GDS Raises Funds for Accelerating Expansion, But Investors Unimpressed

China’s leading data center operator will sell $620 million in convertible notes to Singapore’s GIC and ST Telemedia, as well as local private equity giant Sequoia China

Key Takeaways:

• GDS is raising $620 million through the issue of seven-year convertible notes with a conversion price just 16% above the stock’s latest close
• Funds are being used to pay for an accelerated buildup of new data centers, including a new regional hub taking shape around Singapore

By Doug Young

China’s leading independent data center operator GDS Holdings Ltd. (GDS.US; 9698.HK) is on an expansionary binge.

That’s the message coming in the company’s latest announcement, which says it will issue $620 million in convertible notes to three big-name investors, including two based in Singapore. The announcement also has a slight hint of desperation from GDS, at least based on our interpretation of the notes’ terms.

We’ll get to that shortly, but first let’s look more closely at the actual announcement, which came out after markets closed on Monday. The three buyers of the notes are Sequoia China Infrastructure Fund I, ST Telemedia Global Data Centres, and “an Asian sovereign wealth fund which has a strategic relationship with GDS.”

Sequoia China is the Chinese unit of U.S. venture capital giant Sequoia Capital, and is considered one of the most prominent tech investors in China. ST Telemedia Global Data Centres is a Singaporean telecoms services specialist with close ties to the Singaporean government. The unnamed sovereign wealth fund appears to be Sinapore’s GIC, which formed a partnership with GDS in 2019 to “develop and operate hyperscale build-to-suit (“BTS”) data centers outside of Tier 1 cities in China.”

The notes are due in 2029, and have an interest rate of 0.25%, which is obviously quite low. But the part that led to our earlier observation about a slight hint of desperation is the conversion price, which is $50 per American depositary share (ADS). That compares with the company’s latest closing price of $43.11, meaning the stock only needs to rise 16% over the next seven years for the note buyers to earn a profit by exercising their conversion rights.

To put that in perspective, the more than 20 analysts who follow GDS now have an average price target on its stock of $82.76, or 65% above the conversion price. Of course, these analyst targets are usually a bit inflated. But the bottom line is that the market believes the stock is currently relatively undervalued, meaning a 16% rise over the next seven years looks quite laughable.

A look at the company’s latest quarterly earnings report released in November makes it quite clear what this new money is needed for. In that report, GDS said it was boosting its capital expenditure for 2021 from an originally planned 12 billion yuan ($1.9 billion) to a new 16 billion yuan. That extra 4 billion yuan translates to $633 million, which happens to be just about the amount of the new fundraising.

Investors weren’t too excited about the news, with GDS’ New York-listed shares actually dropping slightly after the news came out. They rebounded a little the next day, and are now up 1.2% from pre-announcement levels. The stock has lost more than half of its value over the last 52 weeks, tracking a broader trend for overseas-listed Chinese stocks. But the shares have rallied somewhat since reaching a nearly two-year low in late January, and are now up about 16.5% from that low.

Big expansion

All the spending is targeted at an expansion that is seeing GDS grow rapidly in both its home China market, and also abroad. The backing by two big Singaporean investors in the latest funding, together with Sequoia China, which also has global ties through its parent, hints that the global part of its expansion could become an important future focus.

The company’s latest financial report showed the total area for its data centers now in service totaled 452,830 square meters at the end of September last year, up 55% from the 291,282 square meters in service a year earlier. The vast majority of that is in China.

That same report showed the company is rapidly building up regional centers in the Hong Kong-Macau area, as well as around Singapore.

That latter part of the plan, which the company is calling its “Singapore Plus” regional strategy, includes a recent agreement to acquire land in the Indonesian city of Batam, approximately 25 kilometers from Singapore, for construction of two data centers with a 10,000 square meters of floor space. GDS is also developing an 18,000 square meter data center in the Malaysian state of Johor, also near Singapore.

The company’s building spree, which also includes strong expansion at home, comes as Beijing lays out big plans to boost China’s data center infrastructure. That saw China’s state planner also announce earlier this month a plan to build five regional data center clusters in the country’s less developed areas to service growing demand in the more affluent eastern part of the country.

While that kind of state support looks good on paper, it’s not showing up yet in GDS’ financials, which look quite so-so. The company’s revenue grew 35.2% in last year’s third quarter to 2.1 billion yuan, which is quite a bit slower than the growth in its data center floorspace. As a result, its utilization rates dropped to 66.3% at the end of last year’s third quarter from 74.2% a year earlier.

The weak utilization and high power prices combined to push the company more deeply into the red during the quarter, posting a 301 million yuan loss versus a 204.6 million yuan loss a year earlier. What’s more, analysts see the company continuing to post more losses this year, even as the big majority of those rate the company a “buy” or a “strong buy.”

As we’ve noted already, the analyst community seems quite bullish on GDS. But everything is relative, and they are even more bullish on the company’s two main competitors, VNET (VNET.US) and Chindata (CD.US). Using their targets as a guide, those analyst think shares of GDS, which is the biggest of the three, are undervalued by about 50%. But they think VNET shares are undervalued by a whopping 74% and see Chindata shares as undervalued by about 62%.

Those views also play out in the three companies’ price-to-sales (P/S) ratios, with GDS trading at the highest ratio of 6.7, versus 4.4 for Chindata and a lowly 1.2 for VNET.

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