Summer Series: NEXTDC Ltd (ASX: NXT)

Bryce Leske: [00:01:28] Welcome to the Equity Mates Summer Series of 2020, brought to you by superhero, the newest broker in town, offering five-dollar brokerage and zero dollar brokerage on ETFs, head to superhero Dot Dotcom to find out more over 12 episodes, we're going to be diving into some of Australia's largest and most well-known companies as selected by you. The Equity Mates community will be unpacking the company, its industry, the outlooks, and key financials. And in some instances, we'll also be taking the tough questions straight to the CEO to do this. As always, I'm joined by my equity buddy Wren. How are you going, bro? [00:02:03][35.1]

Alec Renehan: [00:02:03] I'm very good, Bryce. How are you? [00:02:05][1.4]

Bryce Leske: [00:02:05] I can't complain. Always fun talking stocks. [00:02:08][2.4]

Alec Renehan: [00:02:08] That's it. [00:02:08][0.3]

Bryce Leske: [00:02:09] That's the first cab off the rank in the cloud space for us. [00:02:13][4.0]

Alec Renehan: [00:02:15] Yes. Yes. Well, I'll let you finish the first cab off the rank in the. Yes, the first cab off the rank in the studio [00:02:23][8.2]

Bryce Leske: [00:02:24] now is next. DC ASX Ticker and X t. We have spoken about this during the year. It's been one of the hottest stocks on the ASX and a massive thanks to his zaffar for helping us with the research and analysis of this, a member of the Equity Mates community. So a big shout out and many thanks as always. We're going to be talking about company structure and summary industry context, a bit of the outlook for the future, some financials and then having a crack at a valuation if it is profitable. [00:02:56][32.4]

Alec Renehan: [00:02:57] Spoiler alert. It is nice play. Well, it was it's not a spoiler alert. [00:03:03][6.0]

Bryce Leske: [00:03:04] It is. It was. Maybe not. [00:03:05][1.2]

Alec Renehan: [00:03:05] It has it hasn't been in the last two years. But I think we can have a chat about valuation. [00:03:09][3.4]

Bryce Leske: [00:03:09] Sure, sure. Sure. So next, say Ren, it's a company involved in, I guess, the operation of data centers here in Australia, and it focuses on providing support and infrastructure for companies looking to be involved in cloud and move a lot of there what would traditionally be hardware online into the cloud. [00:03:29][20.1]

Alec Renehan: [00:03:30] Maybe let's do a software, let's do a cloud computing one on want and where data centers fit in just for people who aren't aware or haven't listened to our episode, which they should. Yeah. Traditional business that needed to have technology infrastructure would have to build that infrastructure themselves, would have to get servers, set them up, and then they could store their data on those servers. What cloud computing has really enabled is data centers to hold that data remotely. And so there, I guess, like the key pieces of infrastructure in the technology revolution and they allow companies, everyone from the Amazons and the Microsoft's of the world to the Equity Mates business to store their data remotely. And that data is then stored in a data center rather than us having to set up servers to hold all our data ourselves. [00:04:22][51.8]

Bryce Leske: [00:04:22] Nice. So pretty important space grass and growing space. Yeah, certainly. Do go and listen to our discussion with Natalie Puerco. She really went through the whole cloud industry from going to whoa from Google. [00:04:35][12.4]

Alec Renehan: [00:04:35] We should start on Google. That's a key selling point. [00:04:38][2.3]

Bryce Leske: [00:04:38] She knows what she's talking about. So next, say they've got some pretty big clients for Amazon Web services. Use them. [00:04:44][5.7]

Alec Renehan: [00:04:45] People are probably familiar with Amazon Web Services and Microsoft Azure these days. And next, say partner with them. And then if you're you know, if you're signing up to Amazon Web Services in Australia, you're going through Amazon. But the actual data center that the actual infrastructure may be owned by next day, say. And so I think from the outset, the way to think about data centers all the way, I think about data centers, is there an infrastructure play, really incredibly capital intensive assets that have in an incredibly long life that next day, say, in a few other companies, but actually not that many listed those days build and then operate and store data for companies. And then also, you know, I guess like a white label that Amazon and Microsoft white label that storage as Microsoft website as your Amazon Web Services. [00:05:34][49.1]

Bryce Leske: [00:05:34] Yeah. So when we talk about the importance of the management team, so we thought it'd be a good time to touch on that. The CEO is Craig Scraggy and he was the executive chairman at Asia Pacific Data Center Holdings, a company you used to own. I did apparently is pretty well recognized within the industry for his leadership and IT experience and has really grown next DC from what was a startup operating only a small single data center to now Australia's leading center for this sort of service. So, yeah. Do you still own the Asia Pacific? [00:06:04][29.8]

