GDS moves closer to breakup with REIT spinoff plan

The company could break itself into three pieces next year, one a China-based REIT, one for its China-based data center business, and one for its global data center business

Key Takeaways:

• GDS is reportedly considering a plan to raise 1 billion yuan through a spinoff and separate listing of a REIT containing its China-based real estate assets
• The company also appears to be paving the way for a spinoff and separate listing of its fast-growing international business

By Doug Young

Will 2025 be the year that data center operator GDS Holdings Ltd. (GDS.US; 9698.HK) formally splits into two or more pieces? The answer increasingly looks like “yes,” following a new report saying the company is exploring a potential IPO for a real estate investment trust (REIT) containing its China-based property assets.

This is a story with quite a few pieces, led by the sensitivity of data center ownership and operation in China that has made the market essentially verboten for foreign operators. But that same Chinese market has also become quite overheated with domestic players, both private and big state-owned telcos. As a result, the domestic market is quite oversupplied at the moment, and no one is making big – if any – money on the business.

On the more positive side, the other big story for this industry is the huge potential for new business as artificial intelligence gains momentum. As increasing amounts of computing gets done remotely, rather than on locally based computers, demand for data center-based capacity is expected to soar from applications that require huge amounts of cloud-based computing power.

The negative elements related to the China market have weighed on the stocks of both GDS and rival VNET (VNET.US), the country’s only two overseas-listed pure data center operators. GDS shares have rallied 144% this year, but still only trade at a price-to-sales (P/S) ratio of 2.73. VNET is even worse at 1.0. By comparison, global operators Equinix (EQIX.US) and Digital Realty both trade at P/S multiples of about 10.5.

The broader bullishness on data centers outside China, compared with the more problematic situation inside China, may well be the main force driving GDS towards what looks like a breakup of the company into three main pieces. One would be an operator of data centers in China; one would be a REIT whose primary assets are the real estate where those data centers are housed; and the third would be the company’s global assets.

The latest news, reported by Bloomberg, is focused on the REIT portion of the company. According to the report, GDS is working with advisors to determine potential investor interest in an IPO worth up to 1 billion yuan ($137 million) for a REIT containing its China-based data center property assets. The Bloomberg report said the IPO could come as soon as next year, though no location was given for the listing.

But given the increasing sensitivity of data centers in China, together with the fact that the Bloomberg report cited a yuan-based figure for the fundraising target, we would guess the listing would probably be on one of China’s A-share markets in Shenzhen or Shanghai. Such a listing wouldn’t be too exciting for investors from a growth perspective, at least not in the current market. But it would provide a steady dividend, and we’d expect GDS would pay a return rate of around 6% of the stock price to keep investors interested.

Minority stakeholder

Such a spinoff would leave GDS as the 100% owner of its China data center operations, as well as a minority stakeholder in its fast-growing international business. The domestic operations aren’t too exciting for the reasons we’ve described above. That part of the business generated 2.62 billion yuan in revenue, or 88% of GDS’ total, in this year’s third quarter, according to the company’s latest quarterly report. But the China business grew by an unimpressive 6.1% year-on-year during the quarter.

By comparison, the international business, which the company only launched in 2021, has been growing rapidly as GDS builds up new data centers in Malaysia and Indonesia. As it builds up that business, the international unit’s revenue rose more than sevenfold to 363 million yuan in the third quarter from just 49.3 million yuan a year earlier.

The international business had 51,862 square meters of space in service at the end of September, roughly quadruple the amount a year earlier. It’s also rapidly expanding, with 114,319 square meters of space now under construction. What’s more, the company’s commitment rate for international space now in service stands at 99.3%; and the pre-commitment rate for area under construction stands at 93.9%, up from 78.5% a year earlier.

GDS has been indicating for most of this year that it aimed to spin off the international business into a separate company, though it hasn’t said what such a spinoff might look like. It announced a $587 million fundraising for the international business in March, which valued that part of the business at $845 million. That deal left GDS in control of the international operation with a 56% stake, with the remaining 44% held by new investors including Boyu Capital and Hillhouse.

The March fundraising was followed by an even larger $1 billion fundraising in late October, which saw the international operation’s valuation rise to $1.3 billion – up more than 50% from just a half year earlier. Significantly, the October funding lowered GDS’ ownership in the international operation to just 37.6%, and the company said it would no longer consolidate that business into its financial results and it would no longer have the right to appoint a majority of the company’s board members.

All that appears to show that GDS wants to clearly separate the fast-growing international business from its core China operations, most likely as a separately listed company that could command a P/S ratio similar to those for Equinix and Digital Realty. The easiest way to do that would be to make an IPO for the international company, most likely in the U.S. or Singapore, and for GDS to give its remaining 37.6% of the international business to its current investors as a special dividend. It’s also possible that GDS may simply hold on to the 37.6% stake.

At the end of the day, investors would have three choices for where to put their money. People looking for slow but steady returns, mostly from regular dividend payouts, could invest in the China-listed REIT. Those wanting to bet on the China data center market could invest in GDS through its Hong Kong or U.S.-listed shares, though it’s possible the company could ultimately delist from the U.S. And anyone wanting to bet on the big potential for its international operation could invest in that company if and when it makes its IPO.

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