Keppel Telecommunications and Transportation (KPTT SP) - UOB Kay Hian 2016-12-06: Snowballing Of Profits Begins; Conviction BUY

Keppel Telecommunications and Transportation (KPTT SP) - UOB Kay Hian 2016-12-06: Snowballing Of Profits Begins; Conviction BUY KEPPEL TELE & TRAN K11.SI

Keppel Telecommunications and Transportation (KPTT SP) - Snowballing Of Profits Begins; Conviction BUY

  • KPTT's profit has started to snowball via the Alpha Data Centre Fund, with its maiden acquisition in Frankfurt providing a 7% boost to earnings as expected. 
  • The divestment of T27 remains a positive in our view, as KPTT still benefits from recurring income post capital recycling. 
  • We revise our 2017-18 earnings forecasts by 6% and 9% respectively, as we factor in contributions from the aforementioned. 
  • Maintain BUY with a higher target price of S$2.53, lifted by higher 2017 data centre earnings.


WHAT’S NEW


Alpha DC Fund: Accelerating KPTT’s data centre earnings growth. 

  • Alpha DC Fund (ADCF) had on 11 Nov 16 made its maiden acquisition of a data centre in Frankfurt for €76m. The data centre comes immediately occupied at 50% and the acquisition serves as an example of how ADCF bolsters Keppel Telecommunications and Transportation's (KPTT) ability to acquire income-generating assets, while minimising greenfield asset risks.

Earnings contribution of 7% upon acquisition. 

  • Based on our research, we understand that the data centre is Citigroup’s ex-Frankfurt Data Centre, which has a capacity of 18MW. 
  • For KPTT’s 36.4% stake, the data centre adds an additional 7% to earnings (S$3.9m) at 50% utilisation. At full utilisation, this number rises to S$7.9m.

Reaping additional service fees on top of acquisition. 

  • KPTT will be able to charge development fees for the project. This is a fixed percentage of fund management remuneration payable to Alpha by ADCF during the duration of the sub-advisory services agreement.

T27 continues to provide recurrent earnings post divestment. 

  • It is short-sighted to argue that the divestment of T27 to Keppel DC Reit (KDCREIT SP, NR) at competitive pricing (8.5% cap rate), as opposed to selling it to a 3rd party was detrimental to KPTT shareholders. KPTT will not only be able to share rental income through its 30% stake in DC REIT, but will also earn additional recurring income through offering other services.
  • Not apparent from the T27 divestment, was the additional fees that KPTT can charge directly to clients on power, physical, cyber security services and any other future services/upgrades. This is because KPTT ultimately owns the client relationship which is crucial in our opinion, while DC REIT acts mainly as a landlord without much technical expertise. Furthermore, KPTT can now recycle its capital and channel back to its development business which yields higher returns (IRR>18%).

Data centre projects deliver superior returns. 

  • Data centres deliver superior returns despite their small absolute amount. We understand that the un-levered IRR of each data centre project is roughly 13-14%, expanding to over 18% on a levered basis. 
  • A study by Alpha Investment Partners in 2014 showed that EBITDA margins for wholesale colocation providers (excluding cost of power, which is pass-through anyway) to be 60-70%.

RNAV valuation method translates to S$942m with ADCF included. 

  • We tested our KPTT data centre business valuation (30x 2017F PE) using another valuation methodology – RNAV. We have assumed a cap rate of 7.25-8.50%, the same as those disclosed in KPTT’s accounts. Based on existing data centre assets alone, the RNAV is already valued at S$623m. However, this neither takes into account the potential contribution from ADCF nor the recurrent earnings KPTT earns. 
  • Assuming ADCF fully expends its US$500m funds and acquires another five Frankfurt Data Centres (US$81m each, balance of US$419m left), our RNAV valuation jumps to S$942m, which is close to the relative valuation of S$910m used in our SOTP valuation. 
  • The market is clearly underestimating the potential of the ADCF once fully deployed which we expect to be within 12-18 months’ time.


EARNINGS REVISION/RISK

  • Revising 2017-18 earnings forecasts by 6-9%. Our earnings estimate for 2016 remains unchanged at S$63m. 
  • Factoring in the earnings contribution from additional service fees, management fees and contribution from the Frankfurt acquisition, our earnings forecasts for 2017-18 rises to S$78m (+6%) and S$97m (+9%) respectively.


VALUATION/RECOMMENDATION

  • Maintain BUY with a higher target price of S$2.53. Our target price is based on SOTP, based on the value of its logistics, data centre and investment units. 
  • We continue to apply a 30x 2017F PE to the data centre division, a 50% discount to the peer average of ~60x for data centres.




Edison Chen UOB Kay Hian | Foo Zhi Wei UOB Kay Hian | http://research.uobkayhian.com/ 2016-12-06
UOB Kay Hian SGX Stock Analyst Report BUY Maintain BUY 2.53 Up 2.360




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