NextDC

Sustainable competitive advantages are rare. Most companies grow and succeed because they opportunistically sell something the market isn’t providing. Over time, as others realise how attractive a gap they’ve ‘filled’, outsized returns evaporate. This is how a market economy is supposed to work.

Take recently listed data centre provider NextDC for example. Started by Bevan Slattery, founder of PIPE Networks (purchased by TPG Telecom in 2009), NextDC has, in a very short space of time, done an admirable job. It has opened three data centres in Sydney, Melbourne and Canberra with more on the way in Sydney and Perth.

NextDC aims to benefit from the exploding demand for data and our need to store it. However, as we argued in Telstra Pt I: Five major challenges from 30 May 12 (Hold – $3.54), growing demand for data is more likely to attract competition rather than profits. It’s hard to see how data storage has any sustainable competitive advantages.

This doesn’t mean NextDC won’t be successful—it may well be—but those investing are best to be clear on why. This is a fast moving, opportunistic business, not a great one. Earnings are still negative, and will remain so as the business expands. Plus, today’s buyer is paying a 50% premium to book value which seems too expensive to us.

Thus far, management have executed on their plans and recently announced plans to spin off its data centre assets into a trust via a sale and lease back arrangement (similar to BWP Trust and ALE Property Group). This is a clever move that will release capital to help fund expansion. Not that funding is currently a problem as NextDC is flush with cash after a recent capital raising.

We aren’t suggesting NextDC will fail, indeed, Bevan Slattery, who owns around quarter of the company, will be fighting his hardest to ensure it succeeds. But we’re looking for excellent businesses at fair prices and, right now, this is neither. AVOID.