GDS : 1Q23 Earnings Transcript

REFINITIV STREETEVENTS

EDITED TRANSCRIPT

Q1 2023 GDS Holdings Ltd Earnings Call

EVENT DATE/TIME: MAY 25, 2023 / 12:00PM GMT

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MAY 25, 2023 / 12:00PM GMT, Q1 2023 GDS Holdings Ltd Earnings Call

CORPORATE PARTICIPANTS

Laura Chen GDS Holdings Limited - Head of IR

William Huang GDS Holdings Limited - President

Daniel Newman GDS Holdings Limited - CFO

CONFERENCE CALL PARTICIPANTS

Gokul Hariharan JP Morgan - Analyst

Jonathan Atkin RBC - Analyst

Peter Milliken Deutsche Bank - Analyst

Edison Lee Jefferies - Analyst

Yang Liu Morgan Stanley - Analyst

Dan Newman

Frank Louthan Raymond James - Analyst

PRESENTATION

Operator

Hello, ladies and gentlemen. Thank you for standing by for the GDS Holdings Limited first quarter's 2023 earnings conference call. At this time, all participants are in listen-only mode. After management's prepared remarks, there'll be a question-and-answer session. Today's conference call is being recorded. I will now turn the call over to your host, Ms. Laura Chen, Head of Investor Relations for the Company. Please go ahead, Laura.

Laura Chen GDS Holdings Limited - Head of IR

Thank you. Hello, everyone. Welcome to the first quarter 2023 earnings conference call of GDS Holdings Limited. The Company's results were issued via newswire services earlier today and are posted online. A summary presentation, which we will refer to during this earnings call, can be reviewed and downloaded from our IR website at investors.gds-services.com.

Leading today's call is Mr. William Huang, GDS Founder, Chairman and CEO, who will provide an overview of our business strategy and performance. Mr. Dan Newman, GDS CFO, will then review the financial and operating results. Ms. Jamie Khoo, our COO, is also available to answer questions.

Before we continue, please note that today's discussion will contain forward-looking statements made under the Safe Harbor Provisions of the US Private Securities Litigation Reform Act of 1995. Forward-looking statements involve inherent risks and uncertainties. As such, the Company's results may be materially different from the views expressed today. Further information regarding these and other risks and uncertainties is included in the Company's prospectus, as filed with the US SEC. The Company does not assume any obligation to update any forward-looking statements except as required under applicable law.

Please also note that GDS earnings press release and this conference call include discussions of unaudited GAAP financial information, as well as unaudited non-GAAP financial measures. GDS press release contains a reconciliation of the unaudited non-GAAP measures to the unaudited most directly comparable GAAP measures.

I will now turn the call over to GDS Founder, Chairman and CEO, William Huang. Please go ahead, William.

William Huang GDS Holdings Limited - President

Thank you. Hello, everyone, this is William. Thank you for joining us on today's call. Before I review the 1Q23 results, I would like to take a few minutes to highlight our strategic priorities for the next few years. What are we focused on? What are we trying to achieve? These priorities will be benchmarks for tracking our ongoing performance.

The roots of our business are in mainland China, but in the past couple of years, we began to expand overseas. The two regions in which we now operate, mainland China and international, are at different stages of development; therefore, we have set different priorities for each region, in order to achieve the best outcome for our shareholders.

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MAY 25, 2023 / 12:00PM GMT, Q1 2023 GDS Holdings Ltd Earnings Call

In mainland China, we have grown our business over 20 years, through several distinct phases, to become the leading carrier-neutral data center platform. In the most recent phase of growth, as demand from cloud and internet took off, our priority was to win new business. We achieved an unprecedented level of new bookings, established strategic relationships with all the leading customers and increased our market share.

Our resource strategy was a key success factor. We invested heavily in building up our asset base in all Tier 1 markets, in order to fulfil our customer requirements. Five years ago, we had 20 data centers. Today, we have over 100. We believe it's the largest development program undertaken by any data center company, globally.

In addition to the existing asset base, we secured land and energy quota to maintain continuous supply and grow for many years to come.

