Keppel DC IPO offers new investment class

The structuring of the Keppel group's data centres asset into a Reit opens up a new investment class for Asian equity investors.

Singapore's Keppel Corp is hoping to introduce a new investment category to the Asian equity capital markets after starting to pre-market an initial public offering of its data centre assets. 

The flotation of Keppel DC Reit could raise up to S$540 million ($432 million) according to a term sheet seen by FinanceAsia. The deal will comprise 70% of the group's enlarged share capital, with parent company Keppel Telecommunications and Transport (T&T) pledging to retain at least a 30.1% stake.

Most of the listing company's assets are being spun out of Keppel T&T, which hopes the IPO will unlock value. Pending shareholder approval on November 25, the IPO's formal roadshows will begin in late November ahead of a mid-December listing. 

Syndicate analysts believe Keppel DC Reit's fair value stands around the S$450 million to S$1.1 billion ($743 million to $806 million) range, which equates to a 2015 dividend yield spanning the mid 5% range to mid 6%. 

Pick up to US comparables

Keppel DC does not have a direct comparable in Asia since it will be the region's first data centre Reit. However, Singapore-listed A-Reit and Mapletree Logistics Trust (MPL) both have some data centre assets, which investors are likely to partially benchmark Keppel DC Reit against.

Specifically, data centres account for about 7% of A-Reit's current S$7.5 billion ($5.6 billion) asset valuation and 9% of MPL's S$4.4 billion ($3.52 billion). A-Reit is currently trading on a 2015 dividend yield of about 6.6% and is pretty much flat on the year, while MPL is trading on a yield of 6.4% and is up 11.2% year-to-date. 

Compared to Singapore's S-Reit sector, Keppel DC Reit looks expensive and the Keppel group as a whole has a reputation for pushing investors on pricing. However, during roadshows executives are likely to argue that data centres offer a more stable form of income than other types of property reits.

They will also point to global comparables, which have had a very good run this year and are now trading on forward dividend yields below 5%. US investors, in particular, may be tempted by the pick-up relative to domestic comparables such Digital Realty Trust (DRT), the world's largest listed data centre.

DRT has appreciated 38.8% so far this year and is currently trading on a 2015 yield of 4.84%. It is far larger than Keppel DC with $12.6 billion in assets, 130 blue chip tenants and a portfolio of 24.5 million square feet in net lettable area (NLA).

Smaller US listed data centre Reits have also done well too. QTS Realty Trust is up 32.5% and trading on a 3.9% forward yield. It has an asset valuation of $1.3 billion.

CyrusOne Inc is up 21% and is trading on a forward yield of 3.08%. It has a slightly larger portfolio worth $1.9 billion.

Keppel DC Reit's novelty value could prove to be both an advantage and a handicap. On the plus side, it adds further diversification to Singapore's well-entrenched S-Reit sector.

Data centre reits often command a pricing premium because their future cash flows are extremely stable and visible. High entry barriers make it difficult for new entrants to establish themselves.

Existing tenants also tend to stay put because of the high costs of switching from one data centre to another and the mission-critical nature of the information being held. As a result, data centre reits typically report a higher average weighted average lease to expiry (WALE) than mainstream property reits. 

For example, Keppel DR Reit's current WALE is 7.8 years, one of the highest in Singapore. This is also better than DRT's 6.8 years.

Security and stability are the two key requirements for data centre clients and Keppel DR could benefit from a cluster effect as Singapore has worked hard to provide a supportive regulatory regime.

The Lion City commands 60% of South East Asia's data centre business and intends to turn itself as the region's premier information and media hub. This includes the construction of a 13-hectare data centre park, which is due to open in 2016.

Head in the clouds?

IDC recently forecast strong growth for the data centre industry as more and more firms switch from in-house IT teams to large third party providers, which can provide economies of scale and valued added services.

In its recent annual survey, Cisco also forecast that by 2018, global data centre traffic will triple to 8.6 zettabytes (one zettabyte is a trillion gigabytes). One of the big drivers is the move to cloud computing, which Cisco believes will account for 75% of all data centre traffic within the next four years.

IDC also says that IT spending on public cloud services will increase from $56.6 billion in 2014 to $127 billion by 2018, six times the rate of the overall IT market.

Prospective investors in the Keppel DC Reit will be keen to understand how the company hopes to capture this trend as both reports also flag a clear move towards mega data centres.

