Earnings Call Transcript - VNET Q3 2020

Rene Jiang, Investor Relations Director

Thank you, operator. Hello, everyone. Welcome to our third quarter 2020 earnings call. Before we start, please note that this call may contain forward-looking statements made pursuant to the Safe Harbor provisions for the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on management's current expectations and observations that involve known and unknown risks, uncertainties, and other factors not under the company's control, which may cause actual results, performance, or achievements of the company to be materially different from the results, performance, or expectations implied by these forward-looking statements. All forward-looking statements are expressly qualified in their entirety by the cautionary statements, risk factors, and details of the company's filings with the SEC. 21Vianet undertakes no duty to revise or update any forward-looking statements for selected events or circumstances after the date of this conference call. I will now turn the call over to Mr. Alvin Wang, CEO and President of 21Vianet.

Alvin Wang, CEO

Thank you, Rene. Good morning and good evening everyone. Thank you for joining us on our earnings call today. We are pleased to announce that we achieved strong results once again in the third quarter of 2020. During the quarter, we grew our revenues to RMB1.25 billion, which was in line with our previous guidance and increased our adjusted EBITDA to RMB368.5 million, exceeding our previous guidance. Additionally, our EBITDA margin also expanded to 29.6% in the third quarter as compared to 27.8% in the same period of 2019. In terms of cabinet delivery, we delivered more than 7,000 cabinets in the third quarter of 2020. As a result of our steady organic growth and on-track delivery schedule, we have delivered more than 15,000 cabinets in total since the beginning of the year. Beyond our delivery success, we also continued to make headway in our expansion efforts. During the quarter, for example, we secured two separate resources, both of which are located in the surrounding area of Beijing to the immediate east of the city. Importantly, when completed the combined total IT power of both resources will be around 50 megawatts, helping us to better serve the growing demand for our IDC solutions in the region. Looking ahead, we expect the first stage of both projects to be completed during the first half of 2021. Moreover, in Jiangsu, we have secured an additional 140 megawatts of IT power to be used in the expansion of our Jiangsu campus. In fact, this additional megawatt capacity is around three times the current megawatt capacity of our existing Jiangsu Campus, which was built for a leading public cloud company.

Samuel Shen, Executive Chairman of Retail IDC Business Group

Hi, everyone. This is Samuel. Thank you, Alvin. As always, it is a great pleasure to meet and speak with all of you virtually. I'm quite pleased to announce that since joining the company in May, I continue to be inspired on a daily basis by both the effectiveness of our team and the abundance of opportunities in our industry. To reiterate Alvin's point, we do believe that this new rotating leadership program is quite innovative, and that will help us to better capitalize on increasing opportunities within China's IDC industry. On a personal note, I look forward to utilizing my own technical background and management experience to further advance our technology, integrate our business groups and maintain consistent dialogue with the investment community going forward. Now let's turn to our market outlook. Looking ahead, the broader market trends for the IDC industry in China remain very favorable. In fact, the total market for IT outsourcing services in China is expected to reach RMB350 billion by 2024 according to Frost & Sullivan. Meanwhile, enterprises are seeking flexibility in scaling their demand to control IT-related costs, making the use of third-party data center service providers increasingly attractive. As measured by total revenues, the total market size of the retail data center services market is expected to grow at a CAGR of 11.9% from 2019 to 2024, reaching RMB32 billion by 2024. While the total market size of the wholesale data center services market is expected to grow at a CAGR of 21.3% over the same duration, reaching RMB34.1 billion by 2024, again, according to Frost & Sullivan. As China's IDC industry continues to grow, we will remain committed to the implementation of our dual-core growth strategy, which has delivered strong results since its inception in 2019. As a reminder, this dual-core strategy is focused on providing high-quality, carrier-neutral and flexible IDC solutions to both retail and wholesale customers throughout China. On the wholesale front, we have found that our hyperscale IDC services continue to be highly attractive to large-scale enterprises. Meanwhile, on the retail front, we are also observing increasing demand for scalable and modular IDC solutions. In light of the favorable industry growth trends and our own competitive advantages in China's IDC industry, we expect our dual-core growth engine strategy to continue gaining momentum going forward.

