GDS - Q2 2024

Transcript

Operator (participant)

Hello, ladies and gentlemen. Thank you for standing by for GDS Holdings Limited Second Quarter 2024 Earnings Conference Call. At this time, all participants are in listen-only mode. After management prepared remarks, there will be a question and answer session. Today's conference call is being recorded. I'll now turn the call over to your host, Ms. Laura Chen, Head of Investor Relations for the company. Please go ahead, Laura.

Laura Chen (Head of Investor Relations)

Thank you. Hello, everyone. Welcome to the Second Quarter 2024 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'll 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 Founder, Chairman, and CEO, who will provide an overview of our business strategy and performance. Mr. Dan Newman, GDS CFO, will then review the financial and operating results. Ms. Jamie Khoo, CEO of GDS International, is also available to answer questions. 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 a company's prospectus as filed with the US SEC. The company does not assume any obligation to update any forward-looking statements, except as required under applicable law. Please also note that GDS earnings press release at this conference call includes discussions of unaudited GAAP financial information, as well as unaudited non-GAAP financial measures. GDS press release contains a reconciliation of the unaudited non-GAAP measures to the unaudited, most directly comparable GAAP measures. I'll now turn over the call to GDS Founder, Chairman, and CEO, William. Please go ahead, William.

William Huang (Founder, Chairman and CEO)

Thank you. Hello, everyone. This is William. Thank you for joining us on today's call. In 2Q 2024, we achieved a revenue growth of 18% and Adjusted EBITDA growth of 15%. This growth rate is quite remarkable in current market conditions. It reflects the progress which we have made in stabilizing our China business and the uplift from the highly successful execution of our international strategy. For our China business, we have two key financial objectives. Number one is to grow EBITDA at a steady rate, and then number two is to generate a positive cash flow before financing. We believe that this combination can create significant equity value, and help drive our share price recovery. In order to achieve these objectives, we prioritize delivering the backlog.

At the same time, we take a highly selective approach to new business, targeting orders which fits our inventory and have fixed move-in schedules. This will allow us to grow while minimizing the need for incremental CapEx. We have been following this strategy for a while, and it's starting to produce noticeable results. Over the past couple of quarters, the gross move-in rate has clearly stepped up. In 2Q 2024, it was over 20,000 square meters, the highest level for the past three years. The main reason for this improvement is the contracts which we signed with faster-moving schedules. These are mainly larger internet customers whose business continues to grow strongly. However, we are also beginning to see improvements from orders which have been in the backlogs for longer.

We expect this trend to continue as our customers implement their AI plans. In order to support higher move-in, we need to complete some projects which have been in progress for a while. In the first half of 2024, we brought 45,000 square meters into service. At June 30th, this was already over 20% utilized. In the second half of 2024, we expect to complete another 32,000 square meters. The good news is that this does not require a lot of new CapEx, as we only incur the cost to complete. The first indications of improved demand is customers observing capacity for which they already made commitments. This is underway. After that, we will start to see more new business opportunities...

We are well positioned to support AI demand as we are holding enough land and power quota. In the meantime, we will stick with our strategy of being very selective about what new business we take on. In our international business, we are already seeing very strong demand. We had a phenomenal second quarter with 206 MW of new orders spread across our two campuses in Johor. More recently, we signed a master sales agreement with a global technology company for capacity at our new campus in Batam. This is a major breakthrough, which will lead to further larger orders. Singapore, Johor, Batam, is fast emerging as one of the very largest data center markets in the world, and we have a great market position.

Where is this demand coming from? Part of it is regional expansion, and a part of it is spillover from the U.S., which is mostly AI related. A critical success factor is that we were first mover into Johor and helped to create the market. We anticipated where demand will flow and secure the resource, which give us a time to market advantage. We have shown that we can execute, delivering data centers in record time with the state-of-the-art design and the technology solutions. We have also shown that we can operate, working with the local institutions to source and train talent. From the perspective of our customers, these are really meaningful differentiators.

