NextDC launches offer for landlord

Having spun off three of its largest data centres into the appropriately named listed property trust, Asia Pacific Data Centres (APDC), NextDC is now proposing to buy those properties back again at significantly higher prices.

Selling low and buying high is the antithesis of successful investing, yet we're about to applaud the company for doing just that.

NextDC originally sold the data centres because it needed the cash to expand. The business wasn't generating enough of it internally and couldn't raise it externally; a sale and lease back of its prized data centres was an easy way to raise the money it needed.

Buying back the data farm

When the spin-off was proposed four years ago, NextDC was in a position of relative weakness. Having grown and proven its financial model (see Connecting with NextDC), it now proposes a buyback from a position of strength.

NextDC offered an opening bid $1.85 per security for APDC before increasing that to $1.87 and making the bid unconditional. The $215m purchase price is to be funded from existing debt facilities. That trumps an existing offer of $1.80 made by 360 Capital Group, which has played a shrewd game in flushing out the NextDC bid. 360 Group took an initial stake in APDC before making aggressive overtures and finally launching its own bid. It was enough to awaken NextDC and force it into action.

Buying APDC solves two problems for NextDC. The business pays about $13m in rent annually to APDC for occupancy of the three data centres, a sum it would save by owning the assets. A payback period of 16 years means the assets aren't cheap, but we can't judge the purchase on this metric alone.

Since listing, APDC's net tangible asset backing has increased from $1 a security to $1.43 per security. This is a strategic asset that, once bought in house, is no longer at risk of being devoured by a competitor and will help secure long-term customers.

Although NextDC boasts contracts and options with APDC for the next 40 years, customers reportedly demand more secure tenure and will be stickier with an owner-occupied model than a leased one. Taking everything into account, the deal makes sense.

Changing strategy

It's also clear that NextDC intends to pursue a different financing structure, as its cash flow continues to build – over the four years since listing, it has gone from a $20m a year cash outflow to a $40m a year cash inflow.

To date, NextDC has held little debt and no property. It will now hold its data centres on balance sheet – the three it intends to build and the three held by APDC – and hold more debt.

Usually more debt equals more risk but we don't believe this makes for a riskier business. Quite the opposite in fact. With stable, growing cash flows, this is a business that can handle debt, and property ownership reduces cash outflows while offering more security to customers.

There's a chance that 360 Capital could fight NextDC for APDC and it has already signalled that it wants a higher price. APDC's valuation already looks stretched and, as an arch-opportunist, 360 is likely to act rationally even if it talks greedily. Accepting NextDC's bid will secure a quick and handsome profit while agitating for more risks a steep fall. We don't think an offer much higher than the current bid is likely although that can't be ruled out.

Fears of overpaying and a capital-raising have pulled NextDC's share price down from $4.50 before these shenanigans to as low as $4. Even today, at $4.14, it is a fair way from our buy price.

That said, this is a high-quality business with sticky revenues that are growing swiftly. It is not yet cheap enough for an official upgrade, but those with higher risk profiles might start to build a position at current levels. HOLD.