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GDS Holdings Limited (NASDAQ:GDS)
Q1 2019 Earnings Call
May 14, 2019, 8:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Hello, ladies and gentlemen. Thank you for standing by for GDS Holdings Limited First Quarter of 2019 Conference Call. At this time, all participants are in listen-only mode. After management's prepared remarks, there will 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 -- Head of Investor Relations

Thank you. Hello, everyone, and welcome to the 1Q '19 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 conference call can be viewed and downloaded from our IR website at investors.gds-services.com.

Leading today's call is Mr. William Huang, GDS's Founder, Chairman and CEO, who will provide an overview of our business strategy and performance. Mr. Dan Newman, GDS's CFO, will then review the financial and operating results.

Before we continue, please note that today's discussion will contain forward-looking statements made under the "safe harbor" provisions of the U.S. 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 U.S. 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's earnings press release and this conference call include discussions of unaudited GAAP financial information as well as unaudited non-GAAP financial measures. GDS's press release contains a reconciliation of the unaudited non-GAAP measures to the unaudited most directly comparable GAAP measures.

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

William Wei Huang -- Founder, Chairman and Chief Executive Officer

Thank you, Laura. Hello, everyone. This is William Huang. Thank you for joining us on today's call. We started 2019 right where 2018 left off, with robust growth that is translated into strong first quarter results across our business. Demand remains as strong as ever. In the first quarter, we signed up customers for over 16000 square meter of net additional area committed which exceeded our own target. We are now halfway through the second quarter and it looks very good. Maintaining resource supply in Tier 1 markets is a critical success fact.

Since the beginning of this year, we made significant progress in securing additional land and power for hyperscale development and initiative to finding new projects. We continue to deliver operations resulting in over 60% service revenue growth and over 110% adjusted EBITDA growth year-on-year. Our margin is expanding even faster than we expected. We crossed the 50% threshold for NOI margin and our adjusted EBITDA margin hit 43%, an improvement of over 10 percentage points in one year. We removed the capital overhead by successfully raising around the $595 million of proceeds from the follow-on offering and strategic investment by Ping An.

We now have sufficient equity capital to cover our expansion plans for the foreseeable future. During the first quarter, our new business totaled around 30 megawatts, including four deals with hyperscale customers for over five megawatt each. Three of the deals were with existing customers and one was with a new customer, a global Cloud leader which is doing very well in China. We now have every single hyperscale Cloud service provider including the top-2 global players and all the major domestics ones present in our data centers, giving us a unique position. We continued to add cloud POPs. AWS Director Connect and Microsoft ExpressRoute are now living (ph) inside several of our data centers, further strengthening our position as home of Cloud. We have a good track record of winning business from foreign Cloud payers. If the China market opens up, there could be more opportunities for us.

Enterprise customers accounted for 10% of our new business last quarter. We won several notable new logos including one of the largest auto companies in the world and one of the largest international hotel groups. We also won sizable follow-on orders from one of the biggest banks in China and from the leading card transaction platform.

To finish off on demand, I'm often asked about how the macro situations is affecting us. The further thing I would say is that this has been going on for nearly a year during which time we have continued to rack up impressive sales growth. We are enabling the expansions of the digital economy in China. It's a secular growth story, we have highlighted over the past few quarters how our strategic customer base is becoming more balanced and diversified.

We are tapping into more sources of growth, we have set proprietary expectations and we are well on track to achieve our sales target for this year. Our focus continues to be on Tier 1 markets, where customer located their latency sensitive date, new technology trends are multiplying data volume and at the same time governments policies are making it more and more difficult for data centers to obtain the sufficient power supply where it is needed. To deal with this challenge, we are evolving our resource strategy. We continue to add data centers in key cities wherever we can. Since the beginning of the year, we initiated another four organic project plus one acquisition, which we are announcing today. And at the same time, we have been working on securing large greenfield sites on the border of the cities, where we can develop much larger scale.

This is a long and complicated process as it must work for our customers for power, for network and for the local government. I'm happy to report that these efforts are yielding significant results. Our focus today is on our position in Beijing and Guangzhou. I will update you on Shanghai, Shenzhen and other potential markets on subsequent calls.

Starting with Beijing, during 2018, we initiated four new projects in the city and in 1Q19, we initiated one more, Beijing 8. We believe that our city data centers will become increasingly valuable over time and we are looking at all options to expand our portfolio. Most of our Beijing data centers are in Daxing district, south east of Beijing, which is a premier data center hub. Langfang is an area adjacent to Beijing in Hebei province. It is already a well established data center location serving the Beijing market. With good network connectivity and power infrastructure given the constraints, we see demand moving to Langfang and are positioning ourselves accordingly.