Alec Renehan: [00:06:05] They were acquired by the next day. So they were one of the very first companies I bought. It was around you know, the one we're living together. Yeah, yeah, yeah, yeah. I don't think I held them for that long, but yeah, they've been acquired. And that was what I found when I was looking at ASX listed data centers. There are a few small ones. DC two is a ticker tape, I'm pretty sure. Is another Tica, Macquarie Telecom, I think it's worth about a billion dollars and operates in data centers, but next DSA, which is worth about five billion dollars, is the biggest by a long shot in [00:06:38][33.1]

Bryce Leske: [00:06:38] Australia, eating everyone [00:06:39][0.8]

Alec Renehan: [00:06:39] out. Yeah, in terms of, like, pure-play data center, you know, like obviously don't come at me and tell me that Telstra operates data centers and stuff like that. [00:06:46][7.1]

Bryce Leske: [00:06:47] So their revenue is also growing at a pretty phenomenal rate as well. FY 2012 financial year to 2012, that revenue of one point two million and they've just ticked over revenue of 200 million in FCI 20. So it's certainly growing with the industry and their customer base is growing at 21 percent year on year as well over the last four years. So really positioning themselves as a power player here in Australia. [00:07:10][22.9]

Alec Renehan: [00:07:11] You touched on the CEO before. It would feel remiss of us to move on without talking about their founder, who is probably the least known but one of the most successful entrepreneurs in Australia. Full stop, Bevan Slattery. He's a technology entrepreneur. He's founded a number of technology businesses, but he seems to have a bit of a Midas touch when it comes to technology. He's founded businesses that have sold to US companies, sell to company to Tape J. He founded Next D.A., which is listed founded in Megaupload, which is listed. He founded a number of other technology companies, some of which are listed, some of which have been acquired, is worth, I think, about half a billion dollars. But if you're interested in where technology's going and where cloud and like telecoms and cloud computing and all of that is going, Bevan Slattery is a name to know and someone to watch. [00:08:03][52.0]

Bryce Leske: [00:08:03] Follow the money. [00:08:04][0.4]

Alec Renehan: [00:08:04] Yes. Yeah. Then follow the smart money. [00:08:07][2.6]

Bryce Leske: [00:08:07] Yeah, it's a pretty phenomenal entrepreneur, to be honest. Look, it goes without saying I don't think we need to go too deep into this, but the context around the industry and its competitors, it's in an industry that is really growing and is becoming of more importance to many companies as they go through digital transformation. The rise of cloud computing, you know, has raised demand for obviously cloud hosting companies throughout Australia. Next DC being one of them. As you said at the start, cloud hosting really allows applications and websites to be accessible from anywhere. Really, you don't have to be tied at your desk to your PC. You can be anywhere in the world accessing all this stuff in the cloud, Gmail, you name it. Why are you looking at me like that's a simple level? More and more companies are beginning to transition from single servers to these cloud based alternatives. And, you know, next DC positioning themselves here in Australia as the one to go to for that sort of stuff. So the advantages are that if, you know, it allows for economies of scale and reduced operating costs within the business. So whilst you don't have to maintain the service yourselves, you can just pay for access to the cloud infrastructure that next day say you're offering. And it's a very cost effective way of having some pretty powerful technology at your hands. [00:09:27][79.4]

Alec Renehan: [00:09:28] Yeah, yeah. So I think in terms of the competitors and the industry landscape, as we mentioned next, I say are really the biggest in Australia. They're worth about five billion dollars and they have data centers in most major capital cities. They have a few in Sydney, they've got one in Melbourne, one in Perth and I think a few others. There are some competitors. And obviously demand in the industry grows. They're going to build more and their competitors are going to build more. But I guess the key thing when you're looking at competitors is data centers have different technical standards. And I don't want to go too far down this rabbit hole, so pull me back if I do. But basically, different data centers are appropriate for different levels of, I guess, important when it comes to data. And, you know, there's like some of next Desai's data centers are level four, which are designed to host the most mission-critical computer systems with fully redundant subsystems. And, you know, they have the ability to withstand like power outages and stuff like that. So I think when you're looking at the competitors, you know, you're looking at who's out there, how many data centers they have, what capacity do those data centers have. And then at what he did, I operator and then, you know, then you get into what's their revenue per square foot or what's the revenue per like water and stuff like that. I mean, next, they say are a big operator. They've rolled up a few other companies like Asia Pacific Data Centers, which was another ASX listed player. And really they're trying to be the number one in Australia. [00:11:00][92.0]

Bryce Leske: [00:11:01] So we've spoken about the industry, some of their competitors, and also a summary of the company. Before we jump into future plans and valuation, we'll just take a quick break to hear from our sponsors. So, again, you mentioned at the top of the show they were profitable, they're not profitable, so maybe it's a good time to turn our attention to the financials of the company. [00:11:23][22.6]

