Earnings Call Transcript - VNET Q1 2021

Operator, Operator

Good morning and good evening, ladies and gentlemen. Thank you, and welcome to 21Vianet Group's First Quarter 2021 Earnings Conference Call. With us today are Mr. Samuel Shen, Chief Executive Officer and Executive Chairman of Retail IDC; Mr. Tim Chen, Chief Financial Officer; and Ms. Rene Jiang, Investor Relations Director of the company. I'll now turn the call over to your first speaker today, Ms. Rene Jiang, IR Director of 21Vianet.

Rene Jiang, Investor Relations Director

Thank you, operator. Hello, everyone. Welcome to our first quarter 2021 earnings call. Before we start, please note that this call may contain forward-looking statements made pursuant to the safe harbor provisions of 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.

Samuel Shen, CEO

Thank you, Rene. Good morning and good evening, everyone. Thank you for joining us on our earnings call today. During the first quarter of 2021, we grew our net revenues by 27.1% to RMB1.39 billion from RMB1.09 billion a year ago. Additionally, we grew our adjusted EBITDA to RMB415.1 million from RMB259.4 million, reaching the high end of our previous guidance. Our adjusted EBITDA margin increased to a new high of 29.9% from 23.8% in the prior year period. We attribute this quarter's financial achievements to our ability to capitalize on shifting market demand, our dual-core growth engine strategy and our methodical execution of business expansion. As we transition into a post-pandemic world, leading to an age of digital transformation, we foresee both a multitude of headwinds and tailwinds in the IDC space. Central government's regulation on the supply side of emission peak by 2030 and carbon neutrality by 2060 will lead to near-term challenges, however, should result in long-term sustainable value for industry leaders. Recent intensified competition in certain geolocations could force companies to better compete over operational efficiency, business innovation, and customer satisfaction, all areas in which we've excelled. Lastly, new market entrants in the IDC space might cause near-term market fragmentation yet will create ample M&A opportunities for us in the mid to long-term. On the other hand, central government and financing institutions maintain favorable policies towards the new infrastructure space in support of the digitalizing trend. Data sovereignty, data privacy, and data security are of ever-increasing importance, leading to a shift in customer demand toward major carrier-neutral and cloud-neutral IDC providers. Furthermore, the trend of remote work, increased regulatory compliance, data-driven decision-making, as well as mixed reality, all lead to sustained market demand for IDC. High growth areas such as industrial 5G, blockchain, Internet of Things, and small manufacturing are fueling broader market demand for cloud computing, which will benefit leading IDC providers like VNET. As such, we have seen an expansion of our potential customer base far beyond public cloud service providers and internet companies.

Tim Chen, CFO

Thank you very much for the kind introduction, Samuel. Good morning, and good evening, everyone. I'm very excited about our work here at VNET, and it’s my pleasure to speak with you all today. In my new capacity as CFO, I'm committed to providing shareholders and investors with increased transparency, frequent communications, and more detailed discussions around our outlook. I aim to further enhance our team-oriented culture, bolster our operating efficiency, advance our various ESG initiatives, and more. As always, the teams here at VNET remain focused on strategically allocating our capital to meet our ROI goals and securing diverse and quality funding sources. Before we start our detailed financial discussions, please note that we will be presenting non-GAAP measures today. Our non-GAAP results exclude certain non-cash expenses, which are not part of our corporations. The details of these expenses may be found in the reconciliation tables included in our press release. Please also note that unless otherwise stated, all the financial numbers we present today are for the first quarter of 2021 and in renminbi terms, while percentage changes are on a year-over-year basis. We started off the year with strong first quarter financial results, mainly attributable to our dual-core growth engine and methodical business transformation. Net revenue in the first quarter increased by 27.1% to RMB1.39 billion from RMB1.09 billion in the first quarter of 2020. This increase was attributable to both wholesale and retail IDC growth, as well as increased growth from cloud revenue. Gross profit in the first quarter was RMB323.3 million, representing an increase of 38.1% from RMB234.1 million of the same period in 2020. Gross margins in the first quarter of 2021 were 23.3% compared to 21.5% in the same period of 2020. This year-over-year increase in gross margin was mainly due to our ongoing efforts to improve operating efficiencies. Adjusted cash gross profit, which excludes depreciation, amortization, and share-based compensation expenses, was RMB605.3 million in the first quarter of 2021 compared to RMB417.1 million in the same period of 2020. The adjusted cash gross margin in the first quarter of 2021 was 43.6% compared to 38.2% in the same period. Adjusted operating expenses, which exclude share-based compensation expenses and impairment of long-lived assets, were RMB212.5 million in the first quarter of 2021 compared to RMB177.8 million in the same period of 2020. As a percentage of net revenues, adjusted operating expenses in the first quarter of 2021 were 15.3%, compared to 16.3% in the same period of 2020.

