Alert: Post results takeaways – Focus on Guangdong leases
- Questions have arisen regarding Neo Telemedia, the master tenant at KDCREIT’s Guangdong data centres
- It’s important to note that the tenant has consistently met all rental obligations and has not indicated any issues at this juncture; however, KDCREIT is closely monitoring this situation
- In a worst-case scenario, KDCREIT stands to benefit from having a Sponsor with a well-established team in China capable of taking over property operations and management
- Given the limited information available, we believe it’s premature to take any immediate action; we will provide updates as soon as more information becomes available
What has happened?
We hosted KDCREIT for their post-3Q23 business update release and noted that there has been quite a few questions surrounding the master lease at their Guangdong Data Centres. Neo Telemedia is the master-tenant at Guangdong DC 1 and 2, and will also hold this role at Guangdong DC 3 once it is completed, sometime in 4Q23. Following net losses reported in FY22, Neo Telemedia reported another net loss in 1H23, leading to a correction in their share price since June 2023.
The spotlight has now turned to KDCREIT as the income contribution from the 3 DCs in Guangdong will account for approximately 10%-11% of their revenues. Many questions have emerged regarding the potential impact on KDCREIT should Neo Telemedia face financial difficulties or even bankruptcy in the worst-case scenario. As the Guangdong DCs are master-leased to Neo Telemedia, KDCREIT lacks visibility into the assets’ utilization but continues to receive full rental payments.
Given Neo Telemedia’s income representing 10%-11% of KDCREIT’s earnings, a worst-case scenario involving Neo Telemedia’s bankruptcy could potentially have a maximum 16% impact on DPU. However, it’s important to note that Neo Telemedia has maintained current rental payments and has not indicated any payment delays. While our base case currently assumes no impact on earnings at this stage, we have outlined two scenarios below for illustration:
i) In the first scenario, we assume the master-lease is terminated, and KDCREIT reclaims the space with a utilization rate of only 50%.
ii) In the second scenario, we assume the master-lease is terminated, and KDCREIT receives zero income from the 3 properties.
|DPU||Impact||Implied yield||DPU||Impact||Implied yield|
|1. Assuming 50% utilisation||9.5||-8%||5.0%||9.9||-8%||5.2%|
|2. Worst case||8.6||-16%||4.5%||9.1||-15%||4.8%|
Source: DBS Bank estimates
These scenarios provide a comprehensive view of potential outcomes, but it’s crucial to reiterate that we consider these scenarios as unlikely at this time. KDCREIT is closely monitoring the situation and maintains regular communication with the tenant. While there is currently no indication of leases being impacted or terminated, KDCREIT has highlighted that, in a worst-case scenario, their Sponsor could step in and take over property operations. Over the years, the Sponsor has bolstered its capabilities in China and currently maintains a fully-fledged team based in Shanghai, possessing expertise in development, fit-out, maintenance, and leasing.
Despite concerns about Neo Telemedia’s profitability lingering for the past 1.5 years, these concerns have come to the forefront in our meetings and calls today. At this juncture, there is still no indication that the leases will be affected. Moreover, KDCREIT benefits from having a Sponsor with the capabilities to operate and manage data centres. Security deposits are also in place, which KDCREIT could utilize in the event of any late payments. Additionally, KDCREIT’s Sponsor boasts a well-established team in China, capable of taking over property management if necessary, ensuring a faster transition and minimising any downtime.
The table above illustrates 2 scenarios and their potential impact on DPUs. However, it’s important to stress that both of these scenarios are currently deemed unlikely in our view. Even in the event that these scenarios do materialize, we are aware of the fact that the demand for data centre capacity in Tier 1 cities in China continues to exhibit robust health, with leasing enquiries showing an upward trend in recent times. Despite this, we understand that the recent developments regarding Neo Telemedia may potentially pose a risk to KDCREIT. However, it’s essential to emphasize that, at this stage, it is premature to take any immediate action, given that the tenant has consistently met all their rental obligations and has not signalled any issues. We will maintain a vigilant stance, closely monitoring any further developments and will promptly provide updates as they become available.