Alec Renehan: [00:11:24] Yeah, let's do it. If we start with the revenue, they've had some pretty incredible growth over the past decade. And I'll just ride out the consistency of this growth is pretty phenomenal. So the first year they created revenue was twenty twenty one point three million. And then from there, they did thirty three, forty six fifty nine, eighty nine hundred and eighteen hundred and fifty three hundred and seventy two hundred and one. [00:11:48][24.1]

Bryce Leske: [00:11:49] They went from one million to 33. Yeah. [00:11:50][1.8]

Alec Renehan: [00:11:51] Yeah. Hold on to that one point to that I never lost. Yeah. But I think like for me that consistency of growth is really impressive and obviously, some of that is from acquisitions, some of that is from building new data centers, some of that's from making more revenue from existing data centers. But as a first thing, you look at that level of growth and that consistency of growth is quite impressive. [00:12:14][22.7]

Bryce Leske: [00:12:15] And how is that translating to the bottom line? [00:12:17][2.1]

Alec Renehan: [00:12:17] Good question. So for the first five years, they made a loss and those losses weren't linear, but they range from sort of losing two million dollars to losing a bit over 20 million dollars in financial year 2016. They turned a profit, so they made one point eight dollars million and then 23 million dollars. Things going up, then down to six point six dollars million. Not great. And then the last two years, they've lost money. Ten million dollars and then forty five dollars million. [00:12:46][28.5]

Bryce Leske: [00:12:47] I'm assuming that it's so lumpy because are they you know, are they using money to acquire. What's that balance sheet looking like. [00:12:53][6.7]

Alec Renehan: [00:12:54] They are using money to acquire. The thing is given they're not profitable. But if you strip out some of those things like depreciation and amortization and you look at Abda, they are making money. If you then go down and look at their cash flow statements and you say, well, from a statutory perspective, they may not be profitable, but are they generating cash that they can give to their shareholders? Their free cash flow is actually negative every year. And a big part of that is because they're purchasing a lot of property. So in the last financial year, they spent about four hundred million dollars buying property. So, you know, expanding their datacenter footprint and their free cash flow was negative. The one thing that I noticed pretty quickly is that they're issuing more stock every year. They shoot eight hundred and sixty two million dollars worth of stock this year, five hundred million last year. So it looks like they're funding the expansion through issuing stock, which is something to keep in mind. But look, really, this is a company that is trying to position itself as the biggest in the market. And so I'm sure if we got to speak to the next day, say, CEO, which unfortunately we're not, they would say that they're building a lot of these assets, trying to take a dominant position in the market, and then those investments will pay off for years to come. [00:14:06][71.4]

Bryce Leske: [00:14:07] Nice Ren, So let's look to the future. I mean, for me, this is more about the growth play and the industry that they're in. If they can keep up the growth rates that they have been experiencing over the last few years, you know, they're going to be turning into a pretty sizable company if they continue to get longer term contracts with customers. And I can just say the demand only increasing for their services. So I think the outlook for this company looks pretty good from a from a macro standpoint. They've given guidance for a bit FII 21 of 125 to 130 million, which is up 20 to 25 percent on current. So continuing the growth rates that they've been experiencing. [00:14:48][41.9]

Alec Renehan: [00:14:49] Yeah, it's an infrastructure play. They're trying to build as much capacity as possible and then lock in long term recurring revenue on the back of that capacity as long as they keep growing their top line. I guess it's interesting you would like to see them become profitable again consistently at some point. Yeah, but the share market obviously love it. It's up, what, about 700 percent since it listed. [00:15:09][19.5]

Bryce Leske: [00:15:09] Yeah. Been buzzing this year. [00:15:11][1.6]

Alec Renehan: [00:15:11] Yeah, I think about up 70 percent this year. [00:15:13][2.3]

Bryce Leske: [00:15:14] So in terms of valuation, again, if you're looking at most recently, it's a bit difficult to do given that they are not profitable. Yeah. If you want to take some of the numbers from profit previous the last two years, you could do it that way. And you can also do a comparative valuation and look at where they stack up against some of their competitors using some of their profit numbers from a few years past. If you do that, then they are certainly more expensive on a price to sales ratio against Macquarie Telecom, for example, and desex and a couple of the competitors, you know, next week is much, much more expensive at a price to sales of about 20, whereas the others are between one and a half and four. In terms of a DCF friend, you've had a crack. [00:15:56][42.4]