As of today, we have 388 MW of total customer commitments, out of which 101 MW is already utilized, and 287 MW is backlog. The delivery schedule for most of the backlog is very short, and the customers undertake to move in quickly. As a result, based on the terms of the existing contracts, we expect to have over 350 MW of utilized capacity within 24 months. I will now pass on to Dan for the financial and operating review.

Dan Newman (CFO)

Thank you, William. Following the completion of the first external equity capital raising for our international business, we have started formal disclosure of segment financials. As shown on slide 17, DigitalLand Holdings Limited and its subsidiaries comprises all of our business and assets outside of mainland China, except for some minor third-party data centers in Hong Kong. We refer to this segment as GDSI or International. GDS Holdings Limited and all of its subsidiaries, excluding GDSI, comprises our ultimate holding company and all of our business and assets in mainland China. We refer to this segment as GDSH or China. Starting with the China segment on slide 18, in 2Q 2024, GDSH revenue increased by 8.9%, and Adjusted EBITDA increased by 4.3% year-on-year. In order to show the underlying growth rate, we excluded previously disclosed one-time items from 2Q 2023.

GDSH revenue growth was mainly driven by an increase in total area utilized of 10.2% year over year. As shown on slide 21, MSR per square meter, comparing 2Q 2024 with 2Q 2023, was flat. However, EBITDA margin for 2Q 2024 versus 2Q 2023 was down by 2.1 percentage points. The main reason for this is the increase in power tariffs, which occurred during the second half of last year. Turning to the international segment on slide 19, in 2Q 2024, GDSI revenue increased by 24% and adjusted EBITDA by 80% quarter on quarter. As shown on slide 21, during 2Q 2024, there was a 28 MW increase in IT power utilized. The MSR per kilowatt per month was $135, including power income. As William mentioned, the ramp-up over the next 24 months will be extraordinary.

The rate of progress, quarter by quarter, depends on the timing of capacity completions and contractual revenue commitments. The increase in the next couple of quarters is quite small, but thereafter, it will take off. Turning to CapEx on slide 23. In 1H 2024, our China CapEx totaled RMB 1.8 billion. We expect lower CapEx in the second half of the year, including the proceeds of the BOT data center transfer, and still maintain our RMB 2.5 billion guidance for the full year. In 1H 2024, our international CapEx was also around RMB 1.8 billion. In the second half of the year, we expect CapEx to increase significantly, and it is likely that we will exceed our CapEx guidance for international of RMB 4 billion. Fortunately, the lead time from incurring CapEx to generating revenue in the international business is very short.

Turning to cash flow on slide 24. Following the closing of the Series A new issue for international, GDSH received over RMB 1.5 billion from GDSI on repayment of a shareholder loan. This is included in investment cash flow for the GDSH segment and financing cash flow for GDSI. Including this repayment, cash flow before financing for GDSH will be clearly positive this year, in line with our financial objectives. GDSI cash flow for 2Q 2024 included $448 million, or RMB 3.2 billion, of proceeds from Series A. The remaining $224 million from Series A was received by GDSI in July.

As shown on slide 25, at the end of 2Q 2024, the cash balance of GDSH increased to RMB 8.4 billion, and the net debt to last quarter annualized Adjusted EBITDA multiple decreased to 7.2 times. In order to accelerate our financial transformation, we're working on a number of asset monetization initiatives. Our key strategic goal is to set up a REIT listed in China, holding data center assets. There is strong policy support for new infrastructure REITs, and we have selected a stabilized project to move forward and are working through the regulatory approval process. This will be a first of a kind transaction for data centers in China, and we are strongly committed to making it happen. Turning to international on slide 27.

At the end of 2Q 2024, GDSI had a cash balance of CNY 3.1 billion, pro forma for the second tranche of Series A proceeds. Given the existing level of customer commitments and the strong sales pipeline, we plan to raise further equity for GDSI in a Series B round. The process is already underway. There's strong interest from global investors, and we are confident that this round will set a higher benchmark for the value of our equity investment in international. Finishing on slide 29, we are maintaining our formal guidance for FY 2024 consolidated revenue, adjusted EBITDA and CapEx. However, it is likely that we will raise our CapEx guidance at the time of 3Q 2024 results, when we have a firmer view on the timing and amount of CapEx for international. We'd now like to open the call to questions.Operator, please?