Sharon Liu, CFO

Thank you, Samuel and Alvin. Hello, everyone. Before we start our detailed financial discussion, please note that we will present non-GAAP measures today. Our non-GAAP results exclude certain non-cash expenses, which are not part of our core operations. The details of these expenses can be found in the reconciliation tables included in our press release. Please note that unless otherwise stated, all financial numbers presented today are for the third quarter of 2020 and are in RMB terms and that percentage changes are on a year-over-year basis. Although there was still some degree of uncertainty throughout the macro environment, we delivered strong financial results in the third quarter, maintaining our cabinet delivery schedule, bolstering our operating efficiency and augmenting our utilization rates in turn. As a result, during the third quarter, our revenues were within our guidance range, while our adjusted EBITDA exceeded the higher end of our guidance range. Revenue in the third quarter increased by 27% to RMB 1.25 billion from RMB 981 million in the same period of 2019. Such growth was mainly driven by the industry's healthy growth trajectory and our ongoing capacity expansion, which enabled us to address the uptick in demand for scalable retail cabinet solutions and carrier-neutral wholesale IDC solutions during the quarter. Retail IDC MRR per cabinet in the third quarter increased to RMB 9,074. We added around 7,400 new cabinets during the third quarter. As of September 30th, 2020, we operated and managed 51,476 cabinets. Despite our capacity expansion, our compound utilization rate in the third quarter increased to 64.2% from 61.4% in the second quarter of 2020.

Yang Liu, Analyst

First, I would like to congratulate management for the very strong earnings and the bullish three-year plan. The first question I have is regarding the three-year plan—25,000 cabinets or 180-megawatt addition per year. I find that these two numbers actually—I would like to ask you, how should we think about the relationship between these two numbers? If we divide 180 by 25 directly, that means all the new cabinets will be high power density. Is that the case? Or if we then use the 25,000 cabinet number, that means—if we use standard power density, that means the megawatt number will be less than 180. So could you elaborate more about how to think about the 25,000 versus 180 megawatts? The second question is the split of the new capacity between wholesale and retail. Previously, I think the management mentioned a 40-60 or 50-50 split in terms of the wholesale-retail. And now we are still emphasizing the dual-core growth strategy. So I would like to ask what should be the right way to think about the split in terms of capacity? And the third question, could you please update us in terms of the new customer on the wholesale front? You mentioned a new cloud customer. Could you please elaborate more about the future potential from that customer or independent cloud customer in terms of future demand? Thank you.

Alvin Wang, CEO

Hello, this is Alvin. Thank you, Liu Yang, for your questions. Obviously you paid a lot of attention and made a very good study on our reports and figures. So regarding the 25,000 cabinets and 180-megawatt capacity, let me put it this way. Going forward, in the coming year we have very strong demand from wholesale customers and scale retail customers, which means that we plan for 80% of our capacity to be high-power density, which means that's basically 8-kilowatt per cabinet for around 80%. For the other projects, we still expect strong demand from high-value retail customers, which means that we will allocate around 20% of our total capacity into that segment. So in that case, combined with 80% for 25,000 high-power density and then 20% of our standard, so-called retail cabinets. We will wrap up with 180 megawatts for wholesale and retail customers in the coming year. And I think that this basically addresses your first two questions. And also for new customers in the retail segment—in the wholesale segment, currently we have very strong engagements with all the leading customers, both public clouds and some other leading internet players. We expect that in the coming quarters, we can secure new customers. Not only the leading internet players, but also the new top public cloud players as well. Thank you.

Edison Lee, Analyst

Hi. It's Edison from Jefferies. So I have two questions. Number one is on the 8,000 cabinets that you are securing from, I think, in the east of Beijing, it seems to be an acquisition of a brownfield project. Could you please comment on how much you paid for the brownfield project? And what the location of that—exact location of that capacity is going to be? Number two is in your 25,000 cabinets per year additional new guidance. I assume that is based on 100% organic growth. If not, yes, please correct me if I'm wrong. And in addition to organic growth, what sort of acquisition opportunities are you seeing in the market? And can you talk about any prospects of acquisitions in 2021? Thank you.