Operator, Operator

Your first question comes from the line of Yang Liu from Morgan Stanley. Please ask your question.

Yang Liu, Analyst

Thanks for the opportunity. Two questions from my side. The first one, we see some new entrants backed by property firms, et cetera, entering the wholesale and hyperscale market in the Tier 1 city surrounding areas. But could you please update us in terms of the competition dynamics in the retail market? We see your MRR continue to go up, though the company previously commented that these numbers should be largely stable. What should be the outlook for the retail pricing going forward? The second question is, in the presentation, I saw a new project called N-OR02 to be delivered in the second half of this year. Could you please give more color on where this kind of project is booked by anchoring customer? And is it included in the total 180 megawatts wholesale capacity? Thank you.

Samuel Shen, CEO

Okay, thank you, Yang Liu, for the questions. I'll let Tim take on the MRR, and then I will provide additional details for your second questions. Tim?

Tim Chen, CFO

Sure. Thank you, Samuel. So, Yang Liu, regarding the MRR question and the question also on how we look at the outlook for the retail portion of the business. We did make a comment in the past that we expect it to be stable, and we expect that during the course of this year and next year, the figure will show a flat and slightly rising trend. We do expect that customers will continue to take on some new digital services, and obviously, that will help drive an overall positive trend. I would encourage that you don't look at this necessarily quarter-to-quarter, but perhaps, on an annual basis. Again, management expects that trend to continue to rise as we roll out more of our services. There’s also, in some ways, links to the Neolink rollout. This represents our view of the positive discipline in the market, really focusing on retail enterprise customers and offering more of the services that they require. Hope that helps.

Samuel Shen, CEO

Yes. Additionally, a couple of things. First of all, it is true that we're seeing new entrants coming into the IDC space. However, we have also received a lot of great feedback from the customers that IDC is not just purely a real estate business. It requires years of experience and also provides customers with peace of mind. It is a combination of capital resources and technology combined together. So we welcome the competition. Talking to the customers and assessing market demand, we're still seeing very positive signs for VNET. Speaking of the new logos, HB02, it is true that in the first quarter, we signed a contract with a leading e-commerce platform for services. We also secure a long-term contract with a leading internet company. Additionally, in the first quarter, we have great examples of transforming and upgrading retail customers into wholesale customers. In the past, they tended to choose to colocate their servers and racks in Tier 1 cities; however, given the growing demand, we are provided great opportunities by leveraging our surrounding areas and customizing efforts for those customers. So we're seeing a positive trend, and we hope to continue to see more to come. Thank you.

Operator, Operator

Your next question comes from the line of Timothy Chau from Jefferies. Please ask your question.

Timothy Chau, Analyst

Good morning, Tim and Samuel, thank you very much for taking my question. I have two. Number one is on your mature cabinet utilization, which actually fell to 73%, a pretty big drop. Can you elaborate a little bit on what's going on there? Number two, recent government policies applying to your cities seem to suggest that they are extremely vigilant in terms of power allocation. They also try to ask potential bidders to tell them exactly what customers they will get, what utilization rate they will get, and what applications they're going to use in the data centers? Does it mean that it's almost becoming impossible to have new retail IDC capacity in Tier 1 cities? So how would that affect your retail business? Would it be positive? Would it be negative? How do you see that? Thanks.

