GDS preparing to spin off its global business?

The data center operator is reportedly in talks to sell a stake in its fast-expanding global operation to several major investors, including Hillhouse and Boyu Capital

Key Takeaways:

• GDS is aiming to raise up to $600 million by selling part of its fast-growing global unit that operates data centers in Malaysia and plans to enter Indonesia
• The funding would give a small group of global investors a majority of the global operation’s stock, potentially paving the way for the unit’s spinoff

By Doug Young

Will data center operator GDS Holdings Ltd. (GDS.US; 9698.HK) become the next company to split off its global division from its original China business?

That question loomed large as the company confirmed it was in advanced talks to sell a stake in its young global operation to help fund the unit’s growth. GDS indicated during its last earnings call in November that it was seeking such investment, with an aim of completing the capital-raising move by March.

So, a Monday Bloomberg report saying Hillhouse Capital, Boyu Capital and CDH Investments were in talks to provide those funds doesn’t come as a huge surprise. GDS confirmed that it was in talks with “several private equity investors regarding a potential transaction with respect to its international business,” though it didn’t disclose any names.

The interest by this A-list of regional private equity investors speaks to GDS’ attraction as both a relatively well-run company, and also to the big potential for artificial intelligence (AI) to spark a major new wave of demand for data centers. Such an investment also makes sense for Chinese private equity firms like Hillhouse, Boyu and CDH, which are increasingly looking for targets outside their home China market where the economy is slowing.

The new investors would provide around $500 million to $600 million in new capital, according to the Bloomberg report. GDS previously indicated it would sell a minority stake in the global operation, so we can probably assume the private equity companies would get between 20% and 35% of the global unit for their new investment.

That’s significant, because such investment would make the international unit look increasingly global in terms of its stakeholders, unlike the overall company that is still firmly controlled by its founder, William Huang. GDS is currently 31.8% owned by Singaporean data center operator ST Telemedia Global Data Centres, while Singaporean sovereign wealth fund GIC owns another 3.6%, according to GDC’s latest annual report.

Thus, the sale of 20% to 35% of the international division would mean that more than half of that part of the business would be held by the two Singaporean entities plus the new private equity investors. That could easily pave the way for a spinoff of the international business into a separate company, most likely based in Singapore, which would achieve two key goals for GDS.

On the one hand, it would split off the faster-growing global business from the older China business, allowing the global unit to be more highly valued due to its better potential. At the same time, such a move would also sever ties between the global business and China, easing any customer concerns about hosting their data in centers owned by a Chinese company.

Investors seemed to like the bigger story, though they haven’t been particularly keen on GDS in general these days. The company’s Hong Kong-listed shares rose 18% on Monday after the Bloomberg report came out, and its New York-listed shares followed with a 22% gain the same day. But even after the rally, the stock is still down about 14% so far this year, and has lost more than half of its value over the last 52 weeks.

Gloomy China picture

The contrast between Chinese data center operators and their global peers is quite striking in terms of valuations. GDS currently trades at a price-to-sales (P/S) ratio of just 0.86, while domestic peer VNET (VNET.US) trades at an even lower 0.22. By comparison, global leaders Equinix (EQIX.US) and Digital Realty (DLR.US) trade at P/S ratios of 10 and 8, respectively, which is what you would expect from high-growth companies.

In this case, the big divide owes directly to the difference between the China and global data center markets. China’s ultra-competitive data center market is currently in a “corrective” phase, which is seeing cloud service providers that are one of industry’s largest customers dump a sizable amount of their unprofitable business to focus on larger, profitable users.

By comparison, the global cloud market is a bit healthier in terms of the degree of competition. That shows up on the bottom lines of the four companies we’ve mentioned, with GDS and VNET both losing money in each of the last three years, while Equinix and Digital Realty have been quite profitable over that time.

So, what exactly does GDS’ global business consist of that’s getting investors so excited? The company’s global footprint is all in Southeast Asia, which is a common starting point for Chinese tech companies going global. It began providing services in Singapore in 2021 using data center capacity provided by ST Telemedia, and officially opened its first self-operated facility in the Malaysian state of Johor in last year’s third quarter.

The company was set to bring another similar-sized facility into operation by the end of last year, and has acquired land for another facility in Johor. It has also signed a joint venture agreement with Indonesian sovereign wealth fund, INA, to set up facilities in that country.

As it built up the Malaysia operation, the company was set to log about 4 billion yuan ($556 million) in capital spending for its overseas business last year – more than the 3.5 billion yuan it was planning for China. The company has yet to announce its international capex plans for 2024, though we can probably expect the figure to be as much or higher than last year’s 4 billion yuan. Hence the need to raise cash from new investors, who seem quite happy to pump money into that part of GDS’ business.

The company announced in December that it had secured a 1.27 billion ringgit ($271 million) green financing facility from a group of major Malaysian lenders, so it appears there is plenty of interest from the financial community in helping GDS to fund its global foray. That group of new investors could expand to include stock buyers as well, if and when GDS decides to spin off and separately list its global division.

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