Alvin Wang, CEO

Thank you, Edison, and this is Alvin, again. Thanks for all of your questions. Regarding our new resources in certain areas of Beijing East, we acquired a lease project at a very reasonable price because this is just what we call strong fuel projects. These two projects are located quite close to Beijing. Actually, it's the way we expect—some reliance will be available next year from Beijing's downtown to these two sites. This means we expect it will be very attractive to our leading customers. For these two projects, we have full approval and also power supply capacity ready. So we have very strong customer demand engagements already ongoing. For your second question regarding the growth of 25,000 cabinets, next year, the majority will be our organic growth. We are very cautiously optimistic about more acquisition opportunities in the next years, and if we may make any big acquisitions, it will add beyond this 25,000 cabinets next year, if we make any large acquisition. Thank you.

Edison Lee, Analyst

Hi, Alvin, if you don't mind, I want to follow-up with a question about acquisition opportunities in the market. So, can you share with us your thoughts on where these opportunities are coming from and where the valuation is actually going up? And what would your hurdle rate be when you evaluate these acquisition opportunities in the market?

Alvin Wang, CEO

Yes. Actually, talking about merger and acquisition opportunities, as I said, we are cautiously optimistic since this market is quite hot. There are a lot of new players, new investors, and many have very high expectations at this moment. But still from our side, we have very strong confidence. We have a unique competitive advantage from both capital, technical, and also cost perspective for brand customer acquisition. All these advantages give us a strong foundation to build a very strong position in case of market consolidation. Going forward, we have, from the global market and also from China markets, a firm belief that there will be consolidation going forward. In that case, we will take a very good position there. Thank you.

James Wang, Analyst

Good morning, management. I've got two questions if I may. The first question is just regarding the additional capacity that you've obtained for the existing Jiangsu campus. I just wanted to find out whether you envisaged bringing new tenants to this location or new logos? Or would it be mainly to meet demand for existing customers? The second question is just around the three-year plan. So, could you please shed some light on the revenue and EBITDA growth outlook in that three-year plan? Or if you can't share the numbers, whether the growth rate per annum will be higher than what you've achieved this year? And whether these targets can be achieved without raising additional equity? Thank you.

Alvin Wang, CEO

Thank you for the question. This is Alvin. Regarding our Jiangsu campus, we are very happy to announce that we secured two additional capacities that are very large and also in our size. We have already secured a leading public cloud customer. Going forward, we will definitely serve that customer even better, and at the same time, we do have strong engagement with leading internet customers and also financial institutions. We will add new customers into that campus going forward.

Sharon Liu, CFO

Hi, James, this is Sharon. I will answer your second question regarding the three-year growth plan, as well as other fundraising plans. I think it is too early to provide full year guidance for next year or the year beyond. So the company will provide our outlook in March next year during our Q4 earnings. But at this moment, I can provide some insights from the company regarding the EBITDA margin. As you know, we just announced that we will deliver at least 25,000 cabinets in 2021. Our EBITDA margin will be under pressure next year at the same level as the full year of 2020. However, the EBITDA margin will improve from 2020 to 2022, exceeding 30% and keeping an upward trend. Regarding the financing policy, our policy is to reserve enough capital to support our expansion plan. After the follow-on, we have reserved two sites in the surrounding areas of Beijing and 114 megawatts for the Jiangsu campus. In the future, if we secure more resources, we may consider fundraising in 2021. Thank you.

Arthur Lai, Analyst

Thank you. Congrats management on delivering a very good result. I have two questions. One is more of a housekeeping question. We've noticed that there's a foreign exchange gain this quarter. Can Sharon walk us through how we should think about the math? The second question is we keep hearing your peers in China mention that some of the power grids cannot supply their part in time. Did you see this phenomenon? And also in the future, will that be the near-term bottleneck for growth? Thank you.