Tim Chen, CFO

Okay. I'll take the first question. Thank you very much for the question. I think the first one regarding the mature data center cabinet. Looking at it purely from a quarter-on-quarter basis may be misleading. What we do is, on January 1, we shift all the data centers delivered in a certain year to the next category. For example, if you look at the mature data center cabinets now, these now include all the ones that were delivered in 2019, which means that they actually have less than 18 months of operational history. So if you compare figures year-on-year, that would provide a clearer perspective. So you should actually be looking at the first quarter of 2020 versus the first quarter of 2021. The better measure to focus on would be the compound realization, which eliminates the categorization impacts and rather looks at the overall cabinets that we have available and the percentage utilized. Samuel, can you answer the second question?

Samuel Shen, CEO

Yes. For the second question, as of today, we have many data centers in Tier 1 cities. It is true that the Tier 1 governments are taking the 30-60 policies very seriously. They have policies in place for existing data centers to meet certain performance standards, and newly built data centers must also meet strict performance criteria. We have been in the industry for quite some time, and some of our data centers are exemplary models according to industry benchmarks. In the first quarter, three of our data centers have been shortlisted to receive national green data center certification, and we are proud to say that we have one of the first certifications awarded in Beijing. We will continue to maintain our high standards. Hopefully, that will not only meet the governmental requirements for Tier 1 cities, but we can also extend those traditions and efforts to the surrounding areas.

Operator, Operator

Your next question comes from the line of James Wang from UBS. Please ask your question.

James Wang, Analyst

Good morning management. Thank you very much for your time, and congratulations on the good result, particularly on the EBITDA line. I have two questions. The first one is about competition. One of your peers mentioned that intense competition was isolated in the Jiangsu Province while it has remained relatively stable across the rest of the country, so I just wanted to check whether that's your observation or whether more provinces are facing intense competition, and whether, across the board, pricing or rental rates remain broadly stable or are on a downward trend? The second question is about customer demand. Last year was a pretty strong year in terms of customer demand, partly due to COVID. I wanted to check whether you’ve seen any moderation in demand from cloud customers this year, and have you seen a similar nation-wide pickup in demand from financial institution customers? Overall, are you seeing any acceleration in demand from your retail customers? Thank you.

Samuel Shen, CEO

Okay. Let me take these two questions and welcome Tim to add additional inputs. First, regarding Jiangsu Province, we do have our data center located there. From our conversations with customers, we are confident that the Jiangsu Province data center will be ideal, not just for public cloud service providers, but also for some additional internet companies. We remain optimistic about that. For the second question, COVID-19 significantly impacted the world last year, and China is likely one of the countries in a post-pandemic era. This pandemic has accelerated many transformations, not just among internet companies, but also traditional enterprises. You mentioned the financial services industry and smart manufacturing; we are witnessing strong demand from those sectors as well. I would say the first quarter gave us good confidence that we are on track for the year. Thus, we will continue to execute our strategy and hopefully, continue to drive up the Monthly Recurring Revenue in our retail segment while meeting the customization needs of the hyperscale internet giants.

James Wang, Analyst

Sorry, can I just follow up on the first question, Samuel, just on overall pricing or rental rates? Are you seeing broadly stable trends or any downward pressure on rates or returns? Thank you.

Samuel Shen, CEO

Yes, from the pricing point of view, I would say so far from all the conversations we've had with customers, that was likely just a one-off situation. We don't see any broader impact, not just from Jiangsu Province but also from other regions as well. That being said, I acknowledge that competition exists. However, this competition presents great opportunities for industry consolidation. We are committed to playing the long-term game. Our dual-core growth engine offers additional advantages, as we are not just providing colocation services; we are also providing networking services, bare metal services, and hybrid cloud solutions. That is reflected in our Monthly Recurring Revenue, which continues to climb gradually, indicating positive growth.

Operator, Operator

Your next question comes from the line of Arthur Lai from Citi. Please ask your question.

