India Ratings and Research (Ind-Ra) opines that the business dynamics of the data centre (DC) industry in India are likely to remain robust over the next three-to-five years due to the strong demand outlook and conducive regulatory environment.
Consequently, the industry has attracted investment plans of INR700 billion-720 billion to be implemented over the next five-to-10 years. These ambitious investments will mainly be driven by new, large corporate groups (around 40%) and cloud service providers (around 30%). The demand outlook for new DC capacities is also strong, backed by (a) the rising data usage by retail customers (both on wireless and wireline segment), (b) a robust outlook for enterprise users (public cloud market and hyperscalers), and (c) the emergence of cloud service providers (CSPs). Regulatory actions have been favorable with few structural steps such as the government’s Digital India initiatives, the draft data localisation bill and proposed infrastructure status. The COVID-19 outbreak has also accelerated the shift to the digital medium, exemplifying the Mission Critical Status, which has benefited the DC industry.
DC industry’s business profile is also supported by high entry barriers, moderate competition risk (even from CSPs) and moderate technology obsolescence risk. However, with the total power capacity of around 615MW, the DC industry in India is still at a nascent stage, compared to that in other developed markets. This is exemplified by high player-wise and geographical concentration. The financial profile of the DC industry remains moderate as strong growth in scale, rising profitability margins, comfortable leverage/coverage/return ratio metrics are offset by continued high capex intensity and subdued asset turnover ratios.
Industry Structure: Highly Concentrated Now but Diversification likely over the Next 3-5 Years: The DC industry in India has high geographical/player-wise concentration as the top three and top five cities/players contribute 65%-70% and 85%-90% of the total capacity (in MW), respectively. Ind-Ra expects the industry to remain geographically concentrated over the next 3-5 years as tier-1 cities continue to attract incremental capacity given their strong infrastructure availability and proximity to large data usage hubs. However, the player-wise concentration might reduce given the large, announced investments by new players (cloud service providers and new corporate entrants).
Strong, Long-term Demand drivers in-place: The DC industry is likely to benefit from the strong tailwinds from data usage perspective. The demand of incremental DC capacities will be supported by the rising data usage by retail customers given (a) data usage in the wireless mobility segment increased 60x over 2015-20, and (b) in the wireline segment, penetration level is abysmal (broadband: 7% of the total household, fibre to the home: 1%) giving opportunities for growth. The demand from the enterprise segment will be supported by annual growth of 30% in public cloud market, as per the National Association of Software and Service Companies (NASSCOM), and a rise of hyperscalers. Conducive government policies such as data localisation and proposed infrastructure status, along with COVID-19-led accelerated digital adoption will also provide impetus to data demand.
Entry barriers in DC Industry remain High: The entry barriers in the DC industry are typically high capital cost requirement (INR250-400/MW), the requirement for strong auxiliary infrastructure (power supply and fibre connection) and technologically advanced design requirement. Also, DC operators require robust reputation and customer base as (a) DCs are mission-critical service for tenants, and (b) significantly high investment required by tenants on equipment (3-6x) to be housed inside DCs as compared to the DC’s total capital cost. Hence, Ind-Ra opines significant time and investment are required to enter in the DC industry meaningfully.
CSPs: Likely to Support Revenue Growth of DCs: In the US, despite their significantly large revenue base, cloud service providers (Amazon Work Space, Microsoft Azure, Google Cloud) have been growing at a significantly faster pace (50%-80% CAGR) over a three-to-eight-year horizon) than DC real estate investment trusts (REITs; 5%-15% CAGR over 2018-20). However, CSPs have leased substantial capacity in large US DC REITs. Revenue growth of DC REIT is supported by higher-than-average growth in rental income from CSPs. CSPs as tenants generally have better counter-party credit profile (for DCs) as compared to other enterprise users given (a) generally favorable leasing terms, (b) generally strong credit ratings and (c) large scale and size.
Financial Profile: Persistently Negative FCF mars otherwise Strong Credit Ratios: Over the last few years, DC operators in India have shown strong revenue/EBITDA growth even at a higher base – implying growth is detached from economic volatilities. DC players have also exhibited strong return ratios (in double digits) and comfortable leverage/coverage ratios, considering the rental generating business model. Also, DCs generally have a fixed-cost heavy structure, which gives them an opportunity to expand margins amid the rising demand scenario. However, the industry has seen higher capex intensity leading to consistently negative free cash flow (FCF) and depressed asset turnover ratios (sub 1.0x).
Please refer the attached presentation, which delves deeper into the key credit assessment considerations.
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