GDS Holdings Limited (GDS) Earnings Call Transcript & Summary

Hello, ladies and gentlemen, thank you for standing by for the GDS Holdings Limited First Quarter's 2023 Earnings Conference Call. [Operator Instructions] Today's conference call is being recorded. I would now turn the call over to your host, Ms. Laura Chen, Head of Investor Relations for the company. Please go ahead, Laura.

Thank you. Hello, everyone. Welcome to the First Quarter 2023 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 will refer to during this earnings call can be reviewed 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, our COO, 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 the company's prospectus as filed with the U.S. 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 and this conference call include 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 will now turn the call over to GDS Founder, Chairman and CEO, William Huang. Please go ahead, William.

Okay. Thank you. Hello, everyone. This is William. Thank you for joining us on today's call. Before I review the 1Q '23 results, I would like to take a few minutes to highlight our strategic priorities for the next few years. What are we focused on? What are we trying to achieve? Since priorities will be benchmarked for tracking our ongoing performance. The roots of our business are in Mainland China. But in the past couple of years, we began to expand overseas. The 2 regions in which we now operate Mainland China and international are at different stages of development. Therefore, we have set different priorities for each region in order to achieve the best outcome for our shareholders. In Mainland China, we have grown our business over 20 years through several distinctive phases to become the leading carrier neutral age data center platform. In the most recent phase of growth, as demand from cloud and Internet took up, our priority was to win new business. We achieved an unprecedented level of new bookings, established the strategic relationships with all the leading customers and increased our market share. Our resource strategy was a key success factor. We invested heavily in building up our asset base in all Tier 1 markets in order to fulfill our customer requirements. 5 years ago, we had 20 data centers. Today, we have over 100. We believe it's the largest of development program undertaken by any data center company globally. In addition to the existing asset base, we secured the land and energy quarter to maintain continuous supply and grow for many years to come. Now the market in Mainland China is going through a period of adjustment, we are in a new phase, and we have reset our priorities accordingly. Our #1 priority now is to deliver this RMB 6 billion backlog, which is a result of our past sales success. It is sufficient to drive our revenue growth by over 60% over the next few years. Number two, as we have already won many years of future business, we will be highly selective in pursuing new orders. We will target opportunities which are strategic, a good fit to our available capacity, a fast-moving schedule and adapted financial returns. Number three, we will prioritize increasing utilization of existing assets. We have a large asset base both in service and under construction, which is committed by customers but not yet utilized. As a result, we can deliver the entire backlog with a relatively small amount of incremental CapEx. This enables us to achieve our growth targets while reducing annual CapEx to RMB 2 billion to RMB 3 billion and going forward. Number four, we will only initiate a -- we will only initiate new projects if there is committed demand with confirmed moving schedule. We expect most of our new projects will be expansion phases of existing sites. Number five, building on our success with positive wave of cloud and Internet demand, we will position our products and technology to capture the coming wave of AI applications. For international, our priorities are winning new business and the building market presence. Number one, we aim to develop our international business into a second growth engine, which creates significant additional value for GDS shareholders. Number two, we will anchor and derisk our projects with orders from our home market customers as they expand overseas. Number three, we will also win significant business from top global customers, many of which are established relationships in China. Number four, we will take advantage of our low unit development costs, which comes from our scale, product and the supply chain in China. Number five, we will build a stand-alone business in our international holding company headquartered in Singapore while maximizing synergies with GDS Mainland China. In 1Q '23, our gross new -- our gross new bookings was around 12,000 square meters, split evenly between Mainland China and international. Market demand in Mainland China over the past few quarters has been a bit soft. This is mainly because large customers who committed to a scalable capacity will need more time to absorb their inventory. In this environment, as I just explained, we are targeting high-quality business, which meets our criteria. A good example is the 4,600 meter or 9-megawatt order which we won for Shanghai 18. The customer is a major Chinese financial institution. The pricing is reasonable. And the underlying asset is an expansion phase of our existing Pujiang campus. On the international side, we won 6,400 square meters or 26 megawatts expansion order from the anchor customer for our campus in Nusajaya Tech Park, Johor. You may recall that we are already building 3 data centers on site 1, with total IT power capacity of 64 megawatts, which is fully committed by this customer. We started to construction less than 1 year ago on greenfield land. We are using our prefab design and product shifted directly from China. We are incorporating liquid cooling for part of the capacity as required by the customer. Despite the fact that this is our first project in Southeast Asia, we will deliver the first fully powered data center on this site in early 3Q 23. We estimate that our unit development cost is 20% lower than the local market. The ability to construct so quickly and at such a low cost give us compelling competitive advantages as we expand in the region. Our gross moving for the first quarter was around 13,000 square meter, which is consistent with the level of the past few quarters. Our customers are sounding more positive about their business outlook with new business initiatives and the strategic development as their business picks up, it will flows through to us 1 or 2 quarters later in terms of fast-moving. To adjust to the current environment, we have slowed down our capacity expansion. In 1Q '23, we brought 2,700 square meters of new capacity into service. Over the rest of the year, we plan to bring a further 57,000 square meters into service, split between Mainland China and international. All of this capacity has solid customer commitments and confirmed moving schedules. As a result of our efforts to adjust the pace of development, our utilization rate has gone up from 67% to 72% over the past year. At the same time, our backlog for area in service has come down from 136,000 square meters to 110,000 square meters. Our Mainland China business is going through a 3-year journey to achieve our goals. We are making progress quarter-by-quarter. We have already done the difficult part, which is to win high-quality new business and secure scale resource. Now it's all about exclusion, please stay a little patient and watch us deliver. Our international business is at a different story. There is a great market opportunities on our doorstep, and we know how to win. I'm excited about the prospects for us to create second of GDS. Before I hand over to Dan, I would like to make a few comments about my personal position. After we published the AGM notice a couple of weeks ago, I acknowledge that investors have a number of concerns. GDS was blown out of my vision more than 20 years ago. I have built an exceptional team, which has been a major success fact. For me, leading GDS is about much more than just the financial gains, it is driven by a passion to create something extraordinary. This dedication remains unwavering. And I assure you that nothing has changed in this regard. I want to take this opportunity to address these concerns and emphasize my commitment to our company. I intend to purchase approximately 1 million ADRs and the possible more over the next 12 months, if I'm able to do so. In addition, if the AGM proposal is passed, I commit to the sustaining my ownership percentage above the new schedule. I firmly believe that our current share price does not reflect the true value of our company. I have complete confidence in our ability to enhance our business performance and achieve sustainable growth. Let's creates significant value for our shareholders. Now I will pass on to Dan for financial and operating review.