Sharon Liu, CFO

Thank you, Arthur, for your question. Regarding the foreign exchange gain, it was mainly due to the appreciation of RMB, but it was a non-cash and unrealized gain. For your second question, Alvin Wang will answer.

Alvin Wang, CEO

Yes, Arthur, thank you for the question. Regarding delivery, there are challenges, especially given COVID and others. We are well prepared. First, we have a very strong pipeline, which I mean we have not only from a long-term perspective but also for the near-term as well. We have a strong pipeline in different locations for different projects or different target customers. Second is we have a very strong engineering team and a very strong partnership with our suppliers and partners. So we are very confident to deliver according to our schedule. Even though we have a tough environment, we promised to deliver 15,000 cabinets at the beginning of this year. Right now, we expect that we will deliver 70,000 cabinets, including mergers and acquisitions. Moving forward, we see a lot of challenges, but we remain very confident to deliver strong results. Thank you.

Tina Hou, Analyst

Hi, good morning management. Congrats on the very strong result and very strong future year guidance. My first question is in terms of your 25,000 new cabinet net adds for the next three years, which is obviously a step-up from 2022. So I'm just wondering where does the additional demand come from, is it from wholesale, I assume? Then, are you seeing this from existing customers or from new customers? And also, how do you base your forecast on, or base your guidance on? Is it on already existing demand or orders from customers? Or is it more from a supply angle? Yes. So that's my first question.

Alvin Wang, CEO

Thank you, Tina. Thank you for your questions. At this moment, we expect more than 25,000 cabinets per year in the coming three years. The majority of this capacity will be in the surrounding areas of our Tier 1 cities, namely Beijing, Shanghai, Guangzhou, and Shenzhen. Additionally, we expect that our city-type data center will remain another growth engine for our total business. Regarding the demand, we see strong demand from both wholesale and retail customers. From our perspective, we are very confident that we will gain more market share from our existing customers, namely the top leading public cloud players and internet giants. At the same time, we will expand our customer base into new logos and other emerging players, especially in online streaming, online education, and state-owned projects where we see very strong demand. Thank you.

Tina Hou, Analyst

Thank you, Alvin. My second question is regarding the current third-quarter status. In terms of your current billable cabinets, I'm wondering how much of them are wholesale at this point? And in terms of your retail business, I see some of your retail peers in China have noticed a slowdown in this segment due to COVID, as well as due to more smaller customers going on to public cloud. So, have you seen also some slowdown in your retail segment as well? Thank you.

Alvin Wang, CEO

At this moment, we have a very strong retail operation and a very strong retail customer base. So right now, a significant portion— the majority of our revenue still comes from our retail customers. Going forward, we expect that the wholesale segment will represent a major part of our incremental growth. Our retail business faces challenges, especially during the COVID period. However, we have a diversified customer base from various segments. We see strong demand from segments like online education and online streaming, while we also note some weaknesses from customers like hotels and retail businesses. Overall, we remain confident that our strong customer base and product offerings will continue to drive value for our dual-core strategy moving forward. Thank you.

John Choi, Analyst

Good morning, management and thank you for taking my question. I have two questions. First, I would like to gain a better understanding of your three-year plan. If we look at long-term demand right now, could you walk us through how you see the pricing magnitude, given that we are seeing a lot of supply coming into these Tier 1 city suburbs from your peers? Do you think you'll be able to manage the pricing both on the wholesale and retail fronts, given that the supply continues to increase? As a follow-up, can you walk us through what you expect regarding the IDC, MRR, and utilization rate in the coming years and how it will affect our EBITDA margin? Thank you.