Arthur Lai, Analyst

Hi, I really appreciate the management time. Congratulations on the Q1 continuous margin improvement, and also congrats to the team on the new role. I have two questions. Number one is on the margin side. We saw the gross margin grow 1.5% year-over-year driven by mix. If we compare the dual-core growth engine, which business contributes more to the gross margin? Can we expect similar margin expansion into 2022 or 2023? That’s my first question.

Tim Chen, CFO

I would say that both the wholesale and retail segments do have strong gross margins. The contribution from the wholesale, as you will see over time, will increase. This is because, relatively speaking, retail operates off a much larger original base compared to the wholesale business. So I think as we go forward, we expect continued improvements. As you know, our overall results also include other business units. So as cabinets are delivered and utilization rates increase, we will see continued improvement in gross margins. Hope that helps, Arthur.

Arthur Lai, Analyst

Thank you. And my second question is on the E-JS Campus 02. We understand that your time for renting. Can management give us an update on which type of customers are interested and what kind of timing, and if there were any pricing considerations? Can the company add more value with services to stand out from the competition? Thank you.

Samuel Shen, CEO

I would like to take this question and see if Tim has additional comments. The E-JS Campus 01 has been completely taken up by our hyperscale customers, while E-JS Campus 02 is an excellent data center location due to its proximity to Shanghai. It offers great advantages in network latency and bandwidth supply. Both wholesale and retail customers have shown great interest in this data center. We are in discussions to determine which customer will commit long-term. This is related to previous questions about price competition, but due to the strategic value of location and the expansion capabilities, we are confident in managing negotiations, maintaining healthy returns from wholesale perspectives, and keeping our target IRR in the 10% to 15% range. So, I would say we are cautiously optimistic, and we hope to provide additional information in the coming quarters.

Operator, Operator

Your next question comes from the line of Kyna Wong from Credit Suisse. Please ask your question.

Kyna Wong, Analyst

Yes, thanks management for taking my questions. I have two questions. The first one is actually related to capacity expansion and if your roadmap includes those areas in Jiangsu and others, how are we tracking towards the goal of 25,000 racks? Should we expect 72,000 to X thousand every quarter in the coming years to fulfill this target? And will that lead to capacity expansion during the periods? Would our customer pipeline remain on track considering manageable pricing competition? That’s my first question. The second one is about the ESG roadmap. We see from the ESG report that the company has achieved a certain percentage reduction in PUE last year and that 33% of Chinese data centers leverage green power. Can we expect a more concrete roadmap in 2021 regarding ESG initiatives? Thanks.

Tim Chen, CFO

Hi, Kyna, it’s Tim here. I’ll take your first question regarding the pipeline and the rollout of the cabinets. Yes, we are more back-ended this year. More of the deliveries are expected in the second half of 2021, but regarding increased pressure or competition, that is not the case. We are not discussing customer commitments a couple of months in advance; rather, we have secured commitments from customers for the second half deliveries from locations. So we are confident in managing this timing issue. Beyond 2021, we have already secured about 60% of the required resources. Thus, we are well-equipped to handle our customers' demands moving forward. We are already talking to customers about 2022 and beyond.

Samuel Shen, CEO

Yes, I can provide additional insights from the customer commitment standpoint. Tim and I have reviewed our wholesale and retail segments from customer demand perspectives, and for wholesale customers, we are well ahead of planning discussions before tenders. Based on customer feedback, I have less worry about our ability to deliver the 25,000 racks. In fact, we might have more opportunities based on our resources. Regarding our ESG report, this marks our first year to publish this report. While we have been involved with ESG efforts before, this year symbolizes our commitment to systematic organization and transparency around those efforts. We will continue using a tech-driven and data-driven approach to reduce our PUE while partnering with local governments to engage in green energy initiatives. We hope to share outcomes regularly.

Operator, Operator

Your next question comes from the line of Tina Hou from Goldman Sachs. Please ask your question.