Thank you, William. I would like to start by talking about our financial objectives, which what William said about our business priorities. For Mainland China, number one, we target to grow adjusted EBITDA at a mid-teens percentage CAGR by delivering the backlog. Number two, we will become free cash flow positive by which I mean free cash flow before financing within 3 years. There's already high visibility as to how we will achieve this goal. Number three, we will cap net debt at around current levels and target deleveraging to below 5x net debt to adjusted EBITDA. Number four, we will monetize assets to the extent required to recycle capital and keep within these financial parameters. And number five, we will sustain project level unlevered post-tax IRRs of 10% to 13% by keeping discipline about new business and resources. For international, one, we will pursue a low-risk investment strategy based on firm precommitments. Two, we will target the same investment returns on a portfolio basis as we do for Mainland China. Number three, we aim for international to contribute over 10% of our consolidated adjusted EBITDA within 3 years. Number four, we will take a segregated approach to financing, raising external equity and debt on a dedicated basis and not rely on the capital reserves of GDS Holdings. And number five, lastly, we will create additional value for GDS shareholders in a way which is measurable and helps our share price. Now I'll talk through our financial performance for the quarter. Turning to Slide 20, where we strip out the contribution from equipment sales and the effect of FX changes. In 1Q '23, our service revenue grew by 0.2% and underlying adjusted EBITDA grew by 6.6% quarter-on-quarter. Turning to Slide 21. Net additional area utilized during the quarter was 6,085 square meters. As we disclosed previously, a large customer is redeploying around 17,000 square meters from our data centers in Beijing to 2 of our campuses in Langfang, Hebei province. The move out impacts us for the first 3 quarters of this year. Thereafter, the customer will move into the new locations over about 6 quarters. In totality, there will be a net increase of area utilized by this customer but with a timing difference. If we add back the churn in 1Q '23, the underlying move-in rate was similar to previous quarters at around 12,600 square meters. We expect gross additional area utilized to continue at these levels in 2Q and 3Q '23 and then to step up significantly in 4Q '23 as we have contracts with fast moving. Monthly service revenue per square meter was RMB 2,149 in 1Q '23. We expect MSR to decline by around 4% comparing the final quarter of this year with 4Q '22. Turning to Slide 22. For 1Q '23, our underlying adjusted gross profit margin was up on the prior quarter by 1.4 percentage points, and our underlying adjusted EBITDA margin was up by 2.8 percentage points. At the GP level, this was mainly due to seasonally lower utility costs. At the EBITDA level, there was also some savings in SG&A. Our profit margins are going to fluctuate over the course of this year. Our guidance implies around 45% full year adjusted EBITDA margin at the midpoint, which has not changed. Turning to Slide 23. In 1Q '23, our organic CapEx in Mainland China was around RMB 1.4 billion. And International CapEx was RMB 600 million. Looking at our financing position on Slide 24. At the end of 1Q '23, our net debt to last quarter annualized adjusted EBITDA ratio was 8.1x. If we add back the cumulative investment in international of around RMB 5 billion or USD 700 million, the ratio is below 7x. Our effective interest rate for 1Q '23 dropped to 4.3%. In January of this year, we issued a USD 580 million CB. As a result, our cash balance increased to RMB 10.2 billion or USD 1.5 billion at the end of the first quarter. In a few days from now, we expect to repurchase USD 300 million of an existing CB when it is put, which will leave our pro forma cash position at around RMB 8.2 billion or USD 1.2 billion. Over the remainder of 2023, we had RMB 2.4 billion of project loans to repay. We expect to draw down a similar amount of new project loans. Looking further ahead, in 2024, we have RMB 3.6 billion of project loans to repay. However, as a result of refinancing, which we are currently working on, we expect to reduce this number to RMB 2.1 billion. Once again, in 2024, the amount of debt repayment will be more or less equal to the amount of new drawdowns. Looking at our capital structure plan for Mainland China on Slide 25. As I mentioned, we target to cap net debt at around current levels over the next 3 years. We will, in effect, finance new investments through a combination of operating cash flow and asset monetization to the extent required. Our operating cash flow will strengthen with higher asset utilization and reduced input VAT as a result of lower CapEx. To give an update on the China data center fund, we have signed a limited partnership agreement with the investor. We are now in the process of refinancing the first project, which we intend to inject into the fund. We expect to receive the net cash proceeds from the fund of RMB 1.45 billion on completion of the first asset injection in the middle of this year. Turning to Slide 26, for international. We currently have 6 data centers under construction, 2 in Hong Kong and 4 in Johor. The portfolio totals over 120 megawatts of IT power capacity with over 100 megawatts of customer commitments. The cost to date is around USD 700 million, which we have financed with around USD 400 million of paid up capital and shareholder loans and around USD 300 million of external debt. We have already put in place long-term term loans for all of these projects. As I mentioned previously, we intend to raise additional equity externally, either at the project country or international Holdco level. We will pursue these options over the remainder of the year. Turning to Slide 27. We confirm that our guidance for FY '23 revenue, adjusted EBITDA and CapEx remain unchanged. We'd now like to open the call to questions. Operator, please?