Alvin Wang, CEO

Okay. So, John, thank you for your questions. Regarding the three-year growth plan, the IDC segment has become attractive from both the demand and investment perspectives. We see many new investors and new players entering the market. However, we believe there are significant barriers for new players due to the current competitive environment. We hold a strong competitive advantage in terms of pricing and profitability. Firstly, from the wholesale or overall retail combined perspective, we have a strong economy of scale. We delivered more than 7,000 cabinets this year and plan to increase that figure next year, strengthening our position. This allows us to negotiate better deals with our suppliers. We also have strong customer acquisition capabilities, positioning us to enjoy some pricing premium with high-value customers. Since Samuel joined the team, we’ve worked to enhance our retail offerings, which will translate into increased customer value, maintaining MRR going forward. Thank you.

Sharon Liu, CFO

Hi, John. Regarding your second question about the EBITDA trend, I previously answered a similar question. For the utilization rate, we expect that with the delivery of at least 25,000 cabinets, the compound utilization rate will be at least above 60% in the next three years. However, looking at the utilization rate performance this year, both in our existing data centers and in new deliveries, the ramp-up utilization rates have increased quarter-over-quarter, which demonstrates our strong customer demand momentum. Thank you.

Colin McCallum, Analyst

Thank you and congratulations on the strong numbers. I just had a couple of questions, most of which have been answered. One was, could you provide any color on what you think the total CapEx requirements might be for that three-year build? The second question is regarding Tsinghua Unigroup. I read that there may be some potential restructuring and issues there. It might be difficult for you to comment, but I'd like to know—at least from a Vianet perspective—whether there's any impact on your ability to function, raise capital, or continue to grow? The third question is just regarding the management issue you're classifying as a rotation—could you clarify what exactly you mean by that when you say it's a rotation program? I believe some investors would like to understand it better. Thank you.

Sharon Liu, CFO

Hi, Colin, this is Sharon. Regarding your question about our CapEx, I would say for the additional 25,000 cabinets each year, the CapEx will be at least about RMB5 billion. However, if we secure more resources and pursue some big acquisitions, the CapEx guidance may exceed RMB5 billion.

Alvin Wang, CEO

Okay. Colin, thank you for your question. Regarding your second question, we are in a fast-moving market with dynamic market demands and different momentum from customer segments. This means we keep refining and adjusting our business strategy and organization accordingly. Currently, we have a clear strategy called the dual-core strategy. We are adjusting our organizational structure to better serve our strategy and seize new growth opportunities going forward. Regarding the rotation program, I would say this is a very innovative approach in these markets, especially in the IDC segment. Since we have strong growth momentum and high potential ahead, we need to have more capabilities and talent join the team. Not only from a top management perspective but throughout the organization, we are introducing a rotation program as well. Finally, I believe two minds are better than one, which is why we want more talent to join the team and contribute to our value. Thank you.

Unidentified Analyst, Analyst

Hi, management, and congratulations on such strong results. My first question is regarding our 140 megawatts in service and MoU for wholesale. Could you give us more details on the contracted proportions right now? The second question is, comparing with our continuously improving retail MRR, what is our wholesale MRR level at this moment? Finally, what's our focus on technology development for our IDC business?

Alvin Wang, CEO

Sorry. We are experiencing some voice quality issues. Can you please repeat your first question? Thank you.

Unidentified Analyst, Analyst

My first question is regarding our 140 megawatts in service MoU for wholesale. Could you give us more details about the contracted proportion at this moment? Thanks.

Alvin Wang, CEO

Sure. We have very strong customer engagement at this moment, both with our existing customers and also our new customers. I can say that we have strong ongoing customer demands, some commitments, and some pre-commitments. For our wholesale parts, we see a significant proportion covered by these commitments and pre-commitments. As for retail processing, all our retail capacity is situated in Tier 1 cities, where we see strong customer demand, meaning that we anticipate reaching around 40% utilization rate by the end of the first year for this new capacity. Regarding your second question, the wholesale MRR does vary by customer, and we have different pricing schemes based on location. Generally, we enjoy a market-level MRR, and in many cases, we have a pricing premium due to our high-quality services and strong customer relationships. Thank you.

Rene Jiang, Investor Relations Director

Thank you for joining us today. If you have any follow-up questions, please feel free to contact IR. Have a good day.

Operator, Operator

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.