Tina Hou, Analyst

Hi, management. Thank you very much for taking my questions. I have two questions. The first one relates to recent reports about intense pricing competition specifically for PDD projects. For VNET, what is our customer acquisition strategy? What measures do we follow for each tender that we target? Are there customers for whom we might sacrifice a bit of margin or pricing to secure them, or are we steadfast about our pricing and overall IR return? That’s my first question. The second one is regarding the Shanghai power quota allocation announced in April this year. What is our strategy there, and what’s the progress so far?

Samuel Shen, CEO

Okay, let me answer these questions and invite Tim to add further insights. Regarding the PDD deal, I believe that’s more of a one-off situation. If you examine it closely, you’ll find that it’s not a true apple-to-apple comparison. Details related to business remain confidential, so I cannot share much. However, at a high level for each tender, there’s a CapEx portion and an OpEx portion, which complicates direct comparisons. When major players like Kindle initiate projects, IDC providers, including VNET, express interest. However, we have our internal metrics to gauge our profitability and determine whether it makes sense to offer favorable discounts to secure first-time local customers. We assess all factors before proceeding. Regarding the price impact going forward, from conversations with customers, it seems to stem more from localized factors rather than broad trends. We have several projects outside Jiangsu, including Shanghai, Beijing, Guangzhou, and even Northern China, where competition and pricing remain stable.

Tim Chen, CFO

Yes. Overall, we continue to secure power quotas throughout the different regions. Our strategy and what we've communicated in previous quarters remains. We will continue to secure the necessary quotas for our various projects—some may move slower, and some may progress faster. Currently, we have several applications for projects, and as we have updates to share with the market and investors, we will do so in due course.

Tina Hou, Analyst

Thanks. Just a quick follow-up on that: regarding competition within power quota allocation this year, have we seen more newcomers entering the space? Last year, out of the 18 allocations, 6 went to newcomers, but this year, regulations have tightened. Have we already seen fewer newcomers in the bidding process?

Tim Chen, CFO

I can't comment on other bidders; however, your report captures the situation accurately. The tightened regulations and requirements imply that fewer individuals pursuing quick returns will participate. This puts existing, experienced operators like us at an advantage.

Operator, Operator

Your next question comes from the line of Chris Ko from DBS. Please ask your question.

Chris Ko, Analyst

Good morning, management team, and congratulations on the strong results; and thanks for taking my questions. My first question is about our second quarter adjusted EBITDA guidance. Please help us understand why the midpoint of the second quarter adjusted EBITDA guidance is flat q-on-q. Could it be due to timing issues with the moving schedule? My second question is about the cloud market. There are news reports suggesting potential market share changes and new entrants. What opportunities and threats do management see in this regard?

Tim Chen, CFO

With regards to the EBITDA guidance for Q2, you are correct. As we've explained to the market, our deliveries at this moment are more weighted to the second and fourth quarters. Therefore, we expect that with deliveries of the cabinets and the additional costs incurred, the EBITDA will be affected. This is why we've guided towards numbers that are flat compared to Q1. I'll pass the second question to Samuel regarding opportunities and threats in the cloud marketing.

Samuel Shen, CEO

Regarding the second question, I'd like to provide a broader view. COVID-19 has accelerated digital transformation. Public cloud service providers continue to experience healthy double-digit growth year-over-year, and we see hybrid cloud as the new norm. In contrast, China features numerous cloud service providers. Customers increasingly understand the importance of cloud transformation to thrive in this digital era while simultaneously emphasizing the importance of data sovereignty and privacy. Hybrid cloud has become the new standard. However, public cloud service providers face challenges in maintaining year-over-year growth due to their base revenues. The carrier-neutral IDC sector presents a unique landscape in China, as we provide neutral cloud and carrier services while meeting varied customer demands. We believe we retain a market share between 10% and 11%. We have confidence in our ability to expand and capture further market share moving forward.

Chris Ko, Analyst

Thank you.

Operator, Operator

I would now like to hand the conference back to the management for any closing remarks. Please continue.

Rene Jiang, Investor Relations Director

Thank you once again for joining the call today. If you have further questions, feel free to contact the company's IR. Bye-bye.

Operator, Operator

This concludes today's conference call. Thank you for participating; you may now disconnect.