[Operator Instructions] Our first question comes from Gokul Hariharan from JPMorgan.

My question is on the new targets in China in terms of delivering the existing backlog. Could you talk a little bit about what is the time horizon if it's in the 3-year period that you expect to deliver this backlog? And what are you hearing from your existing customers in terms of the ability to shorten the kind of time to move in from contract for some of this -- some of the backlog? And maybe also if you could talk a little bit about what would be kind of -- where would you get to EBITDA margins? Are we going to stay at similar level for EBITDA margins in the channel business? Or do you see a higher level as we move into a bit harvest mode for the channel capacity?

Yes. Thank you, Gokul. Let me clarify the financial targets. So the base year is 2023. And for most of the financial targets, we're talking about 3 years, plus or minus a few quarters. So for the mid-teens EBITDA CAGR for free cash flow positive, deleveraging to below 5x and incidentally, net income positive. We're talking about 3 years. For the delivery of the backlog, we didn't put a time frame on that because it's a little bit meaningless as we will still have some new bookings to be added to that. So it's a continuous process of adding new bookings and delivery. But this year, I think on a net basis, with the churn that we talked about, the net additional area utilized will be around 50,000 square meters. But next year, we expect that number to be probably 20,000 square meters higher than that. It's not -- that's our business plan base case. Do you want to talk about the more short term, what we're seeing move in, William?

Yes, Gokul, I think it's too early to say this will -- a lot of positive will affect today's this year's revenue. But we do see some positive signals from the market. I believe you're aware that our largest customer, they currently -- they announced that they will split car business. And also we'll probably go to list in any market, right? So in next 18 months, and this is very positive for me. I think this is -- and also the cloud China #1, #2, #3 [ cloud ] all cut their price selling price, which also means they start to pursue market share. It's not like last year or last 2 years to support the business plan. That means a very clear signal to pursue market share, again. So I think it will definitely will impact our move in. But so far, I think the whole sentiment totally changed, but not affect our current -- it's too early to see affect our current moving, but I do believe it will affect our next year or next 2 or 3 years moving schedule, I wish and maybe if possible, they will bring the moving schedule more early.

As we nedd to finish off and talk about the EBITDA margin expectations. So I think once again, referring to us a 3-year target. I would say we're looking for at least 2 percentage points higher EBITDA margin than we achieved in FY '23.

Got it. That's very clear.

We have a question from Jonathan Atkin from RBC.

