manages services, primarily serving large cloud players, Internet companies and financial institutions.
The company generated a revenue of CNY 1.62 billion, CNY 2.79 billion and CNY 4.12 billion in the fiscal years of 2017, 2018 and 2019, showing 53%, 73% and 48% year-on-year growth rates over that period. Meanwhile, GDS has been cutting its costs through an economy of scale and rather savvy supply chain management: the ratio of sales, general and administrative expenses over the total revenue have been decreasing significantly since 2017.
Currently, the company has enormous space for boosting its capabilities across China.
In this report…
EqualOcean presents a comprehensive analysis of GDS Holdings, dissecting the company’s technology, competitive environment, regulations and other factors affecting its business performance and growth strategy. In the two distinct chapters, we analyze the main drivers and challenges facing GDS in the short and medium term.
A result of months of research, expert interviews and thorough analysis, this report is a one-stop solution for global investors trying to assess the real value of GDS Holdings.
► A number of institutional investors have selected GDS as a long-term value creator. The company has received investments from major industry players, including CyrusOne (CONE:NASDAQ), STT (ST Telemedia Global Data Centers), Softbank, Ping An Insurance (000001:SH) and Hillhouse Capital. Most of them have sold their shares as their common investee started outperforming its peer in the recent years.
► The demand for digital hardware facilities is booming. The size of China's data center sector is projected to grow at a 26% CAGR over the next four years, reaching CNY 204 billion in 2020. As the market leader, GDS will benefit from the increasing demand driven by 5G adoption, digitalization (including shifting to cloud and outsourcing IT infrastructure) and Artificial Intelligence.
► We see certain margin-raising potential in the cost control area. As GDS’s business has been growing, the cost structure has been improving, with the EBITDA going up.
In the next few years, we expect GDS to continue to lower its operating costs. The utility cost will decrease as more lower-PUE data centers come into service; sales and advertisement will become more efficient.
► The stock is currently trading at 40x of EV/EBITDA (at 86.63 apiece, as of 9 October 2020). We expect the company's revenue growth rates to be at 38%, 43% and 19% in 2020, 2021 and 2022 respectively. The US peer companies are trading at 25x to 28x. Thus, we slightly upgrade the valuation multiples to 42x, 29x and 24x. The twelve-month target price is USD 92 per share. We give a hold rating to GDS.