Investment Thesis

Chindata (CD) is a hyperscale data center with operations in China, India, and Southeast Asia markets. Further, it’s growing at a very rewarding clip, as it eyes up more than 47% y/y revenue growth rates into the next quarter.

Also, not only does Chindata have a very alluring narrative, but it’s able to lay claim to having two very high-quality clients, ByteDance (BDNCE) and Microsoft (MSFT).

Having said that, no matter how we appraise this company, shareholders are not likely to see any free cash flow any time soon.

With that consideration in mind, I can’t find enough margin of safety while having to pay 18x forward sales.

Exhibitors | PTC

Chindata’s Market Cap:

Source: Prospectus

Chindata has 732 million shares outstanding and 366 million ADS. For readers, we are given the choice to buy the ADSs, which means that its present market cap is approximately $7 billion.

Chindata is a Rapidly Growing Data Center Company

Source: author’s calculations, **high-end company guidance

Chindata did a large acquisition during Q1 2019, which skews its performance for that quarter. However, starting Q2 2020, its growth rates have been growing organically and consistently.

According to Chindata’s own guidance, its Q4 2020 results should see its revenues increase by approximately 47% y/y. These are obviously incredibly fast rates. What’s more, its outlook ahead looks very attractive, too.

Source: SA Premium Tools

Presently, this recently IPOed medium-sized Chinese company only has a single analyst following the stock. However, using her assumptions, Chindata’s revenues could reach $90.3 million in Q1 2021 (RMB594). If indeed Chindata prints this revenue, its revenues would be growing at approximately 50% into the first quarter of 2021.

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What About Path to Profits?

Now, we are faced with my sole issue and why I can’t build a margin of safety in this investment.

Source: Q3 2020 Investor Presentation

On the surface, Chindata’s adjusted EBITDA margins are expected to finish 2020 with margins of 47% and are pointed toward RMB850 million. This figure would be about 110% higher compared with the same period a year ago.

However, just how much of this EBITDA has to be plowed back into the business for future growth?

Source: Q3 2020 Investor Presentation

As you can see above, its capex for its trailing twelve months reached RMB2550.

Hence, even if at some point Chindata’s capex were to stabilize and stop growing, its free cash flow would be negative for a considerable amount of time, most likely well into 3-5 years hence.

And that’s the main issue with these data center businesses; to grow their operations they have to consistently invest in their infrastructure to upgrade and modernize.

Obviously, its customers are only too happy to scale up and pay a third party, such as Chindata, for all their data center infrastructure requirements, but that leaves Chindata with no pricing power and no free cash flow on the horizon.

Valuation – The Stock is Already Fully Priced

Even though Chindata is rapidly growing, it’s already being priced at 18x forward sales.

Consider the following, Oracle (ORCL) is a fully mature business, but its top line is still posting some revenue growth, albeit mid-single digits are fairly paltry when compared against Chindata. Nevertheless, Oracle is being priced at just 4x this year’s revenues.

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Furthermore, Oracle is already posting meaningful amounts of free cash flow, with free cash flow margins of 29%.

Several Investment Risks to Keep in Mind

Numerous risks are at play here. Firstly, this is a Chinese company with investors buying shares via ADSs through a VIE. This means no voting power, no dividends, and currency risks.

Other meaningful risks include that ByteDance being responsible for 82% of its revenue. Even though it’s ByteDance’s Chinese operations, meaning Douyin, that goes through Chindata, not TikTok.

Furthermore, Wangsu makes up a further 7% of total revenue as of Q2 2020. Hence, together with ByteDance, this means that close to 90% of revenues are coming from just two customers. On the other hand, Chindata is also able to boast of Microsoft as another of its clients in Chindata’s Malaysia data center.

Chindata CEO Jing Ju and Bain Capital essentially hold all the voting power.

The bullish thesis here is contingent on Chindata being able to grow its revenues at a solid rate going ahead. Any slowdown in revenue growth rates will compress the multiple that investors will pay for the stock.

The Bottom Line

This recently IPOed stock is rapidly growing. In fact, investors are very likely to turn a blind eye towards its bottom-line profitability, or lack of free cash flow, as long it can continue to rapidly grow its topline.

Having said that, I’m struggling to find the necessary margin of safety, while having to pay 18x forward sales.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.



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