Our major customers endorse this strategy. As a first step, we leased two buildings in Langfang. The first Langfang 1 is already under construction and fully pre-committed. A few weeks ago, we entered into a framework agreement with the Langfang local government for the acquisition of a large greenfield site and the allocations of significant power capacity. We're now in the formal process for the transfer of land use right. With addition of Langfang supply, we are strongly positioned in the Beijing market.

Now, we talk about Guangzhou. Guangzhou was initially a slower market than Shenzhen in terms of the data center development. However, as power supply has become extremely limited incentive, we see demand shifting to Guangzhou. We have a data center cluster in Huangpu district, where our Guangzhou 1, 2, and 3 are located. Today we are announcing the acquisition of another project in the same area, Guangzhou 6. During 1Q '19, we initiated a new project in the Nansha district of Guangzhou. Nansha is a major logistics and I.T. hub which complements our Greater Bay Area presence. The project consists of two buildings, the first of which, Guangzhou 4 is under construction.

We previously disclosed that we have acquired a greenfield site in Guangzhou, which will be hand over to us at year end. Taken altogether, we are well positioned to capture demand in Guangzhou. Outside of Tier 1 markets, our customers also require large capacity for what we call code data which can be located in lower cost remote areas. We are starting to see demand from, and feel our customers to outsource (ph) this as well. Last year we built three data centers in Hebei which belong in this category.

Going forward, we would like to do more projects like this because it's important for customer relationships and with the right structure, it can enhance our return on capital. We have therefore been working for quite a while on developing a joint venture structured at project level which enable us to bring in outside capital from a partner. We are making good progress, we have the world class financial partner lined up, we will keep you updated on progress.

With that I will hand over to Dan for the financial and operating review.

Daniel Newman -- Chief Financial Officer

Thank you, William. Starting on slide 12 where we strip out the contribution from equipment sales and the effect of FX changes. In 1Q19, our service revenue grew by 7.5%, underlying adjusted NOI grew by 10.8% and underlying adjusted EBITDA grew by 14.2% in consecutive quarters.

Our underlying adjusted NOI margin reached 51.3% and our underlying adjusted EBITDA margin hit 42.5% which is 9.5 percentage points higher than a year ago.

Turning to Slide 13. The main driver of revenue growth was the increase in area utilized with over 9700 square meters added in the first quarter. 1Q is seasonally slow because of the cycle around Chinese New Year and we expect the moving cadence to pick up throughout this year.

Monthly service revenue or MSR per square meter decreased by 0.8% quarter-on-quarter which is consistent with our expectations for the full year. Some of the decrease was due to lower power usage during the cold months.

Slide 15 shows the strong quarterly trend in margin improvement at the NOI and EBITDA levels. As illustrated on Slide 15, the split between stabilized and ramping up data centers stays at around the same as for the prior quarter, but the utilization rate for ramping up data centers in 1Q19 was higher. On slide 16, you can see that most of the improvement in NOI margin came from operating leverage on rent, labor and other costs. Our stabilized data centers achieved over 55% NOI margin in the quarter. Across the whole portfolio, we're expecting 1 to 2 percentage points further improvement in NOI margins over the next few quarters.

We've been steadily realizing operating leverage on SG&A, which is reflected in the EBITDA margin. Here again, we're expecting at least 1 percentage point further improvement through the year.

Turning to our CapEx on Slide 17. We paid RMB834 million in 1Q19 and it should step up in the next few quarters.

And our CapEx guidance for 2019, we mentioned that the budget for land acquisitions was around RMB500 million, the Guangzhou and Langfang sites account for less than half. The new data center acquisition in Guangzhou, Guangzhou 6 is at a total enterprise value including cost to complete for RMB550 million. We believe that this data center can achieve a stabilized and annual NOI of over RMB80 million. We target closing the acquisition in 3Q19, subject to conditions around the property lease and power activation. We're working on other potential M&A deals and we hope to announce one more quite soon.

Looking at our construction program, we have one data center, Beijing 4, coming into service in the current quarter and most of the capacity will be committed by then. Across our top-3 markets, we are well positioned in terms of available capacity under construction relative to our sales targets and demand. As at the end of one 1Q19, we have around 227,000 square meters of total capacity in service and under construction, excluding third party data centers, with a total IT power capacity of 463 megawatts. Our total development cost to date and to complete for this capacity is around RMB15 billion. The unit costs for this capacity works out at just under RMB66,000 or $10,000 per square meter, and RMB32,000 or $4800 dollars per kilowatt.

