The fight for Asia Pacific Data Centres heats up

How much are three data centres located in Sydney, Melbourne and Perth, respectively, worth?

That's the question at the heart of the fight over Asia Pacific Data Centres (ASX: AJD), the owner of these centres leased on long-term, triple-net leases to data centre operator NextDC (ASX: NXT).

Not generating enough capital internally and being unable to raise it externally, NextDC spun off Asia Pacific Data Centres in a sale and leaseback transaction at $1.00 per share in 2013.

Enter 360 Capital

Enter 360 Capital (ASX: TGP), managed by shrewd commercial property veteran Tony Pitt. After accruing a nearly 20% stake, 360 Capital proposed replacing current management and increasing returns to shareholders, mainly via a capital distribution funded by increasing Asia Pacific Data Centres' debt.

NextDC's leases expire in 2027 and 2028 but it has three options totalling an additional 25 years to extend them at the then market rates. However, with switching costs very high, its customers demand even more secure tenure and so will be even stickier with an owner-operator model than a leased one.

Moreover, barriers to entry in data centres are also high. As colleague Gaurav Sodhi has noted, you can't just locate a data centre anywhere – it needs to be free of natural disaster risks like earthquakes, floods and so on, relatively close to customers and well connected to power and fibre.

NextDC also has favourable lease terms over the initial 15-year leases – NextDC's rent rises by the CPI each year, with the market rent reviews that occur every five years limited to rises of 10%. Meanwhile, its earnings before interest, tax, depreciation and amortisation from each of the centres has risen at a far faster rate since the spinoff. 

So with demand for data storage and management forecast to increase exponentially between now and the late 2020s, it's likely that Asia Pacific Data Centres would be able to demand substantial increases in rents in 2027 and 2028 if NextDC exercised its options as I'd expect.

NextDC had no choice but to respond.

After some back and forth involving competing offers that were both subsequently raised, 360 Capital now owns 67.3% of Asia-Pacific Data Centres, with NextDC controlling 29.2%.

What now?

After gaining control of Asia Pacific Data Centres, 360 Capital proposed increasing its borrowings and paying a 65 cent capital distribution. However, with this likely needing minority shareholder approval under the ‘financial assistance' provisions of the Corporations Act and NextDC opposing this strategy, NextDC countered by proposing to sell the properties and distribute the proceeds to shareholders. 

In response, 360 Capital argues they could be worth up to $300m or $2.40 per Asia Pacific Data Centres share after debt is taken into account, and offered them to NextDC at this price to satisfy the latter's first right of refusal on any sale. 

Unsurprisingly, NextDC demurred, on the basis that this wouldn't be good value for its shareholders and I tend to agree. At $300m, this would represent a capitalisation rate of 4.69%, close to the capitalisation rate of some trophy office towers have sold at recently as investors continue to push commercial property capitalisation rates to historical lows.

It has instead proceeded with calling a meeting to sell the properties and wind up Asia Pacific Data Centres. NextDC argues that 360 Capital is prevented from voting on this proposal so, if true, any vote would be a fait accompli.

In any case, 360 Capital seems to be in prime position to make a decent return on its average cost base of around $1.85 per share whatever happens, while NextDC will be a similar position to where it is now if the properties are ultimately sold to a third party. However, if NextDC succeeds in having Asia Pacific Data Centres wound up and the properties sold for less than $300m, it could use its first right of refusal to reacquire them at that lower price.

Whatever the ultimate outcome, we should shortly find out what Asia Pacific Data Centre's data centres really are worth.