GDS Earnings: Capacity Growth Expected in the Second Half

No-moat GDS GDS retained its previously announced 2023 guidance following a second quarter where it reported 7.4% year-on-year revenue growth, which was in line with the first quarter; and 16.3% year-on-year adjusted EBITDA growth that was well ahead of the 7.5% reported in the first quarter. However, the outperformance in the second quarter was largely driven by some one-offs, including an early termination from the backlog and a cash reimbursement. Excluding these, second-quarter revenue was up 3.9% year on year and adjusted EBITDA was up 7.5% year on year. The company had previously disclosed that it expects 2023 to be affected by one large internet customer moving out of its downtown data centers in Beijing. As a result, it will record around 17,000 square meters of churn spread across the first three quarters of 2023 and expects additional area utilized net of churn in 2023 to be similar to the levels seen in 2022 of around 50,000 square meters of net add. The company only added 12,248 net utilized square meters in the first half of 2023. However, it expects to start utilizing capacity from its international expansion in the second half with 1) around 30,000 square meters of Chinese move-in and 2) 20,000 square meters of international move-in in the second half, and so now expects to reach or exceed its full-year guidance.

We retain our forecasts and our fair value estimate of HKD 28 (USD 29). The stock price has generally declined since early 2021, when it peaked at over HKD 110 per share. At current levels we see GDS as undervalued, trading on a price/book ratio of around 0.6 times. GDS does not revalue its data centers each year like a property REIT does and we estimate that its early data centers in major city central business district areas have substantially increased in value over time. We believe a P/B ratio of well over 1 is justified. The main catalyst for the share price to move to this valuation would be improved cash flow over the next 2-3 years.