Going back to one 1Q17, our unit cost per kilowatt was RMB35,000. As you can see, it has declined by 8% on a cumulative basis over the subsequent eight quarters. For the new projects which we are undertaking, the unit cost per kilowatt is typically around RMB30,000.

With regard to financing on Slide 18. Following the equity issuance in one 1Q19, our net debt to last quarter adjusted EBITDA multiple has come down dramatically to 4.9 times. Our approach to capital structure remains targeting 6040 (ph) debt to equity at the project level. In our models, this shows leverage going up again for a few quarters to over six times as we make investments ahead of generating EBITDA. We are comfortable with this as we always have been. During 1Q19, we obtained RMB2.3 billion or $340 million of new debt facilities including refinancing.

The current credit environment in China is very favorable for borrowers like us. We're establishing new relationships with Chinese banks which enables us to diversify our funding sources. And we're getting 8 to 10 year tenors and the lowest interest rates ever. For a couple of the facilities that we're working on now, the all-in cost is expected to be less than 6% compared with an effective interest cost in 1Q19 of 6.6%. We're trying to take maximum advantage of this, while at the same time, cognizant of our large cash balance, we're looking at optimizing our debt which includes paying down some loans. It is going to take a couple of quarters to balance this out.

Finally, on Slide 19. At the end of 1Q19, our backlog had increased over 81,000 square meters. We currently have around 118,000 square meters which is revenue generating. The backlog therefore implies that we can grow our revenue generation space by almost 70% without finding any new customer contracts.

Lastly, we reconfirm the guidance which we provided a couple of months ago. I would note that the quarterly cadence should increase over the year. To repeat what William said, we are well on track to deliver our full year targets.

With that, I will end the formal part of our presentation and we would now like to open the call to questions. Operator?

Questions and Answers:

Operator

Thank you. And ladies and gentlemen, we will now begin the question-and-answer session. (Operator Instructions). Our first question comes from the line of Jonathan Atkin of RBC Capital Markets. Please go ahead.

Jonathan Atkin -- RBC Capital Markets -- Analyst

Thanks, very much. I wondered if you could talk a little bit about the timelines that you're seeing for customers in terms of move in. Is that roughly the same or accelerating or taking longer, is there a general trend that you could comment on? And then, if you could also talk a little bit about your revenue, what's your current revenue exposure to non-Chinese customers? And if you could expand a little bit about the interest level on the part of non-Chinese players to enter the market and potentially become customers of GDS? Thank you.

Daniel Newman -- Chief Financial Officer

Okay. Thanks, Jon. It's Dan here. Last year the total, we call it, net additional area utilized or move in was around 46,000 square meters. And I think you will have calculated yourself that our revenue guidance for 2019 implies a move-in over the year, which is significantly higher than that.

In the first quarter, it was around 10,000 square meters. From everything we know about our customers move-in intentions and what is written in the contracts in terms of contractual delivery schedule, we are well on track to achieve the level of move-in that we were expecting. I really can't comment more specifically to say that -- to talk about acceleration or slowdown, nothing can be read into it, it is as as we expected. On your question about foreign customers, of course we have two of the top global Cloud service providers, I prefer to talk about the exposure in terms of the total area committed and revenue, because revenue is a lagging indicators, as you know by around 15 months. So from the top-2 global Cloud service providers that's in round numbers around 5% of our business. And you may have seen recently in terms of market shares, they both have around 6% market share, the Cloud market in China and Amazon, for example on their recent earnings call highlighted that they were doing very well in China. So I didn't think we have any concern about that. Our only concern is to make sure that we are perfectly positioned for their expansion plans.

Other than that, our our business with foreign customers is mostly multinational corporations who typically have financial institutions, who typically have very long track records in China and whose business is very stable. Once again, we have no concerns about that.

Jonathan Atkin -- RBC Capital Markets -- Analyst

Yeah.

Operator

Thank you. Our next question comes from the line of Robert Gutman of Guggenheim. Thank you, please go ahead.

Robert Gutman -- Guggenheim -- Analyst

Hi, thanks for taking the question. So, given the new business booked in the quarter and the timing of deliveries, is there any change in the expectation of the MSR for the year, which I think the guidance was for a down 5%? And secondly, with the new strategic customer, was it one of those two clouds or was it another entity?

