Powering up in China
(+) Delivering acquisitions ahead of expectations
Just as we had turned cautions and lowered our acquisition assumptions for KDCREIT, it has surprised on the upside by delivering two acquisitions in Guangdong, China. Following the successful acquisition of its first data centre in China back in December 2021, KDCREIT has activated its ROFR for another two data centres within the development. The acquisition of the two new data centres will be carried out in two stages.
(1) Guangdong DC 2 (6 Bluesea Intelligence Valley Data Centre):
- Purchase consideration of RMB 760.0m (including VAT)
- Fully fitted data centre with a GFA of c.219,000 sqft
- Assumed completion of acquisition by end of 3Q22
(2) Guangdong DC 3 (7 Bluesea Intelligence Valley Data Centre):
- Purchase consideration of RMB 760.0m (including VAT); first tranche payment of RMB 100.0m
- The initial RMB 100.0m will generate coupons/interest of c.8.0%
- The remainder RMB 660.0m will be paid when fit outs are completed and the property is handed over to KDCREIT (expected by end 3Q23)
- Fully fitted data centre with a GFA of c.222,000 sqft
(+) Healthy initial gross yields of c.8.3%
Based on an initial gross rent of RMB 63.0m for each property, both assets were acquired at a relatively attractive gross yield of c.8.3%. After accounting for VAT, the initial gross yield is at an estimated c.8.0%.
Upon the handover of the properties to KDCREIT, the vendor (Guangdong Bluesea Data Development Co., Ltd.) will sign a 15-year master lease for each data centre. We understand there will be annual rental escalations, and we believe it would range between 2.0% – 3.0% per annum.
(+) KDCREIT expanding its footprint in Bluesea Intelligence Valley Mega Data Centre Campus
Following the acquisition of Guangdong DC 2 and Guangdong DC 3, KDCREIT will now own three of the six data centres to be developed on the campus. All three data centres are developed, and master leased to Guangdong Bluesea Data Development Co., Ltd., a subsidiary of Neo Telemedia Limited (listed on the Hong Kong Stock Exchange; 8167 HK).
Based on Neo Telemedia’s latest quarterly results for 1Q22, its loss for the period increased from HK$18.8m to HK$38.5m y-o-y. We understand that the wider losses for the year was due to higher depreciation and finance costs, as well as utility consumption by its customers.
However, the 15-year master lease should underpin income stability for both the data centres. The vendor has the option to terminate its leases only after year 12, and will have to pay KDCREIT the full amount of rent even while it ramps up the physical occupancy at both the properties.
(+) Sufficient debt headroom to fund both acquisitions
We understand that the REIT intends to fund the RMB 860.0m (RMB 760.0m and RMB 100.0m) in FY22 entirely by debt. Based on our projections, KDCREIT’s gearing will increase by c.1.0ppt to c.38.5% following the transaction in FY22. For the remaining RMB 660.0m due by 3Q23, we believe that KDCREIT may rely on a mix of debt and equity to fund the payment.
In our projections, we have taken a conservative approach to assume that KDCREIT will fund the remaining RMB 660.0m for Guangdong DC 3 through a mix of 35% debt and 65% equity (to maintain gearing at the 36% level). This implies a potential equity fund raising of slightly more than S$90m in FY23. However, the amount of equity to be raised could be lower if KDCREIT’s portfolio undergoes a valuation uplift by the end of FY22.
(+) c.2.6% accretion projected for FY23
As we have only assumed one quarter of contribution from the acquisitions in FY22, the bulk of the accretion will be in FY23. As compared to our earlier projections, the full-year contribution from Guangdong DC 2 and the coupons from Guangdong DC 3 in FY23 will lead to a c.2.6% accretion to DPU.
In our forecasts, we have also taken a prudent approach and assumed that KDCREIT’s borrowing costs will increase by 30 bps over the next three years.
Our thoughts
Amid record-low yields for data centres globally, we are pleasantly surprised by KDCREIT’s ability to embark on this acquisition valued at c.S$320m. The relatively attractive yield of c.8.0% would drive DPU accretion over the next three years. Although the supply of data centres throughout China is expected to grow in the near-to-medium term, the 15-year lease for both properties will ensure income stability. Moreover, we understand that demand for data centres in the Guangdong province continues to remain very strong. The triple-net basis for both the leases at Guangdong DC 2 and 3 also helps to mitigate any potential increase in operating costs, and the annual rental escalations will provide for some organic income growth.
Moreover, the technology and internet sectors in China could benefit from the potential easing of regulations after more than two years of scrutiny by the authorities. The return of rapid growth of the technology and internet sectors should drive stronger demand for data centres in China.
Although we have factored in a potential equity fund raising of c. S$90m by 3Q23 (to fund the remaining payment for Guangdong DC 3), we still expect the acquisitions to be c.2.6% accretive to DPU. Furthermore, if KDCREIT’s portfolio undergoes a revaluation uplift at the end of FY22, the amount of equity fund raising could potentially be lower.
Having exceeded our growth expectations, our projections do not assume any further acquisitions. Any further acquisitions for the rest of FY22 and FY23 will lead to upside to our estimates. In addition to the ROFR for the three remaining data centres to be developed at the Bluesea Intelligence Valley Mega Data Centre Campus, KDCREIT can tap on its extensive network for other third-party acquisitions.
Based on our revised DPU estimates, KDCREIT is currently generating a very attractive forward yield of more than 5.2%. As such, we have raised our TP to S$2.50 and maintain our BUY recommendation on KDCREIT.