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.
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.
- 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.
- 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.