What’s Happening with GDS?
- GDS’ revenue saw a 6.4% year-on-year growth in the third quarter, down from 7% in the second quarter and 15% in the third quarter of 2022
- The company is focused on expanding in Southeast Asia to boost growth while its China market slows down
By Warren Yang
For data center operators like GDS Holdings Ltd. GDS, overseas expansion is becoming a necessity as demand in China cools amidst an economic slowdown.
Despite the anticipation of an increase in demand for data storage and processing facilities to support emerging technologies like AI, the demand for data centers in China is dwindling. In response, GDS is following the trend set by other Chinese companies by turning its attention to Southeast Asia for potential growth opportunities.
The company is under intense pressure to swiftly capitalize on its overseas investments, as investors grow restless due to slow revenue growth in its home market and significant spending to expand abroad.
GDS’ revenue increased by 6.4% year-on-year to 2.5 billion yuan ($345 million) in the third quarter, according to the company’s latest quarterly earnings released last Wednesday. This signified a slowdown from the 7% growth in the second quarter and almost 15% in the third quarter of last year.
However, the company’s gross profit actually decreased year-on-year as its cost of revenue expanded faster than its revenue, due to the establishment of new operations both domestically and internationally. Operating expenses also rose, resulting in a wider net loss.
Nevertheless, GDS achieved a significant milestone during the third quarter with the official launch of its first data center in Southeast Asia. The company initially ventured into the region in 2021 by providing services in Singapore through a data center operated by a third party. This operator, Singapore-based STT GDC, owns a chain of data centers across Asia and is a key investor in GDS, with their relationship dating back to 2014.
Following its expansion into Singapore, GDS has been striving to open its own data center in the neighboring market of Malaysia to cater to the Southeast Asia region. In the third quarter, a 10,000-square-foot space in Johor state commenced operations for a local customer. GDS plans to launch another overseas facility of similar size in the final three months of this year, as confirmed by founder and CEO William Huang during a conference call to discuss the company’s latest results.
GDS has also acquired land for a second campus in Johor, and in Indonesia, it has entered a joint venture agreement with the country’s sovereign wealth fund, INA. With these initiatives, GDS is banking on its new overseas operations to act as a new source of growth.
“For international, our financial objectives are to create a second growth engine,” Huang said.
Huang also highlighted that in China, cloud service providers, which are key customers of GDS, are shifting focus towards quality over quantity, indicating a shift towards profitability. While this might benefit the cloud companies, it has less positive implications for GDS as these customers require less data center capacity. The potential growth from AI companies is overshadowed by the crowded market of unprofitable startups, and the industry isn’t experiencing the expected rapid expansion.
Challenges in China
Reflecting the challenges faced by Chinese data center operators, one of GDS’ main publicly traded rivals, VNET VNET, reported a modest 4% year-on-year increase in total revenue for the third quarter, despite a reduction in net loss, aided by lower operating expenses.
Given the current climate, GDS has established realistic goals for its domestic business, aiming to consistently generate positive cash flow from its operations in China and reduce its debt.
Yet, the company remains a long way from leveraging its existing data center operations to fund new investments. In the third quarter, its investment continued to surpass the cash generated from operations. Additionally, GDS is heavily leveraged, with its interest expenses exceeding its gross profit in the third quarter.
As the company intensifies its international expansion, its spending is anticipated to surge. In the first nine months of this year, capital expenditures for its overseas business totaled approximately 2 billion yuan. With the development of its Malaysia operation, the company expects to spend a similar amount in the following three months, bringing the total for the year to 4 billion yuan – surpassing the 3.5 billion yuan earmarked for capex in China.
GDS aims to fund half of its overseas capex by selling equity and the other half through debt. During the company’s earnings call, management expressed confidence in completing the equity part of the fundraising plan in the first quarter of next year, contingent on capital market sentiments aligning with GDS’ optimism.
Having been established in 2001, it has taken GDS nearly two decades to come close to funding its domestic business without external funds. The timeline required to replicate this achievement overseas remains uncertain.
In an optimistic scenario, a deep-pocketed private equity fund could acquire the company, nurturing it until it gains self-sufficiency. Upon achieving profitability and generating strong cash flow, the new owner could potentially sell the company at a significant profit.
Similar mega deals for data center operators outside China took place last year, further fueling talks of potential sales of VNET and Chindata CD, another major competitor of GDS. Both VNET and Chindata are currently in the process of being privatized by their major stakeholders, potentially leaving GDS as the only publicly traded member among the trio.
All three Chinese companies are currently trading at low valuation multiples, partially explaining the surge in buyer interest. GDS stock trades at a price-to-sale (P/S) ratio of just 1.4, while the multiple is even lower at 0.4 for VNET. Chindata, however, trades at a more respectable 4.
Given the capital-intensive nature of the data center business and the current subdued industry climate in China, swift sales of any of the three companies to independent private equity buyers may be overly optimistic. For GDS, the best path forward appears to be the development of its international operations to offset the decelerating domestic market in China.