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.

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.

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.

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.

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 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%.

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.

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