On February 2, Fitch Ratings downgraded the long-term foreign currency and local currency issuer default ratings (IDRs) from "BBB-" to "BB" and removed its rating from the Negative Rating Watch List (RWN). The Outlook is stable. The company was formerly known as Chindata Group Holdings Limited).
The downgrade reflects Fitch's expectation that Qinhuai Data will face significantly higher operational risks as it changes its strategy to focus on overseas investments. This prompted Fitch to tighten the EBITDA net leverage downgrade threshold to 40x, and calibrate the "BB+BB" threshold to 50x. Fitch expects EBITDA net leverage to remain above 5.5 in the medium term after privatization0x, resulting in a downgrade of two notches.
Fitch added Chindata to RWN on 27 June 2023, following the announcement by the company's controlling shareholder, Bain Capital Entities, that it would take it private. RWN reflects that the transaction may enhance the operational and/or financial risks of Chindata Corporation.
Key rating drivers.
Operational risk has increased significantly: Fitch expects Qinhuai Data to face significantly increased operational risks following its privatization given the new management strategy and China's economic slowdown. additional business risk comes from more aggressive expansion in new geographies; In the case of lower levels of contracted contracts, upfront capital expenditures may be higher; Greater competition in new regions and lack of first-mover advantage; Demand for hyperscale data centers in China is slowing and competition is intensifying.
Increased capital expenditure riskFitch believes the company will face significant investment needs going forward (capex of approximately CNY9 billion in 2023; Capital expenditure in 2022 was approximately RMB4.7 billion) to build its overseas operations. In particular, companies will be exposed to higher capital expenditure risks because they must purchase land before entering into contracts with tenants, and the cost of land in new regions is significantly higher than in China.
Overseas competitive advantage is low: Fitch believes that as Qinhuai Data expands overseas, its competitive advantage in China will be difficult to sustain. In China, Chindata has a competitive advantage due to its large land bank available cheaply, its first-mover advantage as a pioneer in hyperscaler neutral data centers, and its competitive operating costs due to its location in China's lower-tier cities. Moody's believes that its proprietary electronic modules will give it an energy efficiency advantage over its competitors in overseas markets.
EBITDA net leverage deteriorationFitch expects Qinhuai's EBITDA net leverage ratio to deteriorate to 55 times - 59 times (2 in 2022.)3 times; In 2023, it is expected to be 46x), well above the threshold level that triggers Fitch's downgrade (5.).0x. Fitch believes that Qinhuai data retains about 8$500 million in net privatization loans, capital expenditures financed primarily by debt, and lower EBITDA margins will increase leverage.
Expansion-driven capital expendituresFitch expects annual capex of CNY3 billion to CNY5 billion in the medium term. Capital expenditure in 2023 is unusually high, reaching RMB9 billion, mainly for upfront investment in new regions. Because Qinhuai data is aimed at Southeast Asia expansion, capital spending in China is likely to be lower. Due to limited operating cash flow, Fitch expects the company to fund the majority of its capital expenditure through secured project financing, i.e. data centers as collateral.
EBITDA margins are lowerFitch expects Qinhuai Data's EBITDA margin to gradually fall to around 45% by 2026 from a high level of 49%-52% in 2022-2023, as diluted margins from higher electricity prices in China's Shanxi province and higher operating costs in new regions. The company announced in December 2023 that electricity prices in Shanxi Province, where some of its hyperscale data centers are located, will be 60% annual** from January 1, 2024. Electricity prices** will reduce the company's EBITDA margin by 4%-5% per annum. According to management, the price increase is limited to Shanxi Province.
generate recurring revenue; Have a long-term contract: Chindata is rated based on the company's highly resilient business model. If the company's client chooses to terminate the contract early, he will have to pay most of the fees for the duration of the contract. Chindata provides critical infrastructure to its customers, with an average lease term of more than eight years. As of the end of June 2023, 94% of Qinhuai Data's operating capacity has been contracted. However, if new contracts in the new region are not as robust as existing contracts, Fitch may reassess the operational risk profile of Chindata data.
High asset ownership: Chindata holds approximately 94% ownership of its hyperscale, high-spec, carrier-neutral data center portfolio in terms of capacity, which gives it a good access to secured debt financing. However, Fitch believes that institutions are less willing to provide debt to data centres relative to more modest commercial real estate assets.
The scale of the business is small: The scale of Qinhuai Data is smaller than that of Digital Realty Trust, Inc(BBB Stable) and Equinix, Inc(BBB+ Stable) and some of the world's leading data center companies. In addition, the majority of Chindata is located in China, making the company geographically less diversified than its Fitch-rated investment-grade data center peers. However, Chindata intends to explore other emerging markets in Asia to meet the business needs of domestic and foreign customers; As of the end of June 2023, approximately 33% of the company's capacity under construction was located in Malaysia.
data limitations; Customer concentration: ByteDance Ltd., the main tenant of Qinhuai Data) is a private company (accounting for 86% of Qinhuai Data's total revenue in 2022), and Fitch does not have detailed financial information about it. Nonetheless, Fitch believes that Chindata faces limited default risk from ByteDance because it is a successful, fast-growing internet company with a strong corporate brand, a diverse product portfolio and a solid market position, as well as a stable, profitable user base that outperforms many of its senior peers. The data center services provided by Chindata are critical to ByteDance's operations.