Now the market in mainland China is going through a period of adjustment. We are in a new phase and we have reset our priorities accordingly. Our number one priority now is to deliver the RMB6 billion backlog, which is a result of our past sales success. It is sufficient to drive our revenue growth by over 60% over the next few years.

Number 2, as we have already won many years of future business, we will be highly selective in pursuing new orders. We will target opportunities which are strategic, a good fit to our available capacity, a fast-moving schedule, and adequate financial returns.

Number 3, we will prioritise increasing utilization of existing assets. We have a large asset base, both in service and under construction, which is committed by customers, but not yet utilized. As a result, we can deliver the entire backlog with a relatively small amount of incremental CapEx. This enables us to achieve our growth targets, while reducing annual CapEx to RMB2 billion to RMB3 billion going forward.

Number 4, we will only initiate new projects if there is committed demand with confirmed move-in schedule. We expect most of our new projects will be expansion phases of existing sites.

Number 5, building on our success with past waves of cloud and internet demand, we will position our products and technologies to capture the coming wave of AI applications.

For international, our priorities are winning new business, and building market presence.

Number 1, we aim to develop our international business into a second growth engine, which creates significant additional value for GDS shareholders.

Number 2, We will anchor and de-risk our projects with orders from our home market customers as they expand overseas.

Number 3, We will also win significant business from top global customers, many of which are established relationships in China.

Number 4, we will take advantage of our low unit development costs, which comes from our scale, product, and supply chain in China.

Number 5, We will build a standalone business under our international holding company, headquartered in Singapore, while maximizing synergies with GDS mainland China.

In 1Q23, our gross new bookings was around 12,000 square meters, split evenly between mainland China and international. Market demand in mainland China over the past few quarters has been a bit soft. This is mainly because large customers who committed to a scalable capacity will need more time to absorb their inventory. In this environment, as I just explained, we are targeting high quality business, which meets our criteria.

A good example is the [4,600 square meter] (corrected by company after the call) or 9-megawatt order, which we won for Shanghai 18.

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MAY 25, 2023 / 12:00PM GMT, Q1 2023 GDS Holdings Ltd Earnings Call

The customer is a major Chinese financial institution. The pricing is reasonable, and the underlying asset is an expansion phase of our existing Pujiang campus.

On international side, we won a 6,400 square meters or 26-megawatt expansion order from the anchor customer for our campus in Nusajaya Tech Park, Johor.

You may recall that we are already building three data centers on Site 1, with total IT power capacity of 64 megawatts, which is fully committed by this customer. We started construction less than one year ago, on greenfield land. We are using our prefab design and product, shipped directly from China. We are incorporating liquid cooling for part of the capacity, as required by the customer.

Despite the fact that this is our first project in southeast Asia, we will deliver the first fully powered data center on this site in early 3Q23. We estimate that our unit development cost is 20% lower than the local market. The ability to construct so quickly, and at such a low cost gives us compelling competitive advantages as we expand in the region.

Our gross move-in for the first quarter was around 13,000 square meters, which is consistent with the level of the past few quarters. Our customers are sounding more positive about their business outlook, with new business initiatives and strategic development. As their business picks up, it will flow through to us one or two quarters later, in terms of faster move-in.

To adjust to the current environment, we have slowed down our capacity expansion. In 1Q23 we brought 2,700 square meters of new capacity into service. Over the rest of the year, we plan to bring a further 57,000 square meters into service, split between mainland China and international. All of this capacity has solid customer commitments and confirmed move-in schedules.

As a result of our efforts to adjust the pace of development, our utilization rate has gone up from 67% to 72% over the past year. At the same time, our backlog for area in service has come down from 136,000 square meters to 110,000 square meters.

Our mainland China business is going through a three-year journey to achieve our goals. We are making progress quarter by quarter. We have already done the difficult part, which is to win high quality new business, and secure scarce resource. Now, it's all about execution. Please stay a little patient and watch us deliver.

Our international business is at a different story. There is a great market opportunity on our doorstep, and we know how to win. I'm excited about the prospects for us to create second GDS.