You talked a little bit about synergies that you'll be getting in your international operations from China, and I think you talked a little bit about shipping some of the equipment into Malaysia. Can you talk a little bit more about whether it's revenue synergies or back office or operating synergies or other types of benefits that you will get between the core Chinese company and then offshore? And then secondly, I was interested in the demand profile that you're seeing internationally different demand dynamics. I think you've got fairly kind of single thread of demand at least currently in Johor. And what does the prospective kind of sales pipeline look like internationally? Is it Asia? Is it Western customers? Maybe a little bit more color on that.

Hey Jon, this is William. I think -- let me talk about the synergy between international business and the Mainland China business. I think it's very obvious we can leverage this our current product and supply chain and customer platform. This is quite unique, which I don't think the other player in this region has this kind of advantage. So I think the -- that's why we are very confident based on our current advantage we will follow-up our customers. We will follow up for a successful product in China, which we -- I think we're still very fully well divested product, right? And also the supply chain is very important as well. And I think because GDS already get to the -- reached the point which we always with largest builder in the world in the last couple of years. I think this has given us a very, very unique position to get a much cheaper supply chain, right?

sales pipeline...

The pipeline, I think it's not currently in the situation that everybody talk about the Southeast Asia, which is true, Southeast Asia has a huge demand, right? Because if you look at a Chinese customer or a U.S. customer, they all announced a big plan in this region. And so this is not just an announcement based on what's our dialogue between all GDS and all our customers, we do have the real demand in this region. So in terms of pipeline for us, I think we still remain a very strong pipeline from China and also U.S. customers. Again, I say, we also see some domestic demand.

We have a question from Frank Louthan from Raymond James.

As you look forward, what percentage of your installs and sales do you think are going to be AI related? And can you characterize the AI demand that you're seeing between the Mainland China business and the international deployments.

Yes. I think -- number one, I think in China, I think we see it's a little bit early stage for AI driven demand, right? So -- but it's happening right now. I think the -- in China, the big platform all announced -- already announced their AI stuff. And -- but we think it will impact our new booking maybe 1 year after or 2 years after. It's a little bit behind what's happened in the U.S. But I think it will happen, right? So this is in China. In outside -- international business, we have seen some let's say, new demand configuration is more AI-driven. So let's say, we would -- I already mentioned in our Southeast Asia data center. We already implement a liquid cooling stuff. This is mainly driven by the GPU type of server. So I think that this is mainly for the AI stuff. It's happening in Southeast Asia already.

We have a question from Peter Milliken from Deutsche Bank.

My question is about the forward sale. When was that first disclosed? Was it in the 2022 20-F? Or had it been announced previously because I hadn't heard of it before.

Peter, it was disclosed at the time 1 transaction, but they were disclosed at the time when the transactions were done. The counterparty banks, which certainly are amongst the large banks in the world were required to make disclosures and duly did so. So that was 100% in line with the legal requirements. At that time, the system employed by the U.S. SEC was that these disclosures were made in the so-called paper filings. And some institutional investors are in subscribe to services to search people filings and access that information. But as we know now, many do not. As a result, I think quite a few institutional investors who just kind of like relying on Bloomberg or [ Thomson ]. So we're not aware of the disclosure. Ironically, in April of this year, the SEC changed their system. So those disclosures would have been made electronically now and it would have been accessible in the usual way.

Right. Yes. I'm sure the people who invested in the secondary listing would have liked to have known that. Look, my second question is really about why you wouldn't have prepared the bonds to be ready for this change of control event potentially. You've had a few years where you've been aware of this. Why weren't you talking to them about changing covenants and rolling debt and things like that? Why is it -- why does it lead to the sudden point where investors have to make a quick decision on agreeing to this change of control event?

Peter, we operate in an environment where we make very extensive disclosures in our articles of association states that William's ownership, beneficial ownership falls below 5%, then this Class B shares automatically converted to Class A shares. I think everyone's known that as risk factors in our 20-F. And I think since the completion of our Hong Kong IPO, William shareholdings being just above that threshold, and it could have gone below that threshold for any number of reasons. If we'd issue only a relatively small number of shares and the capital rates, for example, this ownership would have gone below that threshold. So I mean this should be very clearly understood it as simple disclosure. Yes, we -- we need to make some changes to our articles subsequent to our Hong Kong IPO is something that all the companies in our category of U.S. ADR companies with secondary listings had to commit after the Hong Kong IPO to implement certain changes to the articles. And so we felt that it would be convenient or appropriate to package together all the changes the articles at the same time in our Annual General Meeting, which is what we're proposing to do.

We have a question from Edison Lee with Jefferies Group.

I have 2 questions. Number 1 is that 1 of your objectives at the early part of the PPT says that you are trying to shorten the lead time from investment in moving to less than 2 years. Is that -- what is the average period right now? And what is your strategy to try to shorten that to less than 2 years? And the second question is about how -- what percentage of your backlog for area in surface is going to hit that completion of the ramp-up period in the next within 2023.

Actually...

I missed the second part of the question, sorry. .