9698.HK GDS.US

The data center operator’s revenue growth slowed in the third quarter, as it officially launched its first offshore data center in Malaysia

Key Takeaways:

  • GDS’ revenue grew 6.4% in the third quarter, slowing from 7% in the second quarter and 15% in the third quarter of 2022
  • The company is investing heavily in Southeast Asia to jumpstart growth as its home China market cools amid a broader economic slowdown

  

By Warren Yang

For data center operators like GDS Holdings Ltd. (GDS.US; 9698.HK), overseas expansion is increasingly looking like a necessity, instead of just a “nice-to-have” option.

Despite talk of a potential surge in demand for facilities to store and process huge volumes of data to power new technologies like AI, demand for data centers in China is cooling as its economy slows after years of breakneck growth. As that happens, GDS is taking a page from what has become a popular playbook for Chinese companies by looking to Southeast Asia for new growth.

Now, the race is on for the company to quickly reap benefits from its overseas investment, as investors grow impatient with its slow revenue growth at home and big spending to expand overseas.

GDS’ revenue grew 6.4% year-on-year to 2.5 billion yuan ($345 million) in the third quarter, according to the company’s latest quarterly earnings released last Wednesday. That represented a slowdown from the 7% growth in the second quarter and nearly 15% in the third quarter of last year.

But that’s not the worst part. The company’s gross profit actually shrank year-on-year as its cost of revenue increased faster than its revenue as it builds up new operations both at home and abroad. Its operating expenses increased as well, with the result that its net loss widened.

Still, GDS marked a notable achievement during the third quarter as its first data center in Southeast Asia officially went online. The company first expanded into the region in 2021 by providing services in Singapore through a data center operated by a third party. That operator, Singapore-based STT GDC, owns a portfolio of data centers across Asia, and is a key investor in GDS, with their relationship dating back to 2014.  

Since its foray into Singapore, GDS has been working to open its own data center in the adjacent market of Malaysia to serve Southeast Asia. That effort came to fruition in the third quarter, with a 10,000-square-foot space in Johor state starting operations for a local customer. GDS plans to bring another overseas facility of a similar size into service in the final three months of this year, founder and CEO William Huang said on a conference call to discuss the company’s latest results.

GDS has also acquired land for a second campus in Johor. And in Indonesia, it has signed a joint venture agreement with the country’s sovereign wealth fund, INA. With these moves, GDS is betting that its new overseas operations can provide a new growth source.

“For international, our financial objectives are to create a second growth engine,” Huang said.

In China, cloud service providers that are GDS’ key customers are shifting their focus to quality over quantity, Huang said, which usually refers to focusing on profitability. While this can be good for the cloud companies, it’s less positive for GDS since those customers require less data center capacity. AI companies could be a future source of growth, but that market is crowded with unprofitable startups and isn’t taking off quickly as expected.

Headwinds in China

Reflecting such headwinds for Chinese data center operators, one of GDS’ two main publicly traded rivals, VNET (VNET.US), reported an unimpressive 4% year-on-year increase in its total revenue for the third quarter, although its net loss narrowed, helped by a reduction in operating expenses.

In this environment, GDS has set realistic targets for its domestic business. It aims to consistently generate positive cash flow from its China operations and reduce its debt.

But at least for now, the company seems a long way from being able to fund its new investment with money from its existing data center operations. In the third quarter, its investment continued to dwarf its cash generated from operations. GDS also remains heavily leveraged, so its interest expenses actually exceeded its gross profit in the third quarter.

As it steps up its international expansion, GDS’ spending is set to continue ballooning. In the first nine months of this year, capital expenditures (capex) for its overseas business totaled about 2 billion yuan. As it builds up its Malaysia operation, the company expects to spend a similar amount in the next three months, bringing the total for all this year to 4 billion yuan – more than the 3.5 billion yuan earmarked for capex in China.

GDS is looking to fund half of its overseas capex by selling equity and half with debt. On the company’s earnings call, management sounded confident that it will be able to complete the equity part of the fundraising plan in the first quarter of next year. Of course, that will depend on sentiment in capital markets, which may not necessarily agree with GDS’ optimism.

GDS was founded in 2001, and it has taken it two decades to come close to funding its domestic business without a need for external funds. How long it will take for the company to replicate that feat overseas is anyone’s guess.

In one rosy scenario, a deep-pocketed private equity fund could snap up the company and hold it until it becomes comfortably self-sufficient. If and when that happens, such a new owner could sell the company at a decent profit, based on its ability to operate profitably and generate strong cash flow.

Some similar mega deals for data center operators outside China occurred last year, and talks of potential sales of VNET, and Chindata (CD.US), another major competitor of GDS, have circulated for quite some time now. Both VNET and Chindata are currently in the process of being privatized by their major stakeholders, which could leave GDS as the only publicly traded member of the trio.

All three Chinese companies currently trade at low valuation multiples, which may partly explain all the buyer interest in them. GDS stock trades at a price-to-sale (P/S) ratio of just 1.4. The multiple is an even lower 0.4 for VNET, although Chindata trades at a more respectable 4.

Considering how capital intensive the data center business is in general, and given the current weak climate for the industry in China right now, quick sales of any of the three companies to independent private equity buyers may be wishful thinking. So, for GDS, at least, the best way forward for now seems to be building up its international operations to provide a hedge against its slowing home China market.

Have a great investment idea but don’t know how to spread the word? We can help! Contact us for more details.

The Bamboo Works offers a wide-ranging mix of coverage on U.S.- and Hong Kong-listed Chinese companies, including some sponsored content. For additional queries, including questions on individual articles, please contact us by clicking here.

To subscribe to Bamboo Works free weekly newsletter, click here

Recent Articles

China’s leading online travel agent Trip.com on Thursday reported its net profit soared more than six-fold to 9.92 billion yuan last year, mainly due to strong post-pandemic demand for travel in both China and internationally.

FAST NEWS: Trip.com annual profit soars on travel rebound

The latest: China’s leading online travel agent Trip.com Group Ltd. (9961.HK; TCOM.US) on Thursday reported its net profit soared more than six-fold to 9.92 billion yuan ($1.38 billion) last year,…
Venus Medtech shares remain suspended

Venus Medtech still seeking cure for governance problems

The transcatheter maker’s shares were suspended last November, and it must still meet several conditions from the Hong Kong Stock Exchange before trading can resume Key Takeways: Venus Medtech disclosed…