COVID-19 and cyber security concerns spur the data centre sector

Flush with newly-raised cash, the listed data centre (DC) operators are on an expansionary push as the pandemic elevates corporate and government requirements for more data storage and better connectivity.

Investor interest has long centred on sector big daddy NextDC (ASX: NXT), which is trading near record high levels despite (or because of) a monster $672 million placement and $191 million share purchase plan.

Mid-tier Macquarie Telecom (ASX: MAQ) recently said it would build a second Canberra DC to cater for government needs, part of the diversified telco’s $100 million debt-funded DC spend for the year. The company also has three DCs at Sydney’s Macquarie Park (one of them under construction).

Dubbed Intellicentre 5, the Canberra facility will deploy “the latest physical and virtual” security credentials.

“(The) risk to government of a cyber breach and the dependency on cloud services are at an all-time high,” Macquarie government division chief Aidan Tudehope said – a prescient remark given the Prime Minister disclosed a massive cyber breach a week later.

“We’re not just going to return to the norm after this pandemic and facilities of this calibre are an essential requirement in Canberra,” Mr Tudehope added.

In truth, the hyperscale suppliers of NextDC and the US-based Equinix will win the contracts from the likes of Amazon and Google.

NextDC was due to report its full-year results in late August.

Small caps spurred on by pandemic

In the meantime, punters haven’t forgotten the listed small fry, who are forging different paths in what remains a highly fragmented market.

Prefabricated DC operator DXN (ASX: DXN) in early June copped an ASX ‘speeding ticket’ after its shares soared from $0.013 to $0.024 over two days. Half of the company’s register changed hands over seven days.

In May, DXN raised a chunky $5.9 million in a rights offer, with the proceeds used partly to finance the $2.7 million acquisition of a Hobart DC. This purchase has now been completed.

Despite the COVID-19 5G tower conspiracy nutters, the diversified 5G Networks (ASX: 5GN) raised $18.3 million in a placement and then reaped a further $4 million in a share purchase plan.

In reality, 5G investors have also enjoyed the pandemic – if that’s the right word – with the shares also trading near record levels.

The company this week reported a $1.5 million loss for the 2019-20 year but almost doubled its underlying earnings to $6.3 million, with its DC revenue also doubling despite running at less than 50% capacity.

Management expects this year’s earnings (EBITDA) to increase to $8-8.5 million, on overall revenue of $60-65 million compared with last year’s $49.8 million (down 1.4%).

Remote working elevates data storage needs

In theory, DCs shouldn’t be that alluring. After all, they’re just large temperature-controlled warehouses with racks that house thousands of client servers. Prerequisites are a handy yet cost-effective location and access to decent energy supply (they consume a poultice of electricity).

The rise of ‘cloud’ computing means an ever greater need to store data, a trend accelerated by the use of videoconferencing during pandemic lockdowns.

5GN chief Joe Demase said COVID-19 has prompted more clients to move their servers out of the office and into DCs – and doesn’t expect this migration to be temporary.

“We have been driving for a while to move them off premises to a DC where we can manage and support their infrastructure, but we think it’s really going to speed up now,” he said.

“(Clients) don’t want to be locked down without the flexibility to scale up and down and it certainly helps them with remote working,” Mr Demase added.

For DXN, the Hobart purchase supplements its DCs at Sydney’s Olympic Park and Port Melbourne’s “cloud alley”, where both NextDC and Equinix have centres.

“We want to be located where we see a competitive advantage,” DXN chief executive officer Matthew Madden said.

“There are three data centres in Tasmania for the entire population and two are for power companies and not for public access.”

DXN also supplies portable modular DCs within shipping containers. Customers can either run the centres themselves, or contract DXN to do so.

Mr Madden said while the virus has delayed some decisions, overall it has brought forward three years of activity in the sector.

5G, meanwhile is not just acquiring DCs, but building fibre cable networks to connect them more effectively.

The company is doing “heavy due diligence” on two or three centres that would add to its existing facilities in Sydney (two) and Melbourne (one). The company also rents a portion of an Adelaide DC.

5G has built its own fibre networks in Melbourne CBD and St Kilda Rd and in Sydney’s Pyrmont and is about to roll out more cable in the Sydney, Brisbane and Adelaide CBDs. Overall, the company has budgeted $3-4 million to connect 67 DCs.

“We think this will be the real growth in the future: clients want high connectivity to a particular DC,” Mr Demase said.

5G’s greater fortunes also lie in cross-selling series to its base of 2,500 customers (mainly mid-market corporates).

“Most are buying one service from us but we would like to get that to two and a half or three,” Mr Demase said.

“If we are selling them a network connection, we also want to sell them a cloud solution and some data centre (capacity).”

He added that rather than selling a client a $500,000 server, the company would rather sell them a cloud services deal and reap $15,000 to $20,000 of ongoing monthly revenue.

Macquarie will report its DC division separately from this financial year, which should provide clarity around its earnings contribution when the company bares all next week.

Overall, management forecasts 2019-20 EBITDA of $63-66 million, around 24% better than previously.

At the time of writing, DXN and 5G were valued by the market at $28 million and $167 million respectively, a far cry from NextDC’s $5.4 billion worth or the $1 billion ascribed to Macquarie Telecom.