Alec Renehan: [00:15:57] This is all very much just an exercise in, I guess, learning for us because it doesn't have free cash flow and it doesn't have earnings. So it's difficult to discount cash flow. Yeah, yeah, yeah. Just for the sake of the exercise, I said, all right, well, let's use a. As the number, because that was a positive number, and so the Persian number there is 30 cents. And I guess just to give you an idea of the range of outcomes that you can get. So using the same inputs, so a 10 percent discount rate, three percent growth rate after the five years, I put in two different numbers. So the first number I put in was the average over the last five years, the company growth, Obediah at 37 percent. And so I said all, let's use that number and say what it comes out. And it came out at nine point forty one, which is pretty in line. Well, I mean, it's a little bit below the current share price at eleven or eleven point twenty five. So it was even expensive. If it was able to continue growing at that 37 percent, which is a pretty big number, then if we say, all right, well, let's not use it to historic growth rate, let's use the growth rate that the company has said it's expecting to say next year, which is that 20 percent. Yeah, and let's say that actually continues for the next five years and then same other inputs after that. It only grows at three percent discount rate of 10 percent. Using that 20 percent number, you get five point twenty five. So about half of what the company is currently trading at or just as a third option, if you were to say over the last five years, its revenue grew at 13 percent. So let's use that as the growth rate, you get a value of four dollars and six cents. So for me, it just shows again that the supposed science of discounted cash flows, whilst useful, is so dependent on the assumption you use, whether you use its historic growth rate for Abida, its forecasted growth rate for the next year, the company's forecasted growth rate or its historic revenue growth rate, you get a range of values from four dollars to nine and a half dollars, all of which are below the current company's current share price of eleven dollars. But it just shows that the real work in the discounted cash flow isn't in putting the numbers in. It's in the proper forecasting of the numbers. [00:18:17][140.4]

Bryce Leske: [00:18:18] Yeah, particularly with the terminal growth, like if you're forecasting thirty seven percent over five years and the company is pretty much gone. [00:18:26][8.2]

Alec Renehan: [00:18:26] Yeah, yeah. Yeah. [00:18:27][0.6]

Bryce Leske: [00:18:28] So yeah, all of those inputs do make a significant difference. And you're right in doing it this way is an illustration of the variances that you can get. But certainly big firms are doing a lot more work. [00:18:39][11.4]

Alec Renehan: [00:18:39] Yeah, yeah. Yeah. So they're doing the forecasting and then and then the other thing that you can do is you can probability wait those outcomes. So you can say the likelihood of them getting 37 percent growth rate over the next five years is 20 percent likelihood. Yeah. Whereas having a 13 percent growth rate might be 40 percent likelihood. And, you know, you probability what those outcomes and then you get a sort of probability-weighted fair value. Yeah, yeah. But honestly, if all of that went over your head, don't stress about it. This part of the summer series is really just an exercise for us to try and learn ourselves as we're going. And what we are constantly reminded of is that while this feels like the most important part of the conversation, it is the least important and the least scientific, because as much as you can dress it up and make it look like you've absolutely nailed what fair value is, things aren't linear. You're not going to get a consistent growth rate. And what we've learned from the experts over and over again is good companies that are on the cutting edge of some industry disruption run by good management teams are the most important thing. And as Paul Wilson said in our most recent interview with him, discounted cash flows to him are just a sense check at the end. They're not the primary method of analysis because if your analysis is off, but a company is a great company that's growing year after year after year, you're going to be fine. Yeah, yeah. I'm very mindful that we go a little bit in the weeds at the end of these episodes. And I think it's worth just reminding ourselves and everyone listening where it should fit in the context of the analysis, [00:20:18][98.5]

Bryce Leske: [00:20:19] Great Ren, So that brings us to the end of next, say, a massive shout out to zaffar from the Equity Mates community who has helped with the research and analysis on this one. And thank you to our sponsors, Super Hero for sponsoring the Equity Mates summer series of 20-20. They are a new broker in town offering five dollar brokerage flat fee as well as zero dollar brokerage on all ETFs. So if you're into the ETF and want to build your core portfolio, head over to superhero.com.au to find out more information and to sign up. We love the platform, love what they're doing, making markets more accessible for everyday investors. So head over and check them out. [00:20:55][36.0]

Alec Renehan: [00:20:55] Yeah. Next day, say, part of the ASX 200. So if you want to buy an ASX 200 ETF, you can do it at zero dollar cost with Super Hero, probably also part of the Australian Technology ETF. The beta shares one [00:21:09][13.5]

Bryce Leske: [00:21:09] I would imagine [00:21:10][0.3]

Alec Renehan: [00:21:10] like that part is I would have seen. Insightfully said, you can safely say. [00:21:14][3.4]

Bryce Leske: [00:21:14] I can picture the top 10. Anyway, we'll leave it there and chat next week. [00:21:14][0.0]

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