Operator (participant)

Thank you. We will now begin the question and answer session. To ask a question on the phone, please press star one one and wait for your name to be announced. For the benefit of all participants on today's call, please limit yourself to one question. If you have more questions, please reenter the queue. One moment for the first question. First question comes from the line of Yang Liu from Morgan Stanley. Please go ahead.

Yang Liu (Executive Director)

Thanks for the opportunity to ask questions. I would like to congratulate you first on the very strong set of results. I would like to ask about the China part, the REITs plan. Could management elaborate more in terms of the timing of this infrastructure REIT? And also what could be the potential valuation when you inject the asset to the REIT, and who could be the... or what type of investor could be the buyer? And what is the current whatever hurdle or key debate between the buyer and the company, and also between the regulator and the company? Yes, thank you.

Dan Newman (CFO)

Thank you, Yang Liu. It's Daniel. I'll answer that question. In order to pursue this strategy, we've selected a single site with two data centers as the seed asset for the REIT. Typical REIT offerings in China historically have been around CNY 2 billion per transaction, and that seems to be a size which the market is comfortable with, and you know, we've selected assets to fit with that. Under the new regulations, the asset must be stabilized. We must own the real estate. So, you know, the asset also qualifies on that basis. There's a series of regulatory approvals that we need to obtain, and we've already been working on this for over one year.

And, you know, we're getting to the level where the regulatory approvals will be sought at central government level. And if that is successful, we will receive approval for to be able to proceed with the offering, which is then valid for one year. We hope to reach that milestone next year. You know, it's not normal to do testing the waters or pre-marketing exercise in China, but, you know, we do have an active dialogue with major financial institutions in China, because we've also been looking at pre-packaging some assets which are not yet stabilized, as a way of creating a pipeline for the REIT. And, you know, we've received very positive feedback.

There's a significant appetite among financial institutions in China to get exposure to new infrastructure, including data centers, which are green, which have very high quality internet company or cloud customers. We think that a substantial percentage of the offering to the public will be taken up by, you know, strategic or anchor type investors. Under the regulations, we will be required to retain a 20%. There is quite a significant public listed REIT sector in China. Those REITs which are real estate based trade on dividend yields, which fall within a fairly well-defined range.

If we take that range and look at it very conservatively, based on the amount of income which we think we will be able to distribute, it implies an EBITDA multiple, which I think will be clearly accretive compared with where we're trading. If you look at our current public market value on a sum of the parts basis to strip out international at the last Series A price benchmark, our China business is being valued at somewhere between nine-to-ten times current EBITDA. The China REIT sector is trading at implied EBITDA, which is a quantum higher than that, so hopefully we will be able to capture that.

Operator (participant)

Thank you for the questions. One moment for the next questions. Our next question comes from the line of Frank Louthan from Raymond James. Please ask your question.

Frank Louthan (Managing Director)

Great, thank you. Can you characterize how much of the business in mainland China is AI driven? And can you give us an idea of the current impact of the Chinese economy to the demand on that base of the business? Thanks.

William Huang (Founder, Chairman and CEO)

Okay. Frank, this is William. The first question is, I think, the current demand, the new demand, in China currently, I think, is 70% is driven by the AI type requirement, including the training and also inference, inferencing. So the remaining 30% is driven by the internet company and also the traditional cloud business. Yeah, this is the... What's the second question?

Dan Newman (CFO)

How is the economy impacting demand?

William Huang (Founder, Chairman and CEO)

I think so far, I think for the training and the cloud business, I think this is not directly impacted from current China macro environment. It's totally opposite. And I think this is based on a lot of the, let's say, tech giants, they are continuing to invest the CapEx to train their own model and also try to in China, there's a lot of startup company is was invested by the venture capital to do the more application type, vertical type of the AI stuff.So this looks like the, it's create a very its own, let's say, environment, right? So it, this is the what happening in China right now.

Operator (participant)

Thank you for the questions. Next question. One moment, please. Our next question comes from Sara Wang from UBS. Please go ahead.

