GDS Holdings Limited

Moat: 2/5

Understandability: 4/5

Balance Sheet Health: 2/5

GDS Holdings Limited is a leading developer and operator of high-performance data centers in China, primarily in the key economic hubs.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview:

GDS Holdings is a company that develops and operates data centers, mainly in China. Its core business revolves around providing colocation services, which essentially means offering space, power, and cooling infrastructure for clients to house their servers and other networking equipment. Think of them as landlords for the digital economy. They cater primarily to businesses, both large and small.

  • Revenue Distribution:
    • The company derives revenue mainly from colocation services. This means selling space, power, and cooling facilities within their data centers to their clients.
    • GDS operates data centers in major markets of China: Beijing, Shanghai, Shenzhen, Guangdong and Chengdu. A limited number of facilities also operate in Hong Kong, Singapore, and Malaysia.
    • For 2021, 2022, and 2023, they reported net revenue attributable to co-location services of RMB6.20, 7.62, and 7.97 billion respectively.
    • Managed services contribute a smaller amount of revenue but also have consistent growth; they generated RMB697, 772, and 789 million, respectively for 2021, 2022 and 2023.
    • There is a minimal contribution from other revenue sources.
    • In terms of regions, the revenue from China is way more dominant than other regions, as almost all the data centers are in China. As per the Q1 2023 Earnings call, 94.4% of the revenue is from PRC and 5.6% from all other regions combined, even though the company is expanding outside China.
  • Industry Trends:
    • The data center industry is booming because of increased digitalization, cloud adoption, and AI development in all businesses.

There is tremendous growth potential, especially in emerging economies. * Increased focus on data security and data sovereignty is driving growth in domestic data centers. * The data centers that GDS provide are a critical part of the supply chain for the technology sector.

  • Competitive Landscape:
    • Competition is strong, with established players and new entrants competing on pricing and service quality.

Competitors include both local and global data center providers. For example, Equinix is a global player in the same industry. * Some notable Chinese competitors are China Telecom, China Unicom, and Alibaba Cloud. * Some customers, including major hyperscale cloud vendors, are also developing their own data center capacity.

  • Differentiation:
    • GDS focuses on high-performance, customized solutions, attracting large, data-intensive customers. They also emphasize colocation services, for businesses that need data centers.

They are focused on high-performance data centers. * They focus their data centers in a limited number of key markets of China, thereby gaining market share. * They also have some international experience in Singapore and other regions. * They are a “carrier-neutral” provider. This means they allow the clients to select whichever communication service they want. * They also emphasize “green” or sustainable data centers.

  • Recent Concerns/Problems:

In its most recent quarter (Q1 2024), GDS had to significantly decrease their projections for upcoming revenue due to higher than previously estimated construction delays. Because of this, the market had a very negative reaction and their shares plunged.

  • The company was also cited to have significant liquidity issues. They are also expecting increased expenses and are having problems with funding.

Financials (in depth):

GDS’s financial situation has had certain red flags, specifically when analysing its recent numbers, and as a consequence, the analysis of it has become harder.

  • Revenue Growth: Revenue has continued to rise, however not as quick as before because of external challenges. In the latest financial year (2023), revenue went up by about 4% YoY, when in the last couple of years it was going up by double digits YoY.
    • This growth is attributable to both co-location and managed services.
  • Margins: They have been unable to expand margins due to increase in cost of expenses and increase in borrowings.
    • Net loss continues to haunt the company. They have been unable to turn profitable even when the revenue numbers have been growing.
    • EBITDA has been consistently around 30% in all of the last 3 years.
  • Cash Flow: Their ability to turn cash positive is a huge concern for investors. Free cash flow is negative and the business is bleeding money.
    • The operating cash flow, although improved significantly in 2023, still remains far below the capital expenditure.
  • Debt: The company has a large amount of debt, especially after its recent acquisitions. They have relied heavily on short-term and long-term borrowing in the past years. They have been using these debt numbers to fuel expansions and acquisitions.

High debt levels have led to increased interest rate expenses. In the latest fiscal year, the finance costs rose to RMB 1.5 Billion, from RMB 983 million in 2022.

  • Profitability: The company has been unable to establish consistent profitability. Instead, they have suffered net losses for the last several years.

This indicates issues with operational efficiency and pricing. * For fiscal year 2023, the company reported a total net loss of around RMB (4.4) billion, which was worse than previous years. For 2022, the company lost about RMB(1.4) billion and for 2021 they lost about RMB(1.1) Billion.

Moat Analysis:

GDS’s moat can be rated as weak to a narrow moat:

  • Intangible Assets: They lack strong proprietary technology or brand recognition. While they have partnerships and unique locations, the advantages provided is minimal.
  • Switching Costs: Some of the clients, especially the enterprise ones, do face some switching costs. Shifting servers and networks to different facilities is extremely costly and time-consuming. However, the price of the service and the ability to provide it to other clients at low prices makes them switch.
  • Network Effects: There isn’t any significant network effect. There are economies of scale but not to a level that can be called an economic moat.
  • Cost Advantages: There is no proof of cost efficiencies in GDS, which can be used to create a meaningful moat.

They use unique locations to establish their data centers, and although it can provide some cost efficiencies, its not a durable moat.

GDS’s overall moat rating will be 2 / 5.

Risks to the Moat and Business Resilience

Several risks can negatively impact the business and erode the moat.

  • Intense Competition: The data center industry is extremely competitive. New players are always entering the market and thereby putting downward pressure on prices and margins.
  • Rapid Technological Changes: Data center technology evolves quickly. If GDS can’t stay ahead of the curve with latest technology they may become obsolete.
  • Concentrated Client Base: If they lose a couple of big clients, that will significantly impact their revenue.
  • Geopolitical Risks: Since their main operations are in China, they can face geopolitical risks, which are very hard to model.
  • Regulatory Risks: The laws of PRC can quickly change, and that might lead to major problems with operations and expansions.
  • Debt Burden: The large amounts of debt means that they have less financial flexibility than other less leveraged companies. If there is an economic downturn, or interest rate rise, this might hamper their operations and cash flow considerably.
  • Profitability Issues: They have had issues turning profitable consistently over a longer time, which points to either mismanaged spending or over aggressive spending.

Despite the above risks, GDS has a high growth potential. There is a growing demand for their products, and they are poised to capture it. But they need to address the concerns of negative free cash flow and net losses before they can be considered as a sound investment.

Understandability:

The business model of GDS is relatively straightforward-leasing data center space. However, you need some understanding of tech concepts to fully appreciate the potential upside of the business. The financial analysis can be tricky though, given the multitude of adjustments.

  • Simplicity: The core business model is easy to understand as it is mainly about leasing space.
  • Technical Aspects: Some technical aspects can be complex to understand.
  • Financial Statements: The many nonrecurring and nonoperating items can be quite confusing.

GDS’s understandability will be 4 / 5 because some of the numbers are a bit complicated.

Balance Sheet Health:

GDS’s balance sheet shows a lot of red flags. High debt and negative cash flows are major concerns.

  • Debt Load: The company relies heavily on debt to fund expansions and acquisitions.

High debt levels with a negative cash flow pose a huge risk to solvency of the company.

  • Current Ratio: A current ratio of slightly over 1 points to serious liquidity concerns. *This also increases risk, as there might be an inability to pay debt and fulfil other obligations.
  • Cash Position: GDS has negative free cash flow, which suggests the business is continuously spending more money than it generates.
  • The positive side is that the operational cash flow is increasing, which could in the future bring a positive free cash flow.

The balance sheet rating of GDS is 2 / 5 due to several concerns about the high leverage.