Daniel Newman -- Chief Financial Officer

Hi, Rob, it's Dan once again. I think the MSR trend is exactly as we expected. We know what capacity is due for delivery this year, we know what the selling price is in those contracts. Sometimes as customers move in, the racks may be empty, they may not be significant or they may not be significant power usage that can affect the the MSR, but the 0.8% decline quarter-on-quarter versus what I commented last time, 5% over the full year is pretty much in line. And yes, the new strategic customer was one of the two top global cloud players. What I think was significant about it is that, as is publicly known, we are hosting a couple of their POPs in two different markets. But we also won for the first time a large order for their Cloud platform.

Operator

Thank you. Our next question comes from the line of Frank Louthan of Raymond James. Please go ahead.

Frank G. Louthan -- Raymond James -- Analyst

Great. Thank you. I wanted to talk a little bit about the guidance and if there was anything sort of onetime helping the EBITDA in the quarter (ph) to kind of do the math that sort of implies that you're going to be above the range if you stay in the sort of -- in this range of margins for the year, maybe tell us why you didn't raise the guidance there and how we should be thinking about that?

Daniel Newman -- Chief Financial Officer

Frank, it's a good observation. All I can say is we thought about it. Just I think we gave guidance two months ago, so it seems a little bit premature, I'd rather wait to see where we are in the middle of the year.

Operator

Thank you. (Operator Instructions). Our next question comes from the line of Cowen and Company, Colby Synesael from Cowen and Company. Please go ahead.

Analyst

Hi, this is Michael on for Colby. Two questions, if I may. First, how would you compare the visibility you have into your leasing pipeline now versus the same time a year ago? And then second, based on what you're seeing in the market, how should we think about MSR trends in 2020 and beyond? Thank you.

William Wei Huang -- Founder, Chairman and Chief Executive Officer

So, I'll answer the first question. The pipeline, we still think, is consistently like what we see in the beginning of the year. Nothing changed and we're still very confident our new booking will be on track.

Daniel Newman -- Chief Financial Officer

The second question is -- Yeah, Michael if we're talking about what we call our city data centers, so here we're going to make a comment like for like. The pricing is stable to firm, I would say, which reflects the market situation. We are consistently getting selling price per kilowatt per month, net or exclusive of power usage of over $100 and that's been the case for the last couple of years and remains the case with the deals that we have done very recently. I can't see anything in terms of dynamic that's going to change in the city data centers, certainly not for the worst.

And then of course we have a significant amount of new capacity, which will start to come on stream from late next year in the sites that we have, that we -- studies disclosed which are on on the borders of the cities. From the very detailed work we've done and the customer interactions, we think that we'll be able to develop the lower unit cost in those sites, there may also be some change in the product mix, it might not all be two (ph) end which course has significant implications for the cost. So, if that's the case ,if either of those is the case, then it will get reflected in the selling price, but the return, as I always say remain the same. Further inter (ph) modeling purposes, it's too early to really build that in a detailed way. I think the the MSR decline, which we've seen is in the city area is really coming to an end. It just has to work its way through over the next four, maybe six quarters.

William Wei Huang -- Founder, Chairman and Chief Executive Officer

And we used to mention even in Beijing, such a specific market, i mean the demand supply -- it's very extremely unbalanced. So what we can say is that in Beijing, I mean the price even goes goes higher.

Operator

(Operator Instructions). Next question comes from the line of Colin McCallum of Credit Suisse. Please go ahead.

Colin McCallum -- Credit Suisse -- Analyst

Yes. Thanks for the opportunity. Just a quick one on the margin issue, it's obviously very strong in the first quarter. I think, Dan you mentioned sort of 1% point more throughout the year. Were you referring to on top of the 1Q19 margin, or were you -- was that comment more kind of a year-on-year kind of comment in terms of starting point for the margin? That's the first question. And then a related point just with the margin going up, I see your'e still obviously making net losses given depreciation and interest charges but with interest charges also coming down you mentioned what would be your thinking for when we might be moving to a net profit situation? Is it possible within this year or is it more next year or the year after situation? Thank you.

Daniel Newman -- Chief Financial Officer

Yeah. Colin, on margin, first of all, the first quarter margin is not a flash in the pan, it's a data point on the trend line. What I was indicating is that, at the NOI level, we can see that it will continue to improve, I'm not saying every quarter in a consistent way but in terms of a trend by one to two percentage points, I said over the next few quarters, I don't want to be locked in to say that's exactly what it would be by the end of the year. But there's going to continue to be a one to two percentage points improvement in the NOI margin over the next few quarters.

And in addition to that, there couldn't be a further 1% improvement due to leverage on SG&A. So if you take those together,I was really saying there's two to three percentage point improvement that we can see with a reasonably high degree of confidence over the next next few quarters.