Sara Wang (Equity Research Analyst)

... Thank you for the opportunity to ask a question, and congratulations on the solid results. I have one question about international business. As Dan just mentioned, there's quite some capacity needed for international business. May I ask what's the future financing plan, especially in the near term as well as in the midterm, for example, the potential spin-off or IPO? Thank you.

Dan Newman (CFO)

Go ahead.

William Huang (Founder, Chairman and CEO)

I think it'll be before Dan answer this question. It's, I think it's, yeah, all the financing requirement is based on our forecast for the next two or three years. So our target is to double the current order number within next three years. So this is our base. So in terms of the financing plan, I think I would like let Dan introduce explain a little bit more. Yeah.

Dan Newman (CFO)

Yeah, I mentioned that, we've started the process for a Series B round. This will be raising capital once again from external investors, global investors, using a similar, will be a similar instrument type of security, convertible preferred shares. Our base case assumption is that the new issue size will be similar to Series A, say $600 million-$800 million. It's possible that we could increase the size, indeed, the appetite is there. Completing that offering, which we aim to do before the end of this year, I think that the next financing that we will undertake at our international holding company level may be mezzanine debt. Certainly, intend to explore that as a way of optimizing the overall cost of capital, international.

At the same time, we are putting in place senior debt at the project level, usually in local currencies. And we are currently undertaking a large syndicated term loan for our Malaysian business. That covers the range of different financing initiatives in international.

Operator (participant)

Thank you for the questions. Next questions will come from the line of Daley Li of Bank of America Securities. Please go ahead.

Daley Li (Equity Research Analyst)

Hi, management. Thanks for taking my question. I have one question about the international business. It seems the ITR in service is in a good momentum in 2Q, up like 50% quarter on quarter. How do we see the trend in Q3 and Q4 for the ITR in service for the international business in absolute value or like quarter on quarter growth? Thank you.

Dan Newman (CFO)

We gave some guidance in the earnings presentation, in the prepared remarks about the timeframe for delivery of a very substantial part of the overall backlog. I mean, we currently have about 280 MW of capacity, which is committed but not yet delivered and utilized. You know, we said that that will be most of that, in fact, said 200, about 260 MW out of 280 MW, will be delivered and utilized and revenue generating within 24 months. Which is a very rapid ramp up, as it implies that our revenue generating capacity will increase by 3.5 times over the next 24 months.

We did not give a quarter by quarter breakdown, but as an indication, over the next two quarters, the second half of this year, the increase in capacity and service and the delivery and utilization will increase by a relatively small amount, but over the course of next year, 2025, the increase will be very substantial.

Operator (participant)

Thank you for the questions. Our next question comes from Edison Lee of Jefferies. Please go ahead.

Edison Lee (Equity Research Analyst)

Thank you for taking my question. Congratulations again. I have two questions. Number one is that for your power capacity or power secured in Southeast Asia, I think that amount increased from 711 MW from your first quarter presentation to 797. So may I know where the incremental is coming from, which location it's coming from? And number two is, you said that you want a big international technology customer at Batam, and can you discuss your customers in Malaysia? Is it still a single company right now, and what do you expect that to change or situation to change or happen over the next couple of quarters?

Dan Newman (CFO)

Edison, hi, Dan here. The first question about the increase in secured resource developable capacity that is at both of our sites in Johor where we completed the land purchases for additional plots contiguous with our existing sites. And you know, where there is power infrastructure in place, and we were able to upsize the amount of power that we were able to obtain through that infrastructure. And then the second question, I think Edison asking about the customer mix-

Edison Lee (Equity Research Analyst)

Yeah.

Dan Newman (CFO)

In Southeast Asia?

William Huang (Founder, Chairman and CEO)

I think currently we already have, let's say, five customer from both China and international, right? Or like, say, the industry, the technology leader. So I think we are very focused on to try to diversify the customer. This is always our target, right? So the current mix is a, let's say around 70% from China. It's not a single customer, it's three of them. And another is also international customer. But based on our current forecast, I think in the next twelve months, the international customer will increase the percentage as well. Ultimately, I think it will be fifty/fifty, yeah, in this region.

