GDS Shifts to Deal-Making High-Gear to Keep Funding Its Money-Losing Operations

Key Takeaways:

• GDS is in talks to sell a minority stake in its international business, according to a Bloomberg report citing unnamed sources
• The company has never made a GAAP-based profit since going public in 2016, forcing it to constantly raise new capital

By Warren Yang

GDS Holdings Ltd. GDS has been a busy bee this year, working as much on new financing deals as on its main business of building and operating data centers. There’s good reason for the fundraising activity. The data center operator is in constant need of fresh capital to fund its loss-making operations, which it’s expanding rapidly to cater to growing demand for internet infrastructure to power future technologies like telemedicine and the internet of things.

The largest of China’s three U.S.-listed independent data center operators is in talks with investment firms and sovereign wealth funds to sell 30% to 40% of its international business for about $300 million, Bloomberg reported late last week, citing unnamed sources.

The report comes a little more than a month after GDS raised $580 million through the issuance of seven-year convertible notes to a group of investors, including private equity and sovereign wealth funds. Before that, GDS raised more cash about a year ago by selling $620 million worth of similar securities.

The company’s ability to continuously attract investors is impressive, given it has never turned a profit since going public in the U.S. in 2016. GDS incurs high costs due to depreciation and amortization of property and equipment, while its power bills and rental costs are also significant. As a result, the company’s gross margin is relatively thin at less than 30%, and narrowed even further in last year’s third quarter as those costs increased faster than revenue.

One of the company’s other big expenses is hefty interest payments on all of its borrowed funds, which alone erased more than 90% of its gross profit in last year’s third quarter. That’s because GDS is heavily leveraged, with its total liabilities amounting to more than double its equity at the end of September.

Another potential troubling sign is GDS’ cooling revenue growth, which slowed to about 23% in the first nine months of last year from 36% in 2021 and 39% in the prior year. Granted, a number of places in China were locked down last year because of Covid-19 outbreaks, which may have affected the operations of some of its customers. But the situation in the preceding two years wasn’t much better.

GDS can comfortably cover its debt payments with cash flow from operations, given that its earnings before interest, taxes, depreciation and amortization (EBITDA) far exceeds its interest expenses. But the company’s EBITDA grew more slowly than its revenue in the first nine months of last year due to its high costs.

GDS’ inability to turn a net profit explains the company’s constant need to seek outside funds to sustain and expand its capital-intensive business model. In China, it plans to cover about 60% of this year’s capital expenditure with debt, while also looking to sell or lease some assets under a new strategy to generate income, CFO Dan Newman said on a November conference call to discuss the company’s third-quarter results.

Southeast Asia Expansion

Within its broader capex budget, GDS also aims to fund about 60% of its spending outside China with debt. But unlike its China-based operation, the company also wants to sell equity in its fast-growing global operation to meet its funding needs outside China, Newman said at that time, which perhaps explains the logic behind the planned sale in the latest Bloomberg report.

GDS started expanding into Southeast Asia, a popular first stop for globally-minded Chinese companies, by developing data centers in and around Singapore starting in 2021. The company provides services in Singapore using a third-party data center, but could eventually replace that with its own new centers being built in Malaysia and Indonesia. STT GDC, a Singapore-based company that owns a portfolio of data centers across Asia, is a key investor in GDS, with their relationship dating back to 2014.

STT’s attraction to GDS is pretty straightforward. While the Chinese company’s financial performance may not be so stellar just yet, the data center industry looks set for strong growth in the years ahead as demand for offsite-based computing and storage rises with cloud-based services. Data center acquisitions by private-equity firms are all the rage now for that reason, contrary to a general slowdown in global M&A activity over the past year.

GDS’ two main domestic peers have also been buzzing with M&A chatter in the past year, often linked to private equity. Chindata Group Holdings CD was reportedly up for sale last April, with suitors including GDS and private equity firm PAG. That same month, VNET VNET also received a takeover offer from a Chinese private equity group, which was followed by a competing proposal from the company’s founder and interest from a number of other potential buyers.

While sales of Chindata or VNET have yet to materialize, some data center companies outside China have been sold in recent mega deals. In December, private equity firm DigitalBridge Group DBRG, along with investment services company IFM Investors, completed an $11 billion acquisition of Switch Inc. And early last year, private equity group KKR and infrastructure investment firm Global Infrastructure Partners acquired CyrusOne Inc. for $15 billion.

In the case of GDS, though, it’s unclear whether it can bring in new investors soon, based on how the Chindata and VNET deals have dragged on. Potential investors in GDS’ international business will need to live with the fact that the company’s non-China operations will probably remain unprofitable for the foreseeable future as they will need time to become established. GDS shares slipped on the day of the Bloomberg report, perhaps reflecting investor caution that a deal might take some time to materialize, if it comes at all.

New York-listed shares in GDS have nearly doubled since the company’s 2016 IPO, but their valuation relative to revenue is still modest. The stock trades at a price-to-sales (P/S) ratio of 2.7, much lower than the 4.8 for Chindata, though well above the 0.6 for VNET.

GDS’ current valuation may also include some discount to reflect a bottom line that is perpetually in the red – unlike Chindata that has been profitable since 2021. Analysts don’t see profits anytime soon for GDS, with those polled by Yahoo Finance expecting the company’s net loss to actually widen this year. But finding cash doesn’t seem to be a major problem for GDS right now, meaning life is likely to go on for the company until the day when it is either sold or manages to turn a profit.