Your question about net income, can I take that offline, Colin and talk to you one on one about that? Not that i'm evading, I just don't know. I think net income will probably not be positive until 2021, maybe the first half of 2021.

Operator

Thank you. The next question comes from the line of Yang Liu of Morgan Stanley. Please go ahead.Yang Liu. your line is open. Please ask your question.

Yang Liu -- Morgan Stanley -- Analyst

Thanks for the opportunity to ask questions. I have three questions. The first one is, can the management comment on the valuation multiple in private markets when you do the M&A project particularly given the credit environment in China kind of improved, I'm not sure if the pricing of the M&A deal also got increased?

The second question, could you please elaborate more about how or what kind of advantage help GDS win order from the the global leading Cloud vendors in China? I'm sure it's previously used another vendor in China.

And the third question is how about the Cloud demand mix in the first quarter? I think the management's previous guide is that the demand from Tier 2 Cloud vendor's in China are particularly strong this year. How about the situation now? Thank you.

Daniel Newman -- Chief Financial Officer

Thanks, Yang Liu. I'll take the first question on valuation multiples. I'm sure you calculated that what I said the implied multiple for the, what we call the Guangzhou 6 acquisition is probably seven times or less than seven times. We evaluate projects from multiple respects but fundamentally our financial approach is always looking at the return on investment, there is a return target that we require and then that valuation translates into a multiple. So it's not -- we're not really talking about what is the market multiple, this is the valuation that we can justify it just so happens, to come out at around seven times in this case.

In terms of the dynamic in the market, we are a cash buyer, I think we're being one of the few if not the only cash buyers for a while. That gives us a special position. I talked before about there being more opportunities. In the past, the competition in terms of on the buy side has come from Asia, Shanghai-Shenzhen Stock Exchange-listed companies, we tried to play a game round injecting data center assets, boost evaluations you know very well the tech stocks in China traded very high multiples. When the Asian market was down, that created an advantage for us. Earlier this year, come back up, we didn't see at least in one situation, the one situation that we were working on, the seller's attention got distracted by the possibility of doing something like that. But then maybe in the last week if there's something positive that's come out of it, we can say maybe the softening of the Asian market will put us back in a stronger position for M&A. I think that's really all I can comment.

William Wei Huang -- Founder, Chairman and Chief Executive Officer

Let me answer your second question, as to how we win the Cloud from the other vendors. I think number one, we -- our position is very clear. We target -- our focus is Tier 1 market. We are the only one -- only path on pay in all the Tier 1 market. That's our focus. So in our sales side we try to fit our strategy to focus on to get more this type of the customer in all the Tier 1 market, because it is very strategic, because most -- almost every Cloud player they want to put their POPs in all the Tier 1 market even from now for the future. Right? So that happens -- that's very strategic for us. So this is our -- which I'll focus.

So the win factor is number one, we are the platform player. Number two, the long term operating track record and consistent supply in all Tier 1 market. And we have the experience to serve the long term customer, right? So I think the service in terms of full service, resource supply and the operating scale and our ecosystem, this is all effect that we win our customer.

In the meanwhile, we bring their POPs in the Tier 1 market, that's our focus. Yeah. The (inaudible) question is that, we noticed that there is a lot of the Tier 2 city demand from the Cloud player, this is a new market. As we mentioned, a couple of the years ago, so we know this market will be another new market for us. So we tried to do more, but in the POPs structure and POPs private equity department, because if we don't have those kind of the element, the return is very poor. So now as we just -- I just mentioned -- we just -- we're almost getting there to step up the right structure with the low cost private equity, to do this type of data center in the future. And from now on, I can say, maybe in the next couple of quarter we can do more, we can fulfill more requirement from our existing customer in a Tier 2 city.

Operator

Thank you. As there are no further questions, I'd like to now turn the call back over to the Company for closing remarks.

Laura Chen -- Head of Investor Relations

Thank you once again for joining us today. If you have further questions, please feel free to contact GDS Investor Relations through the contact information on our website or the Piacente Group Investor Relations. Thank you.

Operator

Thank You. This concludes this conference call. You may now disconnect your line. Thank you.

Duration: 42 minutes

Call participants:

Laura Chen -- Head of Investor Relations

William Wei Huang -- Founder, Chairman and Chief Executive Officer

Daniel Newman -- Chief Financial Officer

Jonathan Atkin -- RBC Capital Markets -- Analyst

Robert Gutman -- Guggenheim -- Analyst

Frank G. Louthan -- Raymond James -- Analyst

Analyst

Colin McCallum -- Credit Suisse -- Analyst

Yang Liu -- Morgan Stanley -- Analyst

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