In addition, Fitch expects demand for data centre capacity in emerging Asia to continue to grow, with room for growth in the sector if demand from existing customers weakens, and that there will be other customers to replace existing customer demand.
Variable Interest Entity StructureThe rating is based on Qinhuai data, and Fitch expects the company to maintain good relations with China** and regulators. However, any change in the relationship may affect the creditworthiness of Chindata because Chindata lacks equity control over its domestic operating companies (including Sitan (Beijing) Data Technology*** and other consolidated subsidiaries) – due to the restrictions on foreign shareholding in Chinese value-added telecommunications services, Chindata only has a contractual relationship with these companies.
Summary of Rating Derivation.
Qinhuai Data's credit profile is two notches lower than Global Switch Holdings Limited (BBB Stable). Both companies have smaller EBITDA than their established U.S. peers, and both have high-spec data centers strategically located close to business and communications centers with reliable power**.
However, Global Switch has a longer operating history, better access to finance and a higher degree of geographical diversification – with 13 data centres in seven European and Asia-Pacific countries – and therefore has a stronger business risk profile than Chindata. However, this was partially offset by a longer average lease period (more than eight years) for Qinhuai Data compared to five to six years for Global Switch. Chindata has a weaker financial risk profile than Global Switch: Global Switch's Fitch** has a net EBITDA leverage of 4 between 2023 and 20248 times - 50 times, while Qinhuai's data is 55 times - 59 times.
Chindata is rated two and three children below Digital Realty and Equinix, the world's leading carrier-neutral data center companies. Both companies benefit from their solid and diversified global operating platforms, better access to financing and more mature debt profiles; Its global footprint has also improved customer retention, as its customers can use a single company's services to meet their data needs in different countries.
However, Digital Realty and Equinix have shorter average lease terms of four to five years and two to four years, respectively, compared to Qinhuai Data. Qinhuai Data's financial risk profile is slightly better than Digital Realty's, as Fitch has a higher 2024-2025 EBITDA net leverage ratio of 58 times - 60x. Chindata has a weaker financial risk profile with Equinix due to Fitch's low 2024-2025 EBITDA net leverage ratio of 34 times.
Qinhuai's rating is one notch lower than PT Tower Bersama Infrastructure TBK (TBI, BBB-AA+(IDN) Stable), Indonesia's second-largest independent telecommunications tower company. Fitch believes that the majority of the contracts signed by Qinhuai Data are fixed** contracts with no ** increase clauses, so Qinhuai Data's contract TBI contracts are robust. The ** increase clause in the TBI contract has alleviated the inflation risk it faces. TBI's credit strength strength is also partially offset by its shorter average contract term of approximately five years. Fitch**, TBI's 2024-2025 EBITDA net leverage ratio is 48 times to 49 times, the financial risk profile of Qinhuai data is weaker than that of TBI.
Rating Key Assumptions.
Fitch's key rating assumptions in this issuer rating study include:
Revenue growth of 19%-36% in 2024-2025 (2023 est.: 27%);
Fitch-defined EBITDA margin of 46%-47% in 2024-2025 (2023 est.: 52%);
Capital expenditure in 2024-2025 of RMB4 billion to RMB4.6 billion (2023 estimate: RMB9.0 billion);
There is no dividend payout in the interim.
Rating sensitivity.
Factors that could individually or collectively lead to positive rating action by Fitch include:
EBITDA net leverage is consistently below 50 times, coupled with a longer record of overseas earnings growth, there was no substantial increase in domestic business risk;
Increased access to finance compared to rating peers.
Factors that could individually or collectively lead to negative rating action on Fitch Factors that could downgrade include:
Debt-financed M&A, capital expenditures, poor performance of overseas expansion, or ** buyback activity resulted in a sustained increase in EBITDA's net leverage ratio to 6.0x.
EBITDA interest coverage is consistently below 25 times (2023 est.: 3.)4 times.
Operational risks continue to rise;
Financing channels have narrowed significantly;
The committed development capital expenditure exceeds the current amount, is not pre-leased or the existing liquidity cannot cover the capital expenditure.
Liquidity and debt structure.
Reliance on external financing:At the end of the first half of 2023, Qinhuai had CNY4.9 billion of cash available, which is only enough to cover short-term debt, the current portion of long-term debt of about CNY1.3 billion and Fitch**'s free cash flow deficit of about CNY3 billion to CNY4 billion over the next 12 months. However, Fitch believes the company's strong relationships with local banks and high asset ownership will continue to fund its data centre expansion.
Issuer Profile.
Chindata is a leading hyperscale data center operator in China. With data center operations in India and Malaysia, it has a high customer concentration, with 86% of Chindata generating 86% of its revenue in 2022 from ByteDance, a fast-growing large internet company.