Edison Lee (Equity Research Analyst)

Hey, thanks. Can I follow up with one quick question? So you said that there are five customers, including China International, and then you said that you want a big international customer in Indonesia. So can I assume that you have one international customer in Indonesia or just one customer-

William Huang (Founder, Chairman and CEO)

Yeah.

Edison Lee (Equity Research Analyst)

In Indonesia, and that's international? And then you have four customers in Malaysia, and that's China and international. Is my understanding correct?

William Huang (Founder, Chairman and CEO)

Yes. Yes, yes.

Edison Lee (Equity Research Analyst)

Okay.

William Huang (Founder, Chairman and CEO)

Indonesia is international, yeah. And the four in Johor is Chinese and international. Yeah, you're right.

Edison Lee (Equity Research Analyst)

Okay, thank you.

Operator (participant)

Thank you for the questions. Next questions comes from the line of Luis Zheng from Citi. Please go ahead.

Luis Zheng (Equity Research Analyst)

Thank you, management, for taking my questions. Congratulations on the strong results with, like, solid national growth signing and then the domestic recovery. I actually got two quick questions. The first one is for the domestic one. I think that, like, the net move-in for this quarter is very encouraging, and the MSR is trending up. Like, how should we think about the pace of the move-in and MSR recovery ahead, and more importantly, the sustainability of the demand? And then second question is for the international. I think some regional or global peers also have their planning in Johor, and we're seeing, like, an increasing DC supply. What is your strategy in SEA, and what are the, like, your advantage over the regional or the global peers?

Also one more thing on, like, the supporting infrastructures, like electricity grid, like, will those kind of stuff limit the near-term supply growth? Thank you.

Dan Newman (CFO)

Luis, I'll begin with your questions about China. The move-in, yes, it is a very clear step up in 1Q23 compared with the level of move-in over the past 12 quarters. And that was continued, in fact, it was even higher in the second quarter. This is partly a result of the contracts we signed in the last 12 or 18 months, which have faster move-in schedules than those that we signed previously. And also the beginning of a pickup in the move-in by customers whose commitments have been in the backlog for longer.

So based on the contractual terms, but also, you know, what we currently know about our customers' intentions, we expect the current level of move-in to continue through next year as far as we have visibility, which I think is very encouraging. For the MSR, you know, we look at MSR on a quarterly basis and compare the rate of change with the same quarter of the prior year. And so over the past few quarters, on average, the MSR has decreased by a little over 2%. And as we go into next year, there will be further decrease, but probably less than the decrease during 2024 as compared with 2023. So it's also encouraging to see that the MSR is bottoming out.

William Huang (Founder, Chairman and CEO)

... Okay. The second question is, I think about our strategy in this region, right? In Johor. I think number one, we are the first mover in this region. Everybody know we are the first mover in this region. And we still in the next three years, I think that we still enjoy the first mover advantage because the time to market and the demand profile still will continue maintain a very strong level. So even after three years, I think still the market size will increase, still continue to increase. So I don't think in short term, in the next five years, it will not an issue for all the player in this region, right?

So I think this is based on our understanding of the market. Yeah. So of course, you can, if we talk about after five years, what will happen? I think our strategy is that, number one, I think we will, we are looking at not only this region market. We are also already start to look at the region, other market in this region. Everybody know GDS is a market creator, so we are not follow, right? So I think we will give you another surprise in the next three years.

Operator (participant)

Thank you for the questions. One moment for the next questions. Follow-up questions from Yang Liu of Morgan Stanley. Please go ahead.

Yang Liu (Executive Director)

Thanks for the opportunity to ask another question. One more thing from my side is regarding the REITs play in China. Could you please talk about whether the REITs will be a public traded REIT or it's a private REIT, or actually you are targeting both? And another thing is, what could be the estimated debt reduction if you can deliver one REIT project to the REITs to inject one asset to the REITs?