Before I hand over to Dan, I would like to make a few comments about my personal position. After we published the AGM notice a couple of weeks ago, I acknowledge that investors have a number of concerns. GDS was born out of my vision more than 20 years ago. I have built an exceptional team, which has been a major success factor. For me, leading GDS is about much more than just a financial gain. It is driven by a passion to create something extraordinary. This dedication remains unwavering, and I assure you that nothing has changed in this regard.

I want to take this opportunity to address these concerns and emphasize my commitment to our Company. I intend to purchase approximately 1 million ADSs, and possibly more, over the next 12 months, if I am able to do so. In addition, if the AGM proposal is passed, I commit to sustaining my ownership percentage about the new threshold.

I firmly believe that our current share price does not reflect the true value of our Company. I have complete confidence in our ability to enhance our business performance and achieve sustainable growth, thus create significant value for our shareholders.

Now, I will pass on to Dan, for financial and operating review.

Daniel Newman GDS Holdings Limited - CFO

Thank you, William. I would like to start by talking about our financial objectives, which mirror what William said about our business priorities.

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MAY 25, 2023 / 12:00PM GMT, Q1 2023 GDS Holdings Ltd Earnings Call

For mainland China, Number 1, we target to grow adjusted EBITDA at a mid-teens percentage CAGR, by delivering the backlog.

Number 2, we will become free cash flow positive, by which I mean, free cash flow before financing, within three years. There's already high visibility as to how we will achieve this goal.

Number 3, we will cap net debt at around current levels, and target deleveraging to below 5 times net debt to adjusted EBITDA.

Number 4, we will monetize assets to the extent required to recycle capital and keep within these financial parameters.

Number 5, we will sustain project level unlevered post-tax IRRs of 10% to 13%, by keeping discipline about new business and resources.

For international, 1, we will pursue a low-risk investment strategy, based on firm precommitments.

2, we will target the same investment returns on a portfolio basis as we do for mainland China.

Number 3, we aim for international to contribute over 10% of our consolidated adjusted EBITDA, within three years.

Number 4, we will take a segregated approach to financing, raising external equity and debt on a dedicated basis, and not rely on the capital reserves of GDS Holdings.

Number 5, lastly, we will create additional value for GDS shareholders in a way which is measurable and helps our share price.

Now, I'll talk through our financial performance for the quarter. Turning to slide 20, where we strip out the contribution from equipment sales and the effect of FX changes. In 1Q23, our service revenue grew by 0.2% and underlying adjusted EBITDA grew by 6.6%, quarter-on-quarter.

Turning to slide 21, net additional area utilized during the quarter was 6,085 square meters. As we disclosed previously, a large customer is redeploying around 17,000 square meters from our data centers in Beijing to two of our campuses in Langfang, Hebei Province. The move-out impacts us for the first three quarters of this year. Thereafter, the customer will move into the new locations over about six quarters. In totality, there will be a net increase of area utilized by this customer but with a timing difference.

If we add back the churn in 1Q23, the underlying move in rate was similar to previous quarters at around 12,600 square meters. We expect gross additional area utilized to continue at these levels in 2Q23 and 3Q23 and then to step up significantly in 4Q23 as we have contracts with faster move in.

Monthly service revenue per square meter was RMB2,149 in 1Q23. We expect MSR to decline by around 4%, comparing the final quarter of this year with 4Q22.

Turning to slide 22. For 1Q23 our underlying adjusted gross profit margin was up on the prior quarter by 1.4 percentage points and our underlying adjusted EBITDA margin was up by 2.8 percentage points. At the GP level, this was mainly due to seasonally lower utility cost. At the EBITDA level, there was also some savings in SG&A.

Our profit margins are going to fluctuate over the course of this year. Our guidance implied around 45%, full year adjusted EBITDA margin at the mid-point which has not changed.

Turning to slide 23. In 1Q23, our organic CapEx in mainland China was around RMB1.4 billion and international CapEx was RMB600 million.

Looking at our financing position on slide 24. At the end of 1Q23 our net debt to last quarter annualized adjusted EBITDA ratio was 8.1

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