One specialist fund manager told FinanceAsia he hopes to hear more about power usage during roadshows as he felt there was a gap in the marketing materials he had received so far. Data centre reits are valued slightly differently to pure property plays and one hurdle Keppel DC will need to overcome is their unfamiliarity with the sector.

In particular, reit investors are used to analysing companies on the basis of NLA, whereas one of the key metrics for data centre reits is power usage. This is because data centres often run up against power constraints long before they run out of space.

In Singapore, for example, data centres account for 1% of available land, but consume 7% of the city state's power supply. For data centre clients, access to more power is crucial to operating ever more powerful computers.

What data centre operators are charging for is access to power and long-standing US operators such as DRT now publish financial results, which show many megawatts of power they have leased that quarter rather than how much floor space.

Boosting margins often comes down to improving asset utilization and providing technical value-added services. 

Keppel DC Reit's portfolio

One of the group's key selling points is its experience in the data centre sector and its ability to innovate. Keppel DC Reit currently has eight assets with aggregate NLA of 524,900 square feet, an appraised value of S$1 billion ($800 million) and a 94% occupancy rate.

The group also has two potential assets in the pipeline, one Keppel-related data centre being built in Singapore and one in Australia.

The overall portfolio has 34 tenants with 96.1% comprising multinationals or government-related entities. By industry type, 42.1% are IT services, 25.8% internet enterprises, 15.1% telcos, 12.9% in financial services, with the remaining 4% corporates.

The group is likely to argue that its rental income is extremely solid, not least because Keppel-related entities account for 30%. Co-locators account for a further 34% and triple or double net lessees are on 28%. 

Further, leases have been structured with annual income escalations of 2% to 4%.

The majority of the portfolio is located in Asia, with Singapore and Malaysia accounting for 45% of the overall valuation, followed by Europe on 30.6% and Australia on 24.4%.

In Singapore, the group has two data centres and is currently building a third. The biggest is S25, with an NLA of 109,574 square feet and valuation of S$263 million ($210 million).

Keppel DC Reit owns it under a leasehold agreement with Keppel T&T, which expires in 2025 with an option to extend for 30 years. It is being leased by Keppel unit Digihub which will sign a 10-year lease with a five-year extension upon listing.

Its Singaporean data centre T25 has a similar leasehold structure to S25. It has an NLA of 36,888 square feet and valuation of S$162 million ($130 million).

This is also being leased by a Keppel entity Datahub. Upon listing, it will sign a 10-year lease with a five-year extension. 

Across the border in Malaysia, Keppel DC owns the freehold to the Basin Bay data centre in Selangor. This has an appraised value of S$45.6 million ($36 million), with an NLA of 48,680. 

Its two Australian data centres comprise Gore Hill in Sydney and iSeek in Brisbane. The former is freehold and has a valuation of S$221 million ($177 million), plus an NLA of 90,955 square feet. Tenants have five to 10-year leases. 

The latter has a valuation of S$34.1 million ($27 million) and NLA of 12,389. It operates 10 to 20-year leases with annual 4% step-ups.

In Europe, the group owns data centres in London, Amsterdam and Dublin. The largest is its Almere data centre in Amsterdam, which has an appraised value of S$135.7 million ($109 million) and NLA of 118,403 square feet. 

This is followed by its Citadel 100 data centre in Dublin, which has an appraised value of S$105 million ($84 million) and NLA of 68,052 square feet.

Finally, its GVT data Centre in London has an appraised value of S$78.8 million ($63 million) and NLA of 24,972 square feet.

Financials

In the 2013 financial year, Keppel DC Reit recorded revenues of S$101.2 million and net income of S$63.2 million. For the first nine months of 2014, it reported revenues of S$80 million ($81 million) and net income of S$47.8 million ($38 million).

Syndicate analysts are forecasting a revenue CAGR of about 4% over the 2015 and 2016 financial years. There will also be a 100% pay-out ratio.

The company is likely to argue that its gearing is on the low side for sector, standing at 27% as of September compared to an industrial S-Reit average of 33.3%. US data centre reits tend to have far higher gearing levels in the 40% to 60% range.

Lead managers for the IPO are Credit Suisse, DBS, Deutsche Bank, Goldman Sachs and Standard Chartered. 

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