Dan Newman (CFO)

Yeah, yeah, yeah, Yang. It's Dan here. So the REIT is listed, will be listed on one of the stock exchanges in China, and it will be offered publicly. You know, the typical REIT offering size I mentioned earlier is about RMB 2 billion. You know, we, as a guideline, I would say that transaction that size, you know, we would expect to deconsolidate around RMB 1 billion of debt. And if we sell 80% of the equity, then we will receive equity cash proceeds for the disposal of 80%, at the valuation of the offering. So the combined effect should be that it helps to increase our liquidity, decrease net debt, and also accretive on an EV to EBITDA multiple basis.

That's a single transaction. Of course, once the REIT is established, the possibility is there for us to drop further assets into it, and, you know, that's what we would hope to do over the longer term. But for now, our focus is just on achieving the first step, which is to set up this vehicle. You asked about privately placed, right? I mentioned earlier that, you know, we're working on prepackaging some assets. That will be privately placed. It takes the form of an asset-backed security. Technically, it is listed on a stock exchange, but it's easier to think of it as a privately placed security. It's a stepping stone in terms of packaging the assets so that it is, you know, ready to be injected into a REIT when the assets are stabilized.

Yang Liu (Executive Director)

Thank you. And one more question regarding the international business. It's very encouraging to see the big new orders. Could you please update us what is IRR trend for the big new orders? Is it stable or rising a little bit, or declining a little bit? Or what, what's the trend compared with the previous orders?

Dan Newman (CFO)

I'd say it's very consistent. Instead, maybe it's easier to talk about, like, a development yield rather than IRR. The development yield is in the low teens, which is quite acceptable to us in terms of a return on our invested capital. These are very high-quality customer contracts. They are, I would say, U.S. standard 10-15 years. Some of them are priced in U.S. dollars, and some of them have escalators. So it's very high-quality business.

Operator (participant)

Thank you for the questions. Next question comes from the line of Jonathan Atkin from RBC Capital Markets. Please ask your question.

Jonathan Atkin (Managing Director)

Thanks. So just a two-parter. What, what about China? And then what about international? So in China, I was just interested in any comments you would have about the contract renewals and churn outlook for the remainder of this year. It looks like you've got a fairly sizable amount coming up for renewal in second half of this year, 12.1% of total area committed. And then internationally, I would agree with William's comments about Johor, and I think you have somewhat of an incumbency or, or early mover advantage. But Johor is something that I was interested in because you were one of the winners of the CFA process. And is there any visibility in terms of timeline as to when you might get that project underway and when that might be ready for service?

Or is it too soon to have a view on that? Thank you.

Dan Newman (CFO)

To understand, on the first part of your question about churn in China, you're right. We have a large amount of contract renewals in the second half of the year. But if we look at the quantum of churn, we measure it in terms of area utilized, the churn as a percentage of our total area utilized. And over the past six quarters, it's been running at an annualized rate of about 5%, which I believe is relatively low by international standards. In you know, absolute terms, it's averaged about 5,000 square meters per quarter. In the second half of this year, it will continue at about that rate. But if we look into next year, I think the 3%-5% annual churn rate would be normal for us.

You know, we don't currently actually have any visibility on any churn, which is, you know, exceptional. Those numbers represent really quite a small percentage of the total amount of capacity, which is coming up for contract renewals, as you pointed out.

William Huang (Founder, Chairman and CEO)

Yeah. John, I think the Singapore project in a year. You know, in Singapore, so I think it's very difficult. What number one is, getting the CFA, it's very difficult, right? The second, now that we win the CFA, but the second question is, issue is, to get the very, very good location of the land is more difficult, right? So fortunately, we are in the process to acquire a land right now. I think we believe it's in the process and should be done in the next couple of months, complete the process.We aim to deliver within, before the end of 2026, to launch the service in the market to the market. That's very pretty firm schedule.

Operator (participant)

Thank you for the questions. In the interest of time, that concludes the Q&A session. I'll now like to turn the call back over to the company for closing remarks.

William Huang (Founder, Chairman and CEO)

Thank you.

Laura Chen (Head of Investor Relations)

Thank you once again for joining us today, and we'll see you next time. Bye.

William Huang (Founder, Chairman and CEO)

Bye.

Operator (participant)

This concludes today's conference call. You may now disconnect your lines. Thank you.