In Keppel DC REIT’s hour-long results briefing, the focus of analysts and media with Loh Hwee Long, CEO of KDC REIT’s manager, and Adam Lee, CFO of the manager, was the REIT’s Guangdong data centres, Guangdong Data Centre (GDC) 1 and 2.
The two data centres were acquired from Guangdong Bluesea Data Development Co (Bluesea), which was the developer and the master lessee of the data centres.
On Dec 15, 2023, KDC REIT announced that Bluesea hadn’t paid rent for 4 months, and KDC REIT had issued a letter of demand to recover RMB48.3 million (equivalent to around $9.1 million) in arrears.
Of this, rental arrears of four months and coupon due as at Dec 15. 2023 amounts to RMB 45 million or $8.5 million, and recoveries including late payment interests and real estate taxes of RMB3.3 million. The letter of demand also has a request for a top up of security deposits of RMB32.2 million ($6.0 million).
In 2021, KDC REIT, when its manager was under a different CEO, acquired GDC 1 for $132 million. In an announcement in July 2021, KDC REIT’s manager had said six data centres were being built within the Bluesea Intelligence Valley Mega Data Centre Campus and KDC REIT had a pre-emptive right of first refusal for the other data centres in the campus according to an announcement in July 2021.
GDC 2 was acquired in 2022, for $148.5 million. At the same time, KDC REIT agreed to acquire GDC3 for $148.5 million. The seller had been fitting out GDC 3 at the time.
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Bluesea, the developer, was the master lessee of GDC 1 and 2. Back in July 2021, OCBC Investment Research had warned that Bluesea was a unit of Neo Telemedia (listed in Hong Kong), and raised doubts as to the ability of Neo Telemedia to pay the contracted master lease rents for 15 years, as was the agreement with KDC REIT.
In October last year, DBS Group Research had cautioned that a worst-case scenario involving Neo Telemedia's bankruptcy could potentially have a maximum 16% impact on DPU.
KDC REIT’s FY2023 DPU fell by 8.1% y-o-y to 9.383 cents. However, 2HFY2023 DPU dived by 16.1% y-o-y to 4.332 cents.
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A number of reasons led to the decline in DPU, particularly in 2H2023. Loss allowance in relation to uncollected rental and coupon income of 5.5 months and recoveries at the Guangdong DCs impacted FY2023’s DPU by 0.649 cents.
For both GDCs, the client is expected to pay rent and all outgoings except real estate tax. The client is also responsible for facilities management. In 2HFY2023, property expenses were higher, and KDC REIT was also impacted by less favourable forex hedges. In addition, as with all S-REITs, finance costs were higher.
During the briefing, CEO Loh said it made more sense to be working on a roadmap with Blue Sea rather than start litigation despite Bluesea being in arrears for 5.5 months, as litigation can be a very long drawn process.
“Part of the conversation or discussions with the tenants [enables] us to get deeper insights into the underlying operations and performance of the Guangdong data centres. [The discussions] also give us insights into how everything works,” Loh says.
While the underlying tenants are China’s major telcos, the ultimate end-users are retails enterprises. We see current headwinds at the macro level. In the past, apart from Covid, there are also some of market developments such as the clampdown of the gaming sector and bitcoin mining business which impacts the underlying performance of the assets,” Loh explains.
“Based on our currrent assessment, the recovery roadmap is going to be the optimal way for us to move forward to work towards recovery of rental arrears as well as working collaboratively with the tenant to ensure the recovery of rental arrears, top up of security deposits and the tenant being current with rental obligations,” he adds.
As at Dec 31, 2023, the valuation of the two GDCs has been retained as though they are on a 15-year master lease with up-to-date rentals. “Post our announcement in December, we have re-engaged the valuers in terms of the disclosure we have made and the opinion is there is no immediate impact on valuation which is why they (the GDCs) are holding firm. If there are material changes to the lease structure or further developments, we will be revisiting this with the valuers and we will communicate this to the market,” Loh elaborates.
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KDC REIT has not made any progress payments for GDC 3. “For GDC 3, we have reserved our rights to give us more optionality and discussions are ongoing, and involves a potential sale to a third party,” Loh says.
China, which comprises GDC 1 and 2 at their full valuations, account for 7.4% of KDC REIT’s AUM. The GDCs were acquired at a capitalisation rate of around 8%, and hence could have contributed about 8% to gross rental income if rents were current, but they are not. As a result, analysts are taking a cautious approach to the impact on KDC REIT's DPU.
“Upcoming debt maturities from FY2024 to FY2025 are low and hence there would be relatively less refinancing risks as compared to most peers. However, ongoing concerns over the credit profile of its master lessee at its Guangdong data centres following rental arrears have created uncertainties over KDCREIT’s distributions outlook,” OCBC Investment Research warns.
“Management mentioned several times during the analyst briefing about working with the master lessee on a recovery roadmap, but details were scant and under current challenging macro and industry conditions in China, we believe the prospects remain dim. We thus expect more provisions ahead,” OCBC Investment Research adds.
“While the tenant made a token RMB0.5 million ($0.1 million) payment towards its arrears, we are more positive that they are working to resolve the situation, although details of time lines remain uncertain. We see this as preferable to the vacant re-possession of the Guangdong data centres, with associated costs and downtime for leasing. As for Guangdong DC 3, KDCREIT is reviewing options including divestment to a third party, which in our view, would be most optimal to generate cash flows for the tenant,” JP Morgan says in an update.
JP Morgan has a neutral rating on KDC REIT, and OCBC Investment Research has a hold recommendation.
